Investors worry that India has passed ‘peak outsourcing’
Investors worry the Indian industry’s juggernaut that is IT outsourcing is slowing down.
Shares in Tata Consultancy Services (TCS), the back office group that is the country’s second-largest company by market capitalization, are down 14 percent since the beginning of the year, compared to 6 percent for the benchmark Nifty 50.
Rival Infosys was down 20 percent to date before reporting strong results in July.
But N Ganapathy Subramaniam, chief operating officer of TCS, brushed aside all concerns in an interview with the Financial Times. The “world needs technological talent and it is scarce these days. And India has the largest pool of technology skills anywhere in the world,” he said.
IT services are an emblem of India’s outward-looking economy, serving major international companies – TCS clients range from AstraZeneca to Citibank, Microsoft and Marks and Spencer. The sector is also a major creator of skilled jobs, employing more than 5 million people. TCS alone hired 118,880 “freshmen” or recent graduates in the fiscal year ending March 2022.
With more than 600,000 employees, TCS is one of the world’s largest private sector employers, after Volkswagen with 673,000 employees, but ahead of the logistics group UPS with 534,000.
But some analysts have been skeptical that IT services growth will continue to be strong, especially if there’s a global recession, and are concerned about the industry’s high employee turnover, which is making salaries more expensive.
Earlier this year, Nomura wrote that a growth slowdown for Indian IT services was “probably earlier than expected”, predicting “tough days ahead for tech spending”. JPMorgan deemed the industry’s “peak growth behind” [it]”.
In early July, TCS missed analyst expectations, reporting a 10 percent increase in year-over-year quarterly revenues to $6.7 billion and an operating margin of 23.1 percent, down 2.4 percentage points from the first. quarter of the previous year.
“It was a challenging quarter from a cost control point of view,” said financial director Samir Seksaria. The lower operating margin “reflects the impact of our annual salary increase, high talent churn management costs and the gradual normalization of travel expenses.”
Other IT service providers are also disappointing investors. Bangalore-based Wipro is down 41 percent since the beginning of the year after several cuts by investment banks. Tech Mahindra, another outsourcer, also fell 41 percent.
Last Sunday, Infosys surprised analysts by reporting that quarterly revenues rose 17.5 percent year over year to $4.4 billion, ahead of estimates. But profit margins, a closely monitored measure of industry profitability, shrank from 23.7 to 20.1 percent over the same period.
Not everyone is pessimistic. In a recent note, Macquarie argued that companies like TCS and Infosys were well positioned to weather an economic downturn: “Unlike [the] In the 2000s, India Tier-1 IT Services companies are strategic partners – not glorified workforce providers who will be the first to suffer from budget cuts.”
Subramaniam agreed, saying customers could “make some customizations, but I don’t think the spending itself will go down” and while “people might not buy new hardware,” they could increase spending on things like cloud computing, for example.
Still, there are definitely things to worry about. In the past, TCS has offset rising costs by increasing productivity and raising prices, or currency gains, Subramaniam said. But this time will be trickier, “because while… [the] rupee has weakened against the dollar, [it] has become stronger against other currencies”.
In addition to the cost of re-travelling as lockdowns ease, Subramaniam said rising payroll costs are also putting pressure on operating margin, which is a factor previous financial year fell short of his ambitious band of 26-28 percent and came in at 25 percent.
But Subramaniam insisted these higher salary costs were “an aberration.”
“It will be less, that’s our feeling, but at least in the near future [for] about two or three quarters. . . if I’m going to hire someone, I’ll have to pay 30 percent more [than] I pay.”
He also believes that employee turnover has peaked. However, he said he was concerned about the tens of thousands of new employees who had worked remotely and “don’t know the culture of TCS”.
Companies like TCS and Infosys, previously the number one choice for millions of graduates with technical skills, now compete with hundreds of start-ups offering high salaries thanks to venture capital financing.
Indian start-ups took out $38 billion in funding last year, according to Fintrackrthree times the previous year.
“You can never match a salary a start-up gives,” said Subramaniam, adding that the slowdown in venture capital funding this year would “bring some sanity” to the recruiting market.
Meanwhile, TCS, founded in 1968, is negotiating a changing work culture, with younger employees expecting more flexibility and choice.
“Senior people 10 years and older want to come to the office,” Subramaniam says. “The younger they feel: look, don’t force me to come.” Younger employees “want a lot more flexibility and a lot more commitment to what they will do and how much time they will take to complete it,” he added. “So we have to change our thinking at that level.”