Organic Vs Inorganic Growth: A Case Study

BY

MIRIAM JACOB

2006

A DISSERTATION PRESENTED IN PART CONSIDERATION FOR THE

DEGREE OF MA IN FINANCE AND INVESTMENT

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 ABSTRACT

In today's dynamic and competitive business environment, growth is not just an

option for companies, it is a vital necessity. No longer is it enough to generate reasonable
amount of profits.Companies now factor in expansion on a large scale in their corporate
vision almost from their very inception. Taking the need for expansion as a given, the
next question that business organizations face is the mode of expansion to adopt. The
different methods by which companies can grow can broadly be classified under two
heads-organic growth and inorganic growth. This dissertation addresses these issues in
the context of the Indian IT Sector.
After reviewing the theoretical background pertaining to both Organic and
Inorganic (Mergers and Acquisitions) growth, discussing some of the pros and cons of
both methods I try to find out, which is in fact, a better business strategy to pursue. An
extensive review of the literature on the financial performance indicators of organic and
inorganic growth will also be undertaken. Given the paucity of research on organic
growth per se, I will be focusing on selected case studies (pertaining to software and
product development industry in the Indian IT Sector) to further explain which is a ‘better
alternative’. Prior literature on both Organic and Inorganic has shown varied results. In
this research, the results from both the accounting studies as well as the independent
sample t-test show that no significant benefit accrues from taking up one form over the
other.

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 ACKNOWLEDGEMENTS

Before I begin, I would like to thank a few people who have supported me throughout the
writing of this dissertation. First and foremost, I express my sincere gratitude to my
superviso r, Mr Mohsen Derregia for his continual guidance during the course of this
dissertation. His insightful comments and suggestions have enabled me to greatly
enhance the value and shape of my written work.

I would also like to acknowledge the support and encouragement provided by my parents.
My mother, for her continual moral support and encouragement throughout this time.
And my father for providing me with detailed responses regarding all my queries and for
his insightful comments regarding the dissertation topic. Their belief in me and my
abilities have taken me a long way and helped me get back on my feet when I felt like
giving up.

I am also thankful to my friends without whom I could never have finished this
dissertation. I especially thank Joe for his continued support and encouragement
throughout the past year. Finally, above all, I would like to thank the almighty without
whose blessings this dissertation would never have been possible.

Thank you all for the time, effort and encouragement shown to me.

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TABLE OF CONTENTS

TOPIC PAGE NO.

ABSTRACT ii

ACKNOWLEDGEMENTS iii

1. AN INTRODUCTION TO THE TO THE DISSERTATION 1-4

2. ORGANIC AND INORGANIC GROWTH: A REVIEW OF THE LITERATURE 5-23

2.1 ORGANIC GROWTH: A THEORITICAL FRAMEWORK 5-6

2.2 INORGANIC GROWTH: THROUGH MERGERS AND ACQUISITIONS 7-8

2.3 HISTORY OF M & A ACTIVITY: MERGER WAVES 8-9

2.4TYPES OF MERGERS AND ACQUISITIONS 9-10

2.5 MOTIVES FOR MERGERS AND ACQUISITIONS 10

2.5.1 VALUE MAXIMIZING MOTIVES:

(A) SYNERGY 10
- OPERATING SYNERGY
- FINANCIAL SYNERGY
(B) IMPROVED MANAGEMENT 12
(C) DIVERSIFICATION 13

2.5.2 NON-VALUE MAXIMIZING MOTIVES: 13

(A) HUBRIS 14
(B) EMPIRE BUILDING 14

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 2.6 AN OVERVIEW OF THE ORGANIC AND INORGANIC RESEARCH FIELD 15

2.6.1 EMPIRICAL EVIDENCE USING EVENT STUDIES 16-19

2.6.2 EMPRICAL EVIDENCE USING ACCOUNTING STUDIES 19-23

3. ORGANIC VS INORGANIC GROWTH: A CHOICE BETWEEN TWO BUSINESS 24

STRATEGIES

3.1 FACTORS THAT INFLUENCE THE CHOICE BETWEEN ORGANIC AND 24

INORGANIC GROWTH
3.2 A CASE STUDY ON THE INDIAN IT SECTOR 25-26

4. THE INDIAN IT INDUSTRY: A BACKGROUND 27-28

4.1 A BRIEF HISTORY OF THE INDIAN IT SECTOR 28-29

4.2 FACTORS THAT ACCOUNT FOR THE SUCCESS OF THE IT

SECTOR IN INDIA 30-31

4.3 CONSOLIDATION, MERGERS AND ACQUISITIONS IN THE 31-32

INDIAN IT INDUSTRY

5. INFOSYS: THE CASE OF AN ORGANIC COMPANY 33

5.1 INTRODUCTION 33

5.2. A BRIEF HISTORY OF INFOSYS 34

5.3 BUILDING A SCALABLE ORGANIZATION 35-37

5.2 A STUDY OF INORGANIC COMPANIES

5.2.1. POLARIS MERGER WITH ORBITECH 38-40

5.2.2. WIPRO MERGER WITH SPECTRAMIND 40-42

5.2.3. HCL TECH MERGER WITH DSL SOFTWARE 43-45

5.2.4. TCS MERGERS WITH CMC 45-47

5.2.5 SATYAM MERGER WITH NETKRACKER 48

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6. ANALYSIS OF GROWTH PERFORMANCE 49

6.1 ACCOUNTING STUDIES 49-51

6.2 EVENT STUDIES 52-54

7. ACQUISITION STRATEGIES OF PRODUCT DEVELOPMENT COMPANIES 55

8. CONCLUSION 58-59

9. LIMITATIONS OF THIS EMPIRICAL STUDY 60

REFERENCES

APPENDIX

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 Chapter1. Introduction

1.1 Background

After the end of the IInd World War, countries followed the policies they thought were
best suited for their respective economies. Russia and China went the Communist way;
the U.S. continued its wholehearted capitalist policy, and so on. However, over the last
few decades, a common consensus ha s been reached by most economic and business
reformists- that the only way forward is to remove trade barriers and move towards a
globalized economy. Countries are throwing open the doors to businesses from across the
world by signing Free Trade Agreements, deregulating currencies and moving towards
full capital account convertibility and encouraging FDI on a large scale. While economic
reforms have tremendous advantages, they come at a price. No doubt they have
contributed enormously towards the growth of business organizations, leading to the
creation of behemoths with annual turnovers equivalent to the GDP’s of many countries.
Conducting business has become bewilderingly complex. The huge returns are combined
with a large degree of risk as well. As companies are realizing this, they are also coming
to the conclusion that the best way to deal with this risk is to attain constant growth. In
today's dynamic and competitive business environment, growth is not just an option for
companies, it is a vital necessity. No longer is it enough to generate reasonable amount of
profits. Companies now factor in expansion on a large scale in their corporate vision
almost from their very inception. Taking the need for expansion as a given, the next
question that business or ganizations face is the mode of expansion to adopt. The different
methods by which companies can grow can broadly be classified under two heads-
organic growth and inorganic growth.
Organic growth refers to the more traditional and accepted practice of expansion
by enhancing sales This is done by a number of methods such as creating more demand
in the market, delivering more value to the customer, building increased customer
relationships, etc., all culminating in an increase in sales figures. It is, largely, an internal
procedure, where the company relies on certain inherent skills to grow from within.
However, while organic growth is no doubt effective, companies today desire growth at

7
an extremely rapid pace. Many times this is possible only through inorganic growth
(mergers and acquisitions). If a company has the required resources, it sometimes prefers
using funds in the acquisition of other existing companies, rather than investing it back
into its own operations. The advantages of such an action is many-fold- not only does it
facilitate immediate growth, it also helps in eliminating competition, capturing larger
market share and in consolidation in the industry, thereby providing enormous benefits of
economies of scale. The profitability of merger and acquisition activity has generated a
small mountain of research over the past 30 years. With each passing decade, more
scientific evidence emerges, permitting us to sharpen our conclusions (Bruner, 2002).
Whatever the means of growth favoured, the basic objective of all companies remains the
same- to become world class organizations with a global presence, and to attain
sustainability in a rapidly changing business environment.

1.2 Objectives of the Study

In this dissertation, I aim to find out if organic (internal expansion) or inorganic growth is
a better way for firms to grow and expand. An extensive review of the literature on the
financial performance indicators of organic and inorganic growth will also be undertaken.
Given the paucity of research on organic growth per se, I will be focusing on selected
case studies to further explain which is a ‘better alternative’. The case study method has
been chosen for the purpose of this research, as this method is best able to explore and
provide an in-depth understanding of complex issues or objects and can extend
experience or add strength to what is already known through previous research. This
method is preferred when examining present day events within real life situations. I will
also look at the ways a company can achieve organic growth, as well as some of the
factors that determine the choice between organic and inorganic growth. Mergers and
acquisitions being the alternative way that the firm can grow, a study of the theoretical
and practical implications of mergers and acquisitions, the relative merits that M&A’s
offer in terms of profitability, increased customer base, tax benefits etc will be
undertaken to see how these factors have influenced the decision to merge..

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1.3 Research Methodology

Vario us approaches have been proposed by researchers to measure the profitability of

mergers and acquisitions namely: event studies, accounting studies, clinical studies and
survey of executives. For the purpose of this dissertation I will be using accounting and
event study method to measure profitability. Accounting studies is used to measure
profitability of firms before and after acquisitions and to see how the merger has affected
financial performance. The focus of accounting studies ranges across net profit, earnings
per share (EPS), leverage, liquidity of firm and return on assets. Events studies are
conducted to examine the abnormal return accruing to shareholders surrounding the
announcement period of the merger. However, there has been a paucity of literature on
organic growth and no research in particular has addressed a methodology to compare the
performance of Organic and Inorganic growth. Where a study has been undertaken, it is
captured within sub questions relating to mergers and acquisitions.

1.4 Organization of the Dissertation

The dissertation is structured as follows. The first chapter serves as an introduction to the
dissertation including background, defining the purpose of study and the structure of the
thesis. Chapter two briefly describes the two alternative ways that a firm can grow, an in
depth analysis of Organic growth and inorganic growth, the theoretical and practical
implications of mergers and acquisitions including strategic motiv es and determinants
behind them will be discussed in this chapter. This chapter also presents some of the
views, perceptions and findings of previous researches in this area. Chapter 3 discusses
some of the factors that influence the choice between organic and inorganic growth.
Section 4 looks at a case st udy on Organic Vs Inorganic growth in the context of the
Indian IT Sector, to determine if growth by internal expansion or through M&A’s is in
fact a better alternative. In an attempt to gain maximum benefit from the advantages of
these case studies, multiple sources of evidence have been used. Secondary data has
mainly been collected through various published sources, journal articles, documented
company material, corporate websites, annual reports and financial magazines. In

9
chapters 5 and 6 the case stud ies are analyzed and discussed. Chapter 8 is made up of the
conclusions that can be drawn on the basis of the material presented.

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 Chapter 2: A Review of the Literature

2.1 Organic ‘AND’ Inorganic Growth: A Theoretical Framework

As businesses ha ve evolved over centuries, the management of these businesses
have adopted strategies of different kinds to sustain them in the dynamic environment
that they exist in. The most traditional way in which companies have achieved growth is
through organic way of growing.

Organic Growth refers to the more traditional and accepted practice of expansion by
enhancing sales. This is done by a number of methods such as creating more demand in
the market, delivering more value to the customer, building increased customer
relationships, etc., all culminating in an increase in sales figures. It is, largely, an internal
procedure, where the company relies on certain inherent skills to grow from within
(Mognetti, 2002). Businesses relying on organic growth use internal development as the
means to achieve their growth (Baines et al, 1999). Firms that develop new products to
cater to a specific market, use this kind of growth strategy. This type of growth strategy
has been in existence since entrepreneurs started their businesses. Any entrepreneur who
wants to exploit his specific set of skills to the optimum level is often led to recruiting
people to help him maximize his potential. Entrepreneurs often expand their horizons to
form partnerships and companies. One of the chief reasons for organic growth strategy in
the earlier years was due to the limited access to capital and therefore, it meant that this
was the only growth route available to a business. One of the key aspects of organic
growth is that the company remains focused on its goals and the employees understand
what is expected of them. A consistency of various sorts is established and this can be
seen from the statement made by the CEO of Text 100, “Our philosophy is to grow
organically so that our methodology, qua lity and culture are consistent around the globe”.
The result of this strategy is that clients of the firm experience the same, high level of
results from their PR programs from country to country. This also is instrumental to
customer loyalty to the brand name that the company has created for years. Organic

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growth ensures that a solid brand name is created through creative marketing although
this could take a long number of years. Organic growth focuses on a ‘niche strategy’ that
is based on dividing the market into segments and concentrating on one particular sector
or niche market (Baines et al, 1999). This strategy is fine as long as the segment is large
enough to sustain long term profitability and growth. As is the case with every strategy,
organic growth strategy also follows a business life cycle which may be short- lived as a
result of a current fashion trend or a cycle which is seemingly everlasting. However long
the cycle, the business will need to ensure that it has sufficient products or services in
other stages of development to counteract the reduction in sales from any product or
services nearing a period of decline. Growing organically can be attractive, but is bound
to be slow in fast changing markets. To explain it better, it takes almost a decade to
transform a new recruit into a fully- fledged partner in a consultancy firm (and even
longer if you keep losing the brightest people to multinationals). So a growing number of
consultancy companies like A.T. Kearney and Mercer Management foremost among
them, have chosen growth by acquisition. (http://www.economist.com) Organic growth
also turns out to be less risky than other growth strategies and in turn sustainable in
nature. It is sustainable in nature as successful growth provides the basis for further
growth. Although a firm cannot be assured of further growth before the business has
established itself in the market.
Most management teams today face an unprecedented challenge. The
convergence of several trends – global excess capacity, increased customer power and
investor scepticism about the economics of M&A have left them with meagre volume
growth, little to no pricing power and a reduced ability to buy earnings. All of this has
placed a huge premium on not just organic growth, but profitable organic growth.

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2.2 Inorganic Growth - ‘Mergers’ and ‘Acquisitions’

In a business landscape that is witnessing massive globalization, companies in both

developed and developing economies, strive to capture a large chunk of the market. In
order to do this, people working in business organizations work extremely hard to be the
best at what they do. Major companies in both domestic and international markets
struggle to achie ve the optimum market share possible. Every day business people from
top to lower management work to achieve a common goal – being the best at what they
do, and getting there as fast as possible. As companies work hard to beat their
competitors they assume various tactics. Some of their tactics may include competing in
the market of their core competence, thus, insuring that they have the optimal knowledge
and experience to have a fighting chance against their rivals in the same business; hostile
takeovers; or the most popular way to achieve growth and dominance – Mergers and
Acquisitions.

Mergers and Acquisitions can be considered as an inorganic method most

frequently used by companies to attain growth in the twenty first century; they present a
company with a potentially larger market share and open it up to a more diversified
market. At times, a merger or an acquisition simply makes a company larger, expands its
staff and production, and gives it more financial and other resources to be a stronger
competitor in the market. Mergers and Acquisitions often pave way for companies to
enter newer markets, and to consolidate their positions in existing markets, there by
positioning themselves as more important players in their segments. This also provides
them competitive advantage over other companies in different product segments.

Although mergers and acquisitions are often interchanged and used as though
they were synonyms, the term “merger” and “ acquisitions” mean slightly different
things(Lubatkin & Shrieves, 1986, p. 497) A merger is a corporate combination of two or
more companies into a new legal entity. In this case the stockholders of the target firm
are offered new stock in the new company in exchange for the surrender of their existing
stock. However when a company takes over another one by purchasing a majority interest

13
in the target company and becomes the new owner, the purchase is termed as an
acquisition. From a legal point of view, the target company ceases to exist and the buyer
“swallows” the business and the stock of the buyer continues to be traded (www.
investopedia.com). Whilst in both circumstances the two companies may merge on the
basis of a contract, there also cases of the so-called hostile take over, in which a company
acquires a controlling interest in a weaker firm against the will of its management.

2.3 History of M&A Activity: ‘Merger Waves’

A distinctive feature of mergers and acquisitions is that they occur in waves.

Merger waves are defined as “periods of time characterized by relatively large numbers
of mergers reported simultaneously in many industries” (Reid, 1968, p. 15) where this
activity intensifies at an increasing rate and then declines rapidly. The pattern of merger
occurrence has led to the view of M&As as reactions to changes in the economic
environment. These changes may vary and differ over time, but are mostly related to
technology changes. Researchers like Jovanovich and Rousseau (2004) have found that
merger waves have been found to be driven by exogenous shocks. In the presence of a
common shock, firms individually reconsider their strategies. The last century has seen
five merger waves (each driven by different strategic motives), where each wave
exceeded the precedent in scope. The first appearances of business mergers in high
frequency were made at the end of the 19th century. This wave saw the creation of steel,
auto, oil and other behemoths. Since then, about five cyclical merger waves have been
observed. Some of the most significant deals struck during this period were- the merger
between Time Warner and America Online (2000; 166 billion), Proctor &Gamble with
Gillette (2005; $54 billion). The current year saw the $33.35 billion merger deal between
Mittal Steel and Arcelor. (Hu, 2002 )
The number and size of mergers and acquisitions being completed continue to
grow exponentially. The last decade of the 20th century saw some of the largest number
of M&A deals being struck. The current year has seen approximately 15,248 merger
deals worth over $ 367,780 million being announced worldwide
(www.economictimes.com).Once a phenomenon seen primarily in the United States,
mergers and acquisitions are taking place in countries throughout the world. It is clear

14
that mergers and acquisitions have become one of the most important corporate- level
strategies in the new millennium.

2.4 Types of mergers and acquisitions:

Horizontal Mergers: involves two firms that operate and compete in a similar kind of
way and who are situated in the same juncture of business cycle. The merger is based on
the assumption that it will provide economies of scale from the larger combined unit.
Vodafone's acquisition of German telecommunicatio ns giant Mannesmann and the
merger between Exxon and Mobil are some of the examples of companies that have
merged via a horizontal merger (Myers et al, 2005, p930)

Vertical mergers: A vertical merger is where companies at different levels in the

productio n cycle combine either as forward or backward integration. In other words it
refers to a merger in which the company expands its business into areas that are at
different stages in the same production path. Unlike horizontal mergers, which have no
specific timing, vertical mergers take place when both firms plan to integrate the
production process and capitalize on the demand for the product. Forward integration
takes place when a raw material supplier finds a regular procurer of its products while
backward integration takes place when a manufacturer finds a cheap source of raw
material supplier. The basic reason for these kinds of mergers is to eliminate costs of
searching for prices, contracting, payment collection and advertising and also to reduce
cost and dependence.

Conglomerate mergers: involves companies in unrelated fields of businesses. Majority of

mergers that have taken place during the 1960s and 1970s have been conglomerate
mergers. Among conglomerate mergers three different types have been dis tinguished:

Product extension: conglomerate mergers involve firms that sell non competing products
and use related marketing channels of production processes.

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Market extension: Conglomerate mergers join together firms that sell competing products
in separate geographic markets.

Pure conglomerate merger: Unites firms that have no obvious relationship of any kind.

2.5 Motives for Mergers and Acquisition

The determinants of merger and acquisition (M&A) behavior have long been a
topic of interest to researchers. Mergers and acquisitions generally are considered to be
rational financial and strategic alliances, made in the best interests of the organization and
its shareholders. But study of past literature shows us that mergers may be influenced by
financial or value maximising motives or non value maximising motives. The main
objective of value maximizing behaviour is to increase shareholder wealth and financial
synergies that arise from the merger activity. Non-value maximizing behaviour relate to
dubious motives of the management which might not be in the best interest of the
shareholder. Berkovitch and Narayanan (1993) suggest three major motives for
takeovers: synergy, agency, and hubris. Other motives include diversification, tax
considerations, management incentives, purchase of assets below their replacement cost,
break up value etc.

2.5.1 Value maximizing motives:

A) Synergy: One of the most important motives for the formation of mergers and
acquisitions is the idea of “synergy”. The synergy hypothesis states that acquisitions may
occur when the combined value of two firms is greater than the sum of the individual
firm values (i.e.: Bradley, Desai, and Kim, 1988).In other words when 2+2=5.Sirowar
(1997) defines synergy as “increases in competitiveness and resulting cash flows beyond
what the two companies are expected to accomplish independently. Synergies can arise in
three major forms: operating synergy (that which is derived from cost economies),
financial synergy (synergies that arise on account of revenue enhancement and
managerial synergy (managerial synergies are realized when the acquiring firm’s

16
management has superior skills, abilities, and knowledge than those of the target firm)
(Trautwein, 1990).

Operating Synergy:

Operating synergies occur when economies of scale and scope are achieved by
combining previously-separate operating units such as production, marketing, R&D, and
administration. Operating synergies allow firms to increase their operating income from
existing assets, increase growth or both. Operating synergy is further categorized into:

Economies of Scale and Scope:

For a firm to achieve a competitive advantage, it can undertake a merger to realize

economies of scale and economies of scope. Since cost savings play an important role,
mergers provide this through economies of scale. Economies of scale refer to the cost
reduction in producing a product from increasing the scale of its production in a given
period (Sudarshanam, 2003, p3). When companies grow bigger through takeover or
merger, economies of scale are said to be achieved as a result of decreases in per unit
costs, which in turn results from an increase in the size or scale of a company’s
operations. The most obvious economies of scale are cost savings from eliminating
duplicate jobs, closing offices and economies of scale in purchasing. Another area in
which operating economies can be achieved is through vertical integration. For example
by combining firms that are at different stages of an industry may achieve more efficient
coordination of the different levels. It is based on the argument that costs of
communication and various forms of bargaining can be avoided by vertical integration
(Weston, 2005, p762). On the other hand, economies of scope relates to the ability of a
firm to utilize one set of inputs to provide a broader range of products and services.
Economies of scope exist when the average costs of joint production are lower than the
average costs that would be achieved by production in separate firms. These economies
result from joint use of inputs or production facilities.
(http://www.hwwa.de/Publikationen/Intereconomics/1999/ie_docs/ie9906-kinne.htm )

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Financial Synergy:

Financial synergy refers to the possibility that combining two or more

companies can lower the cost of capital (Gaughan, 1991). Financial synergies result in
lower cost of capital which can be achieved through increased access to cheaper capital,
the establishment of an internal capital market, and/or reduced systematic risk. One
source of financial synergy is the lower costs of internal financing in comparison with
external financing (Copeland et al, 2005, p762). For example, a firm with large cash
flows and limited investment opportunities may combine with a firm that may need
additional finance on account of its limited internal funds and large investment
opportunities. Combining the two firms, results in advantages from the lower costs of
internal funds availability.
Another potential source of synergy is the tax benefits got from increased debt
capacity. The debt taking capacity of firms increase as a result of mergers and takeovers.
This is because when two firms combine; their earnings and cash flows become more
stable and predictable, which, in turn allows them to borrow more than they could have
as individual entities. In addition, it also creates a tax benefit for the combined firm. This
tax benefit can take the form of either higher cash flows or a lower cost of capital for the
combined firm. The bidder company can then use the unused tax benefits of the target.
The target firm may have losses because of which it wouldn’t have used up its tax
benefits which the bidder can make use of, after the merger.

B) Improved Management:

Some takeovers are primarily undertaken with the belief that a merger can
improve efficiency by combining firms of unequal managerial capabilities (Copeland et
al, 2005, p 760 ). A relatively efficient bidder may acquire a relatively inefficient target.
In such a case the bidder may feel that its management skills are such that the value of the
target would rise under its control and improved management. On the contrary, the bidder
may seek a merger with a target firm because it believes that the management of the
target firm can improve the efficiency of the bidder. Manne (1965) suggests that, through
the market for corporate control, acquisitions are a solution to the agency problem. Firms

18
whose efficiency is poor as a result of agency problems will be acquired and replaced,
and their performance improved. The implicit threat of potential takeovers has a
disciplining role on managers, possibly forcing them to follow shareholder value-
maximizing strategies. Authors like Brealey Myers (2005) take improved management to
mean the determination to force painful cuts or realignment of the company’s operations.

C) Diversification:
One of the salient facts of the merger wave was the diversification motive as a
managerial objective. The rise of corporate diversification has been one of the major
business developments of the last 50 years (Matsusaka, 1993). As markets become
saturated, the company may need to find alternatives to maintain the profit margins and
bring about stability to the growth rate. The best solution available to any management is
to diversify either geographically or product wise. When expanding geographically, the
company can still maintain the same technolo gy and product line in the newer markets.
Another motive behind diversification is to lower their risk and exposure to certain
volatile industry segments by adding other sectors to their corporate portfolio. Mergers,
particularly cross-border mergers, then represent the fastest way of acquiring access to
new markets and, later on, of achieving cost savings.

2.5.2 Non-Value Maximizing Motives:

Mergers may also be the outcome of some other motives, not keeping with the view of
maximizing shareholder wealth. T he varied ambitions of managers lead to inefficiencies
in the relationship between them and the owners of the firm resulting in agency problems.
Prior research has advanced other, less desirable reasons for mergers and acquisitions,
including managerial hubris (Roll 1986), empire building by managers of cash rich firms(
Jensen 1986) and building market power(Eckbo1992). In all of the above cases managers
try to maximize their utility function. Merger activity often results from acquiring firm
managers’ acting in their own self- interests rather than in the interests of the firm’s
owners (Jensen and Meckling, 1976). Shleifer and Vishny (1998) argue that acquisitions

19
are often the easiest and quickest way for managers to achieve their personal goals,
through introducing the company in new ventures.

A) Hubris:
The hubris hypothesis was first advanced by Roll (1986), and implies that
managers seek to acquire firms for their own personal motives and that the pure
economic gains to the acquiring firm are not the sole or even the primary motivation in
the acquisition. The hubris hypothesis suggest that the bidding firms managers make
mistakes in evaluating target firms, but undertake acquisitions presuming their valuations
are correct. Managers often tend to over estimate the potential synergies from a merger
when in fact there are none. Roll (1985) uses the word “hubris” to define managers who
are overconfident about their own abilities. This overconfidence, leads them to believe
that they are capable of obtaining gains from the acquisition of another institution. This is
particularly true in waves of consolidation, when managers blindly follow the markets
and change their beliefs on conglomeration versus strategic focus or when multiple
bidders compete for the same target.

B) Empire Building:
Unlike in the case of the hubris hypothesis, which proposes that management
inadvertently over pay for target firms, the managerial hypothesis suggest that managers
will knowingly overpay in takeovers. Empire building occurs when managerial discretion
is sufficient to allow managers to diversify the firm’s activities by making acquisitions
that benefit or entrench themselves at the expense of shareholders. A traditional empire
building argument is that managers act in their self-interests and larger firm size brings
them more benefits. Mangers may be motivated to increase their compensation by
increasing the size of the firm through non-value maximizing mergers or engaging in
“expense preference” behavior by over-consumption of perquisites. (Since managerial
compensation is frequently tied to the amount of assets under their control, managers are
more likely to seek higher rates of growth in assets than profits (Marris 1964). Managers
also may intentionally acquire businesses that require their personal skills in order to
make it costly for shareholders to replace them.

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 2.6 Overview of the Organic and Inorganic Growth Research Field

The determinants of merger and acquisition (M&A) behavior have long been a
topic of interest to researchers. Stewart, Harris, and Carleton (1984) observe that
empirical studies on M&A behavior have typically followed one of two general
strategies. Some researchers have examined the differences between the pre-merger and
post-merger performance of merged firms. Others have focused on identifying
differences in the characteristics of firms involved versus those not involved in M&As.
Despite each having its flaws, both strategies have produced some valuable insights into
M&A behavior. The profitability of merger and acquisition activity has generated a small
mountain of research over the past 30 years. With each passing decade, more scientific
evidence emerges, permitting us to sharpen our conclusions. Therefore it is appropriate to
consider the latest findings along with earlier studies to synthesize some insights from the
literature

Research offers four approaches to measure M&A profitability (Bruner 2002). They are
(1) Event Studies (2) Accounting Studies (3) Clinical Studies and, (4) Survey of
Executives.

In this section, I will analyze the different criteria used by researchers to evaluate merger
success. I will then review the available empirical evidence relating to the performance or
the profitability of Organic as well inorganic growth (mergers and acquisitions)
beginning with event/ stock return studies and then moving to accounting based studies.
For the purpose of this dissertation, I will be using only the accounting and event study
methods as mentioned earlier. Surveys and clinical studies are not test of hypothesis; they
aim to describe rather than test (Bruner 2002).

21
2.6.1 Empirical evidence using event studies:

Researchers have used a number of measures to evaluate acquisition success.

However, the most common approach to measuring the performance of M&A’s is
probably the event studies method. Event study is an important research tool in
economics and finance. Event Studies examine the abnormal returns accruing to
shareholders for both bidders and targets during a period surrounding the announcement
of the merger or acquisition. Abnormal returns are calculated by subtracting the raw
returns (change in share price) from a benchmark i.e. the return expected by the
shareholders for that period.

One of the most comprehensive research done in the recent past is the one by
Andrade et al(2001) where they discuss the reasons for merger and also try to find out the
long term effects of mergers. Some of the reasons cited by them in the paper are
efficiency related reasons such as economies of scale or synergies; attempts to create
market power, by forming monopolies or oligopolies; market discipline, by removing
incompetent managers. In their paper, Andrade et al study all acquirers and targets in the
merger and acquisition database of the University of Chicago Centre for Research in
Security Prices database over a 25-year period. Measuring value creation or destruction
from mergers is a central objective and two commonly used event windows for
measuring are the three days surrounding the merger announcement and a longer window
spanning several days before and after the merger announcement. In the study conducted,
firstly they used a short window period of three days around the announcement and found
out that returns over that period are economically and statistically significant and
positive. The combined values of the acquirer and target they found to increase by 2% of
the total initial value of the acquirer and target. The combined returns were positive and
of the same magnitude, but no longer statistically significant when they used a longer
window i.e. 20 days before the announcement until the acquisition closed. They also
found that acquisitions funded by at least some stock have combined returns that are
essentially zero. Acquisitions funded without stock, were found to have positive
combined returns. Post-acquisition returns were found to be (insignificantly) positive for
acquisitions that are not equity-financed and (insignificantly) negative for acquisitions

22
that are equity financed. In the ir paper, they also provide evidence to further prove the
fact that merger activity strongly clusters by industry by looking at the evidence in 1990s.

Loughran and Vijh (1997) studied the post acquisition returns from the point of view of
shareholder wealth gains from 947 acquisitions during 1970-1989. They classified their
sample based on the mode of acquisition (i.e merger or tender offer) and the form of
payment (stock or cash). Both these variables have been examined from the context of
wealth gains from acquisitions. As per the results of their study they found that the post
acquisition returns of acquirers stock are related to both the mode of acquisition and the
form of payment. On average, the acquirer stock returns were found to be greater than
matching stock returns in cases where tender offers were made and where cash was used
as a mode of payment. The acquirer stock returns were found to be smaller than matching
stock returns in cases where a merger offer was made and stock was used for payment.
During a five year period following the acquisition, they found that, firms that complete
stock mergers earn significantly excess negative returns of -25.0% where as firms that
complete cash tender offers earn significantly positive returns of 61.7%. They examined
the overall wealth gains of target shareholders by combining the pre-acquisition and post
acquisition returns and found that contrary to what is popularly believed in finance
literature (that target shareholders gain from all types of acquisition), their study found
that whereas target shareholders who sell out soon after the acquisition effective date gain
from all acquisitions, those who hold on to the acquirer's stock received as payment find
their gains diminish over time.

Three major motiv es have been suggested for takeovers: synergy, agency and hubris.
Berkovitch and Narayanan (1993) in their paper on Motives for Takeovers –An Empirical
Investigation aims to distinguish among these competing hypothesis by looking at the
correlation between target and total gains. It has been argued that correlation should be
positive if synergy is the motive, negative if agency is the motive and zero if hubris is the
motive. For this they analyzed 330 successful tender offers from 1963 through 1988.
They computed the cumulative abnormal returns based on a specific window period.
Total gain was defined as the sum of acquirer and target gains. It was found that on

23
average, takeovers yield positive total gains. In 49.4% of the cases it was found that,
acquirers obtained positive gains, while in 95.8% of the cases, target gains were positive.
The total gains were found to be positive in 76.4% of the cases. Further the correlation
between the target gains and the total gains is positive and highly significant. Based on
the empirical evidence they concluded that total gains are mostly positive implying that
synergy is the primary driving force in mergers and acquisitions. They also found that in
takeovers with positive total gains, the total gains increases with competition for the
target. In takeovers with negative total gains, the same decreases with competition.

Agarwal et al (1992) undertook an extensive research on 937 mergers and 227 tender
offers from the period 1955 to 1987 and evaluated post merger performa nce after
adjusting for the firm size and the beta –weighted market returns. They concluded that
shareholders of acquiring firms experienced a statistically significant wealth loss of about
10% over the five years after the completion of the merger.

Frank s, Harris and Titman (1991) undertook a study of 399 US mergers in the period
1975-1981 and found that shareholders of target firms experienced substantial
announcement gains averaging 28%.

Acquirers appear to have no gains around the announcement date, but there is no
evidence of significant losses. When the target and buyer figures are weighted by market
capitalization, the sample acquisitions appear to be value creating events around the
announcement date as shown by the average 3.9% gain for the takeover portfolio. They
found that target gains are higher in all cash-bids than in bids using all equity or mixture
of securities. Furthermore, all-equity bids show significant bidder losses, likely reflecting
downward revaluation of the bidders assets- in –place. Bids that are either contested or
opposed also lead to significantly higher target gains.

They also reported that post merger share price performance is sensitive to the
benchmark employed. Using an equally weighted index, their findings confirmed earlier
studies that find negative post merger performance. However, use of a value –weighted
benchmark results in positive post merger performance.

24
Thus from an analysis of the above literature, it is evident that virtually all researchers
have reported large positive returns to shareholders of target firms. Shareholders of target
firms are found to be better off with abnormal returns in the order of 20% to over 43%.
On the other hand, most researchers have found that sharehold ers of the acquiring firm
experience wealth losses on average, or at best, break even. Studies of targets and
acquirers combined seem to suggest that these transactions create some value .Further
there was found to be some variation in acquirer and target shareholder wealth
performance across merger types.

2.6.2 Empirical evidence using accounting studies:

In addition to event studies, many researchers have also used accounting-based studies to
assess the long term financial performance of firms involved in M&A’s. Accounting
studies examine the reported financial results of acquirers before, and after, acquisition to
see how financial performance changed (Kaplan, 2006). Financial ratios like return on
equity return on assets, earnings per share, etc., are some of the commonly used tools
employed to measure the financial aspects of corporate performance. By evaluating
acquisitions on the basis of operating performance provides additional insight into the
impact of mergers. Further accounting- based studies also allow the researcher to study
private and unlisted target and acquirer companies for which price data are unavailable.

Healey et al examined the post-acquisition performance of 50 large mergers between US

public industrial firms completed between 1979 and mid 1984.They analyzed the
operating performance for the combined firm relative to the industry median. They found
that asset productivity increases significantly for these firms following acquisition, which
contributed to higher operating cash flow relative to their non- acquiring peers. They also
found that the operating cash flows of merged firms actually drop from their pre-merger
level on average, but that the non- merging firms in the same industry drops considerably
more. Hence the post merger operating performance improve s relative to the industry
benchmark. Further this performance improvement was found to be particularly high for
firms with highly overlapping businesses. Transactions with high business overlap were

25
found to have 5.1% improvement in post merger performanc e whereas other types of
mergers did not.
Healey et al also found that mergers do not result in cuts in long term capital and R&D
investments, as these sample firms have been able to maintain their capital expenditure
and R&D rates relative to their industries after the merger.
Transaction characteristics such as the form of financing, whether the transaction is
hostile or friendly and size of the target firm are frequently cited as important to the
ultimate success of mergers. In their paper, Healey et al used post merger cash flow
returns for different types of transactions to examine each of the hypothesis associated
with these characteristics. From the results, no significant performance differences were
found in case of each of the above characteristics.
Further a strong positive relation between post merger increases in operating cash flows
and abnormal stock returns were found at merger announcement, indicating that
expectations of economic improvements explain a significant proportion of the economic
revaluation of the merging firms.

In his paper on “Does operating performance really improve following corporate

acquisitions”? Ghosh (2001) addresses two questions related to the performance of
merging firms. First, he tries to find out if the operating performance actually improves
following acquisitions. For the same purpose he uses a sample of all mergers and
acquisitions that were completed during the period 1981 through 1995. In an attempt to
overcome some of the limitations of the results of past literature on the same subject, he
uses a research design that accounts for superior pre-acquisition performance of merging
firms. He compares the post- and pre-acquisition operating cash flow performance of
merging firms relative to the merged firms to determine whether operating performance
improves following acquisitions. Firms are matched on the basis of pre-acquisition
performance and size of merging firms. Using this methodology however, he did not find
any evidence that merging firms were able to increase operating cash flow performance
following acquisitions.
Secondly he tries to find out if performance of merging firms is related to the method of
payment used in acquisitions. Based on the results of his study, he found that operating
cash flow increases significantly following cash transactions after accounting for any

26
superior pre- acquisition performance. Further the improved performance was found to
arise on account of higher sales growth rather than reduction in costs. Therefore, the
results suggest that cash acquisitions succeed in better managing the assets of combined
firms.

Ravenscraft and Scherer (1988) studied 471 acquirers between 1950 and 1977. They
made use of financial ratios such as operating income/ sales and cash flow as profitabilit y
variables and concluded that there is no significant increase in post merger profitability.
Further they also found that the financial performance of target firms deteriorated after
the merger as compared to before the merger. Most of the targets post-takeover profit
decline was attributed to asset value write-ups. Also, purchase accounting and the entry
into new i.e. diversifying lines of business were also found to be associated with material
and significant decreases in profitability.

From an analysis of the above literature a number of interesting results are found -
Ravenscraft and Scherer (1988) found when measuring performance with accounting
profitability that mergers led to decline from the merging firm’s pre- merger performance.
The decline in performance was found to be largely dependent on how accounting rules
were applied. For when purchase accounting was applied, the performance was found to
be worse than when pooling accounting was employed (Sudarshanam 2003, p19).Healey
et al (1992) reported that pre- merger operating performance of the merging firms, relative
to their industry medians, persist even after the merger. They found that there is
significant operating performance improvement after the merger. This improvement is
also found to be positively and significantly related to stock returns. However, Ghosh
(2001) found that acquisitions don’t in fact lead to any significant improvement in
operating performance.

Although there is a burgeoning literature on growth via acquisition, there is little

on organic growth. Most is captured within sub questions relating to mergers and
acquisitions.

27
Dickerson et al (1997) investigated the impact of acquisitions on company performance.
They did this in two ways- first they investigated whether there was a permanent shift
effect on performance following a company’s first acquisition. They then examined to
see if there were any differential returns to acquisition growth and internal growth. For
the purpose of their study, they utilized a panel of large quoted UK companies over the
period 1948 through 1977. Their results show no evidence that acquisition has a net
beneficial effect on company performance as measured by profitability. On the contrary
Dickerson et al found that acquisitions have a systematical detrimental impact on
company performance. They also found that not only was the co-efficient on acquisition
growth much lower than on internal growth, but there was additional and permanent
reduction in profitability following acquisitions. Based on the results of their study, they
concluded that internal growth rather than growth by acquisition has a more favorable
effect on company performance as measured by profitability. Their results further
confirmed what American researchers had already found out i.e takeovers do not lead to
enhanced performance as measured by profitability.

Aaronovitch et al (1975) in their paper on Mergers, Growth and Concentration attempts

to answer a number of questions regarding the impact of acquisition and mergers on the
growth of firms and concentration. One of them being whether growth by acquisition
(external growth) is at the expense of internal growth. Firms grow, in general, from both
internal and external sources. It could be argued that the over-all growth of the firm will
not depend upon the relative use of the two sources. If, for example, the finance available
for expansion purposes is fixed for the firm, then growth may be roughly the same
whatever the source. On the other hand it is impossible to argue that rapid internal growth
generates the profits and high share price which make acquisitions and external growth
easier to achieve. For the purpose of their research they coined together a group of firms
whose assets exceeded £ 5 million at the end of 1957. They tested the two alternatives in
two ways-first to see whether the total growth is associated with the acquisition
proportion, and second to see whether external and internal growth are positively or
negatively related. They found that for each of the periods total growth is positively
associated with the acquisition proportion. The evidence for the relationship between
external and internal growth is not so consistent. In the first sub- period the relationship

28
was found to be positive and significant but in the second sub-period it was found to be
negative and insignificant. When firms which were not acquired at all were excluded, the
relationship was then found to be positive and significant for the whole period as well as
for the sub-period. However, from their results they did not find any evidence suggesting
a possible trade-off between external and internal growth. Moreover on a cross-sectional
basis they found that internal and external growth are complements than substitutes.

29
3.0 Organic ‘VS’ Inorganic Growth: A CHOICE Between Two

Business Strategies

“What can fifty years of research tell us about the profitability of mergers? Undoubtedly
the most significant results of this research has been that no one who has undertaken a
major empirical study of mergers has concluded that mergers are profitable; i.e. in the
sense that they are more profitable then alternative forms of investment.”(Hogarty, 1970,
p. 220)

3.1 Factors that influence the choice between Organic and Inorganic Growth:

In cases where the expansion program is directed toward growth in the same
product area, yet another argument is made for sticking to the internal expansion route.
Present management knows the industry and has an established reputation. Companies
that are ‘people-centric’/ ‘knowledge intensive firms’- where the integration process is
difficult to achieve after the merger has been effected is another example of an instance
to use the organic form of growth to grow and expand. For example Infosys, one of
India’s largest IT Company’s largely depends on the organic form growth to expand for
this very reason. In addition, firms that develop new products to cater to a specific
market, is also better off using this kind of growth strategy. When diversifying, however,
acquisition maybe the preferred route, and most businessmen agree that expansion by
acquisition can be extremely effective. The increasing number of completed mergers each
year is, in fact, evidence of the important part acquisitions play in the expansion and
diversification of business organizations. Acquiring a going business organization that is
well managed and profitable, and is also an important factor in its field, can be the most
expedient means of expanding a business organization quickly. In one move a product
line is added, a marketing organization is acquired and product development team is
taken over. And, to top it all off, there is a complete management hierarchy to run the
operation. The slow painful process of new product creation and distribution is bypassed.
What might have required years is achieved in a few months. A major impetus for
takeovers by companies can be to increase its market reach which is best seen in the
merger between Polaris and Orbitech.

30
However, management tend to look with something less than enthusiasm upon the
acquisition approach to expansion. They point out the difficulties in making an
acquisition at a fair price. It is argued, too, that in moving into a new product area by
internal expansion, the company buys new machinery and equipment the latest technical
advances. When in contrast, the acquisition route is selected; the acquiring company
generally must be satisfied to get older facilities.

3.2Case Studies on the Indian IT SECTOR

With the growing interest in the contribution of the IT industry to the Indian economy, a
number of studies that have been undertaken show that it is set to increase to 7% of the
Gross Domestic Product (GDP) by the end of 2008. (Economic Times, 22 October 2004).
The IT industry in India is home to some of the most renowned names in the global
software market such as Infosys, Wipro, Tata Consultancy Services, HCL Tech, Satyam
computers e.t.c. These companies have become renowned on account of the various
business strategies that they have implemented. For this reason, I have chosen to study
the performance of an organically growing company in the Indian IT (software) industry
to compare with inorganically growing companies with the aim of finding the better
business strategy of the two. Key ratios and other growth indicators are compared relative
to the organically growing company- to compare if an increase in growth is achieved
through organic or inorganic means. Infosys has been chosen as the organically growing
company which serves as a benc hmark against which companies that have made
acquisitions (inorganic) such as Polaris, Wipro, HCL,TCS and Satyam are compared.
Different indicators of performance of these companies that have made acquisitions with
and without the merged entities are then compared with Infosys as a standalone to see if
there were any significant changes on account of the particular business strategy(organic
or inorganic) chosen by the management.
In this research, the companies under review have used different strategies to aid them in
their quest for growth (intellectual capital) that cannot be captured quantitatively.
Therefore I make use of a case study approach augmented by quantitative analysis to do

31
an in depth analysis of these companies to find out if a particular business
strategy(Organic Vs Inorganic) was better for their growth or not. The case study
methodology helps us to analyze the context and processes involved in the phenomenon
under study (Hartley, 1994).

32
4.0 The Indian IT Industry: A BACKGROUND

“Software is more than just another industry- it is a central intermediate good in the new
digital economy.”- Anonymous

4.1 Introduction:

Technological revolutions sometimes bring unexpected opportunities for countries. India,

a relative laggard among developing countries in terms of economic growth, seems to
have found such an opportunity in the information technology revolution as an
increasingly favored location for customized software development. (Arora and
Arunachalam, 2001 ) This has given India an elite position in the software field globally
and is mainly attributable to scientific and technical manpower and suitable infrastructure
for research and development that has been built over the last 2 decades. Just as China
opened its doors to Foreign Direct Investments in the 1980s, India took the initiative to
liberalize a decade later. Before economic liberalization, India’s dominant economic
philosophy was one of self reliance where the country’s requirements were met, to the
extent possible, within the borders of the country. This self-reliance became an end in
itself, leading to a very broad production base, but insufficient attention to efficiency and
productivity (Forbes, 1999). Even though, liberalization was achieved a bit too late, the
software industry evolved rapidly eclipsing other Asian superpowers to become the
leader in the last few years. In just about a decade and a half, India has emerged as a
major exporter of software services in the international economy. This remarkable feat
has been accomplished as a result of extraordinary growth of Indian software products in
the global market. The industry has emerged as one of the fastest growing sectors in the
Indian economy with a compound annual growth rate (CAGR) exceeding 50 per cent
over the last five years and a turnover of US$ 10.25 billion (www.ibef.org). In the year
2000, following the recession in US there was a widely held fear that the market for
Indian software would also collapse. However software growth held, although at lower
rates of growth and led to the diversification of the industry into other geographical and
related markets. In the last two years the more phenomenal boom in growth has come
from the IT enabled service sector, which grew at about 70% in 2001-2002. The industry

33
is fast emerging as a major contributor of export earnings in India. Latest figures released
by National Association of Software and Service Companies (NASSCOM) estimate that
software exports accounted for well over 16.5% of all exports from India. A NASSCOM
McKinsey report further estimated that by the year 2008, revenues of the Indian software
market would reach US $35 billion. More interesting in assessing the importance of
software to the overall economy is the statistics that the software industry accounted for
over 10% of the growth of India’s GDP in the late 1990’s (Kumar, 2000). According to a
recent survey, it was found that employment rose from around 285,000 in 1999-2000 to
about one million in 2004-05, or at a compound rate of about 28.5 per cent per annum.
Thus, even though the software and IT-enabled services sector started from a small or
negligible base a decade back, its rapid expansion at an annual compound rate of more
than 30 per cent per annum between 1998-99 and 2004-05 has ensured that it is today an
important presence in the economy.

4.2 A brief history of the Indian IT Sector

If Microsoft, IBM, Oracle, Sun Microsystems all has one similarity, it is that all of them
are big global software companies, who have set up operations in India on a massive
scale. The latest entrant in the market is Google Inc. who is scouting for a base station to
start operations. The favorable atmosphere for an international firm to set up operations
in India has come about in a small space of time. The Indian software industry is perhaps
the most outstanding industrial success story of independent India. From a humble
beginning in 1970 when Tata Consultancy Services was founded, through a period of
gradual growth in the 1980s, the industry came of age in the 1990s and by 2002
accounted for more than 2% of Gross Domestic Product and 15% of exports from the
country. The post liberalization period has been a period of explosive growth of the
software industry. Software exports were just Rs. 1.35 billion in 1990-91 but went up to
Rs. 25.2 billion in 1995-96, Rs. 283.5 billion (US $ 6.2 billion) in 2000-01, and US $
7.68 billion in 2001-02 (Nasscom, 2002). Domestic companies entered the industry by
providing low-cost, skilled manpower to clients in developed markets. In the years
immediately preceding 2000, Indian software companies obtained many projects to solve
the “Y2K” problem (Arora et.al., 2001) The internet and e-commerce explosion helped

34
companies graduate to large-scale coding assignments that actually developed new
applications. The late 90s saw a spate of venture capitalists coming to India of which
almost 70% was routed to the software industry. (Nigam, 2001)

India IT Software and Services Industry

US$ billion

SOURCE: NASSCOM

35
4.3 Factors that account for the success of the IT sector in India:

Over the last five or six years, the industry has grown at over 50% per year over the last
five years. Analysts have concluded that if this trend persists, software exports may
account for a full quarter of Indian exports within the next five years. This paradox of
India’s success in a technology service industry when the economy itself is
technologically backward often leads to debates and also raises hope for other backward
economies for an encore. The big question is ‘what are these factors that influence
success ’. To answer this question, it is imperative to look at the evolution and salient
facts of the software industry.

The success of the Indian software industry can be attributed to factors on both the
demand and supply sides (Krishnan, Gupta and Matta, 2003). In the 90’s, large
corporations were under tremendous pressure to reduce their costs and yet exploit the
potential benefits of advances in information technology. These corporations moved
towards activities that concentrated on areas of their core competence and started
outsourcing other activities. Indian software companies built on a strong human
resource base to create organizational processes to quickly absorb new technologies and
ramp-up internal delivery capabilities in a short time to meet customer requirements and
at the same time ensure on-time delivery at an acceptable level of quality. Using cost
arbitrage as an entry strategy in an emerging business, they opportunistically expanded
their business, at the same time building more sophisticated organizational capabilities
within (Athreye, 2002). Another reason for Indian software companies to use their
reduced cost advantage is because of the large pool of talent available. This talent pool is
developed due to the large presence of technical institutions in the country.

The phenomenal success and growth of the Indian software industry is quite
extraordinary if one considers that India is still a very poor country where more than a
third of the population cannot read or write and infrastructure investment (generally and
in IT) is poor. Heeks (1996) argues that the Indian so ftware industry’s success has been

36
due to the wage advantage enjoyed by software programmers, as they are key to
understanding Indian exports.

Software Export as a percentage of India’s Total Export

Source: NASSCOM

The large exports from India can be explained by reduced software wage costs. With the
personal PC revolution in Europe and America receiving a boost, demand for software
services in India increased. In their capacity, the government also encouraged MNC’s to
set up operations in Special Economic Zones which were give tax breaks.

4.4 Consolidation, mergers and acquisitions in the Indian IT industry

Mergers and Acquisitions (M&As) have been a prominent trend in the advanced
capitalist countries since the late nineteenth century. However, it has gained importance
in developing countries in recent times. The total number of M&A’s increased about
three- fold in the last decade. Business consolidation by large industrial houses,
consolidation of business by multinationals operating in India, increasing competition
amongst domestic companies and competition against imports have all combined to spur
mergers and acquisitions activities in India. This increase suggests that the new economic
environme nt of the nineties has facilitated M&As. Mergers of firms belonging to the
same business groups operating in similar product-lines appeared to dominate the
Merger-wave in India.(Beena, 2004)

37
 Although Indian firms have traditionally used organic growth as a business strategy,
inorganic growth through acquisition of other firms was being flagged as a possible strategy,
though very few acquisitions were actually made in the early part of the last decade.
(Athreye, 2003). This development was greatly facilitated by the financial liberalization set
in motion in 1991. In the latter part of the last century, many businesses started to be getting
noticed in the global market and this was facilitated by listing the companies on overseas
markets which added an important element of visibility and credibility in the technical
services business. In turn the availability of various stock exchanges to list on drew venture
capital financed funding and encouraged M&A activity.

The ‘Big Five’ IT companies in India were aware of these developments and almost
all of them set up corporate venturing funds, possibly to enable them to scope the potential of
these activities. They realized that M&A would be the way to go to realize manufacturing
capability on a large scale, which India lacks, and so a new dimension to the industry has
been the exploration of possibilities through M&A. This trend also shows that the software
firms are confident in managing large global corporations and are willing to risk large
investments to corner a new niche should one become visible. (Athreye, 2003)

38
 5.0 ‘INFOSYS’: The Case of an ‘ORGANIC’ Company

5.1 Introduction:

Infosys, one of India’s leading information technology (“I.T.”) services

companies, is also one of the fastest growing firms in the country. The company’s sales
rose from less than Rs.1.16 million in 1981 to Rs 19 billion in 2001( Annual report
2001). Today, Infosys is the third largest company in India, with a market capitalization
of more than $21 billion. Based in the emerging information technology (IT) centre of
Bangalore; Infosys in 1999 became the first Indian company to be listed on the Nasdaq
and the first to benchmark its organizational practices to global standards. Thus being the
first company to successfully take Indian entrepreneurship to a global level. Today the
company has an annual growth rate of about 70%, revenues of 2.152 Billion USD and
had a net income of 555 Million USD (Annual report 2005).
The company boasts of seventeen state-of-the-art software development facilities
throughout India and one development centre in Canada. Infosys uses an extensive non-
U.S. based (off-shore) infrastructure to provide managed software solutions to clients
worldwide. The state-of-the art facilities enable it to provide quality, cost-effective
services to clients in a resource-constrained environment. The software services offered
by the company include application development (on a fixed-time and fixed- fee basis), E-
Commerce and Internet consulting; software maintenance .The rise of this IT Company is
primarily through organic growth.

However, one could easily dismiss Infosys’s story as that of just another Information
Technology services company in a developing country that was fortunate enough to
exploit the Y2K opportunity at the turn of the century. However, Infosys’s story suggests
that there is much more than serendipity at play here. It is the story of an enterprise that
has systematically built up a most modern, scalable enterprise for harnessing intellectual
capital in the new information economy (www.Infosys.com)

39
5.2 A Brief history of Infosys:

Infosys was founded in 1981, when seven professionals led by Mr. Narayan Murthy,
currently the chairman and chief mentor, collectively invested $1000.The company was
formed with the goal of achieving sweat equity and creating wealth legally and ethically
in India .This was a daunting task, as at the time the Indian government was more
concerned about redistributing wealth rather than creating it. Infosys’s competitive
advantage has historically been derived from low wage costs in India relative to service
providers in the United States. Their Initial foray into the U.S. market was through a
company called Data Basic Corp. as a “body-shop” or on-site developer of software for
US customers (Raghuram, 2003). In the year 1987, Infosys formed a joint venture with
Kurt Salmon Associates to handle marketing activities in the United States. These initial
entries into the US market proved to be a stepping stone for Infosys growth in the years
to come. The years 1981 to 1991 proved to be difficult ones for Infosys which aimed to
create large-scale software factories using contemporary technology, methodology and
software tools. This was because before deregulation in 1991, an array of tariff and non-
tariff barriers made it exceedingly difficult for companies to import computers and other
electronic equipment. Further the inability to scale-up operations because capital, labor
and product markets remained under developed was another problem faced by them. In
addition, the premium at which one could value shares in an IPO was decided by a
government officer rather than the market. As a result these values were always low,
which meant that equity was not a viable option for financing, and debt was the only
option that was left. In 1991, partly from pressures from the IMF and shrinking currency
reserves, the Indian government began liberalizing the economy. This led to the
abolishment of duty on all imports brought in for export purposes and foreign
investments were allowed. The office through which the IPO was valued was abolished.
These changes brought about many new opportunities for Infosys. In 1993,
Infosys went public on the Indian stock exchange with a market capitalization of $10
million. In 1999 Infosys was listed on the NASDAQ with a market capitalization of $ 10
billion.

40
5.3 Building a ‘scalable Organization’

What most distinguishes Infosys from other companies in the same industry is the way
that it has systematically built up a post- modern, scalable enterprise for harnessing
intellectual capital in the new information economy (Garud et al 2003). Nandan Nilekani,
Infosys s CEO and managing director, uses the term “scalability” to refer to Infosys s
ability to grow from past experiences even while maintaining the integrity of operations.
In a broader sense, scalability means Infosys can simultaneously increase revenues and
profitability while growing across cultural value systems and value chains. This
scalability is built into the company’ s DNA, and it pervades the way the company
develops software, mentors employees, formulates strategy, and governs itself. Further,
this scalability has allowed Infosys to evolve continually. Scalability is a particularly
important concept for IT enterprises.

The management at Infosys attributes their success to a business model which rests on
four pillars- Predictability, Sustainability, Profitability and De-risking(PSPD in
short). It appears to be second nature for Infoscions to offer a “model” in response to
queries pertaining to their strategy. Whether it is “global delivery” or “customer
relationship”, Infoscions have models that encapsulate past experiences for future use.
These models act as frameworks “of” Infoscions experiences that serve as frameworks
“for” realizing their aspirations (www.Infosys.com). To quote Mr Nandan Nilekani, CEO
of Infosys “PSPD models are used to predict the revenues of the company for a period
ranging from 4-12 quarters. Based on the predictability of this model, certain revenue is
assured which in turn ensures that the company is able to manage the growth that is
expected of them. The model aims to achieve a revenue stream which is sustainable and
does not die down in a few months and needs to be replaced by some other revenue
stream. Derisking means that one should not become overly dependent on one
technology, one particular business or one kind of service offering”

The four strategic goals encapsulated in the PSPD model are, in turn, accomplished
through a set of sub- models and guiding principles. For instance, the Relationship model
plays an important role in ensuring predictability and sustainability of revenues. This

41
model emphasizes the creation of long-term relationships with each client. The model
plays an important part in the company’s business strategy as almost 85% of their
business is generated from repeat customers. Infosys’s competitive advantage has
historically been derived from low wages costs in India relative to service providers in
the United States and Europe. To meet this end they follow the Global Delivery model.
The logic underlying this model is to shift a major portion of project execution from
costly “on-site” client locations to relatively cheaper “off-shore” locations in India. In
addition to reducing costs of operation of Infosys, the model also allows Infosys to
leverage the time difference between India and its major markets in US and Europe,
thereby reducing project execution time (Kumaraswamy et al, .2003)
As a knowledge- intensive co mpany, Infosys recognizes the value of its human assets in
maintaining and increasing its competitive position. They believe that its continued
success is attributable to the highly skilled and talented IT professionals it employs .
Infosys heavily invests in its programs to recruit, train and retain qualified employees
(refer appendix 1).
Moreover, the company has become the first Indian organization to place a value on its
human resources capital and brand equity in its balance sheet, stressing the importance it
places on these intangibles. To quote Mr Narayan Murthy, chairman of Infosys “while
the value of our Human Resources for fiscal year ’97 is placed at Rs 2,785.6, brand value
is pegged at Rs 1728.3 million. Cumulatively the value of intangibles is Rs 4,513.8
million, which is four times the value of our intangible assets”. The rationale behind this
is based on the company’s belief that intangible assets provide a tool to their investors for
valuing the market-worthiness of the company (Raghuram.S, 2001). “There aren't many
companies growing like this," says Infosys CEO Nandan Nilekani, who helped found the
company 25 years ago. "Companies haven't been investing enough in people. Rather than
train them, they let them go. Our people are our capital. The more we invest in them, the
more they can be effective."(Fortune New York: Mar 20, 2006.Vol.153, p. 41).

42
 Key Drivers Key Dimensions

Organic Inorganic Increasing Large No. of

Growth Growth No. of projects
Employees
Broader
Service
Diverse
Portfolio
Growth Employees
Acquisitions
Customers &
– Increased Investments
No., Size
and Infrastructure
Diversity Requirements
Key Implications

Opportunities Threats

Leveraging Bureaucracy
Visibility
Loss of
agility K ey Challenges
Leveraging
Capabilities Organizational
Expectations response
Scaling Up Alignment
Employee
Ensuring Excellence
Morale

Key Growth Aspects of Infosys

Source: www.infosys.com

At its core, Infosys thrives on its ability to connect clients problems that lie distributed
across the globe with software solutions created in India. Value creation occurs as
software services are offered where they generate maximum revenues whereas
capabilities are deployed where they are most cost effective (www.infosys.com) .The
Company maintains a high track record for delivering high quality solutions across the
entire software cycle. This coupled with their strong domain expertise help maintain good
relationships with their existing customers. As a result of the long history of client
retention, the company derives a significant proportion of its revenues from repeat
clients. Approximately 28.9% and 35.0% of their revenues from their top 100 clients
during fiscal 2006 and 2005 have been contributed by entities that have been the
company’s clients since fiscal 1998.

The different aspects of Infosys – growth, employee involvement, entrepreneurship,

governance – have all served to create and build a unique ambience about Infosys as a
company with a difference.

43
5.4 A Study of Inorganic Companies

According to analysts with the computer industry, commoditizing and consolidating very
fast, mergers had become inevitable in the global market. The case was no different in the
Indian market. The period after 2000 saw a spate of mergers taking place. This was
mainly due to dwindling profits and the industry slowdown that occurred due to the
internet bubble. A few significant mergers undertaken by the top 5 Indian IT companies
are given below.

5.4.1. Polaris merger with OrbiTech:

Polaris Software Lab Ltd is one of India's leading institutions contributing to the
knowledge economy of the global financial services marketplace. Headquartered in
Chennai (India), Polaris has established its solutions and services globally and has
contributed to the realization of the business visio n of some of the world's leading giants
in the Banking, Financial Services and Insurance (BFSI) vertical. Polaris ranks 9th in
NASSCOM’s top 20 exporters list for 2004-2005. Besides being recognized by the
Smithsonian Institute in 1993 for creating the first banking solution on a distributed
architecture, Polaris also has the distinction of being the world's first CMMI (Capability
Maturity Model Integrated) Level 5 Certified Company (www.polaris.com). Polaris
provides high quality products and customized information technology (IT) solutions to
several multinational clients and spans over ten countries of the world. Their business can
broadly be divided into software development, migration and re-engineering services,
maintenance, product enhancement and enterprise resource planning (ERP) solutions.
Initially the company started off by developing an end-to-end retail banking solution for
Citibank India. From there the company established many wholly owned subsidiaries in
places like Singapore, New Jersey and the first overseas development centre for Citibank
in Los Angeles. By early 2000, Polaris had bagged orders from several prestigious clients
including NEC Sony; this enabled the company to reduce its dependence on a single
client (namely Citigroup). By the year 2000 the company had revenues crossing the Rs 2
billion mark.

44
OrbiTech:

Established in 1985, OrbiTech is a SEI CMM level 5 company that serves as a

development centre for all Citigroup entities. The company was formed by the merger
between Citicorp Overseas Software Ltd a 100% Citigroup unit and a Global Support
undertaking, the technology department of Citibank India. Initially, the company catered
solely to Citigroup’s businesses providing products and services. OrbiTech’s competence
lies in its ability to provide project management and software development services with
a high level of customer satisfaction.

The Merger:

On May 22, 2002, Polaris Software Labs announced its merger with Orbitech Solutions
(Orbitech). This proved to be one of the la rgest mergers in the software industry in the
Asia-Pacific region. The combined value of the merged firm exceeded Rs 27 billion. It
was also one of the biggest acquisitions in terms of Intellectual Property Rights. It was
estimated that the merged entity would have 3,800 employees and combined revenue of
over Rs 6 billion.
The merger was expected to result in significant operational synergies, with significant
cost savings through streamlining of infrastructure and rationalization of vendors. The
merged company would continue to be known as Polaris. Under the terms of the merger,
the shareholders of OrbiTech were to receive 14 newly issued equity shares of Polaris
(face value of Rs 5) each for every 25 OrbiTech shares (face value of Rs 2) held by them.
The valuation favoured Polaris shareholders. The total enhanced share capital of the
merged entity was estimated to be approximately 97 million shares.

Benefits of the merger:

Analysts felt that the merged entity was better positioned to capitalize on new
opportunities by acquiring new customers and enhancing existing relationships. The
merger provided Orbitech with a better platform to deliver its products in the market; it
gave the company access to 96 new clients and operational geographies, access to a
strong sales and distribution network, and exposures to areas other than banking. Polaris

45
on the other hand benefited from the access it got to 57 IPRs of OrbiTech corresponding
to 10 product lines. Each product line had an estimated potential of building a $ 20
million business over a five year period. In 2002-03, the merged entity’s assets stood at
Rs 1330 million. It had invested Rs 633.8 million towards capital expenditure mainly in
creating off shore development facilities. The revenues of Polaris for the nine months
ended December 31, 2003, stood at Rs 581.39 crores in comparison to Rs 401.74 crores
during the corresponding period the previous year. The profits for the same period stood
at Rs 67.70 crores in comparison to Rs 54.23 crores. In addition, the company’s stock
price touched a high of Rs 257.55 in 2003.

Organic Vs Inorganic Growth:

Year
Infosys
Polaris Consolidated
Growth growth
April Stand with Growth%
% (stand
to alone OrbiTech
alone)
March

Revenue(in
2005-06 689.95 .58 833.41 4.12 32
Rs crore)
2004-05 685.11 17.84 800.43 25 44
2003-04 581.39 44.72 640.35 48.55 31
2002-03 401.74 41.49 431.06 46.72 39
2001-02 283.94 N.A 293.80 N.A.

PAT 2005-06 61.65 -75.11 22.02 -65 27

2004-05 53.43 -21.08 62.92 -12.85 53
2003-04 67.70 24.84 72.20 18.28 30
2002-03 54.23 -12.03 60.94 3.62 18
2001-02 61.65 N.A. 58.86 N.A N.A

Table 1
5.4.2 Wipro merger with Spectramind:

46
Wipro:
Wipro Technologies, the Global IT Services division of Wipro Limited is an India based
global IT services, IT solutions and technology services center. Established in 1980 the
company has more 30 offices worldwide with 50,100 employees and over 300 customers
across USA, Europe and Japan including 50 of the Fortune 500 companies. Some of its
noteworthy customers are Boeing, Cisco, IBM, prudential etc to name a few. In1997,
Wipro received the CMM level 3 certification from the Software Engineering Institute. In
addition, in 1998, Wipro Technologies became the world's first CMMI level 5 certified
soft ware services company. Continuing this trend, in 2001, Wipro became the world's
first PCMMI level 5 certified. In November 2002, it was ranked among the top 10
software services companies in the world by Business Week. As of 2004, it was the 4th
largest company in the world in terms of market capitalization in IT services. With
revenues in excess of US $2 billion, Wipro is one of India's major companies.

Spectra mind:
Spectra mind is an IT consulting firm located in Hyderabad (India), specializing in
Software Quality Assurance and Testing for small, medium and large software
development projects. The company was incorporated in the year 1994, with a view to
bridge the gap between industry requirements and the curriculum of educational
institutions and to meet the ever-increasing demands for quality professionals. The main
services provided by the company are consulting, implementation, business
transformation and operational solutions for clients managing the business and
technology complexities of the digital economy.

47
The merger:

In July 2002, the Wipro Technologies acquired controlling equity interest in Spectramind
eServices Private Limited, a leading IT-enabled service provider in India providing
remote processing services to large global corporations in the US, UK, Australia and
other developed markets. The aggregate purchase price for the acquisition, including the
cost of acquisition of the shares previously held by the Company, was $102 million.

Benefits of the merger:

Wipro-Spectramind has emerged as the industry’s pinup boy for success story
(www.voicendata.com). Spectramind’s valuation of $ 131 million at the time of its
acquisition by Wipro put the limping BPO industry back on the funding track. Coming
within the Wipro fold meant two benefits for Spectramind- an ability to scale the business
sustainably because of Wipro’s deep pockets and customer traction. The effects of the
merger have been felt by Wipro as well. By merging with Spectramind it has been able to
make an entry into the BPO business. Clubbed with the vast IT experience of two
decades and a diverse domain expertise, Wipro-Spectramind is well equipped to serve
customers worldwide. By integrating the 2700 member team of Spectramind, post
acquisition, the team has grown to 5100 in all. In addition from just eight clients before
the acquisition, Wipro-Spectramind doubled the client base to 15 clients while only
marginally increasing its marketing costs. The company has also showed strong fina ncial
performance during the year 2002-03 registering profits of $ 9 million for the first time.

48
 Organic Vs Inorganic Growth:

Year
Infosys
Wipro Consolidated
Growth growth
Stand with Growth%
April % (stand
alone Spectramind
to March alone)

Revenue(in
2005-06 10403.74 41.82 10756.47 30.30 32
Rs crore)
2004-05 7335.98 39.16 8255.03 38.24 44
2003-04 5271.46 28.16 5971.62 35.58 31
2002-01 4113.10 15.61 4404.75 22.48 39
2001-02 3557.63 N.A 3596.33 N.A N.A

PAT 2005-06 2020.48 35.17 2067.40 26.95 27

2004-05 1494.82 63.39 1628.53 58.17 53
2003-04 914.88 12.50 1029.20 16.65 30
2002-01 813.23 -6.12 882.30 -.36 18
2001-02 866.11 N.A 885.45 N.A N.A

Table 2

5.4.3 HCL Tech- DSL Software Merger:

HCL Tech:
The youngest of India's "Big 5” IT service companies, HCL Technologies has over
the last decade slid into the global business agenda with its offering of software led IT
solutions, remote infrastructure management services and business process outsourcing.
Having made a foray into the global IT landscape in 1999 after its IPO, HCL Technologies
focuses on, technology and R&D outsourcing, working with clients in areas that impact and
re-define the core of their business. Partnerships and risk-sharing have been integral to
company's growth. The company leverages an extensive global offshore infrastructure and
its global network of offices in 16 countries to deliver solutions across select verticals

49
including Financial Services, Retail & Consumer, Life Sciences, Aerospace etc. Product
Engineering and Technology services along with Applications & Enterprise Consulting
services contribute equally to the revenues. HCL also has a rapidly diversifying geographic
mix with Europe and Rest of the World yielding 25% and 15% revenue, respectively.
North America revenues continue to dominate with a share of about 60%.
For the twelve month period ended 30th June 2005, HCL Technologies along with its
subsidiaries had revenues of $764 million and employed 24,000 professionals

DSL Software:
DSL Software is a Joint Venture between India's leading IT Company, HCL Technologies
and Deutsche Bank AG, with HCL Technologies holding 51% equity. About a decade old,
DSL Software Limited was established in April 1992 as a wholly owned subsidiary of the
Deutsche Bank Group and is headquartered in Bangalore, India. Over years, the company
has grown into a strong banking and financial services focused IT Services Company with
more than 450 software and banking professionals based out of Bangalore, Singapore,
Frankfurt, New York and London. DSL Software offers end-to-end solutions in application
and development. The company also brings together in-depth business knowledge in areas
including trade finance, custodial services, private banking, asset management and
electronic banking with IT skills to deliver high quality and cost effective services

The merger: In October 2001, HCLT acquired a 51 per cent stake in the holding company
of Deutsche Software Limited, Deutsche Bank’s IT services subsidiary in India, for US $
25 million along with management control. The merger will reinforce HCLT’s presence in
the global financial services segment, one of the largest end-user markets for IT services
globally. DSL services Deutsche Ba nk’s IT requirements in Frankfurt, London, Singapore
and New York through a 500-person IT software services operation in Bangalore

50
Organic Vs Inorganic Growth:

Year
Infosys
HCL Consolidated
Growth growth
Stand with DSL Growth%
July % (stand
alone SOFTWARE
to June alone)

Revenue(in
2005-06 1530.03 20.03 34171.23 14.18 32
Rs crore)
2004-05 1274.74 30.14 3040.20 34.90 44
2003-04 979.51 14.36 2253.59 29.64 31
2003-02 856.55 2.88 1738.40 21.33 39
2001-02 832.56 N.A 1432.80 N.A N.A

PAT 2005-06 329.27 1.09 618.72 -9.84 27

2004-05 325.72 4.24 686.23 133.16 53
2003-04 312.47 -22.61 294.32 -12.20 30
2003-02 401.95 -5.82 335.20 -27.04 18
2001-02 426.78 N.A 459.45 N.A N.A

Table 3

5.4.4 TCS (Tata Consultancy Service) merger with CMC:

TCS:
Tata Consultancy Services (TCS) is a leading global IT services provider and was the first
billion-dollar Indian IT services organization by annual revenues. Since its inception in
1968, TCS has pioneered many of the significant developments in the Indian IT services
industry, including the offshore delivery model for IT services. TCS is a division of Tata
Sons; the holding company of US$13 billion Tata group, one of India’s best known and
most respected business conglomerates. TCS is a global organization with offices in 32
countries and development centers in 10 countries. Their service offerings span a range of
activities, from strategy consulting and system integration services to off shore
development centres for some of the most sophisticated software development in the world
covering many different industries such as finance, banking insurance, telecommunications

51
etc. TCS’s clients comprise of some of the world’s largest and well-known organizations.
TCS has developed extensive experience in providing end-to-end IT services, integrating
multiple technologies and delivering solutions in multiple geographies for its global clients.
It is the largest Indian IT services organization in terms of revenues as well as profits. TCS
reported co nsolidated revenues of $2.97 billion (U.S.) in the fiscal year 2005-2006.

CMC (Computer Maintenance Corporation): CMC was incorporated on

December 26, 1975, as the 'Computer Maintenance Corporation Private Limited'. The
Government of India he ld 100 per cent of the equity share capital. On August 19, 1977, it
was converted into a public limited company. In 1978, when IBM wound up its operations
in India, CMC took over the maintenance of IBM installations at over 800 locations around
India and, subsequently, maintenance of computers supplied by other foreign
manufacturers as well. Taking over the activities of IBM in India, including many of its
employees, helped the company to imbibe a service-oriented culture. This is demonstrated
by their long-standing customer associations and ability to provide high-quality and reliable
service. In 1992, the Indian government divested 16.69 per cent of CMC's equity to the
General Insurance Corporation of India and its subsidiaries who, in turn, sold part of their
stake to the public in 1996. In 1993, CMC's shares were listed on the Hyderabad Stock
Exchange and the Bombay Stock Exchange (BSE).

The merger:
In October 2001, TCS acquired a majority stake (51%) in the previously government-
owned CMC Limited, the public sector infotech and software education company, at Rs
196.73. The Tata’s later picked up an additional 16.69 per cent through an open offer at Rs
281.26. After Tatas took charge of CMC post-privatization in October, profit and growth
are the new id ioms among top management. Post the acquisition, the company posted a 400
per cent jump in y-o-y profits for the quarter ended December 2001 and expected to post a
near 100 per cent jump in profits for the full year. CMC has built an unrivalled reputation
for itself in India by building built state-of-the-art IT solutions for railway reservation, BSE
and insurance companies, years before IT honchos became household names. It now plans
to leverage that advantage in the international market with backing from TCS. Form TCS's

52
standpoint, the take-over of CMC has been for strategic reasons. CMC has a significant
market share in India in software development. Besides, TCS has little exposure in domain
knowledge areas in railways, ports, pore utilities, oil and gas. On the other hand, CMC has
a large and comprehensive high quality exposure in these areas. CMC has domestic sales of
Rs 442 crore, which is about 85 per cent of its total revenues. (For TCS, the figure is a low
10 per cent). In addition, CMC brings to the table its expertise in infrastructure
development, its domestic orientation and its presence in specialized areas of education and
training

Organic Vs Inorganic Growth:

Year
Infosys
TCS
Growth Consolidated growth
Stand Growth%
April % with CMC (stand
alone
to March alone)

Revenue(in
2005-06 11302.59 38.74 13386.23 36.26 32
Rs Crore)
2004-05 8146.33 N.A 9824.36 228373.49 44
2003-04 N.A* N.A 4.30 N.A 31
2002-03 5012.38 N.A N.A N.A 39
2001-02 4171.38 20.16 N.A N.A N.A

PAT 2005-06 2974.25 51.39 2967.21 33.20 27

2004-05 1964.64 12163.67 2227.58 127921.82 53
2003-04 16.02 1330.36 1.74 N.A 30
2002-03 1.12 N.A N.A N.A 18
2001-02 N.A N.A N.A N.A N.A
*TCS was originally a division of Tata Sons, a holding company of the Tata Group. In the year 2003-04 it
became a separate company with CMC Ltd as its subsidiary.

Table 4

53
5.4.5 Satyam Computer Services Ltd:

Established in 1987 as a Software Service Provider, Satyam Computer Services Ltd is

among the top five software development companies in India. The company offers a wide
array of solutions customized for a range of key verticals and horizontals. Satyam, an SEI
CMM level 5 company, has over 30,000 dedicated and highly skilled IT professionals
across development centers in India, US, UK etc just to name a few. The company’s
primary activities are to provide information technology services and software
development products. The range of services include consulting systems design, software
development etc. The company provides services to customers from a number of industries,
including manufacturing, banking and financial services, insurance, telecommunications,
healthcare. Satyam has a track record of partnerships that is longer than any other similar
company based in India (www.Satyam.com).Acquisitions: August 2000 IndiaPlaza.com;
May 2002 NetKracker

Organic Vs Inorganic

Year
Infosys
Satyam
Growth growth
Stand Consolidated Growth%
April to % (stand
alone
March alone)

Revenue(in
2005-06 5014.48 40.60 5125.84 42.08 32
Rs crore)
2004-05 3566.64 35.54 3607.67 36.88 44
2003-04 2654.94 -10.77 2635.56 16.54 31
2002-03 2075.38 64.96 2261.54 10.03 39
2001-02 1803.72 N.A 2055.32 N.A N.A

PAT 2005-06 1239.75 65.24 1149.06 59.35 27

2004-05 750.26 34.99 721.09 37 53
2003-04 555.79 80.80 526.31 37.76 30
2002-03 307.42 -31.60 382.06 386.70 18
2001-02 449.38 N.A 78.50 N.A N.A
Table 5

54
Chapter 6.0: Analysis of growth performance (Accounting Studies):

Even though the management of different firms justifies their decisions to adopt a
particular business strategy, the outcome that comes from implementing them may vary.
This section looks at some of the key indicators of performance that can help us decide
whether a particular business strategy was the right choice or not. In the period under
review, the merged firm’s performance is compared against the organic firm’s
performance. Researchers have used accounting studies to measure the relative
performances of both types of companies. In an important study done by Meeks (1977),
financial indicators such as revenue growth, Return on Assets (ROA), Return on Equity
(ROE) e.t.c are used to measure performance of the firms under review. Some of these
measures are calculated in the following section to conclude whether a particular business
strategy is better or not.

Sales Growth and Other Key Indicators: Perhaps, the best indicator to gauge
whether a company has grown is its revenue from sales. This is the most traditional of all
of the growth indicators which is still being (extensively) used by fundamental analysts to
study companies. The investors (owners) of the company are also interested in the sales
figure as this is the main source of reve nue from which shareholders could expect to be
paid dividends. Prospective investors may also be interested in the revenue factor as it is
often a good indicator of the company’s financial health. In an effort to study the growth of
companies as merged firms and individual companies, I have studied the five year
performance of the companies, once they have made an acquisition to their previous
performance as well as with that of the organic company. In the case of HCL Tech it can be
seen that the Inorganic growth strategy of HCL Technologies helps the company to grow at
a faster rate than as a standalone. The Organic growth rate for the company was 2.8%
whereas the inorganic growth of the company was 21.3%. Comparing the figures of Infosys
as a standalone, it can be seen from table 3 that the growth achieved by HCL Tech post the
acquisition is still less than the growth figures realized by Infosys as a stand alone. In the
case of Wipro LTD, the company has been able to successfully manage its acquisition
activity which is reflected from the better performance of Spectramind post acquisition. On

55
comparing the figures (refer table 2) it can be seen that again the Inorganic growth strategy
of Wipro LTD helps the company to grow at a faster rate than as a stand alone.

Earnings growth and revenue growth are retrospective in nature. When a comparison of the
rate of change in earnings are compared, the loss faced by the company in fiscal year
2003(-.35% as against -6.12%) is again minimized on account of the acquisition. However,
on comparing the figures with that of Infosys it can be seen that the total growth achieved
is less than that of Infosys (refer table 2). Compared to its peers TCS (refer table 4) and
Polaris (refer table 1) have outperformed the growth rate of Infosys (37%) in the Topline.
Polaris was able to turn around the growth rate (3.62% against -12.03%) in profit margin
within 5 months of its acquisition of OrbiTech. This is on account of the fact that the
company is much smaller than Infosys, with a much smaller base.

Marketing and Selling expenses as a %age of sales: Profitability ratios allow more
specific analysis of profit margin, for eg expressing individual expenses as a proportion of
sales or a cost of sales. These ratios help identify if there are any irregularities or changes
in specific expenses from year to year. While studying the balance sheets of Infosys, Wipro
and Polaris, the Marketing and selling expenses as a %age of sales show an increase in the
figures from 2002 to 2003. However HCL Tech unlike the peer group, their marketing and
selling expenses as a proportion of sales has come down from 18.1% in 2001 to 16.18% in
2002.

PE ratio:
One of the most publicized ratios for a public company is the price/earnings ratio or
PE ratio (Elliott and Elliott, 2006). The PE ratio is significant because by combining it with
a forecast of company earnings, analysts can decide whether the shares are currently over
or undervalued. Based on these results they can decide whether to buy the shares in a
particular company or not. The PE ratio of Infosys is found to be 32.43. As Infosys keeps
excess cash reserves and other marketable securities on the balance sheet, value is reduced.
The return on capital employed is much higher than the returns on cash, thereby bringing
down the overall values of the combined returns. This in turn translates to a low PE ratio
for Infosys. To maintain a high PE ratio in the market Infosys has to earn two times of its

56
cost of capital as returns on capital employed. Market is more likely to be more sensitive to
the company which is growing inorganically than an organically growing company. Any
positive contribution from the acquired companies to the Bottomline (inorganic growth) of
the parent company leads to positive response from the market. Wipro is a good example of
this, as their P/E ratios range from a low of 35.26 to 45.67 in the period under review.
Wipro has consistently been able to achieve a higher PE ratio than Infosys.

Cash flow from operation: “Cash flow” is one of the most vital elements in the
survival of a business. Cash flow from operations is the firm’s net cash flow resulting
directly from its regular operations, calculated as the sum of net income plus non-cash
expenses tha t were deducted in calculating net income. It shows the firm’s ability to
generate consistently positive cash flows from operations. From an analysis of the balance
sheet it was found that figures for cash flow from operation for all the companies decreased
following the acquisition. For Wipro, the cash flow from operation following the
acquisition stood at -91.53 (951.17 to 859.64). For HCL tech the cash flow from operating
activities stood at -2.6 (499.50(standalone) to 449.31(consolidated)), Polaris (71.04
(standalone) to 68.44(consolidated) (refer appendix 5, 6). A possible reason for this could
have been that the se acquisitions were undertaken for strategic purposes, which fitted well
into their present business. It can be concluded from an analysis of the above companies
that there is no certainty that cash flows increase following an acquisition.

Return on capital employed: Return on capital employed is an important ratio that

indicates the efficiency and profitability of a company’s capit al investments. The ratio can
also be seen as representing the efficiency with which capital is being utilized to generate
revenue. It is commonly used as a measure for comparing the performance between
companies and for assessing whether a company generates enough returns to pay for its
cost of capital. It can be seen that the growth in return on capital employed for Wipro
(25.37 as against 34.15) and HCL Tech (16.74 as against 23.21) has decreased following
the merger. On the other hand, Satyam Computers (17.38 as against 3.99) and Polaris
(11.85 as against 4.07) show positive figures following the acquisition. In the period under
consideration, an analysis of Infosys’s profit and loss account (refer appendix 12), it is
observed that Infosys has reasonably been able to maintain its return on capital employed.

57
6.1 Event Studies

Event studies are techniques of empirical financial research that enables analysts to assess
the impact of a particular event on a firm’s stock price (Bodie et al, p 381). The main
underlying assumption to such a study is the happening of an event. However, in my
research (Organic Vs Inorganic growth), the market model of calculating abnormal returns
cannot be used as there isn’t a particular event that has taken place for the Organic growth
Industry. Therefore, I have used Independent sample t- test to estimate whether the returns
from undertaking inorganic growth is any better than the returns from undertaking organic
growth.

Independent sample t-test

In the previous section, a study of the effect of Organic Vs Inorganic growth on firm
performance was undertaken by measuring key financial ratios and comparing relevant
tables. This section aims to study the returns from firms engaging in inorganic growth
strategies compared to those growing organically from the point of view of the shareholder.
In an attempt to study the returns from both sources the independent sample t-test method
has been used. The independent t-test is used when one wishes to compare the statistical
significance of a possible difference between the means of two groups on some
independent variable and the two groups are independent of one another. The groups are
considered independent if a member of one group cannot possibly be in the other group.

The first step involves the calculation of the returns across both groups (organic and
inorganic). Returns for this purpose has been defined as:

Rit = Pit-Pit -1
-------------- + D
Pit-1
Where:
Rit is the daily return for company i at the end of day t

58
Pit is the share price for company i at the end of day t
Pit-1 is the share price of company i at the end of day t-1
D is the dividend yield

Bruner (2002) defines returns as the change in share price and any dividends paid,
divided by the closing share price the day before. The independent sample t-test has been
used to determine if the two samples were statistically the same, if the results were found to
be dissimilar then to test to see which is a better alternative between the two. To undertake
the independent sample t-test the organic company has been taken as one variable and the
inorganic company representing the industry has been taken as the second variable. This
can be achieved by comparing the means, standard deviation from the mean and the
standard error.

Assumptions underlying the independent sample t-tests:

It is assumed that both samples come from normally distributed populations with
equal standard deviances (or variances).The distribution of the dependent variable for one
of the groups being compared must have the same variance as the distribution for the other
group being compared (equality of variance assumption).

F-test (Levene’s test):

The Leve ne’s test of “equality of variance” is used to determine if the two
populations in the sample are the same. This tells us if we have met our second assumption
given above (i.e. the two groups have approximately equal variance on the dependent
variable). If the Levene's Test is significant (the value under "Sig." is less than .05) (refer
appendix 15), and the two variances are significantly different. If it is not significant (Sig.
is greater than .05) (refer appendix 15), the two variances are not significantly different;
that is, the two variances are approximately equal. To measure the Levene’s test for
“equality of variance”, we define the null and alternate hypothesis as:

H0 : s 12=σ22 (null hypothesis)

59
H1 : s 12≠σ22(alternate hypothesis)

Where: s 12 is the variance of the first sample

σ 22 is the variance of the second sample

If the ‘sig’ value is less than 0.05, you reject the null hypothesis; on the other hand if it is
above 0.05 you do not reject the null hypothesis.

T-test: The t-test has been undertaken to evaluate the equality of means between the two
variables in our sample. The null and the alternative hypothesis for the t-test is as follows:

H1 : µ1 =µ2 (null hypothesis)

H1 : µ1≠µ2 (alternate hypothesis)

Where: µ1= is the mean of the first sample (inorganic growth)

µ2 = is the mean of the second variable (organic growth)

Plugging the values into the SPSS package we first try to find out if the variables satisfy the
“equal variance assumption”. The results from table 2 provided in appendix 2 shows the
significance value for the Levene’s test as 0.139 which is greater than 0.05. Hence in the
above case, we do not reject the null hypothesis which shows that the assumption of
heteroscedasticity has not been violated. From the given figure, we pick the test labeled
“equal variances assumed”.
To test the equality of means between the two variables (returns) in the sample we use the
t-test as explained above. From an analysis of the results, the value for significance was
found to be .625, which is again greater than 0.05, which shows that we cannot reject the
null hypothesis. Therefore, it can be concluded that the returns of the two groups are equal
based on the results of the t-test. These results are also consistent with those found by other
researchers like Tsakalotos(1997) and Aaronovitch(1975), which suggests that firm
performance has not been enhanced on account of the merger.

60
Chapter 7.0: Acquisition Strategies of Product development companies:

From the above analysis of the growth in revenue, net profit, cash flow from operation, and
ROCE of the companies in the software sector, I have found that there is no appreciable
difference between Infosys Tech Ltd which has grown organically and other companies
which ha ve during the period under review acquired other companies as a means to achieve
faster growth. Extending this study to another arm of the IT sector (namely product
development) I examine if a similar trend is observed i.e that there is no discernable
difference between Organic and inorganic growth. For this purpose I have chosen an Indian
company Subex Azure Ltd. Product development companies are few and far in between in
India and such companies operating in the telecom space is quite rare. So in order to make
an informed analysis of the performance of product development companies I have chosen
to study the performance of Subex Azure Ltd alongside Cisco, which operates in a similar
line.

7.1Subex Azure Ltd:

Subex Azure was founded in 1992 by entrepreneur Subash Menon. Initially the
company started off as a systems integrator in the areas of coverage for wireless networks
and test and measurement for voice and data. Gaining substantial domain expertise in the
telecom space over a span of six years and realizing the huge growth potential presented by
the Telecom Software applications business, the company entered this lucrative field in
1998. Subsequently it transitioned fully into a telecom software player by mid 2000. Subex
has a global presence across North America, Europe, Africa and Asia. Some of their
clientele include AmericaTel, T-mobile, Tiscally, and Vesper. Subex operates in the niche
area of telecom revenue maximization. RevMaxTM , the Revenue Maximization suite from
Subex includes RangerT M- a Fraud Management System and INcharge T M-a Revenue
Assurance Solution (www.subexgroup.com).

Acquisitions: The following are the acquisitions made by the company:

January 2001 - 4th Generation Inc, New Jersey, USA
May 2001 -Magardi, Inc Ottawa Canada
July 2004 - Fraud Management Activity of Alcatel in UK

61
August 2004 -Fraud Centurion from LightBridge US

7.2Cisco:

Past literature and common belief holds that the acquisition of high-technology firms in
rapidly evolving markets normally results in failure (Mayer et al, 2003). Cisco, however,
has successfully grown through the conscious and deliberate use of acquisitions of high-
technology firms to become a dominant global networking equipment provider. Most
business observers agree that t he major component in Cisco's phenomenal growth has been
their resolute commitment to expanding their product line through aggressive acquisitions .
From the time of its IPO, Cisco has not stopped growing. Since 1995, the "New Goliath,"
as Cisco is known throughout the business and finance communities, has acquired more
than sixty companies (Rifkin,1997).It has spent more than $18 billion acquiring nine
companies in 1998 and 14 in 1999, an average of more than one acquisition per quarter
over a five year period(DiGeorgio,2002). Since shipping its first product in 1986, the
company has grown into a global market leader that holds the No 1 or No 2 market share in
virtually every market segment in which it participates (Cisco annual report 2004)

The company was established with the aim of building and selling routers. Until 1993, the
company's fortunes were tied almost exclusively the router (Rifkin, 1997). In 1993, Cisco's
management team realized that the market was changing rapidly. With the advent of faster
and more intelligent "internetworking" devices like switches and hubs, and the growth of
the Internet and Intranets, Cisco needed expertise beyond its current capabilities.
Management realized that if they could not develop a particular technology quickly enough
in house, they would have to look outside to acquire the same or lose the opportunity
(Drexhage, 1998). Starting with the $89 million acquisition of Crescendo, a switch maker,
in 1993, Cisco has set a relentless pace for acquisitions

7.3 Analys is:

On analyzing the performance of Cisco over the last five years it can be seen that the
company has been able to achieve record performance over all of their operation metrics.

62
Cisco has demonstrated solid execution on its three long term financial priorities. For fiscal
year 2005 the company increased its revenue by 12.5 %( from 22 billion to 24.801 billion
in 2005). This increasing trend has been maintained from fiscal year 2004 onwards. Their
profitability has also grown steadily (refer appendix 11).From losses in fiscal year 2001,
the company was able to pick up and make a come back with profitability increasing by
almost 286.6% in fiscal year 2002-03. For fiscal year 2005 their profitability figures
increased by 15.5%. The return on capital employed for the year 2005 was 28.74% as
compared to the previous year’s figures of 50.67%. A key competitive advantage for Cisco
is how they are able to use their technology to drive productivity. In 2005 the company was
able to achieve a key metric by reaching their target productivity goal of $ 700,000 in
annualized revenue per employee which has gone up by approximately$250,000 as
compared $ 450,000 in fiscal year 2001 when the goal was set. In addition the head count
in fiscal year 2005 increased by 12%. Cash flows from operations were recorded at $ 7.6
billion compared to the previous year’s figure of $ 7.0 billion.
Subex Azure Ltd also showed similar performance patterns. Over the past five years the
company has been performing consistently with regards to their profitability, sales figures,
cash flows etc. For fiscal year 2005 their profitability grew by 46.49% to reach Rs 37.85
crores. Revenues increased from Rs 60.26 crores in fiscal year 2001-02 to Rs 184.33 crores
in the year 2005, a gain of almost 58 %( refer appendix 10, 14). The head count also has
shown a steady increase over the past five years. On an average the employee base of the
company has increased by 30% each year. The cash flow from operations for fiscal year
2005 increased by 45.95% as compared to the pervious year’s figure of just 4.65%.

63
Chapter 8: Conclusion:

Growth has become the new buzzword for all companies today. Every small company
seeks to become a medium-sized concern, and every medium-sized concern seeks to
become a large scale global corporation. Competition is brutal and expansion-either
internally or through the acquisition route has become the norm rather than the exception.
Over the course of this study, I have examined the methodologies as well as the pros and
cons of both the organic and inorganic routes of growth. I have also examined the
suitability of one method over the other in the context of the Indian IT Sector (software and
product development).

This has been achieved through both qualitative as well as quantitative studies. Qualitative
analysis has been carried out through large scale filtering of data obtained by means of
secondary methods of data collection. Qualitative research was embarked upon in this
dissertation by carrying out a case study of one organic company in the Indian I.T. sector,
namely Infosys, and subsequently comparing it with other inorganic companies in the same
sector, to find out if any significant gains were achieved as a result of the merger.
Quantitative studies have been undertaken as well through analysis of impact of mergers
and acquisitions, i.e. inorganic growth, as well as organic growth, on the firm's financial
performance. These studies have been facilitated through both accounting studies as well as
an independent sample t-test (to calculate returns).

The results of these tests have been analyzed from two perspectives: from the point of view
of the firm and from the point of view of the shareholders. From the firm's perspective the
results from accounting studies establishes tha t there are no significant gains as measured
by profitability or revenue following the merger and acquisition. In fact, the inorganic
company performed on par or in some cases even worse, than the organically growing
company.

From the point of view of the shareholders also it was found that the returns to the
shareholders from the inorganic company were equal to those from the organic company,
implying that there was no significant increase in the post merger period. These results

64
confirm or validate earlier research conducted in this regard. Aaronovitch et al (1975),
Hogarty (1970) find that there is no possible trade off between one form over the other.
Thus, this dissertation is in line with previously gathered empirical evidence.

Finally, my conclusion is that organic and inorganic growth strategies cannot be considered
as substitutes for one another. They are, rather, complementary (Weston, 1999). Internal
growth and mergers are not mutually exclusive activities. In actual fact they are mutually
supportive and reinforcing. Growing, successful firms use many forms of M&A's and
restructuring/organic growth based on opportunities and limitations. For example when
Organically growing firms reach a saturation point in growth, in order to sustain the growth
momentum they go in for Inorganic growth.
The characteristics and competitive structure of an industry also influence the strategies
employed. In the case of the IT sector, people are the main assets. The whole rationale
behind the IT success story lies in its skilled workforce. In such a situation, mergers and
acquisitions would throw up massive problems of integration as there are a large number of
personnel involved. Different management philosophies would be harder to assimilate.
Cultural incompatibility could be a reason for the average performance of IT companies in
the post merger period. However, within the IT space itself, product development
companies like Subex Azure Ltd and technologically enabled companies like Cisco
Systems as analyzed in the previous chapter have been successfully growing by acquiring
other companies. This is largely attributed to the fact that in these companies with a high
level of technological infrastructure, the number of people involved is relatively fewer and
as such these companies face integration problems on a far lower scale as compared to the
software development companies. Another example of an industry whose structure and
processes support the adoption of an inorganic growth strategy is the steel industry. This
industry is mainly capital intensive and as such faces integration problems on a far lower
scale. The pros in this case outweigh the cons.
Hence, through our studies it is evident that the characteristics and competitive structure of
an industry influence the choice between organic and inorganic growth.

65
Chapter 9: Limitations of the Study:

In an attempt to realize the research objective, a mix of research methods has been
employed. However, as is the case with any empirical study, there are certain limitations
associated with it. One of the main limitations of this study is that empirical evidence on
organic growth as a business strategy in comparison with inorganic growth is limited. As a
result there is no set pattern for measuring the performances. This in turn, provides
problems to compare the accuracy of the study as there aren’t any benchmarks to compare
with.

The quantitative method that has been used as part of the methodology is different from
previous empirical studies. Usually researchers undertake the event study method to
calculate the abnormal returns accruing to shareholders following the merger
announcement. However, in this study it was not possible to do that as there was no ‘event’
in the case of the Organic Company. Instead the independent sample t-test was calculated
to see if there were any differences in the returns across the two groups (Organic and
Inorganic). The information with regards to the merged/acquired (Inorganic) company and
the Organic Company was found manually through the World Wide Web (Company
websites). Thus a possibility of occurrence of human error is unavoidable.

Finally, a drawback of accounting based performance evaluation criterion in order to

measure the impact of Organic and Inorganic (M&A’s) on the profitability of the company
is that companies can use a number of techniques to make their balance sheet look strong,
optimistic and attractive to shareholders. As a result of this the published accounts may not
be a genuine account of the companies’ true financial position.

Various researchers have also criticised the use of ratio analysis to evaluate the
performance of the company. There are also attributes about an organization such as
reputation, intellectual capital, leadership that cannot be quantified in numerical terms.

66
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 APPENDICES

APPENDIX 1
Infosys Revenue (Rs in Crore)

REVENUE

2001-02 2670

2002-03 3728.55

2003-04 4888.28 REVENUE

2004-05 7032

2005-06 9255

APPENDIX 2
Infosys He adcount

NO OF EMPLOYEES

40000
35000
30000
25000
20000 NO OF EMPLOYEES

15000
10000
5000
0
05-'06 04-'05 03-'04 02-'03 01-'02

73
APPENDIX 3

YEAR NO OF EMPLOYEES GROWTH %

2001-02 9831 82
2002-03 10378 9
2003-04 15876 48
2004-05 25634 61
2005-06 36750 43

Revenue per Employee:

Revenue per
Year Revenue No of employees
employee
2001-02 2670 9831 0.27
2002-03 3728.55 10378 0.36
2003-04 4888.28 15876 0.31
2004-05 7032 25634 0.27
2005-06 9255 36750 0.25

APPENDIX 4
Infosys Technologies Ltd.

Profit & Loss – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 9255.00 7032.00 4888.28 3728.55 2670.00

Expenditure 6109.00 4534.00 3186.16 2379.92 1565.25
Operating Profit 3146.00 2498.00 1702.12 1348.63 1104.75
Interest 1.00 1.00 0.75 0.75 0.71
Gross Profit 3145.00 2497.00 1701.37 1347.88 1104.04
Depreciation 409.00 268.00 230.90 188.95 160.65
Profit before Tax 2736.00 2229.00 1470.47 1158.93 943.39
Tax 315.00 325.00 227.00 201.00 135.43
Net Profit 2421.00 1904.00 1243.47 957.93 807.96

Operating Cash flow 2830.00 2172.00 1474.37 1146.88 968.61

Capital Employed 6897.00 5242.00 3253.43 2860.65 2080.31

Gross Profit Ratio 33.98% 35.51% 34.80% 36.15% 41.35%
Return on Capital 35.10% 36.32 38.22% 33.49% 38.84%

74
Appendix 5
Wipro Ltd.

Profit & Loss – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 10403.74 7335.98 5271.46 4113.10 3557.63

Expenditure 7768.67 5388.26 4034.39 3038.15 2463.07
Operating Profit 2635.07 1947.72 1237.07 1074.95 1094.56
Interest 3.13 5.57 3.52 2.93 2.89
Gross Profit 2631.94 1942.15 1233.55 1072.02 1091.67
Depreciation 292.26 185.97 151.60 137.94 141.89
Profit before Tax 2339.68 1756.18 1081.95 934.08 949.78
Tax 319.13 261.36 167.07 120.85 83.67
Net Profit 2020.48 1494.82 914.88 813.23 866.11

Operating Cash flow 2312.74 1680.79 1066.48 951.17 1008.00

Capital Employed 6420.45 4892.44 3507.59 3330.21 2532.54

Gross Profit Ratio 25.30% 26.47% 23.40% 26.06% 30.68%
Return on Capital 31.47% 30.55% 26.08% 24.42% 34.19%

Profit & Loss (consolidated) – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 10756.47 8255.03 5971.62 4404.75 3596.33

Expenditure 8084.18 6126.48 4567.75 3230.92 2492.27
Operating Profit 2672.29 2128.55 1403.87 1173.83 1104.06
Interest 3.49 5.61 3.51 3.02 2.97
Gross Profit 2668.80 2122.94 1400.36 1170.81 1101.09
Depreciation 290.97 228.17 197.18 157.22 142.82
Profit before Tax 2377.83 1894.77 1203.18 1013.59 958.27
Tax 339.10 274.96 168.06 127.60 72.90
Profit after Tax 2038.73 1619.81 1035.12 885.99 885.37
Minority Interest 28.67 8.72 (5.92) (3.69) 0.08
Net Profit 2067.40 1628.53 1029.20 882.30 885.45
Extraordinary items - - 2.29 (61.80) -
Net Profit after
2067.40 1628.53 1031.49 820.50 885.45
Extraordinary items

75
 Operating Cash flow 2358.37 1856.70 1067.88 859.64 1028.27

Capital Employed 6612.72 5282.63 3754.95 3477.43 2592.75

Gross Profit Ratio 24.81% 25.72% 23.45% 26.58% 30.61%
Return on Capital 31.26% 30.83% 27.41% 25.37% 34.15%

APPENDIX 6
Polaris Software Lab Ltd.

Profit & Loss – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 689.95 685.11 581.39 401.74 283.94

Expenditure 622.56 586.17 468.44 312.75 209.09
Operating Profit 67.39 98.94 112.95 88.99 74.85
Interest 0.55 0.82 1.18 1.05 0.04
Gross Profit 66.84 98.12 111.77 87.94 74.81
Depreciation 46.44 38.40 31.61 18.39 9.39
Profit before Tax 20.40 59.72 80.16 69.55 65.42
Tax 7.10 6.29 12.46 15.32 3.77
Net Profit 13.30 53.43 67.70 54.23 61.65

Operating Cash flow 59.74 91.83 99.31 72.62 71.04

Capital Employed 531.27 529.36 493.76 438.41 244.07

Gross Profit Ratio 9.69% 14.32% 19.22% 21.89% 26.35%
Return on Capital 2.50% 10.09% 13.71% 12.37% 25.26%

Profit & Loss (consolidated) – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 833.41 800.43 640.35 431.06 293.80

Expenditure 748.00 684.93 518.42 333.86 221.46
Operating Profit 85.41 115.50 121.93 97.20 72.34
Interest 0.79 1.13 1.42 1.00 -
Gross Profit 84.62 114.37 120.51 96.20 72.34
Depreciation 49.45 40.69 33.18 18.58 9.58
Profit before Tax 35.17 73.68 87.33 77.62 62.76
Tax 13.15 10.76 15.13 16.17 3.90
Profit after Tax 22.02 62.92 72.20 61.45 58.86
Minority Interest - - - (0.51) -
Net Profit 22.02 62.92 72.20 60.94 58.86

76
 Extraordinary items (0.71) (4.87) (2.36) (6.40) -
Net Profit after
21.31 58.05 69.84 54.54 58.86
Extraordinary items

Operating Cash flow 70.76 98.74 103.02 73.12 68.44

Capital Employed 540.90 531.10 490.40 410.56 238.89

Gross Profit Ratio 10.15% 14.29% 18.82% 22.32% 24.62%
Return on Capital 4.07% 11.85% 14.72% 14.84% 24.64%

APPENDIX 7
Tata Consultancy Services Ltd.

Profit & Loss – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 11302.59 8146.33 17.74 1.97 NA

Expenditure 7966.37 5890.53 0.03 0.10 NA
Operating Profit 3336.22 2255.8 17.71 1.87 NA
Interest 4.49 10.4 0.20 0.00 NA
Gross Profit 3331.73 2245.4 17.51 1.87 NA
Depreciation 257.38 133.22 0.84 0.10 NA
Profit before Tax 3074.35 2112.18 16.67 1.77 NA
Tax 357.48 280.76 1.49 0.75 NA
Net Profit 2716.87 1831.42 15.18 1.02 NA

Operating Cash flow 2974.25 1964.64 16.02 1.12 NA

Capital Employed 5609.33 3321.05 47.08 36.84 NA

Gross Profit Ratio 29.48% 27.56% 98.70% 368.39% NA
Return on Capital 48.43% 55.15% 32.24% 2.77% NA

77
Profit & Loss (consolidated) – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 13386.23 9824.36 4.30 NA NA

Expenditure 9588.04 7016.40 0.03 NA NA
Operating Profit 3798.19 2807.96 4.27 NA NA
Interest 9.14 15.45 0.20 NA NA
Gross Profit 3789.05 2792.51 4.07 NA NA
Depreciation 282.43 158.82 0.84 NA NA
Profit before Tax 3506.62 2633.69 3.23 NA NA
Tax 509.57 396.99 1.49 NA NA
Profit after Tax 2997.05 2236.70 1.74 NA NA
Minority Interest (29.84) (9.12) - NA NA
Net Profit 2967.21 2227.58 1.74 NA NA
Extraordinary items (0.47) (250.68) 4.94 NA NA
Net Profit after
2966.74 1976.90 6.68 NA NA
Extraordinary items

Operating Cash flow 3249.17 2135.72 7.52 NA NA

Capital Employed 5998.81 3477.54 47.08 NA NA

Gross Profit Ratio 28.31% 28.42% 94.65% NA NA
Return on Capital 49.46% 64.05% 3.69% NA NA

APPENDIX 8

HCL Technologies Ltd.

Profit & Loss – (Currency: Rs. in Cr.):

2004-05 2003-04 2002-03 2001-02 2000-01

Revenue 1530.03 1274.74 979.51 856.55 832.56

Expenditure 1117.94 872.87 606.26 401.48 356.53
Operating Profit 412.09 401.87 373.25 455.07 476.03
Interest 5.62 5.48 1.06 1.73 0.52
Gross Profit 406.47 396.39 372.19 453.34 475.51
Depreciation 67.56 56.89 49.31 35.47 22.53
Profit before Tax 338.91 339.50 322.88 417.87 452.98
Tax 9.64 13.78 10.41 15.92 26.20
Net Profit 329.27 325.72 312.47 401.95 426.78

Operating Cash flow 396.83 382.61 361.78 437.42 449.31

78
 Capital Employed 2859.98 2291.18 2315.58 2101.80 1704.58
Gross Profit Ratio 26.57% 31.09% 37.99% 52.93% 57.11%
Return on Capital 11.51% 14.22% 13.49% 19.12% 25.04%

Profit & Loss (consolidated) – (Currency: Rs. in Cr.):

2004-05 2003-04 2002-03 2001-02 2000-01

Revenue 3471.23 3040.20 2253.59 1738.40 1432.80

Expenditure 2593.96 2063.79 1744.65 1273.60 939.60
Operating Profit 877.27 976.41 508.94 464.80 493.20
Interest 10.18 9.69 4.92 7.40 -
Gross Profit 867.09 966.72 504.02 457.40 493.20
Depreciation 151.58 165.20 157.51 93.80 40.05
Profit before Tax 715.51 801.52 346.51 363.60 453.15
Tax 49.80 25.25 28.03 25.90 36.90
Profit after Tax 665.71 776.27 318.48 337.70 416.25
Minority Interest (46.99) (90.04) (24.16) (2.50) 43.20
Net Profit 618.72 686.23 294.32 335.20 459.45
Extraordinary items - - (46.39) - -
Net Profit after
618.72 686.23 247.93 335.20 459.45
Extraordinary items

Operating Cash flow 770.30 851.43 405.44 429.00 499.50

Capital Employed 3442.41 2632.40 2299.06 2001.92 1979.55

Gross Profit Ratio 24.98% 31.80% 22.36% 26.31% 34.42%
Return on Capital 17.97% 26.07% 12.80% 16.74% 23.21%

APPENDIX 9
Satyam Computer Services Ltd.

Profit & Loss – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 5014.48 3566.64 2654.94 2075.38 1803.72

Expenditure 3443.06 2594.94 1880.64 1581.45 1192.15
Operating Profit 1571.42 971.70 774.30 493.93 611.57
Interest 2.72 0.76 0.75 0.72 9.60
Gross Profit 1568.70 970.94 773.55 493.21 601.97
Depreciation 122.81 103.94 111.61 124.18 117.46
Profit before Tax 1445.89 867.00 661.94 369.03 484.51

79
 Tax 206.14 116.74 106.15 61.61 35.13
Net Profit 1239.75 750.26 555.79 307.42 449.38

Operating Cash flow 1362.56 854.2 667.4 431.60 566.84

Capital Employed 4333.64 3217.02 2580.76 2134.88 1930.40

Gross Profit Ratio 31.28% 27.22% 29.14% 16.58% 33.37%
Return on Capital 28.61% 23.32% 21.54% 14.40% 23.28%

Profit & Loss (consolidated) – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 5125.84 3607.67 2635.56 2261.54 2055.32

Expenditure 3626.48 2654.81 1886.95 1699.44 1636.65
Operating Profit 1499.36 952.86 748.61 562.10 418.67
Interest 5.54 0.91 1.02 1.84 11.76
Gross Profit 1493.82 951.95 747.59 560.26 406.91
Depreciation 137.28 113.30 115.02 179.69 630.31
Profit before Tax 1356.54 838.65 632.57 380.57 (223.40)
Tax 207.48 117.56 106.26 61.76 35.14
Profit after Tax 1149.06 721.09 526.31 318.81 (258.54)
Minority Interest - - - 63.25 337.04
Net Profit 1149.06 721.09 526.31 382.06 78.50
Extraordinary items - - (12.92) (35.01) -
Net Profit after
1149.06 721.09 513.39 347.05 78.50
Extraordinary items

Operating Cash flow 1286.34 834.39 628.41 526.74 708.81

Capital Employed 4317.25 3298.12 2653.68 2198.25 1968.62

Gross Profit Ratio 29.14% 26.38% 28.36% 24.77% 19.80%
Return on Capital 26.62% 21.86% 19.83% 17.38% 3.99%

APPENDIX 10
SUBEX Azure Ltd.

Profit & Loss – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 184.13 117.24 89.18 70.38 59.16

Expenditure 130.18 81.6 64.73 54.31 49.74
Operating Profit 53.95 35.64 24.45 16.07 9.42

80
 Interest 2.64 2.42 1.43 2.25 1.21
Gross Profit 51.31 33.22 23.02 13.82 8.21
Depreciation 9.08 7.12 4.12 3.65 3.42
Profit before Tax 42.23 26.10 18.90 10.17 4.79
Tax 3.08 0.80 1.15 0.56 0.32
Net Profit 39.15 25.30 17.75 9.61 4.47

Operating Cash flow 48.23 32.42 21.87 13.26 7.89

Capital Employed 181.54 123.27 79.93 63.06 52.93

Gross Profit Ratio 27.87% 28.34% 25.81% 19.64% 13.88%
Return on Capital 21.57% 20.52% 22.21% 15.24% 8.45%

Profit & Loss (consolidated) – (Currency: Rs. in Cr.):

2005-06 2004-05 2003-04 2002-03 2001-02

Revenue 184.33 117.23 89.19 70.83 60.26

Expenditure 131.24 80.99 64.66 54.32 50.72
Operating Profit 53.09 36.24 24.53 16.51 9.54
Interest 2.68 2.44 1.44 2.26 1.25
Gross Profit 50.41 33.80 23.09 14.25 8.29
Depreciation 9.23 7.17 4.18 3.68 3.49
Profit before Tax 41.18 26.63 18.91 10.57 4.80
Tax 3.33 0.91 1.15 0.55 0.32
Profit after Tax 37.85 25.72 17.76 10.02 4.48
Minority Interest - - - - -
Net Profit 37.85 25.72 17.56 10.02 4.48
Extraordinary items - - - - -
Net Profit after
37.85 25.72 17.56 10.02 4.48
Extraordinary items

Operating Cash flow 47.08 32.89 21.94 13.70 7.97

Capital Employed 181.11 124.09 80.28 62.91 51.97

Gross Profit Ratio 27.35% 28.83% 25.89% 20.12% 13.76%
Return on Capital 20.89% 20.73% 21.87% 15.93% 8.62%

81
APPENDIX 11
CISCO Systems Ltd.

Profit & Loss – (Currency: $. in Mil.):

2005 2004 2003 2002 2001

Sales 24801.00 22045.00 18878.00 18915.00 22293.00

Interest 620.00 700.00 131.00 (209.00) 1130.00
Total Revenue 25421.00 22745.00 19009.00 18706.00 23423.00
Expenditure 17385.00 15753.00 13996.00 15996.00 24297.00
Gross Profit 8036.00 6992.00 5013.00 2710.00 (874.00)
Tax 2295.00 2024.00 1435.00 817.00 140.00
Net Profit 5741.00 4968.00 3578.00 1893.00 (1014.00)

Operating Cash flow 6874.84 6507.68 4523.17 3945.67 4121.98

Total Equity 23174.00 25826.00 28029.00 28656.00 27120.00

Gross Profit Ratio 32.40% 31.72% 26.55% 14.33% (3.92%)
Return on Capital 24.77% 19.24% 12.77% 6.61% (3.74%)

APPENDIX 12
Return on Capital Employed. (ROCE)

Company Year ROCE Growth%

INFOSYS 2001-02 38.84 N.A
2002-03 33.49 -0.14
2003-04 38.22 0.14
2004-05 36.32 -0.05
2005-06 35.10 -0.03

WIPRO LTD 2001-02 34.15 N.A

2002-03 25.37 -0.257
2003-04 27.41 0.080
2004-05 30.83 0.125
2005-06 31.26 0.014

POLARIS 2001-02 4.07 N.A

2002-03 11.85 1.91
2003-04 14.72 0.242

82
 2004-05 14.84 -0.008
2005-06 24.64 0.66

HCL TECH 2001-02 23.21 N.A

2002-03 16.74 -0.279
2003-04 12.80 -0.2353
2004-05 26.07 1.0367
2005-06 17.97 -0.310

SATYAM
2001-02 3.99 N.A
COMP
2002-03 17.38 3.355
2003-04 19.83 0.141
2004-05 21.86 0.102
2005-06 26.62 0.217

APPENDIX 13

CISCO: REVENUE: ($ MIL)

Growth%
Revenue in $ mil
Year
2005-06 22293 N.A
2004-05 18915 (0.18)
2003-04 18878 (0.01)
2002-03 22045 16.7
2001-02 24801 12.5

PROFIT
Growth%
Profit after tax
Year
2005-06 (1014) N.A.
2004-05 1893 286.6
2003-04 3578 89
2002-03 4968 38.8
2001-02 5741 15.5

83
 CASH FLOW FROM OPERATION :

OPERATING CASH Growth%

Year FLOW
2005-06 4121.98 N.A
2004-05 3945.67 (4.27)
2003-04 4523.17 14.63
2002-03 6507.68 43.87
2001-02 6874.84 5.64

RETURN ON CAPITAL EMPLOYED

RETURN ON CAPITAL Growth%
Year EMPLOYED
2005-06 (3.74) N.A.
2004-05 6.61 (2.76)
2003-04 12.77 93.1
2002-03 19.24 50.67
2001-02 24.77 28.74

84
APPENDIX 14
SUBEX AZURE LTD: REVENUE: (Rs in crore)

Growth%
Revenue in $ mil
Year
2005-06 184.33 57.23
2004-05 117.23 31.43
2003-04 89.19 25.92
2002-03 70.83 17.54
2001-02 60.26 N.A

PROFIT
Growth%
Profit after tax
Year
2005-06 53.09 46.49
2004-05 36.24 47.7
2003-04 24.53 48.57
2002-03 16.51 73
2001-02 9.54 N.A

CASH FLOW FROM OPERATION :

OPERATING CASH Growth%

Year FLOW
2005-06 181.11 45.95
2004-05 124.09 4.65
2003-04 21.94 60
2002-03 13.70 71.89
2001-02 7.97 N.A

RETURN ON CAPITAL EMPLOYED

RETURN ON CAPITAL Growth%
Year EMPLOYED
2005-06 20.89 (0.07)
2004-05 2O.73 (0.05)
2003-04 21.87 20.87
2002-03 15.93 84
2001-02 8.62 N.A

85
T-Test

Group Statistics

Growth
N Mean Std. Deviation Std. Error Mean
Types
Return Inorganic 35 .035371960 .1001594791 .0169300420
Organic 35 .021541954 .1328965272 .0224636131

Independent Samples Test

Levene's Test t-test for

for Equality of Equality of
Variances Means
95%
Confidenc
Mean Std. Error
F Sig. t df Sig. (2-tailed) e Interval
Difference Difference
of the
Difference
Lower Upper
Equal -
.01383000 .02812899 .06996053
Return variances 2.241 .139 .492 68 .625 7 28 .04230052 78
assumed 45
Equal
-
variances .01383000 .02812899 .07003778
.492 63.203 .625 .04237776
not 7 28 29
96
assumed