SQS tests India – and a lot more besides!

We met up last week with Rudolf van Megen and Rene Gawron, CEO and CFO respectively of Cologne-based and AIM-listed independent testing services company SQS Software Quality Systems AG. Although only a small player in the grand scheme of things (FY07 revs c. €121m) there were three aspects of SQS that really piqued our interest.

First, it’s that SQS is a testing services pure-play. Now, it also claims to be the “global leader in independent software testing and quality management services”, though it’s not actually the largest software testing business globally (we think that honour belongs to Wipro, with some $400m in testing revenues over the past 12 months). But, we don’t know of any other pure-play that comes close. You might already know my views on testing services (see my 'opening rant'!) – that this is a great, but little understood, service line which is attracting more attention as CIOs lean more towards ‘making do and mending’ legacy applications rather than buying replacement software. Quality players attract predators, sometimes from unlikely quarters (remember when Capita bought Mission Testing back in 2002?), and we can’t believe that most of the ‘usual suspects’ wouldn’t have designs on SQS.

The second aspect of SQS that intrigued us was its firm belief in using earn-outs as a key incentive in its reasonably prolific acquisition strategy. We’ve been stimulating a lively debate of late (see Earn-outs?) on this topic, but it’s very clear which camp SQS belongs to. They find that an unambiguous profit-based earn-out with a two (or sometimes three) year time frame not only helps to retain top people, but also bridges the gap between the seller’s (often aspirational!) asking price and the SQS’s view on valuation. It’s helped that in most cases, SQS has acquired to open new markets (or, as in the UK with Cresta, a reverse-take-over), so the issue of integration isn’t so acute. We think integration will become more of a challenge as SQS relies increasingly on offshore delivery (see below), but it sounds to us like van Megen and Gawron are already on the case.

The third aspect about SQS that we think is a model other S/ITS companies should pay close attention to is its June acquisition of a majority stake in Indian firm, VeriSoft. Prior, SQS used Egypt (for German and French speaking resources!) and South Africa for low-cost service delivery, but the numbers were small (200 among some 1,400 total employees). VeriSoft brought access to 150 India-based testing professionals to add to the mix. SQS management reckons the ‘sweet-spot’ offshore/onshore effort for testing services is around 3 offshore for every 1 onshore - you don’t need to do the sums to see where SQS will be growing headcount fastest! To be honest, we do wonder whether 3:1 is aggressive enough – most of the Indian SIs can reach 90% offshore mix on mature testing projects. But Gawron makes the legitimate point that packaged software product testing (a staple service for many Indian SIs) lends itself to a higher offshore mix than enterprise application testing, SQS’s domain. Nonetheless, 75% offshore is very good if SQS can get there, and is around the average mix Indian SIs achieve across their broad range of IT service lines.

So despite its modest size, we think many players in the S/ITS sector could learn a lot from SQS, and we will certainly let you know how their ambitious growth plans – both organic and acquisitive – take shape.