February 19, 2013
BANGALORE: The slight improvement in profitability at Indian software services firms in the December quarter is only a flash in the pan, and margins are headed inexorably downwards, analysts said.
February 19, 2013
BANGALORE: The slight improvement in profitability at Indian software services firms in the December quarter is only a flash in the pan, and margins are headed inexorably downwards, analysts said.
For more than a decade, software firms enjoyed one of the highest profitability levels for any industry, but a confluence of forces is pushing margins to levels seen for businesses dealing in commoditized goods.
Within the next two years, experts predict that operating margins will fall to below 20% (the average is 25% now for Infosys, TCS, Wipro and HCL Tech) and settle at a level that just about takes it past single digits. For comparison, in the quarter to September, the average operating profit margin for corporate India was 14.5%.
"Over the next five years, profit margins of Indian IT firms could be 11-15%, similar to their global counterparts," said Sid Pai, Asia-Pacific president at outsourcing advisory ISG Information Services Group, referring to rivals such as IBM and Accenture.
Greater Competition among Indian Companies
Pai anticipates greater competition among India's largest outsourcers as they manage a greater number of businesses that are highly technical and solutions-based. This, in turn, will result in higher upfront investments. "Indian IT firms are yet to become global. Margins will fall as they begin this journey," he said.
Among the biggest contributors to higher costs will be the need to hire more employees at client locations in the US and Europe. Customers, too, will be increasingly aggressive about asking service providers for deeper discounts, especially as large technology outsourcing contracts worth several billions of dollars come up for renewal. Even among service providers, higher-margin companies TCS and Infosys have more to lose than HCL Technologies and Wipro.
Infosys and Wipro declined comment while HCL and TCS did not reply to an email seeking views.
"The earlier margin levels are not feasible in the current world as the software industry deals with price reductions and other cost factors," said Pradeep Mukherji, president and managing partner at outsourcing advisory firm Avasant.
Moreover, there is growing consensus that the outsourcing industry is at a stage where it is now imperative to invest heavily to master emerging technologies such as data analytics, cloud and mobility solutions as companies face competition from upstarts who could potentially deliver the same services at lower costs.
In the December quarter, the top four IT services firms reported margin expansion of less than one percentage point, but analysts are not convinced this can be sustained even in the near term.
Avasant's Mukherji is convinced these are realities the Indian IT firms will not only need to learn to live with but get around by investing in initiatives to improve revenue productivity.
Only service providers that invest in and successfully move up the value chain can hope to slow down the rate of decline in margins. Efforts are already on at some companies to embrace automation more wholeheartedly.
"Margins may remain under pressure and decline moderately during 2013. Wage inflation is likely to be the most important pressure point for Indian IT services companies with a large offshore workforce in India," wrote Niraj Rathi and Sreenivasa Prasanna, analysts at India Ratings in their recent client note. "The trend towards shorter contract lengths will also lead to higher customer attrition rates in the year apart from impacting margins due to higher client acquisition costs than in 2012."
Courtesy: ET
