Will margin pressures end the glory days of India’s IT industry?

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In August, Infosys – India’s second largest IT company – decided to reduce the average variable payment for employees to 70%.

The reason was lower operating margins in Q1FY23. An uncertain economic environment is also one of the causes.

Variable compensation is the incentive that companies give to their staff, based on their performance.

High attrition rates have led to increased salary costs. Thus, the operating margins of Indian IT companies were affected in the last quarter of FY23.

In August, Wipro withheld variable pay for its staff for the same reason. Other reasons cited for the move were inefficiencies in its talent supply chain and investments in technology.

Citing sources, news outlets reported that from C-suite level managers, employees would not receive any portion of their variable pay. Employee grades ranging from entry-level to team leaders would receive 70% of the total variable pay.

In April-June, Infosys saw its operating margin drop 3.7 percentage points from a year earlier to 20.1%.

Meanwhile, Wipro’s IT services margin fell from 18.8% to 15%.

Earlier reports said Tata Consultancy Services had also reduced, or at least postponed, variable payments for the April-June quarter after its margins came under pressure. However, the latest reports indicate that TCS did not make any cuts in variable compensation, which was paid out without any delay.

In September, TCS ended anniversary raises for side hires who complete a year with the company. He will now stick to the industry standard for annual salary increases. But, anniversary pay hikes will continue for freshmen. This comes at a time when the industry is facing demand constraints in its majority markets. Budgets are also under pressure and closing deals is taking longer.

After a jump in margins and profits in the quarters following the Covid-19 outbreak in March 2020, IT services companies now find themselves facing their biggest profit challenge in more than a decade. .

With operating expenses outpacing revenue growth, the industry’s operating margin fell to more than a decade of 23.2% in Q1FY23. In the third quarter of FY21, its operating margins had reached a seven-year high of 28.8% of revenue or total revenues. But margins have fallen since then, despite double-digit revenue growth.

According to ratings agency Crisil, the IT sector is also expected to see revenue growth decline from 19% in FY22 to 12-13% in FY23. decline in revenue growth in eight years. The reason: the tightening of IT spending by customers in the United States and the European Union.

And, experts say, the industry could continue to face pressure on margins despite a drop in expected attrition. Even if bloated talent spending is contained, the pass-through of rising wage inflation and churn costs to customers will be critical for margins to recover. So how long will this scenario last?

According to DD Mishra, Senior Director Analyst, Gartner, the pressure on margins will continue for a very long time. The differentiation between suppliers is decreasing. The dream race of IT companies is over.

So what can IT companies do to successfully meet the current challenge?

According to DD Mishra of Gartner, the cost proposition becomes secondary to the value. Cost competition is counterproductive in the long run. The shift from labor arbitrage to technology arbitrage was necessary to manage margin pressure.

The restraint in variable compensation also indicates that growth prospects for IT companies are softening as US and European clients tighten their budgets. In Infosys’ latest earnings call, CEO Salil Parekh also pointed to a bit of a “slowdown in decision-making” from customers. With many headwinds, the industry has no choice but to move away from cost arbitrage. This is not a new prescription. But it’s now or never, if the industry wants to see another dream unfold in the years to come.

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