As consulting firms enter tech, problems grow for Indian IT companies

The quarterly earnings season for India’s outsourcing firms has begun on a cautiously optimistic note. Tata Consultancy Services Ltd., the largest of the country’s software exporters, reported better-than-expected growth of 8% in net income. Its operating margin, which had slumped to a seven-year low of 23% in the three months to June, rose by 1 percentage point as Mumbai-based TCS dialed down on new hiring.  

From here on, however, things may get challenging. European clients, which typically account for a quarter to a third of Indian firms’ sales, are almost certain to cut their tech budgets — at least until the war in Ukraine comes to an end and energy supplies normalize. The more important US market may also disappoint as the Federal Reserve slows the economy to tame inflation.

Some American companies might still look to information technology to shed costs as they hunker down for a recession. That means new outsourcing orders. However, the pandemic-era splurge on IT is now in the rearview mirror for Indian vendors. The coders they could hire easily during Covid-19 lockdowns are getting restless with a lack of career progression since the reopening of the global economy. TCS’s attrition rate last quarter was more than 21%. 

All these are transient problems for an industry that came into its own at the start of the millennium — the Y2K bug put India on the world map of tech services. Two decades later, the publicly traded Indian software exporters garner more than $100 billion in revenue, employ 2 million people and have a market capitalization of nearly $350 billion. TCS alone is more valuable than International Business Machines Corp.

But size has come at the expense of agility. The outsourcing industry is all about helping global companies reduce friction at work, something that consulting firms have been doing better of late.

Managed tightly from headquarters in Mumbai or Bengaluru, Indian IT firms still have a strong labor-cost advantage when it comes to large-scale enterprise software. The locus of demand, however, is moving away from implementing technologies from SAP SE or Oracle Corp. at clients’ premises. Demand for cloud-based workflow automation has seen ServiceNow Inc.’s revenue surge sixfold since 2015, while sales at the San Francisco-based Atlassian Corp. have bulked up eightfold thanks to Jira, a cloud-based application for tracking projects.

The rapidly growing German startup Celonis SE, a pioneer in so-called process mining, claims to help customers “fix inefficiencies they can’t see.” Salesforce Inc., which owns the business productivity tool Slack, had a third of SAP’s revenue in 2017. Now it’s just 12% smaller. Shopify Inc. commanded a 19% share last year in digital-commerce software, against Oracle’s 6%, according to Bloomberg Intelligence.

In implementing new-age IT platforms, the Indian outsourcing players are lagging way behind the likes of Accenture Plc and Deloitte Consulting.

In 2015, Accenture acquired Cloud Sherpas, a small outfit of 1,100 employees of which 500 were Salesforce implementation consultants. Seven years later, cloud is a $26 billion business for Accenture, growing at 48% annually. Indian outsourcing firms have also ramped up cloud-based offerings, but they’re struggling to build scale in popular new technologies like the human-resource management system offered by Workday Inc.

Tech is now a big part of what consulting firms do. Which is why they’re getting into the nuts and bolts of their clients’ operations —  or at least boosting their capability to do so. McKinsey & Co., which in recent years has acquired more than 20 tech-related companies, hired Jacky Wright, previously Microsoft Corp.’s chief digital officer, as its first-ever chief technology and platform officer last month. Deloitte is aggressively recruiting coders and investing in training them on new technologies.

As the dividing line between business and tech blurs at global corporations, Indian software vendors risk falling further behind their consulting rivals. Outsourcing companies are comfortable talking to the in-house tech czars at large corporate clients. But when it comes to deciding priorities, functional heads are increasingly calling the shots. And they don’t speak the language of tech. A related trend is the rise of citizen developers — non-IT professionals coming up with automation applications for their teams using so-called low-code platforms such as Appian. 

Mind you, Salesforce and Workday implementation may not offer a ticket out of a global recession next year: The new IT players are also worried about demand. But at least they’re more plugged into the future of work — flexible, digital and often remote — than their traditional enterprise-software rivals. Top-tier Indian outsourcing firms should by now have built billion-dollar franchises around implementing the newer platforms. To get back into the game, they will need meaty acquisitions and a hard look at the state of work in their own firms, starting with freshers’ pay that has been stuck for nearly two decades at around 350,000 rupees ($4,250) a year. 

The Mint reported last week that entry-level positions in the Indian IT industry may be slashed by 20% in the financial year that will start next April. That might give the outsourcing firms a little breather on profit margins. But too much focus on the current slowdown may be unhealthy. It’s the future they need to confront — and make bold bets on.