Investors fear India has passed ‘peak outsourcing’

Investors fear that India’s IT outsourcing industry juggernaut is slowing down.

Shares of Tata Consultancy Services (TCS), the back-office group that is the country’s second-largest company by market capitalization, have fallen 14% year-to-date, compared to 6% for the benchmark Nifty 50 index.

Rival Infosys had fallen 20% year-to-date before posting strong results in July.

But N Ganapathy Subramaniam, chief operating officer of TCS, dismissed any concerns in an interview with the Financial Times. The “world needs technological talent and there is a lack of it today. And India has the largest pool of tech skills in the world,” he said.

IT services are an icon of India’s outward-looking economy, serving huge global corporations – TCS’ clients range from AstraZeneca to Citibank, Microsoft and Marks and Spencer. The sector is also a major creator of skilled jobs, employing more than 5 million people. The TCS alone hired 118,880 freshers, or new graduates, in its fiscal year, which ended in March 2022.

With more than 600,000 workers, TCS is one of the largest private sector employers in the world, behind Volkswagen with 673,000 employees but ahead of logistics group UPS with 534,000.

But some analysts are skeptical of continued growth in IT services, particularly in the face of a global recession, and worry about high employee turnover in the industry, which is making salaries more expensive.

Earlier this year, Nomura wrote that a slowdown in Indian IT services growth was “probably sooner than expected”, predicting “difficult days ahead for technology spending”. JPMorgan estimated that the “spike of industry growth behind [it]”.

In early July, TCS beat analysts’ expectations, reporting a 10% year-on-year increase in quarterly revenue to $6.7 billion and an operating margin of 23.1%, down 2.4 percentage points. compared to the first quarter of the previous year.

“It was a tough quarter from a cost management perspective,” said CFO Samir Seksaria. The lower operating margin “reflects the impact of our annual salary increase, the high cost of managing talent turnover and the gradual normalization of travel expenses.”

Other software houses also disappoint investors. Bangalore-based Wipro is down 41% year-to-date after several downgrades by investment banks. Tech Mahindra, another contractor, is also down 41%.

Last Sunday, Infosys surprised analysts by reporting quarterly revenue up 17.5% year-on-year to $4.4 billion, ahead of estimates. But profit margins, a closely watched measure of industry profitability, fell from 23.7% to 20.1% over the same period.

Not everyone is pessimistic. In a recent note, Macquarie argued that companies such as TCS and Infosys were well placed to weather an economic downturn: “Unlike [the] In the 2000s, India’s Tier 1 IT services companies are strategic partners – not glorified personnel providers who will be the first to bear the brunt of the cuts.

Subramaniam agreed, saying customers could make “some readjustments, but I don’t think the spending itself will go down” and while “people might not buy new hardware,” they could increase their spending. in cloud computing, for example.

Still, there are certainly things to worry about. In the past, TCS has offset rising costs by increasing productivity and raising prices, or through foreign exchange gains, Subramaniam said. But this time it will be more delicate, “because if [the] the rupee weakened against the dollar, [it] strengthened against other currencies.

In addition to travel costs again as lockdowns eased, Subramaniam said rising labor costs also reduced operating margin, which last exercise exceeded its aspirational range of 26-28%, reaching 25%.

But Subramaniam insisted these higher wage costs were “an aberration”.

“It’s going to decrease, we think, but for the foreseeable future, at least [for] about two or three quarters. . . if i have to hire someone i will have to pay 30% more [than] I pay.

He also thinks employee churn has peaked. However, he said he was worried about the tens of thousands of new entrants who were working remotely and “unfamiliar with the TCS culture”.

Previously the first choice for millions of graduates with technical skills, companies such as TCS and Infosys now compete with hundreds of start-ups offering high salaries thanks to venture capital funding.

Indian start-ups soaked up $38 billion in funding last year, according to Fintrackrthree times the previous year.

“You can never match a salary that a startup gives,” Subramaniam said, adding that this year’s slowdown in venture capital funding would “bring some sanity” to the recruiting market.

Meanwhile, TCS, which was founded in 1968, negotiates a changing work culture, with younger employees expecting more flexibility and choice.

“Older people, 10 and up, want to come to the office,” Subramaniam said. “The youngest they feel: look, don’t force me to come.” Younger staff “want to have a lot more flexibility and a lot more involvement in what they are going to do and how long it will take them to complete it,” he added. “So we have to change our way of thinking at that level.”