It’s Delivery over Margins for IT Cos
The prevailing economic uncertainty over North America and Europe could result in many Indian IT companies turning to focus on delivery instead of margins
At a time when Indian IT majors are struggling to offset poor quarterly results amidst hopes of a macroeconomic reset in its key markets, there seems to be a growing trend among these companies to prioritize delivery over margin improvements in the near term. In fact, one of their key challenges appears to be an overflowing bench strength lying unutilized.
Given that the focus is on cost optimization efforts amidst concerns of a further demand slump, it comes as no surprise that the IT majors are looking to focus on delivery as a means to customer retention when the tidings change. In recent times, both TCS and Infosys have reported big order wins of $10 billion and $2.1 billion respectively.
Lower margins caused by higher wage bills
However, this comes at a time when both the companies are also reporting lower margin estimates during the fourth quarter. The reasons were all too familiar – higher employee costs. In the last earnings call, Infosys CEO Nilanjan Roy said bench strength grew 20% due to the demand drop and utilization declined by 80%. TCS has a similar story to tell.
Roy believes that while utilization has struck a low now, it would get better over the next few quarters. However, Infosys is clear that it would recalibrate hiring for the next couple of years based on the available pool, growth expectations and attrition trends. Given this scenario, the challenge on margins just grows bigger.
Concerns over margin growth expectations in FY24
A recent note from Kotak Securities says margin growth in FY24 could’ve been overestimated. This, the note says, is based on assumptions of an easing of supply side constraints and an improvement in utilization. However, given what we know from market leaders such as TCS and Infosys, it doesn’t seem likely, unless of course the demand patterns change big time.
Both Infosys and TCS expect operating margins to improve in FY24, though the fact that they failed to meet market guidance in FY23 needs to be factored into the mix. Higher salary and travel costs were the main reasons for this miss. Infosys reported operating margins of 21-22% while it was 24.5% in the case of TCS.
Though the situation does not warrant worries for now as several large cost deals and projects with short-term ROIs are continuing even as discretionary projects have been put on hold by customers due to the global economic slowdown. So, companies are just carrying the extra costs forward, including higher wage bills till such time as demand picks up.
Robust order book with quicker revenue realization
The case of TCS is worth mentioning here. The company said its order book comprises large deals in the $50 to $100 million range that could convert into revenues at a faster pace. In a chat with ET, CEO Rajesh Gopinathan confirmed that the company will prioritize capturing demand over fixing efficiencies to improve margins for the short term.
In other words, margin recovery would have to wait till the demand bounces back. In case of any volatility, the IT majors would be looking to capture the demand first before moving in to fix the cost efficiencies. However, if stability returns faster, they could shift their focus back on getting better margins.
Given this uncertainty, it makes more sense for IT majors to go after a large deal pipeline with some mega deals included. And if this happens, the companies will have enough headroom to go after higher margins. A spike in deal pricing also could potentially enhance margins that will give them more time to fix the efficiencies.
