Utilisation a key margin driver in Q2 for IT companies

Even as growth picks up, companies need not have high bench strength, as attrition levels remain benign

The second quarter has been the best in six quarters for tier-1 software services companies. Not only has growth returned to the sector, what is relevant is the growth is broad-based. After last year’s 11 per cent revenue growth, the top-tier technology companies have reported a 14 per cent revenue expansion in the second quarter. While it’s a given that the sector’s growth will not return to earlier levels of 25 per cent and above, some levers to improve margins remain. Antique Stock Broking says continued strength in large verticals such as banking and financial services and manufacturing have contributed to 50 per cent of revenues.

Not only has revenue growth improved, it is accompanied by a robust margin expansion. Tier-1 IT companies have seen their margins expand by 180 basis points to 27 per cent. In the past, robust growth has also brought other related issues such as attrition and wage inflation. However, this time around, companies may not face so many issues, believe analysts. For starters, the second quarter has seen utilisation levels improve sharply for a few tier-1 players like Infosys. Higher utilisation levels imply a slimmer bench and this improves revenue per employee.

Another interesting shift seen in the second quarter are high utilisation levels seen in the second quarter. Kotak Institutional Equities says excluding trainees, utilisation rates vary between 79 per cent and 85 per cent for the top IT companies (excluding-Wipro). Utilisation is in line with or higher than historical average. There is a subtle shift in the manner in which companies are looking at their bench strength and utilisation levels. These are levels seen during the boom years of IT. While many believe sustaining these levels may be difficult, Kotak Institutional Equities believes utilisation will improve in the coming quarters. Companies have historically maintained a high bench strength due to higher attrition rates.

However, in the current environment, even if growth picks up to 20 per cent levels, the companies will still be able to function at 85 per cent utilisation levels. The reason for this is that attrition is expected to remain benign as the supply of engineers is currently higher than demand. Credit Suisse says: “The fact that the demand environment is improving is well discussed, this time the usual acceleration in wage pressure that accompanies improving demand seems absent. Attrition has remained low and wage inflation remains in single digits.” Companies are in a better bargaining position than before and this is expected to continue due to structural changes in the supply-demand scenario.