Cost escalation owing to scarcity of talent and more frequent use of temporary workers on onsite locations, especially in the key US market, is likely to affect the growth of IT majors in FY20.
Indian IT services firms such as TCS and Infosys have announced a record number of deal closures in the past couple of quarters. The delivery of these projects is expected to take off during this financial year.
According to analysts, the growing attrition, as in the case of Infosys, and rising sub-contracting costs, reported by industry leader TCS, are some of the factors likely to affect the projects, dragging the growth as well as profitability of the sector. In Q1FY20, TCS, even with its industry lowest attrition numbers, reported the highest ever sub-contracting share of revenue. “We’ve taken very strong measures, and some of the attrition here is what we call involuntary attrition and some of the attrition is also for individuals who will leave to go to graduate schools or for higher education, and that is somewhat seasonal,” Infosys Chief Executive Officer, Salil Parekh, had said while addressing concerns around the high attrition of 23.4 per cent reported by the company in the June quarter compared to 20.4 per cent in Q4FY19.
Higher costs from strengthening the sales team, setting up overseas development centres, sub-contracting expenses (7.5 per cent of revenue) and recruitment in overseas locations led to a 320 basis points YoY decline in EBIT margin for Infosys. “Considering, this is a seasonally high attrition quarter, an attrition rate in excess of 23 per cent is very high (for Infosys) which could impact project delivery at some point,” wrote Harit Shah, analyst, Reliance Securities in a note to investors. Further, cost escalation owing to scarce digital talent and higher onsite hiring can lead to execution risks and further margin pressure for the company, noted Shah.
Higher cost of services are likely to pull down Ebit margin for the Bengaluru-based company to 21.5 per cent in FY20 and, thereafter, improve to 22.6-22.8 per cent in FY21-22, said Neerav Dalal, research analyst with Maybank Kim Eng Securities.
On the other hand, even with 11.5 per cent attrition rate, TCS is likely to see the cost pressures increasing due to local hiring and spends towards contractual staff in the US. In Q1, TCS reported their highest ever subcontracting costs at 8.4 per cent of the revenue. Both TCS and Infosys have been steadily increasing local hiring in the US by roping in local staff who command a higher salary package.
“While the US campus hires command over $70,000 (typically), we see a sharp wage inflation for modestly experienced local (US) resources, with professionals with three years’ of experience potentially commanding 25-30 per cent higher pay than when they started out. Thus, we are not sure that local onsite pyramid can be built out nearly as effectively as offshore (India-based) pyramid,” wrote Viju K George, analyst with JP Morgan.
Consequently, George notes that TCS is likely to struggle to hit the low-end of its 26-28 per cent target Ebit margin band unless rupee offers adequate support. Margin pressure is going to a big challenge for other companies in this space as well.