IT margins to remain under stress till 2020 as competition is high: Icra

Price led competition and chasing limited new opportunities will impact business

Indian IT services firms will see margins reduced in the next two years as they face the challenge of increased competition for deals, growing automation and the limited number of newer opportunities. These firms will see margins drop to as low as 21.2 per cent by 2020, says a new report by Icra.

The industry’s operating margins have moderated from 24-25 per cent to 23-24 per cent over the last few quarters and despite higher efficiency and automation margins will decline from 23.5 per cent in FY2017 to 21.2 per cent in FY2020 estimates said the report.

“While companies have increased spending on digital technologies and awarded new contracts, the overall IT budgets have moderated leading to lower incremental spends. The trend reflects the challenging operating environment characterised by pricing pressure on commoditised IT services, wage inflation, higher onsite costs necessitated by visa curbs as well as lower discretionary spend by corporate,” said Gaurav Jain, VP, Icra.

The growth of Indian IT Services companies has been impacted by lower demand led by uncertain macro-economic environment, lower deal sizes in digital technologies, cloud adoption and high competitive intensity from local as well as international players, he added. Banking and Financial services have been the worst impacted with the exception of insurance sector.

The aggregate growth of Indian IT Services companies was at 3 per cent during Q2FY2018 (8.1 per cent in dollar terms) compared to CAGR of 17.1 per cent experienced over the FY2013-2017 period.

A 9.7 per cent growth was observed in last fiscal, FY2017. The lower growth was due to the rupee appreciating by approximately 4 per cent versus US dollar during the quarter said Icra.

While analysts agree that rupee appreciation had an impact on the margins, they still see strong growth indicators in favour of the domestic giants. The share of Indian players in Global IT Sourcing market stood at 67 per cent in CY2016 (60 per cent in CY2012), however incremental gains are expected to be at a slower pace.

Accodign to an ICRA note, Indian IT Services companies are expected to register compounded annual growth rate (CAGR) in mid-to-high single digits for the period FY2017-2020. 

“Barring rupee appreciation, which cannot be predicted with certainty, we see enough scope for a healthy growth in this sector. We expect Indian IT sector to continue having a healthy share in the market despite pricing pressure,” said Ravi Menon, Analyst, Elara Capital.

A Bloomberg report last week had noted that Indian giants like TCS and Infosys will have to be more aggressive with their digital service portfolio as these services still contribute less than 25 per cent of the revenues. Jain also noted that these new service areas will start showing return in the medium term i.e. within three years.

“If you notice international IT giants like Accenture operating at 15 per cent EBIT margin compared to a TCS operating at 25 per cent EBIT margin, it is difficult to maintain the differential margin. Certainly, margins will trend lower,” said Madhu Babu, Analyst, Prabhudas Lilladher. 

Analysts noted that tighter hiring, larger digital spend and an overall slow growth of about 6 per cent in the sector will continue to drag the business but digital services will pick up in the long term.