An inflexion point

IT industry can change fundamentally

For several quarters, the information technology (IT) industry has been cautious, pointing to concerns about margin pressures, slow demand, and a high employee churn. Company after company provided similar careful guidance, and said clients were cutting discretionary IT expenditure, budgeting only for projects with an instant cost-cutting impact or immediately positive revenue implications. The news that Tata Consultancy Services (TCS) and insurer Transamerica have decided to terminate a $2 billion contract due to the challenging macro environment is a pointer that these worries were not unfounded. The deal in question, signed in 2018, involved TCS working with US-based Transamerica to enable the digitisation of over 10 million policies into a single integrated platform over a 10-year period. While TCS (which registered FY23 revenues of $27.9 billion) can survive the hit to revenues without much ado, this could certainly affect the already poor sentiment in the industry.

Many investors view the IT sector as a play on the US economy, as well as a generic hedge against a weaker rupee. Although the rupee has weakened substantially against the dollar in the past 12 months, IT stocks have registered slow growth alongside the gloomy guidance. The Nifty IT Index has underperformed, gaining 7.4 per cent in the past year, while the Nifty has increased over 22 per cent. Valuations for the IT Index have fallen slightly to a price-to-earnings ratio of around 24.9 from around 25.9 a year ago, as analysts have downgraded many players. Some analysts claim this is still a high discount, given macro headwinds in the global economy. Moreover, industry watchers are suggesting that global IT services are at an inflexion point. After decades of preferring to outsource IT-related functions and services, global majors across a wide swathe of industries are considering setting up their own in-house global capability centres (GCCs).

Indeed, industry body Nasscom has been lobbying for GCCs to be located in India, with some degree of apparent success. Nasscom claims that around 45 per cent of such GCCs are based in India. The reasons for this shift in strategy range from simple cost-cutting to the belief on the part of businesses that the specific needs of their respective sectors, and of individual companies, could be best served by a dedicated in-house IT department. In calendar 2023, it’s likely that GCCs located in India will see a significantly higher net headcount addition than the $200 billion Indian IT industry. In the past three years, the number of GCCs in India has grown from around 500 to over 1,700, employing over 1.5 million professionals with deep penetration across Fortune 2000 companies and across multiple sectors. This is encouraging as GCCs employ high-end IT professionals, domain experts in respective sectors, and lower-tier support staff as well.

GCCs aim to digitally transform their respective businesses, enable the parent to compete more effectively against new-age start-ups, drive research, and develop solutions, products, platforms, and intellectual property for global utilisation. In effect, GCCs usurp the role of many IT services outfits, and this could put a question mark on the future of the Indian IT services business model. While GCCs bring in investment and provide employment, they reduce the wealth-creation prospects of listed IT services outfits. Hence, this could be an inflexion point rather than a simple cyclical slowdown. The IT industry will have to reinvent itself in the face of this competition. If it cannot, there could be further valuation downgrades.