IT firms offshore work to cut costs

Faced with budget constraints and margin pressures, Indian IT services providers such as Tata Consultancy Services (TCS), Infosys, Wipro and HCL are moving more work offshore (to India) rather than onsite (at the client’s site) in a bid to contain costs.

The offshore-onsite mix has changed from 70:30 ratio to 85:15. While this benefits clients who do not want to pay extra in a slowing economy, it also helps IT companies utilise their bench strength better. Holding a bench at offshore locations is cheaper by two-and-a-half times (since salaries are paid in Indian rupees) compared to maintaining a bench onsite (paid in dollars, euros or pound).

The top four IT firms (since Satyam is now out of the pack till it restates its figures), note analysts, have increased their offshore revenue component by 80-150 basis points (bps) to optimise costs. Moreover, fixed-price contracts have also been increased by 2-4 percentage points (or 200-400 bps) over the quarter because they deliver better realisations than time and material billing.

For instance, TCS, India’s largest IT software and services exporter, saw an improvement in operating margins by 53 bps through moving more work offshore and the offshore mix also improved by 106 bps in the third quarter that ended December 31, 2008. “In this quarter, we have achieved an offshore movement of 106 basis points and achieved a good volume growth of 2.42 per cent and then maintained our pricing,” said N Chandrasekaran, TCS’ chief operating officer, during an analyst call after the last quarterly results.

India’s second-largest IT services player Infosys’ offshore volumes sequentially grew 3.3 per cent, while onsite volumes dropped by 1 per cent in the quarter. The company is also seeing its offshore revenues going up as most of enterprise resource planning (ERP) work is done from offshore now. Moreover, the IT heavyweight feels that telecom majors in France and Germany have announced budget cuts and hence need to engage with offshore players.

However, moving work offshore also implies lower margins for IT firms because the billing rates offshore are almost half that of onsite. According to Sabyasachi Satpathy, director and co-founder of Mindplex Consulting, an outsourcing advisory services firm, “There is a definite rebound towards offshoring and the vendors are cutting down the onsite work. The reason being that there are not enough projects and the clients also want to reduce costs. This culminates in the IT companies taking a hit on their toplines.”

“The margins of the IT companies are hit because their clients heavily cut down on the discretionary projects. In fact, on a quarterly basis, the margins are hit 2-3 per cent,” said Avinash Vashistha, chairman and CEO of research and advisory firm Tholons.

In the the twin challenges of customers looking for price cuts and stiff competition between vendors chasing fewer deals, analysts say that cost-cutting will be the foremost driver that will hit the IT companies’ margins. “Margins can vary between 20- and 30 per cent depending on the type of the project, its pricing and the vertical that is being served,” added Satpathy. TCS has increased its offshore revenue by 1per cent and sees more offshore movements in the coming quarters. Wipro’s revenue mix from fixed price went up by 440 bps and offshore mix rose by 90 bps in the quarter.

HCL Tech saw the same trend with realisation in constant currency going for offshore by 1.5 per cent, while the onsite went down 1.2 per cent in the quarter (Q2 for HCL Tech) under review. “There is a cost for knowledge capture, which is called transition and then there is a cost for moving onsite work offshore or moving from existing vendor employees to your employees,” said Vineet Nayar, CEO, HCL.

For Infosys, the pricing on reported basis fell 5.8 per cent onsite and 4.6 per cent offshore and it considers this as one big operational lever. “This increase in offshoring is not enough for our IT firms as of the total outsourceable potential, we have explored only 15 per cent of it. So there is a long way to go,” explained Vashishtha.