Infosys' bench-building, thinning mid-mgmt raises margin worry

The likely beefing up of bench strength and a thinning middle management layer at Infosys Technologies has raised concerns among some analysts but many believe the fears are exaggerated.

Over the past two months, the Infosys management is believed to have indicated to investors and analysts their intention to build slightly larger bench strength, to gear up for any big opportunities that may come its way.

"The company needs some flexibility in its model," a company official said, noting there was a need to keep a "strategic bench" to seize any opportunity.

For the past three-quarters now, Infosys has reported employee utilisation rates, excluding trainees, in the range of 77.5-79.1 per cent. The net utilisation rate for December quarter was 78.7 per cent.

Historically, the company's net utilisation rates have ranged between 76-80 per cent, with the exception of 2001-02 when it breached the 80 per cent mark.

It now appears that Infosys would look at scaling down its employee utilisation towards the lower end of its historical range, to keep its code writer pipeline sufficiently beefed up to take up any large contracts.

Infosys closed the third quarter with a shade below 50,000 employees on its rolls.

Some analysts believe bench-building investments would impact company's profitability metrics. The rupee's volatility against the dollar has added fuel to margin worries. The rupee has appreciated 1.4 per cent against the dollar since January 1.

Industry estimates show that a 1 per cent appreciation in the dollar shaves off margins by 30 basis points. Also, there is little to suggest any significant improvement in pricing even as new clients are coming in at above average rates.

But then, repeat business contributed over 93 per cent of company revenues in December quarter, suggesting minimal impact of higher prices from new clients on company's profitability.

Tuesday, Citigroup Investment Research said, "we think INFY is also adding to its bench to reduce lead-time for client ramp-up programs, though this may affect margins slightly over the next 2-3 quarters."

Citigroup expects EBIT (earnings before interest, taxation) margins to fall by 30 basis points for 2006-07, on this count.

The mammoth recruitment drive of fresh graduates seen at Infosys has also raised questions about its ability to manage its ever-growing workforce.

A fortnight ago, JP Morgan downgraded Infosys, noting the company has "too many foot soldiers and not enough commanders."

Infosys' policy of hiring more fresh graduates than competitors has led to delivery issues, according to JP Morgan.

Companies often see fresh graduates as a key lever to improve margins as they reduce average salary costs. In a note to clients, JP Morgan said, "while demand remains strong, we believe that Infosys is facing middle management crunch, a supply side issue that would take 9-12 months to get resolved."

"Utilisation of middle management (staff with 3-6 years experience) has reached unsustainable levels. We believe that Infosys had significant issues in getting the right middle managers to execute some new large projects," it said.

It said only 12 per cent of Infosys workforce fell in the mid-management bracket for the December quarter as against 15 per cent and 20 per cent in 2004-05 (April-March) and 2003-04 respectively. Infosys has the highest proportion of fresh graduates in its workforce among its peers at 59 per cent.

JP Morgan has cut its 2006-07 and 2007-08 earnings per share estimates for Infosys by 3 per cent and 4 per cent respectively. It said the management guidance for 2006-07 may also come below market expectations.

"While skeptics worry about a very bottom-heavy employee pyramid, we think INFY's near-term problems come from growing inflexibility in moving staff around across different services given increasing specialization in each service line as it scales up," Citigroup said.

However, many analysts remain optimistic. An analyst with a domestic brokerage noted that the company's utilisation rate does vary over the quarters and too much should not be read into a minor tinkering exercise that the company might carry out.

A higher bench did not seem to worry the analysts too much at UBS Warburg either, with the investment bank noting that the company had sufficient levers to offset any negative impact.

UBS believes Infosys has maintained its fresher recruitment mix at 70-80 per cent over the past few years. It expects the impact of a higher bench at 50-75 basis points in earnings before interest, taxation, depreciation, and amortisation margins.

"We believe, Infosys has enough levers to protect EBITDA margins, despite the higher bench offshore." In a month from now, Infosys will detail its earnings guidance for 2006-07.