Capgemini’s ace of spades is focused domain expertise, not end-to-end transformation

The Bottom Line: It’s hard to do everything. Enterprises should value Capgemini for deep domain expertise across its defined playing fields but go elsewhere for end-to-end transformation

HFS believes Capgemini has the potential for end-to-end consult-design-engineer-implement-build-run services, but that’s rarely what it delivers.

Capgemini’s ‘playing field’ priorities of applied innovation are delivering business value across “customer first, intelligent industry, and enterprise management, globally,” but we are not witnessing wide-scale transformational deals across the playing fields. Instead, Capgemini is going for domain focus rather than big and broad.

Capgemini’s 2021 update – what’s new?

After seeing Capgemini’s 2021 market approach at its annual global analyst and adviser summit, it’s clear to us that it needs to carve out a more precise position between the consulting-centric firms like Accenture and Deloitte and offshore-centric system integrators with proven engineering credentials like Wipro and HCL.

As we heard last year, its emphasis remains on its three core playing fields of Customer First (a riff on customer experience), Intelligent Industry (a vehicle for Altran), and Enterprise Management (good old apps and infrastructure services), as Exhibit 1 depicts. Capgemini threads these concepts through with two enabling pillars of cloud and data/AI (artificial intelligence) and buttresses them with cybersecurity and sustainability.

Capgemini stays focused—not “big and broad”—with its client approach

Capgemini seems to have abandoned its objective of driving “multi-tower” deals (mega end-to-end digital transformation deals) that its leadership has been touting for the past few years. Instead, the firm is holding fast to a simplified portfolio management approach as a unified way to get its 300,000 employees to deliver consistent value to clients.

It seems Capgemini has realized its best bet for bringing business value to its customers is actually via its playing field towers—each a distinct single-tower approach. Each tower caters to a specific CxO audience, allowing for a triad of strategic footholds. So, Capgemini’s ace of spades is getting focused rather than going broad.

Exhibit 1: Capgemini’s Corporate Strategic Framework

Source: Capgemini, 2021

Performance during the pandemic has been strong, but its lower profit margins may expose Capgemini in the forthcoming talent dearth

With its focus strategy is bearing fruit, Capgemini has managed the pandemic well so far. Both revenue and operating margin are up for 1H 2021 (Exhibits 2, 3). Altran (newly christened as Capgemini Engineering) has been somewhat digested, and its leadership realizes there are additional valuable assets in the Altran family, like Cambridge Consultants and its creative consultancy frog being reborn yet again as part of Capgemini Invent.

Exhibit 2: Lumpy but improving – quarterly revenues of major IT service providers over the pandemic ($M USD)

Source: Source: HFS Research estimates and public data sources, 2021

However, in Exhibit 3, it’s clear that Capgemini’s operating margins are still relatively low compared to its peers, and the increasing cost to deliver services puts margins at further risk. While the firm did not report Q3 profit margin, it did upgrade its margin goal for the year to more than 12.7% (up from 12.5% – 12.7%). The next phase of the post-pandemic economy is to cope with the colossal attrition levels we see happening across all service providers; attrition currently ranges between 30% and 60% in India and 20% and 30% globally, and it’s increasing continuously in the current climate. Ultimately, the cost of salaries and new staff acquisition will add significant pressure to pricing and margins, and this is before we factor in the increase in travel costs we anticipate now that the pandemic is receding.

Exhibit 3: The “great resignation” is coming for your profit margins – quarterly profit margins of major service providers, 2020–present

Source: HFS Research estimates and public data sources, 2021

Manufacturing becomes Capgemini’s headline capability with the Altran Ingestion

We noted a consequence of the Altran ingestion is a shift in revenue contribution; manufacturing has become the group’s predominant industry, edging out BFSI (banking, financial services, and insurance). We believe this foretells the future swim lane for Capgemini—going deep on its Intelligent Industry focus. As its 1H results note, “engineering is back.” We’re not sure it ever went away, but it is most certainly in heavy demand as design, IT, and engineering skills come together to help enterprises be thoughtful about transformation beyond straight-up tech investment.

Yet, the key point here is that there is a marked difference between industry-led solutions and the new engineering-heavy capabilities Altran brings to Capgemini. In manufacturing, there is a natural overlap, but for other sectors, more nuanced narratives are required. The emphasis on design thinking and the reorganization of disparate consulting talent under the frog brand are an attempt to drive engineering into adjacent segments while emphasizing a consulting-led approach. Capgemini claims it has won 300 deals with Altran capabilities and now boasts ~50,000 people with engineering talent. The company is clearly changing in terms of size and culture. But it needs to carve out a clearer position between the consulting firms like Accenture and Deloitte and offshore-centric system integrators like Wipro and HCL with proven engineering credentials.

Getting globalization right is critical

During the analyst summit, two themes struck a chord: sustainability and globalization. We applaud Capgemini’s sustainability agenda and bestow as many compliments as possible on its firm-wide agenda and results as well as its efforts to enable clients. Capgemini discussed globalization in two key ways:

1. We’re global, mais oui. As a France-headquartered firm, its power center has always been in Europe. The firm has struggled to grow its footprint and client base in pursuit of recognition as a global firm. As it stands today, more than 50% of revenue comes from outside Europe, and the US has emerged as its single largest country market. We expect a continued tour de force in the US to amp this growth. But the stated intent now is to push mergers and acquisitions in Asia to fix Capgemini’s other geographical weaknesses.
2. Underachieving with India. While Capgemini sought to balance its onshore/offshore delivery capabilities and improve its operating margin performance when it acquired iGate back in 2015, its utilization of India over time has been inconsistent. However, in pursuit of its mission to achieve 14% operating margin performance by 2025, the firm now has 50% of its resources based in India and continues to invest in innovation centers and other local capabilities. It is essential for Capgemini to embrace India more effectively. Although Capgemini has bolstered its workforce in India, iGate capabilities have largely been subsumed without a sizable uptick in India utilization.

Capgemini has thus far managed the pandemic well, but it hasn’t taken as much advantage of the strong demand environment as many of its Indian-heritage TWITCH (TCS, Wipro, Infosys, Tech Mahindra, Cognizant, and HCL) peers. Looking ahead, the battleground will be around talent, and India will be center stage as attrition is at an all-time high. Consequently, the battle for talent has taken on a new dimension. The operating margin buffer of the Indian-heritage providers likely puts them in a better position to push for fresh talent aggressively and absorb the wage hikes. This, rather than capabilities, might decide the leadership in the market over the coming quarters.

Takeaways

• Capgemini is holding fast to its strategic framework and with it going deep on specific “playing field” domains enabled by cloud and data.
• Enterprises should take advantage of Capgemini’s deep and growing domain expertise aligned to its playing fields, but if end-to-end transformation capabilities across domains is what you require, consider other firms.
• We expect the “great resignation” war for talent will have operating margin implications that some firms with room to spare will manage well, while others will struggle.