Price premium concerns continue for IT sector on cramped client spending

The industry has continued to depend on execution levers like expanding margins, with the exception of TCS which made the most of rupee depreciation in FY19

Digital traction has remained strong over the past year, but software providers need to ramp up the digital portfolio if they want to command a price premium note sector analysts. Q4 witnessed a unanimous view from all IT providers that client spending will continue on track, especially in digital technology, yet pricing premium on these projects seems far off at present.

In the absence of strong price premium, IT sector has continued to depend on execution levers like expanding margins, with the exception of TCS which made the most of rupee depreciation in FY19.

“Even at this point, almost 70 per cent of the business for most players is from legacy technology where pricing is very competitive. There is excellent scope in digital growth but they need to ramp it up to at least 50 per cent of the revenue share to be able have a positive net impact on pricing,” said Pareekh Jain, founder of Pareekh Consulting.

He added however over the next two years, based on company comments, a higher price premium can be expected for the players. TCS has been doing a better job in pricing and margin because of the scale of their execution across large deals. This is something that midcaps have had to struggle with simply due to the lack of scale and higher percentage of the SG&A expenses.

 

Pricing pressure was noted by HCL Technologies during their Q4 earnings, due to the scale up of their Mode 1 business, which comprises largely of legacy services. In the absence of a pricing premium, analysts note, the companies will have to push for operational efficiency, cost rationalization, revenue growth and strong hedging models to benefit from currency fluctuation to boost margins. 

TCS currently has 31 per cent digital revenue share, Infosys at 33.8 per cent, 35 per cent for Wipro and 28.3 pwer cent for HCL Technologies. Their biggest competition Accenture has reported over 60 per cent digital and new technology revenue since past couple of quarters.

During the Q4 results, last month, Mumbai headquartered Tata Consultancy Services (TCS) noted that pricing in US, the largest market for IT services, continues to be low despite an overall price stability witnessed by the company.

North America comprises 50.7 per cent of business for TCS, 56.8 per cent of Wipro, 61.2 per cent of Infosys and 64 per cent of HCL Tech’s business as of Q4. Note Wipro and HCL report revenue share for Americas as a whole and not North America specific.

“Given the fragmented nature of the European market, pricing is typically higher (there) compared to a large scale market like US, where the economies of scale have resulted in lower prices. US is probably the lowest priced location among developed markets, “said Rajesh Gopinathan, CEO and MD, TCS addressing price concerns post Q4 results. 

TCS has however reiterated that the IT industry by itself is extremely price resilient with an equally slow pace of price depreciation for products/ services. Analysts believe that without favourable currency benefits, the competitive intensity in the market will remain high with these “complex pricing “models continuing to become a norm.

Infosys has maintained that due to macro uncertainties clients budgets are expected to remain flat in 2019 on a percentage basis but there would be higher budget allocation towards the newer (digital) technologies resulting in margin uptick in FY20. 

That said, the past six quarters have witnessed record deals in the IT sector. The deal rush has resulted in additional sourcing pressure, further denting margins for the software providers irrespective of their size. Lower rates of project renewals and pricing are also ongoing concerns for the software vendors. 

Company	Operating Margin	YoY growth	Digital Revenue
Accenture	13.3%	20 bps	60 %
TCS	25.1%

(30 bps) 31% Infosys 21.4% (330 bps) 33.8%
Source: Companies, Accenture Dec-Feb, TCS & Infosys Jan-Mar quarter