AI Startups Positioned to Revolutionize India's IT Services Despite SaaS Sector Underperformance
As global AI agents begin automating legacy system migrations, Indian IT firms are confronting a significant valuation crisis. This development has prompted venture capital firms like Lightspeed Venture Partners to actively seek entrepreneurs capable of enhancing margins through advanced automation technologies.
The SaaS Shortfall: India's Missed Opportunity
Despite several software-as-a-service startups preparing for public market debuts this year, India has failed to capitalize on the SaaS boom of the 2010s, according to Dev Khare, partner at Lightspeed Venture Partners. "Over the last 15 years, SaaS has come in under expectations as a category, in terms of how many $5 billion-plus companies we expected to emerge from India," Khare stated in an interview.
While India has witnessed notable SaaS successes including Freshworks (listed on Nasdaq) and Zoho (which has expanded from small business contracts to enterprise deals), only a handful of truly innovative companies emerged from that era. These include healthtech firm Innovaccer, contract management company Icertis, and data observability platform Acceldata. Notably, these companies were founded by Indians who initially started operations in India before relocating headquarters to the United States.
The Fast-Follower Problem and AI's Disruptive Impact
Khare identified the proliferation of fast-follower companies as a primary issue during the SaaS era. "In the pre-AI era, Indian companies could still enter mature categories in the US or Europe and work their way up from the small and medium business segment to the mid-market," he explained. "It was essentially the same product, just lower priced."
Fast-follower strategies allowed companies to minimize research and development costs, assume lower risks, and capture market share with more mature products. However, with artificial intelligence transforming enterprise markets, this model has become obsolete. "I don't think the opportunity for India anymore is to wait 10 years for AI market leaders to emerge and then disrupt them from the bottom," Khare emphasized. "Entrepreneurs need to go at problems immediately, and lead if possible."
Targeting the $283 Billion IT Services Sector
While India may have underperformed in SaaS, AI startups are now exceptionally positioned to disrupt the country's massive information technology services sector. Lightspeed identifies three primary opportunity areas: application building from scratch, software implementation services, and application maintenance services.
"There are massive revenue streams across three segments of IT services that have not been automated," Khare noted. "India has got a good shot, given the legacy of IT services here."
Lightspeed has already invested in the $23 million Series A round for vibecoding startup Emergent last year, and participated in the company's recent $70 million Series B funding in January led by SoftBank Vision Fund 2 and Khosla Ventures. The firm is currently exploring opportunities across the remaining two segments, with companies like Ressl (an AI-powered Salesforce implementation firm that raised $500,000 from Y Combinator) and Realfast (which secured $2.75 million from RTP Global, DeVC, and Peak XV Partners in 2024) already making strides.
VC Interest and Industry Consolidation
Lightspeed joins a growing list of venture capital and growth funds seeking startups that can transform how the $283 billion IT services industry operates. Early-stage investors including Bessemer Venture Partners, Peak XV Partners, Stellaris Venture Partners, Accel, and Elevation Capital are targeting sector-transforming startups, while growth-stage funds like TVS Capital Funds have also entered the arena.
Although AI-first disruption of IT services remains in early stages with few startups raising substantial funding, Khare predicts inevitable consolidation. "These are likely to be clever entrepreneurs who will acquire IT companies running at 20% net margins, bring them onto their platform, and then drive margins upwards of 40%," he projected.
Market Impact and Agentic AI Disruption
AI disruption continues to generate significant concern among IT services companies. Recent announcements by US-based Palantir and foundational model startup Anthropic have sparked anxiety among industry incumbents due to their ability to automate work traditionally central to IT services revenue.
During its earnings call, Palantir revealed that its AI platform Hivemind can now autonomously migrate data from legacy systems to new systems—a task historically performed by IT services firms. Meanwhile, Anthropic announced its agentic AI system Claude Cowork, designed to streamline white-collar work, followed by plugins that automate tasks across multiple applications within a single system.
These developments have significantly impacted Indian IT stocks. TCS, Infosys, HCLTech, Wipro, and Tech Mahindra fell between 3.73% and 7.19% at market close following the announcements. Even with partial recovery, the Nifty IT index closed down 0.56%, with eight of ten stocks ending in negative territory.
Key Industry Takeaways
- The Indian SaaS boom of the 2010s failed to produce the anticipated volume of $5 billion+ companies that venture capitalists had projected.
- The strategy of building cheaper versions of existing Western software has become obsolete in the AI era, with immediate innovation now representing the only viable entry point.
- AI startups are specifically targeting the $283 billion IT services sector, focusing on automating manual application maintenance and implementation processes.
- Venture capitalists anticipate a trend where AI-first founders acquire legacy IT firms operating at 20% margins and utilize automation to elevate them to 40% margins.
- Breakthroughs in agentic AI from companies like Anthropic and Palantir have already caused significant declines in the stock prices of India's leading IT firms.
