With North America and Europe contributing as much as 60% of revenues, shifting business onshore will help trim costs and boost margins at these software companies.
The trend was reflected in the first quarter results of these firms. Wipro Ltd reported offshore revenue from services grew to 48.5% in the June quarter, from 48.2% in the March quarter, and 47.7% in Q1 FY20. Overall operational efficiencies and cost control added 100 basis points to Wipro’s margins sequentially.
Mindtree posted a 2.1% sequential growth in offshore billing in the June quarter, and 11.3% growth year-on-year (y-o-y). Larsen and Toubro Infotech (LTI) reported a tad higher offshore revenue (78.9%) in Q1FY21, compared with Q4FY20 (78.8%) and Q1FY20 (78%), adding to the bulk of its 70 basis points margin growth.
Tata Consultancy Services (TCS) and HCL Technologies do not disclose their offshore mix in total revenue.
Infosys reported that offshore revenue was little changed at 72% of the total in the June quarter despite overall strong performance. Its operating margin, however, narrowed by 150 basis points due to operational issues such as lower utilization of staff and higher on-site mix.
“Companies have indicated that a lot of deals that moved offshore due to the pandemic have not been renegotiated. This means that at significantly lower delivery costs, offshoring will offer some margin advantage," said Amit Chandra, an analyst at HDFC Securities. Generally, projects are initiated on-site and after they reach a level of maturity, they are moved offshore, which is typically at one-third of the onsite delivery cost.
Chandra said even 1% additional offshoring can add 30-50 basis points gain to margins.
A lot of the shift stems from the fact that clients across industries are struggling to keep businesses afloat, and are dependent on IT vendors to mobilize a large part of this work remotely. Several vendors, including TCS, are mobilizing remote working solutions as a complete service offering given that global travel curbs are also impacting on-site deployment of talent.
“Both vendors and clients are figuring out what works best in terms of the offshore mix. The fact is vendors earn more revenue from on-site services but right now everything depends on how demand works out in the next two quarters (till December). As of now, most work is being done offshore as far as customers can accommodate and may go back as soon as demand returns," said Sanchit Vir Gogia, chief analyst and CEO, Greyhound Research.
With several global clients struggling, and movement to cloud shaving off a lot of infrastructure project revenues and automation solutions, IT spending is likely to shrink, Gogia said.
“With regards to onsite-offshore ratios, we are at 21% onsite; we have one of the lowest ones globally and we have continued to keep pushing work offshore and we’ll continue to do so. This is one good habit that can come from the pandemic," said Sanjay Jalona, chief executive and managing director at Larsen and Toubro Infotech, during the first-quarter earnings call on 14 July.
Jalona, however, said such a shift does not happen overnight and it depends on the kind of work that is done.