IT services giant DXC announced yesterday its $2 billion acquisition of Luxoft, a Switzerland-based product engineering and digital services provider. Luxoft will become a “a DXC technology company,” and its current CEO Dmitry Loschinin will stay on and report to DXC CEO Mike Lawrie.
Will the combination of a $24 billion IT services juggernaut and a $900 million European digital firm work? Time will tell. But the motivations that brought these two together are clear.
Let’s start with the acquired. While Luxoft may be based in Switzerland, it is a Central / Eastern European firm through and through. You can see this heritage in its digital and engineering talent, most of whom hail from Central or Eastern European countries. I had the opportunity to visit Luxoft in Bucharest a few years ago, and what struck me was not only the breadth of their engineering talent, but also the depth of their industry expertise. Eighty percent of Luxoft’s engineers have a PhD, and 70 percent of billable resources have more than five years of experience. And its industry experience in automotive and financial services (specifically capital markets and investment banking), is unrivaled among IT services providers.
It’s in the automotive industry that Luxoft really shines. Automotive clients represent nearly a quarter of Luxoft’s business. And this is soon to be 30 percent given the pace at which it’s growing. A unique combination of smart engineers who deeply understand this market, combined with technology, frameworks and accelerators makes Luxoft both a product engineering and digital services firm. As we wrote last year, “Luxoft has very solid positions in three significant areas of automotive, including human-machine interface, digital cockpit, human-machine interface development and under-the-hood technologies.” This is not a your-mess-for-less firm.
But this industry specialization also is Luxoft’s Achilles heel. A significant portion of its revenue is concentrated at two large financial services companies, and when the winds changed at these firms and they decided to insource more, Luxoft took a hit in the market, even as it was growing other parts of its business. A challenge for Luxoft is that other publicly traded product engineering and digital firms in this space – like Globant and EPAM – also are growing quickly but don’t have the revenue concentration or geopolitical concerns that Luxoft does.
Then there’s DXC. As we wrote way back in 2016 on the HPE-CSC merger, prior to the DXC brand unveiling, “The focus on increasing digital capabilities also puts a premium on high-end, vertically specific consulting services, focused on front and middle-office data and applications. These consulting services serve as a funnel into next-generation, consumption-based managed services, so without this front-end consulting capability, traditional managed services firms will suffer.”
While industry-specific digital consulting has been an aspiration for DXC from day one, its reality today is more sobering. DXC has more than $14 billion in annual contract value coming up for renewal in the next 24 months, and most of that is traditional ADM and infrastructure work. As we’ve described in the ISG Index™ several times, these deals will likely be smaller even if they do renew, which is no guarantee given that more than half of incumbent providers lose the entire scope of work in competitive negotiations.
DXC also has seen several high-profile executive departures over the past year, namely Karan Puri who came over from HCL to run DXC’s Americas business. This came on the heels of a significant revenue drop. Needless to say, it’s been an extremely tough environment for DXC ever since the HPE-CSC merger was announced.
So why Luxoft? And why now?
It’s not about customer synergies. Even if there were some to be had, the two firms would be doing very different things – Luxoft likely working in the front/middle office, DXC working in the back office. And it’s not about geography. DXC is a $24 billion firm that can be anywhere it wants to be.
What it is about is talent, which correlates with one of the main messages we see written plainly in the earnings statements of the major outsourcing and as-a-service firms over the past couple of quarters. The biggest concerns are not what you’d expect: geopolitical tensions, increasing tariffs, higher interest rates. The biggest concern from the C-level is access to digital talent.
DXC needs a major injection of digital talent to catch up with its faster-moving peers who are all fighting for a share of the emerging $40 billion digital services market. The fact is Luxoft has this digital talent today and has better access than most to an additional pool of 450,000 potential Central/Eastern European digital resources (investor presentation, page 6). This, plus Luxoft’s lagging market performance in comparison to its peers made them a prime target for DXC.
Are we likely to see other mid-size hybrid product engineering/digital firms get snapped up in the near future? It’s just a matter of time, but the premium will likely be much higher. For now, Luxoft gets a massive injection of funding and resources to help it scale more quickly and move into adjacent verticals, and DXC gets the digital talent it desperately needs to tap into a hyper-growth market.
About the author
Stanton helps enterprise clients maximize the value of their digital investments. He is also lead analyst for the quarterly ISG Index Insider, helping service providers understand how disruptive technologies are transforming the IT services market. Stanton is a recognized expert in emerging technologies and services, and has been quoted in CIO, Forbes and The Times of London.