Saturday, May 10, 2008

Lenovo and Infosys: An overview of two pioneering companies and the business environments in which they were created

The following overview was written by Ted Chan in 2008 as part of my masters program at the MIT Sloan School of Management and was edited by Victoria Slingerland. If it is of use to you, I would appreciate a comment or e-mail. Please use all appropriate academic citations. I would enjoy a further dialog on the topic if you are interested.

Lenovo and Infosys: Two pioneering companies and the business environments in which they were created
By Theodore (Ted) Chan
MIT Sloan School of Management

Introduction

Infosys, an Indian-based information technology and consulting firm, and Lenovo , a leading Chinese personal computer manufacturer, are remarkable companies with unique organizational structures and cultures. These characteristics allowed them to overcome challenges posed by the business climate of their countries while leveraging some of the distinct advantages. This paper describes their development in the context of their business and financing environments, and provides comparison and analysis with regards to the challenges they faced.

Overview of Infosys

Infosys was founded in 1981 and is led by now world-renowned CEO Narayana Murthy in Pune, India. The company had one unique characteristic from the beginning. Murthy established a culture of ethical behavior at Infosys that included running a highly transparent organization and not giving into the corruption that was rife in India at this time. In 2005, India scored a very poor 2.9 out of 10 on Transparency International’s corruption index and this is after what was considered to be substantial progress following the 1991 governmental reforms. Infosys gained a leading reputation as an ethical Indian company, which greatly aided its business with international firms. During this period in the 1980s, when Infosys laid much of its cultural and reputational groundwork, its growth was actually relatively slow. In 1991, after ten years in operation, its revenues were about 50 million rupees, or less than $2 million USD. (Abdelal et al. 2007, Nanda and Delong, 2002)

India provided many challenges for an emerging business with its corrupt, bureaucratic government and lack of infrastructure; however, it also offered one major competitive advantage in low-cost skilled labor. For instance, in 1994, programmers and systems analysts in India cost less than 1/10th the cost of hiring one of those resources in the US, Japan, Germany or France. (Abdelal et al. 2007, Nanda and Delong, 2002)

It was the fiscal reform early in the 1990s that allowed growth to take off at Infosys. In 1991, India was trying to overcome a severe fiscal crisis and made major reforms that were highly beneficial for businesses. The reforms of 1991 made it possible to open foreign offices, improved capital markets, and created new opportunities. It also helped to reduce the effect of the corrupt bureaucracies that hindered doing business in India. This also marked a period of intensified competition, with many multi-national corporations choosing to compete in the Indian market or setup low-cost development centers. Infosys paid its employees in the top 10 to 15% of the salary ranges, ensuring they could compete for top talent and continue to provide a product that would be considered high quality. It also was one of the first Indian firms to offer a stock-option plan. Infosys also invested heavily in a new facility that cost 130 million rupees in 1993, nearly their entire revenue for that year (95 million rupees in 1992, and 145 million in 1993). (Nanda and Delong, 2002; Kummerle, 2003)

Infosys continued to be a leader in corporate ethics and transparency in India. It was the first Indian company to use US GAAP accounting standards and meet the ISO 9001 software quality standard, along with publishing a number of audits, disclosures and reports that had not historically been part of the Indian way of doing business. (Kummerle, 2000)

Thanks in great part to the 1991 reforms, Infosys went public in India in 1993. Prior to this point, they had very little financing. As a service business, they were typically cash flow positive and had only four moderate size loans prior to the IPO. The firm rapidly took off and revenues nearly doubled in 1994 to 301 million rupees. (Kummerle, 2003) After several years of sustained growth, Infosys went public in 1999 in the US on the NASDAQ stock exchange. By the end of 2007, it employed over 88,000 employees with revenues over $3.1 billion USD and a market cap of over $30 billion USD. (Wikipedia, Yahoo Finance) It is interesting to compare these two liquidity events to the course Lenovo had to take with the less sophisticated financial markets in China.

Overview of Lenovo / Legend

The story of the company now known as Lenovo is a parable that fits well with the transformation of the Chinese economy. Founded in November 1984 in Beijing, two important developments coincided with its roots: the reform of Science and Technology System and the rise of new non-governmental science and technology enterprises in their district in Beijing.

While Infosys was a private enterprise, Lenovo had state involvement from the beginning in the form of the Institute of Computing Technology (“ICT”). What is interesting is that Lenovo’s development often seemed in spite of opposition from the state, which provided advantages to Lenovo’s state owned competitor, Great Wall. The reform of the Science and Technology system in China meant that the ICT’s funding was to be cut at a rate of 20% starting in 1985. Facing this uncertainty, the institute saw new enterprises being set up by research institutes to profit from technology businesses, including computing. As such, the new company was set up as an “institute run enterprise” and called Institute of Computing Technology (ICT Co.) With little chance of direct funding for the company, the eleven initial founders resourcefully raised 200,000 RMB that was loaned to the ICT, which then placed it on its balance sheet and loaned it to the company to provide the startup capital. ICT also provided office space, utilities, and key access to administrators within the government. A major break occurred early in the life of ICT Co. with the first project being a paid contract with CAS; the 700,000 yuan earned gave the company much needed capital. (Lu, 2000; Chen et al., 2001)

ICT Co. used this capital to pursue its first product, a Chinese word processing add-on card for the IBM PC. The product was an instant success, rapidly winning more than 50% of the market share for word processing add-on cards. This accounted for nearly 1/3rd of the company’s revenue. ICT Co. became Legend some time during this period and continued to create computing products. The 27 new profitable technology products between 1985 and 1988 accounted for approximately 80% of sales. Legend’s growth was rapid. Excluding Hong Kong Legend, employees went from 44 in 1985 to over 630 in 1991. During this time, sales revenues grew to 680 million RMB from 3 million in 1985. This growth permitted a reciprocal relationship with the ICT; the company paid off the initial 200,000 RMB loan, with an additional 3,650,000 payment over the first three years, and 1,200,000 per year thereafter. (Lu, 2000; Chen et al., 2001)

In 1987, ICT partnered with Daw, a small Hong Kong company to create Hong Kong Legend Technology Co. This operation grew rapidly, reaching $11.74 million by the end of 1988, which provided capital to purchase a manufacturer, QDI. Prior to the relationship in Hong Kong, Legend had not manufactured computer systems as they lacked the permits to do so in mainland China. Getting into manufacturing was initially a challenge for Legend, but they were able to overcome it and gain market share in motherboards. Sales grew from 30,000 motherboards in 1990 to 5 million in 1995. In Hong Kong Dollars, this growth was from $78 million HKD to nearly $2.5 billion HKD, a remarkable rate over a five year span. They went public in Hong Kong in 1993, raising $220 million HKD. Hong Kong, then still a British colony, provided the mechanism for internationalization, along with the primary source of financing for Legend to approach both the domestic and later the international market. (Lu, 2000; Chen et al., 2001)

On the PC front, the Chinese market saw a significant change in 1992 brought on by a Memorandum of Understanding signed between the US and China. This lowered import tariffs from 35% to 15% and removed many quotas and licenses for goods coming into China such as computers. It also improved foreign intellectual property rights. Legend had to decide whether to continue to manufacture its own PCs. At the time, Legend was struggling to meet its sales goals, and its operations management was somewhat inefficient, with an inventory turnover of 1.7, compared to 5 to 6 turns for its competitors. Re-organization in 1994 helped solve the issue. With a leaner, more focused sales force, and a strong new general manager, Yang Yuanqing, Legend improved turnover to 7x by 1995. They also captured 5.7% of the market that year, which was second to only Compaq and AST. (Lu, 2000; Chen et al., 2001)

In 1996, Legend seized on the fact that the foreign industry players were releasing products in China 4 to 5 months behind overseas launches, while charging higher prices due to the import tariff. Legend cut its own prices by 30% and used a first to market strategy with their new technologies, essentially offering the hottest new technologies at a lower price. As Infosys had found their local knowledge important, Legend’s understanding of the competitive landscape in China was a key advantage. In 1997, Legend captured the #1 spot in the Chinese market in desktop PCs with this strategy, gaining a 9.4% market share. Meanwhile, Legend also began to differentiate its products more based on meeting local needs. (Lu, 2000; Chen et al., 2001)

Distribution remained an important part of the business as well, as Legend continued to sell products made by Hewlett Packard, Toshiba and Sun. This distribution ability was an important company asset following the 1992 Memorandum of Understanding. Legend’s local knowledge was an advantage over joint ventures or lower quality mainland distributors that other foreign entrants had to rely on. (Lu, 2000; Chen et al., 2001)

Legend became Lenovo in 2004 and set its 2005 revenue goal at $10 billion US, a lofty target. Key to achieving this would be their Internet strategy. China has the most Internet users in the entire world, nearly 172 million users by late 2007. In 2000, however, only 1.4% of the Chinese population (16.9 million people) was on the web (double the number from six months prior). Lenovo set about being a key provider to these users. Their Tian Xi product launched in 1999, which was especially geared towards getting lower knowledge users on the web quickly and easily. As with other initiatives, Lenovo was successful in continuing to grow as the Internet emerged in China. Dr. Charles Zhang, the CEO of Sohu.com, indicated that China surpassed the US as the world’s largest Internet user in 2006. (Forbes, 2006; Danwei, 2007)

Lenovo acquired IBM personal computing division in 2007 with funding from Texas Pacific Group and two other US private equity firms. This gave Lenovo one of the world’s leading brands for marketing its PCs. As of 2007, Lenovo was approximately 40% owned by public share holders, 42% owned by Legend Holdings (65% of which is owned by the Chinese government, 8% by IBM and 10% by Texas Pacific). (Wikipedia, IBM Website)

Analysis of the Environments that Created the Two

Both Infosys and Lenovo are leading global companies forged in the unique economic environments that their nations’ emerging economies presented. Legend is an interesting case as it combines some of the advantages and disadvantages of state ownership and participation. While many of their resources to start the company, including the intellectual property, came from the CAS, the government was also restrictive in issuing the necessary permits. Meanwhile, Infosys faced an environment where the government was largely a barrier in the form of corruption and bureaucracy. Their ability to overcome this by using a completely ethical framework turned into a major asset in winning business in the future with foreign companies.
Both Infosys and Lenovo navigated difficult financing environments with a combination of skill in the form of building cash flow positive businesses and early breaks that supplied them with precious capital. While both had initial public offerings in 1993, it is interesting to note Infosys had its IPO in Bombay and then later in the US, while Lenovo had its in Hong Kong, and to date has not listed on the Chinese exchange. This is indicative of how behind China’s financial system has historically been. Only recently has listing in China been considered a palatable alternative to more developed foreign exchanges.

Both utilized important cultural knowledge in order to navigate the business environments of their nations, an advantage over foreign multi-national companies that attempted to enter the market. This was especially important as, right around the same time in 1992, both companies faced increased competition from foreign companies due to changes in governmental regulations and policies. Both Infosys and Lenovo leveraged their cultural knowledge to stay at the head of the market despite intense competition.

Conclusion

Infosys and Legend/Lenovo were both uniquely entrepreneurial firms that used effective strategies and organizational designs to navigate the tricky business and financing environments of their countries. At the same time, they leveraged low production costs, strong local knowledge of distribution and the ability to cut through bureaucracy that held back many competitors. While they share some characteristics, this paper has also discussed some of the differences between them and the business environments in their respective nations. These include the funding environment, the ease of doing business internationally and the macroeconomic environments. Overall, both are remarkable companies with stories that are intrinsically tied to the business environments in which they were created.

Bibliography

“Infosys in India: Building a software giant in a corrupt environment”, Rawi Abdelal, Rafael di Tella, Prabakar Kothandaraman, 2007; Harvard Business School. (Abdelal et al. 2007)
“The Legend Computer Group Company,” in Qiwen Lu, China’s Leap into the Information Age (Oxford, 2000), Chapter 3 (pgs. 63-103)
“A Technology Legend in China”, Henry Chen, Harry Qin, Greg Ye, Zheng Yin and Michael Rukstad, 2001, Harvard Business School.
“Infosys Technologies,” Ashish Nanda and Thomas Delong, May 23, 2002; Harvard Business School. (HBS case 9-801-445)
“Infosys: Financing an Indian Software Start-up”, Walter Kummerle,, 2003; Harvard Business School.
Lenovo Group Investor Fact Sheet, http://www.pc.ibm.com/ww/lenovo/investor_factsheet.html
Wikipedia, Lenovo and Infosys Entries
“China Surpasses US in Internet Usage”, by Natalie Pace, Forbes Magazine; April 3, 2006.
http://www.forbes.com/2006/03/31/china-internet-usage-cx_nwp_0403china.html
“172 million Internet users in China”, by Maya Alexandri, Danwei, October 2007.
http://www.danwei.org/internet/chinas_number_of_netizens_cont.php

2 comments:

SEO Mehboob said...
This comment has been removed by a blog administrator.
Ted Chan said...

Thought I would add this good interview on the IBM PC / Lenovo integration from the McKinsey Quarterly with Lenovo Chief Purchasing Officer Qiao Song.

http://www.mckinseyquarterly.com/Operations/Purchasing/Integrating_purchasing_in_MA_An_interview_with_Lenovos_chief_procurement_officer_2132