Will margin pressures end the Indian IT sector's glory days?

Citing sources, news agencies reported that from managers to the C-suite level, employees would not receive any portion of their variable pay. Employee grades ranging from freshers to team leaders would get 70 per cent of the total variable pay.

In April-June, Infosys saw its operating margin fall 3.7 percentage points from a year earlier to 20.1 per cent. 

Meanwhile, Wipro’s IT services margin fell from 18.8 per cent to 15 per cent.

Earlier reports indicated Tata Consultancy Services had also reduced, or at least deferred, variable payouts for the April-June quarter after its margins came under pressure. However, the latest reports say that TCS has made no cuts to variable pay, which was paid out without any delays. 

In September, TCS put an end to anniversary hikes for lateral hires who complete a year at the firm. It will now stick to the industry norm of annual salary hikes. But, the anniversary salary hikes will continue for freshers. This comes at a time when the industry is facing demand constraints in its majority markets. Budgets are also under pressure and closing deals is taking more time.

After a jump in margins and profits in the quarters following the Covid-19 break-out in March 2020, IT services firms now find themselves facing their biggest earnings challenge in more than a decade. 

With operating expenses racing ahead of revenue growth, the industry’s operating margin declined to more than a decade low of 23.2 per cent in Q1FY23. During Q3FY21, its operating margins had reached a seven-year high of 28.8 per cent of the total income or revenues. But, margins have been going downhill since then, despite double-digit revenue growth.

According to ratings agency Crisil, the IT sector is also estimated to see its revenue growth fall from 19 per cent in FY22 to 12-13 per cent in FY23. This would be the steepest fall in revenue growth in eight years. The reason: Tightening IT spends by clients in the US and the European Union. 

And, experts believe, the industry may continue to face margin pressure despite lower projected attrition. Even if inflated talent expenses are contained, passing through the increased wage inflation and attrition costs to customers will be essential for margins to recover. So, how long will this scenario last?    

DD Mishra, Senior Director Analyst, Gartner says, margin pressure will continue for a very long time. Differentiation between providers is diminishing. IT firms’ dream run is over.

So, what can IT firms do to successfully face the present challenge?

DD Mishra of Gartner says, cost proposition is becoming secondary to value. Competing on cost counterproductive in long run. Transition from labour arbitrage to technology arbitrage needed to handle margin pressure.

Withholding variable pay also indicates that the growth outlook of IT firms is softening, as US and European clients tighten their budgets. In the latest Infosys earnings call, CEO Salil Parekh also indicated a bit of “slowing in the decision making” from clients. With headwinds aplenty, the industry is left with no option but to move away from cost arbitrage. This is not a new prescription. But it’s now or never, if the industry wants to see another dream run in the years to come.