Editor’s note: Infosys gradually develops a product-company-like culture through increased collaboration with startups and software companies, says Bozhidar Hristov, senior analyst at Technology Business Research.

​HAMPTON, N.H. – Investing in startups highlights Infosys’ appetite for innovation but risks averse, margin-driven culture

While Infosys continues to refrain from large-scale acquisitions the company stays on course to invest in startups to gain access to talent and IP necessary to build brand and portfolio supporting its ongoing renew-new strategy. During 4Q16 Infosys invested in Denmark-headquartered artificial intelligence (AI) startup Unsilo; U.S.-based software defined server firm TidalScale; and India-based startups Stellaris Venture Partners and ideaForge, gaining access to a network of advisors/entrepreneurs and unmanned aerial vehicle solutions, respectively. These moves extend Infosys’ 18-month startup investment spree and put greater pressure on its product development and sales teams to gain rapid ROI.

Additionally, Infosys’ CEO announced the company was considering developing a software solution that can help the company reach critical mass from “as a Service” sales.

TBR sees these investments as a twofold opportunity. First, building out portfolio offerings while leveraging IP from startups ahead of demand helps Infosys gain an edge around its innovative thinking. Investing in startups bears minimal risk around integration and requires a smaller investment compared to a large-scale purchase. Second, even if Infosys does not gain ROI from services enabled through startups’ IP, it gains exposure to product-company-like thinking and development cycles.

Mastering the latter could turn Infosys into an attractive buy over the next three to five years, during which we believe the IT services market, and India-centric vendors in particular, will experience consolidation mainly due to automation.

Infosys will seek to broaden its market appeal and gain new customers by leading with software-led discussions

TBR believes Infosys made the conscious decision to sideline investments in strategy consulting-like capabilities and instead enhance its core IT-centric expertise to secure software-led opportunities. Development of software-enabled services and stand-alone solutions will help Infosys build a foundation for business stemming from clients’ IT modernization initiatives.

Embedding automation in service delivery and applying design thinking concepts around IT architecture transformation will secure Infosys’ position on the services supply side. Culture transformation and software-company-like account management, however, are key attributes for Infosys to address as it tries to change its image.

While Infosys’ revenue increased 6% year-to-year to $2.55 billion in 4Q16, the company recognized RBS contract ramp-down and seasonality headwinds causing its sequential performance to decline 1.4%, resulting in overall revenue deceleration for the third consecutive quarter on an annual basis. Infosys’ Business IT Services’ line of business, fueled by IT modernization opportunities within application development and infrastructure services subsegments, which grew 16.5% and 21.5% year-to-year respectively, fueled Infosys’ top line.

The company’s investments in AI-enabled solutions delivered though MANA, Skava, Panaya and EdgeVerve portfolio offerings helped Infosys drive managed services sales and create a foothold with clients seeking to adopt these products on a stand-alone basis. We expect Infosys’ performance to rebound in 1Q17 and end FY17 on a high note, delivering 9.5% year-to-year growth, meeting its new revenue guidance of 8.6% to 9% in U.S. dollars. Long-term sustainability, however, will require a disciplined execution of its strategy and addressing executive departures.

Operating margin improved 20 basis points year-to-year to 25.1% in 4Q16 mainly due to the company’s tight expense management structure and benefits gained from automation in service delivery.

Expanding application modernization capabilities helps Infosys secure digital transformation opportunities on the services supply side

Despite ongoing pricing pressure in the commoditized services domain, application development and maintenance services continue to generate a bulk of Infosys’ sales (32.5%), expanding 3.7% year-to-year in 4Q16. While a large portion of the sales growth stems from supporting outstanding contracts, we believe Infosys is can cross-sell and upsell existing accounts to application modernization services offerings deploying metrics-based frameworks that addresses client pain points for web delivery, including re-engineering and re-hosting, among others.

During 4Q16 Infosys bolstered its application modernization capabilities forging an alliance with open-source, document-oriented database vendor, MongoDB. The alliance highlights Infosys’ decision to steer away from competing through a consulting-led approach, investing instead in India-based application modernization capabilities.

We believe the partnership is a natural evolution of Infosys’ portfolio development, and efforts to secure small-scale, high-volume revenue stream in core service lines through deploying knowledge-based IT architectures can help minimize services cost.