Contributors

Fostering Innovation in the New Florence

Part One–Vinnie Mirchandani levels the playing field for CIOs to drive innovation. In this first of a two-part interview, he reflects on the IT state.

by Joseph Vales, Kerry Ann Vales

Vinnie Mirchandani is one of the most respected consultants in the enterprise software and IT services industries. Initially trained as a CPA, he was a driving force in shaping PricewaterhouseCooper’s international consulting practice. For several years at Gartner, Mirchandani broke new ground in quantifying the cost
of ownership associated with application software and systems integration.

Three years ago, he formed Deal Architect Inc. and now levels the playing field for buyers in complex software, outsourcing, and offshoring negotiations. He is also a prolific blogger and his Deal Architect blog is a must-read for many top executives in the software and outsourcing industries. He is posed to contribute to a soon-to-be-launched online community called Techspend. It is aimed at buyers of software, hardware, telecom, and technology services.

Mirchandani is someone I would go through walls for as he represents the highest level of integrity and professionalism in the consulting and advisory markets. In the first of a two-part column, he discusses the state of innovation in technology and how CIOs can foster innovation.

JV: How sophisticated are buyers of software and offshore outsourcing services? On one hand, buyers use the services of firms such as Deal Architect to guide them through the procurement process. On the other hand, the gross profit margins of leading software and offshore development firms are very high.

VM: Buyers of software and offshore services are not really as sophisticated as you would think for their sizes. Just look at the 90-plus percent gross profit margins of leading software firms like Adobe or Oracle, or the 40- to 50-percent margins of the top-tier offshore application development vendors. These margins make a strong statement on who shapes market pricing and where the balance of power lies. Sellers are still more sophisticated with dedicated and very experienced contract attorneys and sales teams. In contrast, most corporate procurement executives just go from transaction to transaction doing two or three deals a year or even one major outsourcing deal every few years.

JV: High margins typically mean a lack of competition. So buyers have fewer choices?

VM: The market can be made competitive. One of my complaints with deals I’m involved with is that buyers eliminate a lot of the competition early. Buyers in general favor vendor consolidation and prefer to work with a small group of vendors. There is actually a lot of choice in this market, but many companies don’t take advantage of it.

JV: What services does Deal Architect provide? How do you level the playing field for buyers?

VM: It can vary. In the case of software, we support buyers in all stages of the procurement process, from defining requirements to shaping the procurement process through scripted scenarios and feature function evaluations. In the case of outsourcing transactions, we support the due diligence process. We accompany CIO teams to offshore locations as they tour development centers. We advise them and help them focus on risk management such as continuity risks and intellectual property risks. We also provide quite a bit of negotiation advice.

JV: Do most clients seek your negotiation advice early on in the procurement process or in the later stages?

VM: Every once in a while, clients will ask me to review a contract drafted by their attorneys. But this doesn’t leverage our real value. You can lose so much negotiation value in the up-front steps where you begin to define terms and deliverables and shape the contract. We passionately tell our clients that we should be involved right from the beginning to set the direction for a best-value solution. Nevertheless, if a client calls and says we are down to two vendors and just need help negotiating, we will support them and provide it as needed.

JV: From your vantage point of seeing the market from so many perspectives, what do you think of the state of technology innovation? Is innovation dying or is innovation flourishing?

VM: Innovation is absolutely flourishing! If you cut through the fog and the noise, we are really in the midst of a revolutionary time. This is what Florence must have felt like during the Renaissance. There is so much happening in so many different technology areas and, for a change, many of the technology initiatives do not require eight- or nine-digit budgets. A few examples are: the mobile internet/the new web; open source; sensor telemetry that combines RFID, GPS, and wireless technologies; software as a service (SaaS); digital content and new media with blogging and pod casting; analytics from master data management and the next generation of predictive analytics; and biometrics for security.

What is really exciting is that this time Florence is virtual—open source excitement from Scandinavia, mobile commerce excitement from Japan, and BPO from India. Innovation is happening all around us, despite the noise around consolidation
and the death of innovation, and “IT
doesn’t matter.”

JV: This sounds great. But in the consulting work we do for vendors, we see lots of technical recommendations that are safe-bet/incremental solutions.

VM: Here is the problem. The best innovation is happening at two ends of the spectrum. The first is with very smart and innovative CIOs doing their own applied innovation. They are taking building blocks from the technology world and then assigning their own “tiger” teams to do the innovation. The other end of the spectrum has a whole new generation of start-ups leveraging a brand new set of economics in the industry such as open source, cheaper broadband, more powerful/less expensive chips, etc. They are building new economic models that are just scary.

JV: So where is innovation not flourishing?

VM: Unfortunately, where innovation is not happening as much is with the bigger vendors. They are stuck in older cost models, in older thinking. They are still operating under four- or five-year-old research and development models. For the dollars received from customers, they are not generating much
innovation.

My expression is that if I were to give the Red Cross $1 and they only used 10 cents towards charity, I would be angry. That is what is happening at the large software firms. They are only spending between 7 to 15 percent of their revenues on R&D, and most of that budget is going into older projects or coming up with eight different versions of the same products. There is not much innovation going on for the money buyers are giving them. And then they spend 30 to 50 percent of revenues on SG&A. Joe, no offense, but no patents will ever come out of that annual spend!

JV: But what about CIOs? Are CIOs spending enough on innovation?

VM: I wish they had more to spend. A big part of the problem is that the bigger vendors are soaking up 60 to 70 percent of their technology budgets. It is what I call the utility part of the budget. It goes into the 22 percent CIOs pay the software providers for maintenance. It goes towards outsourcing fees to the large outsourcers for contracts signed four to five years ago. Some of the budget even goes into Y2K projects that now have to be written off and impact the CIO’s budget. So they are stuck in a model where the bigger vendors eat up most of the CIO’s budget and what industry veterans now describe as “entitlement programs.”

JV: Is this going to hurt the role of the CIO in his own organization if he can’t spend enough for innovation, and his spending is primarily focused on maintaining the status quo?

VM: I think it is a huge opportunity and a risk for most CIOs. I like to reference Gallagher, the comedian. He would tell jokes and spend time smashing fruits. A good CIO has to do both as well. He has to smash down utility spend and go around telling jokes. In this case, the jokes are about delighting business users with innovation. So it’s a tricky thing to half-get the knife out and half-get the magic out, but the smart CIOs are learning to do that. But, if you are just going to shepherd your utility spend and only manage it along, I think you are at risk.

JV: Is the market embracing the new technology players?

VM: Gradually. You just can’t ignore all the new innovation that is emerging in the new Florence. But corporate buyers tend to be cautious. Nevertheless the economics are just so compelling. Also, so many CEOs are reading about new technologies, and they go back to their CIOs and ask “what are you doing and why aren’t you looking at this?”

JV: Do you see some of the major software firms evolving into outsourcing providers competing directly against the largest ITO firms?

VM: Absolutely. It is going to happen, but not because they actually want to go there. If you talk to the software executives, they like the margins from software: build it once and sell it many times over. They don’t really like armies of people. If you ask them about ser-vices, they will talk about web services or software services, not people services. But the way economics are headed, the software leaders are going to either barter more aggressively or move to the top of the outsourcing channel. You and I have both seen some BPO transactions where the software vendor is only getting three percent of the transaction value. The software providers see the revenue generated by outsourcing vendors and they start thinking about moving to the top of the food chain by commoditizing the labor, not the software.

In part two, Vinnie Mirchandani will discuss how angioplasty is impacting process efficiencies and how the BPO market is evolving.

Mirchandani can be reached at VMirchan@ATT.NET. His views on the state of the IT and BPO markets can be read daily on his personal blog at www.dealarchitect.typepad.com.

This article was co-authored by Kerry Ann Vales. For more information, she can be reached at KAVales@aol.com.

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