IT cos take fixed-price route to boost margins

IT cos take fixed-price route to boost margins

Bangalore: Information technology (IT) vendors such as Tata Consultancy Services Ltd (TCS), Infosys Technologies Ltd and Wipro Ltd are increasingly entering into fixed-price contracts with customers, which, they say, would allow them flexibility in automating processes and using fewer workers, thus boosting margins.

In fixed-price contracts, customers agree to pay a certain amount for a project completed within a certain deadline, and the vendor is free to choose how many people to deploy. Many contracts are typically time and material contracts in which the billing is done based on the number of employee hours spent on a project.

Traditionally, Indian vendors have earned a large chunk of their revenues by billing customers for time and material projects, but are now looking at more revenues from fixed-price projects to mitigate the impact of the rising rupee and wage inflation on their profitability.

Fixed-price projects are also more short term in nature, while the time and material are long-term contracts that give longer revenue visibility for companies.

“We want to increase the fixed-price revenues, but it depends on what the customers want," said V. Balakrishnan, chief financial officer of Infosys. The company earned 30% of its Rs4,106 crore revenue for the quarter ended September from fixed-price deals.

“If the customer is not clear with the specifications, there could be cost overruns that will hurt you," he said, pointing to the challenges in such fixed-price contracts. “There’s a trade-off, but (Infosys) has always delivered 99.5% of projects on time."

TCS, the industry leader by revenues, has maintained its fixed-price contract revenues in the range of 40-50% of its overall revenues, which, CFO S. Mahalingam says, is “optimal". “Time and material projects assure us continuous stream of revenues, but we want fixed-price projects because that helps us position ourselves as a solutions provider," says Mahalingam.

Wipro Technologies, the global information technology services arm of Wipro, says it is aiming to break the “linearity", or revenue growth linked to the number of people added, and earn better prices through fixed-price contracts, according to Rajesh Ramaiah, corporate treasurer of Wipro.

Satyam Computer Services Ltd saw a sharp increase in its fixed-price revenues over the past five years to 39.35% in the quarter to September, from 23% in the last quarter of fiscal 2002. However, “the sharp rise in the second quarter of fiscal 2007 would be more of an aberration possibly because of a spate of projects having been executed in that mode," says Satyam chief financial officer V. Srinivas. Indeed, Satyam has seen a decline in fixed-price revenues over the past four quarters. “The decline could be on account of some large deals being ramped up, which in the initial stages could be in the (time and material) mode to be followed by fixed-price mode," Srinivas says.

The advantage with such fixed-price deals is that a vendor can earn better margins and improve productivity by reusing the methodology. “If you are able to get the right pricing and execute well, margins in fixed-price projects could be higher by 400-500 basis points, or (4-5%) compared with the time and material projects," Infosys’ Balakrishnan said.

Fixed-price deals are common in the US, a matured outsourcing market. “As Indian vendors move up the outsourcing curve, we can see more deals being signed in fixed-price mode," said Avinash Vashista, CEO of Tholons, which advises clients on their outsourcing strategy. “Any deal upward of $5 million (about Rs20 crore) annually and extending to over five years would be structured as fixed-price contract (by Indian vendors)."

Even mid-sized vendors such as Sonata Software Ltd are looking at increasing their fixed-price revenues, says B. Ramaswamy, its chief executive. The company earns about 10% of its revenues from such contracts now.