BNP Paribas Securities India Pvt. Ltd has recommended investors to reduce their exposure to Infosys Ltd because the company’s focus on high-margin projects is not working in the current weak demand environment. Infosys shares have already underperformed large-cap peers this year, with its revenue growth lagging behind.
The moot question is if the firm will now make adjustments to its strategy of raising the share of higher-value solutions such as consulting and systems integration as well as products and platforms, as it had envisaged under the Infosys 3.0 plan. As a recent report by JPMorgan India Pvt. Ltd rightly puts it, “That’s not where the market opportunity is naturally gravitating today—Accenture’s migration to outsourcing is a good example. The ‘bread-and-butter’ business is probably suffering at Infosys as a result of Infosys 3.0. In this context, Infosys 3.0 is perhaps ill-timed and inappropriate for the times, with the result that Infosys is unable to walk the pricing versus volume trade-off.”
A majority of work (over 70%) being outsourced to Indian companies currently falls in the “bread-and-butter” category. And Infosys’s revenue growth in these traditional services such as application maintenance, infrastructure management and business process outsourcing has been below company average. It isn’t surprising that Infosys has been losing market share in the past many quarters. But, according to analysts, the company is now getting more flexible with its strategy. Of course, it goes without saying that it will be a while before the gains from such a shift will result in market share gains.
As pointed out in this column earlier, it will be a tall order for Infosys to achieve its seemingly conservative revenue growth forecast of 8-10%. In this backdrop, the stock can be expected to continue to underperform.
What about other Indian IT firms which have been far more open about accepting relatively lower-value work from customers? Will they take a hit on margins as a result? Needless to say, with the rupee where it is, maintaining margins is hardly an issue. But even without the benefit of the rupee depreciation, it must be noted that margins in the IT business thrive when volume is growing. The JPMorgan report states, “Volume growth allows multiple benefits that include leverage of general and administrative spends, greater utilization and more extensive use of the pyramid (fresher-to-lateral employees ratio). Volume growth at stable pricing is the biggest enabler of margins.”