The insourcing threat for Indian IT
The Nifty IT index has underperformed the market by 22% so far this year, on the back of underperformance of over 10% in 2016. This is hardly surprising; growth rates have fallen to single-digit levels owing to multiple headwinds the industry is facing.
Indian IT companies have a much larger share of revenues coming from traditional services, where demand is flagging and pricing is under pressure. While demand for digital services is robust, multinational companies such as Accenture Plc and relatively new firms such as EPAM Systems Inc. and Globant SA are capturing a disproportionate share of this pie. To add to this, Indian companies also have to deal with restrictions on visas and rising on-site wages as a result of the increasing rhetoric against immigration.
Another major threat for Indian companies has been the rise of insourcing or the increase in the number and scale of captive centres being set up by former clients.
Analysts at Nomura Research point out in an 11 September report that global in-house centres (GICs) are the next big worry for Indian IT companies. Currently, these centres account for around 25% of global outsourcing spend, but are growing at a faster pace compared to work done by Indian outsourcing service providers. “Over the past five years, India GIC revenues have shown a 12.4% CAGR (vs 9.3% CAGR for top-4 Indian IT names) over FY12-17,” Nomura’s analysts said in the report. In the five years before that, Indian companies were growing at a much faster pace compared to GICs. CAGR is short for compound annual growth rate.
Another troubling finding in the report is that the trend of increasing GICs isn’t just restricted to large clients. “An equal participation in terms of new GIC set-ups is being seen from clients with revenues less than $5 billion... GIC adoption is increasing beyond the most mature outsourcing verticals (BFSI, Tech and Mfg) with other verticals are also playing catch up. For example, 40% of the Retail GICs were established in the past five years,” said the report. BFSI is short for banking, financial services and insurance.
The trend towards insourcing is being driven by the need to have greater control over the work done, and feedback from GICs suggests they are better able to adapt to new innovations and technological developments, vis-à-vis handling work through an outsourcing partner. Besides, while employee costs at GICs may be relatively higher, they get offset to some extent by the mark-up charged by outsourcing firms to cover their selling costs and to earn a return on their investment.
While Indian companies can try and counter the threat by either increasing investments in innovation organically or by making relevant acquisitions, these will entail costs and put pressure on margins. As such, GICs not only pose a threat to growth, but also to margins.