Zeroing in on IP-led Services as an Investment thesis

Pari: Hello everyone! I’m Pari Natarajan, CEO of Zinnov and I’ll be your host today. We have a special guest with us who will help us kickstart our newest series, Decoding Private Equity. It is my pleasure to introduce Charles Phillips, Managing Partner & Co-founder of RECOGNIZE, a technology growth equity firm with over USD 1 Bn in assets focused on building software engineering companies. Having previously helmed Oracle as its President, Infor as its CEO/Chairman, and Morgan Stanley as its Managing Director, Charles is a technology leader through and through, who champions Intellectual Property-led services as an investment thesis. Welcome Charles.

Charles: Good to see you, Pari. Thanks for having me.

Pari: So we’ll start with some of the mega trends and how did you have a really good portfolio of investments you have done. What are some mega trends your investment thesis is based on?

Charles: So the thesis for the whole fund called Recognize was around the next generation of services companies. And we thought, one there’s a huge shortage of talent and so, we’d have to be resourceful and flexible on where you find talent. And the industry always did that a little bit already, but I think having these major centers and facilities where everybody comes to one place, probably is going the way people want to diversify locations. Talent is in a lot of different places that we didn’t look before. And so distributed development as opposed to having five big centers, having hundreds of places distributed as one thing. And so we thought under that model we’re more likely, because of our backgrounds in industry to be able to find those people wherever they are, it didn’t have to be in one place anymore.

And I think the other second one you alluded to is that because of the evolution of the technology Cloud and Microservices, you can build a solution a different way where you assemble a set of services, a set of applications. The solution is the total package presented by the technology services companies, and we’ve seen this model start to emerge where the SaaS service that people pay for a client is paying for is actually going to the services vendor.

Because there’s so much complexity of different services, different applications, different cloud environments, that’s not one thing anymore, and it’s easier to integrate them on the cloud today than it was before. And so, let the technology services company be responsible for determining the best component for any particular service or function, and let them be essentially the general contractor and a SaaS relationship is with the services companies.

Typically it was these software company sold differently on their own and you’d have 20 contracts instead of one. So in this case, you would have a kind of a virtual SaaS company with access to many different applications and microservices to assemble the right solution. So that’s kind of a new role for services companies if they can pull it off, I understand the IP, and understand the value to the customer, that complexity hiding that from them, being able to deliver consistent security, service level agreements, across all of that is a role, kind of a managed service that someone could take on.

So it’s a new concept, seeing a little bit of it now. So that’s another theme that we’re focused on.

Pari: Charles, you have seen the evolution of Oracle, Infor and other enterprise software companies and you know, if you look at the role of Hyperscaler and then that’s increased quite dramatically over the last 10 years…how these companies are building up. And they’re also going into industry clouds, very vertical, solution focused capability.

And you also talked about how the cloud creates a need for an IP led virtual SaaS based services companies. But what do you see the role of Hyperscalers in the evolution of the tech service industry?

What would they play on if you look at the evolution of services, you had the infrastructure companies. Then you had the Y2K which kind of led the services for a long time. Then the whole internet led the service a long time. So now going forward, what would be the role of Hyperscalers in driving these?

Charles: It’s funny you mentioned the term industry cloud. We used that back in 2010, I think of 2011 at Infor because we had to compete with much larger companies by specialize in certain industries. And so each industry had a different set of services and applications they needed. They didn’t want to see things provision in their environment that had no applicability to their industries.
So we set up virtual industry clouds. If you’re in healthcare, here’s a set of services you need. Nothing in there is outside of your industry, and they’ve viewed it as a healthcare industry cloud. Now, it may have all been on AWS, but we had different instances and environments for each industry.

And so I think the Hyperscalers can do some of that. And like in healthcare, have a separate section of the cloud that’s HIPAA compliant, FedRAMP for instance for government. And then you start to add in more content around it to make an industry specific. And so that is an interesting kind of way the Hyperscale is to go and usually once you cover a lot of market, you start looking for more growth. You tend to verticalize over time. So I wouldn’t be surprised if they started to do that.

Pari: So if you look at it, they have strong partnership with Accenture, Capgemini, Deloitte. Now EY is splitting out their advisory business on services business. So one is these large companies… and will there be a need for a more niche partners? How do you see that partnership of these companies evolve?

Charles: There may be specialists that have certain capabilities in the cloud, around security or data management or data propagation. And then because of the pricing, customers always complain about the pricing in the cloud.

It’s not as much competition between them as you like. People say they can go multi-cloud, but they really don’t. They usually pick one and so they’re really on one cloud and then you have to negotiate on your own. So as long as that pricing umbrella continues to increase and it gets more expensive. There may be room for people who willing to take kind of the B level cloud for a cheaper price and we’ll see. But it’s enormous amount of investment needed to build a hyperscaler cloud. So I think these would be more regional, a step up above a colo.

Pari: Okay, got it. So they’re going to be these hyperscaler, but what about their partners? Will they work with, kind of best of breed partners who focus on healthcare services? Or do they look at, based on regional services partners, how do you think they will architect the services partnership on top of their Google and Microsoft and Amazon?

Charles: I think they’re going to lean toward vertical. What they want is workloads in their workloads that they can’t get through that are most difficult to get to are the ones that are complicated, more vertical oriented. And so they’re looking for partners that understand how to transition those workloads. What’s needed, how can we recreate at least the capabilities on the cloud because they don’t have that expertise. And so to get to those workloads, they’re going to rely on partners who kind of operate in that industry and have that expertise. They can help where they can in terms of the core infrastructure and data migration and things like that. But understanding the fundamental requirements what has to be there for each industry, that’s a big task. And so that’s where partners can help a lot.

Pari: So the industry focus and workload within the industry could be merchandising and retail. There could be partners, like specialists in that area that could potentially work with those companies. In that context, if you look at the last few years, the fastest growing services companies are companies like Epam, companies like Globant, you have seen GlobalLogic bought by Hitachi. These are companies focused on more engineering services. And how do see the evolution of the next set of company? Are we going to see more of Epams or more of Infosys, or more of Accentures? If you have a lens looking into the future, how do you see this next generation of company grow?

Charles: Yeah, we had recognized, we survey about 500 CIOs every couple of months. We have seen a clear trend of a mix shift toward custom development. Because once you get your ERP systems in and most people have them by now, you turn to more differentiated applications that are unique to you, at least to your industry.

And once you get into that area for value add and differentiation, you’re more likely to think about some unique application that you determine it could differentiate the company. Those are the things that tend to get funded because people see some direct value in it. And so there’ll be a greater need for engineers who can build, do the digital engineering, build custom applications, around the same standards that they’re used to around hyperscaler clouds.

But let’s move those applications into the cloud and now taking advantage of all the data that we’ve collected, all the integrations that are already there so you can build a better and different type of application than before. So we own a company in Ukraine that competes with all the companies you mentioned called Ciklum.

And so we’ve been going through that. So obviously there was a big trend around developers in Eastern Europe just because they have such a technical skillset and for digital engineering, they were known for that, as opposed to doing things around ERP, or extensions, or integrations and implementation work.

And so while the situation in your claim is obviously hard to predict what happens there, the thesis of engineers in that region who have a special capability in digital engineering is probably still there.

Pari: Got it. So you see that trend continues. You also mention about these very vertical specific, workload specific, company coming on top of hyperscalers and you have coming like SpringML. So what is investment thesis there and how do you see that growing?

Charles: One of the things we look for is what are ecosystems that are underserved? And so we thought the Google Cloud, while it’s growing fast and it’s large is quite a bit of ways behind AWS and Azure.

So it’s being the third largest cloud and they don’t have the same ecosystem of partners. And so, knowing Thomas Kurian, the CEO of the Google Cloud, who we work together at Oracle and many other relationships there. It made sense for us to build a company around Google Cloud to see if we can burn off some of the backlog.

They’ve signed, you know, billions of dollars worth of backlog with clients, so they need to get things implemented. That’s their number one priority right now. And so, SpringML focuses on exactly that. They have a lot of skills on Google Cloud and Google Analytics. They’ll do some digital engineering, but it’s all dedicated to Google.

And that helps you in the partnership. Because they’re not worried about SpringML moving something to AWS or to Azure. That kind of singular purpose and the partnership can be a little more transparent and open. And so they’re doing very well right now.

Pari: Interesting. If you take the large system integrators, they have a shop which is focused on Azure. There’s a shop which is focused on Google, and they’re probably delivering whatever the customer is looking for. So there’s no differentiation what Google will get versus working with this company SpringML which largely focused on Google. So there is lot more alignment on the goals between the two companies.

Charles: Yeah, a lot more co-innovation. And we’ve done the same thing with the Oracle Cloud. So we have another company called AST that only does Oracle Cloud migrations and applications as well. They’re the largest independent Oracle partner focused mostly on the public sector and same thing, but because Oracle knows that their interests are completely aligned with AST.

And that if they send them a lead, it’s going to go in the Oracle cloud and nowhere else you get a different type of partnership. So that’s one of the advantages of the specialists as we’re building these next generation of companies, that they don’t have to be all things to all people. If you’re essential, you have to do everything. You get a lot of revenue, you got to produce every quarter. You don’t at this size.

Pari: One of the challenges faced by these specialist services company. If you think of services companies which are providing services on SAP or Oracle or Microsoft, pre-cloud era and now, one of the issues is scale.

None of these companies became really big company like Accenture or you know, Infosys, TCS, and Cognizant. Now you see, one hyperscaler focused company being a billion dollar services company and half a billion dollar services company that have enough headroom to grow?

Charles: Yeah, I think that’s possible. Whether it’s another center that’s unlikely, these companies because the sensor does, like I say, everything globally, but you could see just the size of these companies and the growth and the backlog they’ve created.

That’s certainly possible over time and there’s a ton of applications and data yet to be migrated. So the migration, while it’s not as new as it once was, you still have kind of half the workloads roughly that are sitting there and these are the tougher workloads to get to cause they tend to be more verticalized.

Pari: Got it. So there’s still room because there’s a lot of backlog and several billion dollars of backlog just burning through the backlog will potentially create a large company.

Charles: Yeah. And then there’s a whole area of intercompany processes.

And so, even if you get your own infrastructure in pretty good shape, in your own applications, you still have a ton of trading partners and suppliers. And how you transform that into cloud and make that more agile and modernize those relationships, that’s going to take a long time, over many, many years, that’ll fuel the growth.

There’s only so much productivity you’re going to get as a company by automating what’s inside your four walls, because now that you’ve outsourced key parts of your organization, you hit limit on productivity which is what we’ve seen in the numbers actually.

And so it’s going to have to go beyond one organization. It’s going to be families or companies are working together, to produce a certain product for a certain industry

Pari: Got it. So one of the other question I had is lots of private equity firms right now focused on technology services as a key investment. Tech broadly, and even within tech, tech services as a big area, because they’ve seen that this industry is pretty attractive cash generator, you know, very difficult to lose money in this area. It’s fast growing because of all the trends you talked about. What could founders especially could get from working, partnering with Recognize compared to other private equity firms?

Charles: Well one, we are super focused on this one area, mostly other firms tech services is just one more thing they do. This is all we do. Two, we were mainly founded by operators. So the two that you’re probably aware of, myself and Frank D’Souza, a former CEO of Cognizant. And so our networks in terms of helping you recruit people, our operational background in terms of looking at delivery, marketing, go-to-market, you name it, we rely on those networks and the ability to get to other people. And then introductions to clients. I mean, we know a lot of CEOs and CIOs. We sit on some Fortune 500 boards as well. So between Frank and I, if we need to reach a company and one of us knows someone’s there and so we don’t buy hundreds of companies, we’re only going to have 10, so we can focus and help them, kind of one at a time. And so that kind of, concierge service, I guess is the differentiation.

Pari: It’s a very huge difference and being an operator you understand how they’re driving. And, one other question I had is you’ve been legendary in the Oracle acquisition story. Turning Oracle into a platform so how are you going to use some of those magic on the company you are buying.

Charles: A lot of the companies we’re buying, they’re fairly young CEOs who have not done any M&A.

And so obviously between Frank and I have done a lot of that and kind of made the mistakes, know what works, what didn’t work, and know what the risk are and what the look out for and we also can source acquisitions for them. So most of the acquisitions are existing companies. The add-ons that we’ve done, they’ve made, it’s been companies we’ve found for them, actually all of them we’ve found for them and say, ‘Hey, this might be a good fit. Why don’t you take a meeting.’

And so we have our sourcing engine. We’re constantly looking at companies that are out there. We have a newsletter we send to 2,500 tech services CEOs every couple of weeks, so they kind of be in the flow and know what we’re thinking and can reach us when they need to.
We hold conferences for tech services CEOs, not just our own portfolio companies, but for a broad section of the industry. And so we have kind of a eyes and ears that are out there looking and hearing things. And so that’s on behalf of our company so they don’t have to do that.

Pari: Thanks Charles. It looked like a very interesting combination that you have the funding, you have the inorganic engine built for them. You also provide the go-to-market as well as capability across global location, how do you get that team up and running So the founder is very passionate about growing the company and you have all the other capabilities to enable these.

Charles: Yeah, we are aiming to be the most entrepreneur friendly firm out there, given all of our backgrounds you would expect that. And so that’s is a big part of our differentiation. It’s also the type of relationship where we want and we think works to grow companies. So this is not typical private equity where it’s mostly about leverage and cutting costs. This is about growth and innovation.

Pari: Great. thank you, Charles. It was very interesting to understand the trends which is driving the market, the role of Hyperscalers and how it is creating the next generation of digital engineering and the modern system integrators and also great to understand the role you all personally play in driving growth for the companies you buy. It was very insightful. I really enjoyed the conversation. I’m pretty sure the audience will as well.

Charles: Well, thank you Pari. You’ve been one of our good partners, by the way, so appreciate all you do as well.