Margin squeeze forces IT firms to make tough calls

Faced with intense margin pressure, they are reducing variable payouts, instructing employees to avoid unnecessary travel and exploring other ways to cut costs in an attempt to protect their profits.

Industry insiders and experts see the companies taking harsher steps such as putting more junior engineers on projects, reducing subcontracting expenses and even deferring increments and bonus payments in coming quarters. Mid-level and “mid-senior” employees might even see their salaries cut, with chances of redundancy not being ruled out.

That is not good news as the $227 billion sector is a significant job creator and contributor to the gross domestic product of Asia’s third-largest economy.

“What IT firms are dealing with is one potential problem and another real problem,” Siddharth Pai, Founder and Managing Partner of venture capital firm Siana Capital Management, told DH. “The potential problem is what recessionary impact will have on companies. But it is still in the realm of the unknown. There is uncertainty over the demand environment which is also getting weaker.”

The real problem was the astronomical rise in engineer salaries, especially in the 3-6 years and 6-10 years experience bands, following a talent crunch during the pandemic.

“This is not a sustainable thing as companies are now stuck with high-cost resources who can’t do the billing that they are expecting. So, reduction in variable payment makes sense,” Pai said. “Given the margin squeeze, IT firms will continue to reduce costs and most of the pain will be felt by the mid-level staffers.”

The margins of most large and mid-tier IT companies contracted in the first quarter of the current financial year.

Market leader Tata Consultancy Services’ operating margin fell to 23.1 per cent, a drop of 190 basis points from the previous quarter. Infosys’ margin contracted 1.5 per cent sequentially to 20 per cent during this period. Wipro’s woes were bigger, with its operating margin dropping 200 basis points to 15 per cent in the three months.

The story is no different for most mid-tier IT companies, with their management teams identifying rising wage costs as the key factor eating into their margins.

Multiple levers to pull

IT firms spent around 57 per cent of their revenues on employee wages in the latest first quarter. Therefore, deferring bonus payout and delaying salary increments are some of the options they have in protecting their margins.

They are also looking at various other levers such as increased automation, more offshoring and price raise in certain verticals to offset the margin pressure, experts said. “Increasing (the) offshore component by at least 1-2 per cent, raising pricing in certain pockets along with putting in efforts to win more fixed-cost contracts are the other levers available for Indian service providers to support margin,” said Pareekh Jain, the founder of Pareekh Consulting. “Though automation is an ongoing initiative, IT firms can increase their share.”

“As far pricing is concerned, there are pockets like oil & gas, pharmaceutical and niche skills such as Cyber security which can fetch higher prices for outsourced contracts, ”Jain added.

He sees companies pushing for more solutions that can be delivered with minimum people support and experimenting more with the employee pyramid to cut costs.

With a record number of fresh engineering graduates being onboarded in the last one and a half years, service providers are manning the team, executing projects with a suitable number of junior hands to keep the cost low.

“We know how the pyramid was. So, we are quite confident in the go-forward model of taking out the cost from our structure,” Infosys Chief Financial Officer Nilanjan Roy has said.

In the last financial year, the top four IT firms - TCS, Infosys, Wipro & HCL Technologies - onboarded around 2 lakh fresh engineering graduates. These companies plan to add around 1.5 lakh freshers in the current year.

Through such massive addition, IT firms are also looking to reduce their dependence on subcontractors. Projects outsourced to third parties shot up to around 11-12 per cent, versus 5-6 per cent in the pre-pandemic period.

“If demand slows down owing to recessionary impact in key markets, IT firms will resort to the reduction of subcontractors, and right employee mix in projects to protect margins,” Sanjeev Dahiwadkar, the founder and CEO of mid-tier IT firm ITShastra, said. “ If push comes to shove, reduction in headcount is not ruled out. It all depends on the demand environment. Senior and mid-level employees will face the heat in that case.”