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BT500: The Return of the IT Bellwethers

BT500: The Return of the IT Bellwethers

India's IT services industry—including TCS, Infosys, Wipro and HCL Technologies—has rebounded strongly, with demand climbing thanks to clients' increasing need for digital services, driven by the pandemic

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A once-in-a-decade opportunity.” That’s how Rajesh Gopinathan, CEO and MD, Tata Consultancy Services (TCS) describes the current robust demand environment for information technology (IT) services. Not since the 1990s has the sector witnessed such a boom period. From a nascent industry worth about $150 million in 1991, the IT industry exploded to top $5.6 billion by the turn of the millennium. Two decades later, they are back at it. The top four—TCS, Infosys, Wipro and HCL Technologies—are set to clock double-digit revenue growth this fiscal. Their deals pipelines are overflowing, with strong demand in emerging areas such as cloud computing, artificial intelligence (AI) and cybersecurity, amid an across-the-board digitalisation drive in the post-pandemic world.

Consider this. The global market for technology and business services jumped 40 per cent between July and September, the fastest quarterly growth in at least seven years, according to data from technology research and advisory firm Information Services Group. In fact, ISG has doubled its 2021 forecast for managed services growth to 10.1 per cent since the start of the year, and lifted its forecast for cloud services growth to 25 per cent from 18 per cent.

This is a result of the ongoing structural shift in the way businesses globally are operating since the pandemic. For example, while the education and retail sectors are accelerating their digital transformation, hotels and airlines are adopting contactless check-ins. Businesses are increasingly migrating their data to the cloud. This is causing a spike in demand to build new business models using data science, cybersecurity and AI. And forecasts are constantly being revised.

In April, Gartner had estimated global IT services spending would rise 9 per cent this year, sharply higher than the 1.7 per cent growth in 2020. The IT research and advisory firm has since hiked its forecast to 11.2 per cent and its 2022 forecast to 8.6 per cent from 7.3 per cent.

“The demand environment continues to be very strong, and our September quarter pipeline—among the highest in recent times—mirrors the buoyancy in the market,” says Jatin Dalal, President and CFO, Wipro. The pandemic, he adds, has accelerated the digital and cloud journey for Wipro’s customers, and the company believes that they are still early in this cycle.

This is reflected in India’s services exports growth, which touched a 13-quarter high in the April-June quarter. This growth was driven by the software business and transportation services, the Reserve Bank of India said in its October bulletin. “Major IT companies continued to benefit from pandemic-induced demand from international customers and adoption of new models,” the central bank said.

That did show up in the latest BT500 rankings. Nandan Nilekani-led Infosys gained two places to the 4th position, while Noida-based HCL Tech climbed three places to 12th. Bengaluru-based Wipro rose six places to 13th and Tata Consultancy Services (TCS) retained its 2nd position.

The overwhelming demand has left the top IT players scrambling to increase their headcount commensurately. But there is a dearth of freshers with the know-how to handle the next-gen technologies, which has sparked a talent war. And hiring is a double-edged sword, as a larger employee count raises costs and dampens profit margins.

But for now, IT firms are raking in the moolah. Some more than others.

Rishad Premji-led Wipro’s annual revenue run-rate surpassed the $10-billion mark in the quarter ended September, with $2.4 billion added in the past 12 months alone. That will help it narrow the revenue gap with HCL Tech, India’s third-largest IT company, whose revenue is estimated to grow 11.1 per cent to $11.3 billion in FY22. Wipro says it is “confident of gaining market share” and attributes its revenue growth to a two-year-long structural and managerial transformation.

In 2019, Rishad Premji took over as Wipro’s chairman from his father, Azim Premji and, a year later, Frenchman Thierry Delaporte was brought in as CEO. This January, Wipro also rejigged its structure to create four strategic market units and two global business lines. “Both of these changes have led to a change in the mindset with a clear focus on revenue growth. They’ve become aggressive in terms of acquisitions, which propelled the growth. Clearly, Wipro is on a roll,” says Neerav Dalal, Research Analyst at broking firm Maybank Kim Eng Securities. “I think they will maintain this momentum over the next couple of years.”

HCL Tech, though, has lagged behind its peers this year due to a decline in its products and platforms category business, which accounts for about a tenth of total revenues. While the Roshni Nadar Malhotra-led company logged a 13.1 per cent increase in its services revenue (in constant currency terms) in the September quarter, its products and platforms revenue declined 5.5 per cent. The unit has now logged three straight quarters of sequential decline.

HCL Tech signed 14 large deals in the quarter, with their total value 38 per cent higher than in the previous quarter. But Dipesh Mehta, Senior Research Analyst at broking firm Emkay Global, expects the products and platforms business will remain a drag. “No one has high expectations from this business. However, the management expects some uptick in Q3, which we need to see,” he says. However, Dalal of Maybank Kim Eng Securities already has a verdict, “In FY22, HCL Tech will be the slowest in terms of revenue growth.”

At the other end of the scale, Infosys raised its FY22 revenue growth forecast in October to 16.5-17.5 per cent from 14-16 per cent on the back of strong demand-led digital transformation. In fact, its 19.4 per cent revenue growth in the September quarter was its fastest in 11 years. Sequentially, its revenue growth was 6.3 per cent, outperforming TCS for the fourth straight quarter.

And all of them are investing to grow their market share.

The it companies are stepping up investments in the emerging demand areas including cybersecurity, AI, machine learning, and, especially, cloud computing. TCS believes the industry is still in the initial stages of cloud transformation, with only 20-30 per cent of workloads migrating to the cloud so far.

Wipro is doubling down on its cloud and next-generation capabilities. “Next-gen technologies and services will lead industry growth. We expect incremental growth in areas such as digital, cloud, data, engineering and cybersecurity,” says Wipro CFO Dalal.

With Wipro FullStride Cloud Services, it has committed to invest $1 billion in cloud technologies over the next three years. Wipro, which employs over 79,000 cloud professionals, has signed significant cloud-related deals with Telefónica Germany O2, Verifone, E.ON and Metro AG.

Infosys, through its one-year-old cloud platform Cobalt, offers 35,000 cloud assets and over 300 industry cloud solution blueprints. “Those are what clients are really gravitating to. We also see good traction and very strong growth on our data and analytics capabilities,” says Pravin Rao, COO, Infosys.

Broking firm Motilal Oswal expects HCL Tech will emerge stronger on the back of deep capabilities in the infrastructure management services space, investments in cloud, and digital capabilities given the “expected increase in enterprise demand for these services”.

Clearly, there is robust demand. However, what could pop the bubble is the lack of talent supply.

From a demand perspective, the IT business remains very healthy and broad-based. Managing the supply side is the only challenge at the moment,” says Mehta of Emkay Global.

The top four companies added a combined 53,964 employees in the September quarter, up from 17,076 a year ago. But their average attrition rate shot up to 17.1 per cent, from 12.5 per cent in the previous quarter, ranging between Wipro’s 20.5 per cent and TCS’s 11.9 per cent.

The quartet has, therefore, doubled its fresher hiring for the current fiscal to 160,000. TCS alone plans to hire 78,000 freshers, while Wipro, Infosys and HCL Tech expect to hire 17,000, 45,000, and 22,000 freshers, respectively.

They are also working on employee retention policies in addition to the fresher hiring initiative. Infosys and Wipro have both raised salaries twice this calendar year. Infosys has also dramatically increased the number of promotions and rolled out a skill-based compensation increase. “We have also enhanced employee engagement through additional interventions like skill tags, career acceleration and learning opportunities, to increase our pool of digital talent,” says Infosys COO Rao. Meanwhile, HCL Tech has added restricted stock unit (RSU) grants to its compensation mix to retain high performers.

But all these talent acquisition and retention plans come with a cost—margins.

Since touching a 22-quarter high of 21.7 per cent in the third quarter of FY21, Wipro’s operating margins have dropped in each subsequent quarter to end up at 17.8 per cent in the latest second quarter. “Post the acquisition of Capco (this March), the company said that the medium-term sustainable margins could be in the range of 17-17.5 per cent. There is no change to this position,” says Wipro CFO Dalal.

HCL Tech’s operating margins, meanwhile, fell 60 basis points (bps) sequentially to 19 per cent in the September quarter, while Infosys’s EBIT (earnings before interest and taxes) margins fell 10 bps.

Smaller companies like Mindtree and L&T Infotech, however, reported a sequential improvement in margins in the latest quarter on the back of strong revenue growth and better employee utilisation. “Now that their employee utilisation has peaked, they will need to recruit more,” says Dalal of Maybank Kim Eng Securities. He says one should not expect any improvement in margins for at least the next six months for IT companies.

And it’s not only because they have to pay top dollar for quantity, but also quality.

Margins are going to be challenging largely because of the fact that the parameters are changing right now,” says Deven R. Choksey, MD, KRChoksey Investment Managers, a wealth management firm. “The requirements of skill sets are changing from coding to machine learning, statistical and arithmetic modelling, algorithms, etc. Now, those fields are not going to be easily available till the time schools start producing them enough in the coming years. There will be a bigger challenge in the form of unavailability of skilled people, or maybe a high cost of availability. This will be a constant struggle for companies on the margin front,” he predicts.

State governments have taken notice of the shrinking talent pool and are taking measures to ensure that their universities produce students who are qualified to handle emerging technologies. None more so than Karnataka, whose capital Bengaluru is home to many IT companies.

“At the university level, we are ensuring students will be industry-ready and employable so that the supply can scale up in big numbers,” Karnataka’s IT Minister C. N. Ashwathnarayan tells Business Today. “Tech knowledge will be part of the curriculum at the degree college level and subjects including AI, cybersecurity and cloud computing will be taught now.”

The Karnataka government has partnered with Tata Technologies Limited to transform 150 Industrial Training Institutes (ITIs) across the state into technology hubs with courses in advanced CNC machining, industrial robotics and digital manufacturing, manufacturing process control and automation.

Infosys, though, isn’t waiting. Rao says that, in the past few quarters, the company has met nearly 80 per cent of its digital talent demand with internal reskilling. Infosys has also expanded hiring across “a wider range of education and skill profiles”.

That’s more a long-term plan. The heightened talent demand should ease going into FY23 as the companies hire freshers by the thousands in the next few months. And that should help their margins as well.

“These freshers will become billable towards the end of this calendar year or next year, and these IT players will benefit from a flatter employee pyramid, and so will be able to manage margins. But it would be wrong to assume that margins will improve by 100 bps. They may improve by 30-40 bps,” says Maybank’s Dalal.

IT companies will have to manoeuvre smartly to stay a step ahead of any curveballs, such as the current talent crunch, to capitalise on the robust demand.

This is, after all, a once-in-a-decade opportunity.

@dilasha