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In 2021, investors in Indian stocks have been a happy lot. Investors in Indian information technology (IT) services companies, even happier. The benchmark BSE Sensex has gained 19% so far this year, but share prices of the top three IT companies—TCS, Infosys and Wipro—have appreciated 24%, 45% and 75%, respectively. For the second straight year, they have given top returns.

Like 2020, this outperformance came on the back of growing revenues. As the pandemic disrupted how industries operate, businesses across the world invested more in digitization and cloud. India-based technology outsourcing companies were ready to tap this opportunity. In the most recent September quarter, the topline of TCS, Infosys and Wipro grew 17%, 21% and 30%, respectively, compared to the corresponding period last year.

The momentum is likely to persist in 2022. According to Gartner, a technology research and consulting firm, global IT spending grew by 0.9% even in the first pandemic year, 2020. Further, it has projected a growth of 9.5% in 2021 and 5.5% in 2022. In particular, IT services, which grew 1.7% in 2020, is projected to grow 11.2% this year and 8.6% next year. Top Indian IT services companies have consistently outperformed global growth—and are expected to do so in 2022 as well.

However, growth brings its own challenges for any labour-dependent industry, and it’s no different for the Indian IT services sector. Its slow progress to delink revenue growth from headcount growth, and the intensifying war for technology talent, is already affecting profitability. The key question in 2022 will not be around growth, but around margins.

Headcount Matters

For a long time, Indian IT services companies have been trying to increase their revenues without adding people proportionately. The quest for such 'non-linear' growth is driven by both hard and soft reasons. On the financial side, IT companies and their shareholders get more bang for their buck if each resource earns more. At the same time, IT companies can avoid the complexities that come with scale, especially managing culture.

As companies started focusing on digitization, products and platforms, the expectation was that revenue per employee could go up. However, in 2021, the numbers are mixed. For TCS, this metric remained flat. Infosys ended with higher revenue per employee, but the improvement was not consistent through the year. Both HCL Tech and Tech Mahindra ended the September quarter with lower revenue per employee compared to a year ago. Wipro is the only exception.

War for Talent

Overall, the gains registered by the Indian IT services sector had less to do with a structural change, and more to do with belt tightening amid talent shortages. IT services companies have been fighting for talent on multiple fronts: from their peers, from nimble and well-funded startups, and from a market pool that has often been failing to deliver the skill sets most in demand.

Attrition rates have risen across the top five companies: from 10-12% in the December 2020 quarter to 15-20% in the September 2021 quarter. Even TCS, traditionally a low attrition company, saw its attrition rates increase by 4.3 percentage points during the period to 11.9%. Besides competition within the IT services sector, venture capital-funded startups have been weaning away talent that would have at one point joined IT services. Despite these challenges, the top five IT companies alone saw a net increase of over 200,000 in their headcount in the last one year.

Eroding Margins

The demand for talent has pushed up salaries. While there has been competition for talent for a few years now, salary expectations of prized IT talent have skyrocketed in the past year. According to Xpheno, a staffing firm, engineers possessing certain in-demand skillsets were expecting an increment of 50-120% in 2021, against 10-40% in 2020. For IT companies, paying more for talent puts pressure on their margins. In 2021, all five IT majors have seen their margins slip in the June and September quarters.

The shortage of skills is a global phenomenon right now. As a result, the Indian IT services sector continues to enjoy a cost advantage compared to the US and Europe, its two main geographical contributors of revenues. Its pipeline of deals and revenues is rich. But it will probably have to deal with lower margins in the coming year too—at least till it finds a solution to talent shortage.

 

www.howindialives.com is a database and search engine for public data

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