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Concerning Utilization Rates At Indian Outsourcers

Posted on Tuesday, Aug 18th 2009

Gartner predicts that IT spending will fall 6% this year to $3.2 trillion. TPI estimates that the value of global outsourcing new contracts has fallen 22% in the first half of the year to $19 billion, with no significant improvement expected in the second half. None of these numbers paint a good picture for the $60 billion offshore Indian IT industry. NASSCOM, the Indian Software and Outsourcing industry group, recognized the impact of the recession and predicted that the software industry’s growth rate in India will fall to single digits compared with 15–16% growth last year and 30% two years ago.

However, growth is bound to return. A recent NASSCOM–McKinsey report projects the Indian software industry to grow to $225 billion by 2020, of which $180 billion is projected to come from overseas compared with the present $47 billion. Eighty percent of this overseas growth is projected to come from the emerging markets of Africa and Eastern Europe. Indian domestic customers will also grow from the present $12 billion contribution to $45 billion by 2020 given that the country’s federal and state governments have already outlined investments worth $8 billion in information technology over the next few years.

Tata Consultancy Services (TCS) had an impressive quarter. Revenues of $1.48 billion grew marginally over previous quarter’s $1.43 billion. Compared to the previous year, revenues slipped 3% from $1.53 billion. EPS of $0.16 was 23% higher than the previous quarter, and the company managed to eke out growth of a cent over last year’s performance.

By region, American revenue contributions remained flat at 57% with the European contribution declining marginally to 28% from 29% a quarter ago. However, there was growth in the emerging markets of Asia Pacific and India; these regions’ contributions grew to 9% and 4% respectively.

Headcount was down by 2,746 over the quarter. TCS’ utilization levels are high compared to peers’ and hover at 71% including trainees and 79% excluding trainees. This rate might fall soon, as TCS expects an additional 24,885 people to join them from various college campuses. Of that number, almost 1,000 are expected to join in the current quarter. Like their peers, TCS is looking to improve their onsite presence and will be selecting 250 recruits from US campuses. Attrition stood at 12.8% for the trailing twelve-month period, with 12.1% in the IT services business and 20.5% in the BPO segment.

Unlike their peers, TCS’ volumes grew 3.5% over the quarter with pricing impacting 0.25% of overall growth. The BFS, Retail and Pharma segments were either stable or showed minor improvements, but TCS were still concerned about the slowness in Manufacturing, Telecom and Hi-Tech.
TCS is investing in platform-based services. The previously acquired Diligenta platform in the insurance policy servicing field in the UK has already released its first enhancement. Within platform BPO offerings, TCS is investing in four to five pilot customers for their HRO and F&A space.

TCS’ stock is trading at INR 509.20, approximately $10.60.

tata

Infosys’s Q1 results saw revenues grow sequentially by 0.1% to $1.12 billion, exceeding the market’s expected $1.07 billion. EPS of $0.55 was also higher than the expected $0.47 and grew by a cent over the last year. In rupee terms, revenues grew 13% and net income grew 17% over the year.

Maintenance revenue contributions was up from 22% a quarter ago to 23% while consulting revenues fell from 25% to 24%. Most verticals remained stable, save for a marginal increase in telecom from 16.7% earlier to 16.9% in the current quarter. Revenue contributions remained flat by geography.

Infosys saw more opportunities for their platform-based solutions, especially in the payment area; replacement of legacy transaction systems, especially in core banking and in securities trading and processing. They are also seeing increased activity in the Nordic regions, Continental Europe, Australia, and South Africa.
Overall volumes fell 1.1% over the year with onsite volumes falling 2.1% and offshore volumes 0.6%. In constant currency terms, revenue per employee fell 1%. Utilization, excluding trainees, fell to 70% compared with 75% a quarter ago. Even though there was a gross addition of over 3,500 employees during the quarter, their company reduced its headcount by 945. This was their first-ever quarter of headcount reduction. Attrition remained stable for the quarter at 11.1%. A year ago, this number stood at 13.6%.

Earlier this year, Infosys made job offers to 18,000 potential employees, and the company plans to honor these offers. Going forward, their utilization levels are projected to be as low as 68%. For every percentage drop in utilization, Infosys will have to let go of 0.4% in margins. Yet, they plan to train these new employees suitably in the coming months to ensure that when the economy picks up, Infosys isn’t left hunting for talent.

Most Indian companies have recognized the need to expand their onsite presence. Infosys, for example, is placing 1,000 onsite employees during the year. Obviously that is an expensive proposition. No wonder they are forecasting EPS for the full-year to decline by 11.1%–12.4% to $1.97–$2.00 per share with revenues expected to fall by 3.1-4.6%.

Infosys is sitting on $2.2 billion worth of cash. While they are considering 12–15 deals worth $1 billion and expansion in Europe, Latin America, Australia and Japan through acquisitions, they could also look at some SaaS companies to add to their portfolio.

Their stock is trading at $41.90 having risen from the $28 levels it was trading at in the previous quarter. The market capitalization has grown to $24 billion.

infy

Wipro, the third-largest Indian software exporter, also beat the market’s expectations. However, this was their third consecutive quarter of falling IT revenues. IT Services revenues of $1.03 billion declined 1.3% sequentially and 3.3% over the year. On constant currency terms, revenue declined 3.0% sequentially 2% over the year.
However, Wipro management seemed optimistic about the future as they claimed to see the first signs of stability in the business with volumes beginning to stabilize and reductions no longer as steep. Wipro claims to be focusing on “Go-to-market and driving significant pperational productivity” initiatives.

The company is focusing on delivering end-to-end integrated solutions across their differentiated business lines of Infrastructure, Software and BPO support as clients continue to demand vendor consolidation. They have increased their investments in emerging geographies and are focusing on improving the quality of their sales people and hiring more onsite talent to “drive the needs of transition and change management capabilities.” Wipro hopes to leverage their proximity to customers to attract emerging opportunities.

During the quarter, Wipro’s onsite realization improved sequentially by 1.3%, while offshore realization dropped by 1.1%. Overall volumes dropped 1.5% in the quarter against a 6.3% decline in the previous quarter.

Utilization improved sequentially by 160 basis points to 70%. Wipro added 711 employees to their IT business during the quarter. Higher utilization helped expand the segment’s margins, which grew 0.6% over the quarter and 1.5% over the year to 22.3%. Attrition was much lower than peers’ at 8.4% but grew from the 7.9% recorded a year ago. Nearly 7,500 recruits are expected to join Wipro from college campuses during the year.

Wipro is continuing to invest in technology and R&D. They are specifically looking at a cloud computing strategy which covers building and managing private clouds, adopting public clouds and building hybrid infrastructures to attract clients who are considering adopting these technologies. They have already developed applications such as a Mortgage Origination Platform for the banking industry, a Comprehensive Information Management System for hospitals, and Hosted Document Management and Electronic Data Interchange.

They are also pursuing a “green IT initiative” which will aim to reduce the carbon footprints and energy needs of multiple industry verticals. They launched a solution for the telecom industry, “Wipro’s eCO-NET”, which uses a combination of network energy diagnostics tools and end-to-end network energy operations management frameworks to conserve energy.

For the current quarter, Wipro expects revenues of $1.04–$1.05 billion from their IT Services segment, with margins expected to expand by 0.5% to 22.2%.

Wipro’s stock is trading at $15.41, taking its market capitalization to $22.5 billion.

wipro

The recent accounting fraud had left Satyam (NYSE:SAY) in a big mess. However, the 43% stake acquisition by Tech Mahindra (NSE:TECHM.NS), which is 31% owned by the British Telecom Group (NYSE:BT), has put Satyam back in the news. Tech Mahindra bought over their stake in Satyam for a sum of $580 million in April of this year.

Satyam recently announced for the quarter ended December and managed to post a surprising profit of INR 1.6 billion ($32.86 million). Revenues were reported at INR 24.15 billion ($495.58 million) with 95% contribution from exports and the balance from domestic businesses. The company did not provide earlier year numbers as they are in the process of being restated. However, they did say that they ended both January and February on a profitable note.

Nearly 2,000 employees left the company after some of its senior managers were found to be behind India’s worst accounting fraud. At the end of the March quarter, headcount had was down to about 42,000 employees. But Tech Mahindra’s CEO feels that Satyam is overstaffed and needs to adopt significant cost-cutting measures if they are to perform. They have already placed 8,000 employees on home leave on sharply reduced pay.

The new management is helping boost customers’ confidence. They have already added 25 mid sized customers, but the loss was far greater. Of the 500 clients that Satyam actually had (Ramalingam Raju had bloated the number to 600), 100 had left the company on account of the scam. They believe that the worst is over for the company and that estimated revenues of $1.1 billion to $1.3 billion for the year represent the bottom.

They too are seeing traction in emerging geographies and verticals. While US customers are still wary of returning, European and African customers are not. Satyam is looking at European customers worth $50 million over the next four to five years from. Non-US customers contribute 50% of overall revenues. Among verticals, the company is seeing good opportunities in healthcare, retail and utilities.

The stock is trading at $5.48 with a market capitalization of $1.48 billion.

satyam

Of all the Indian outsourcing players, Cognizant Technology Solutions (CTSH) is gaining ground. Cognizant focuses more on technology consulting and given that discretionary spending is being cut, it is surprising that their revenues continue to grow steadily.

Recent Q2 reports showed revenue growth of13% over the year and 4% over the previous quarter to $776.6 million. The market was looking for revenues of $760 million. EPS of $0.50 was also significantly higher than the market’s expected $0.37. Operating margins grew to 19.5% compared with 17.5% a year ago.

Eighty percent of revenues came from North America while Europe contributed 18%. The rest of the world contributed the remaining 2%.

The banking and financial services segment stabilized during the quarter and represented 43% of the total revenue. The healthcare services segment grew 7.9% sequentially and contributed slightly more than 26% of the overall revenue. In the coming quarters, analysts expect this segment to grow as the recession has forced US-based government agencies and healthcare firms to cut costs and deal with a shortage in personnel. Retail manufacturing logistics grew 7.6% sequentially and contributed over 17% of revenues for the quarter.

Cognizant is continuing to invest in the emerging geographies of Asia-Pacific and have strengthened their presence across Australia, Japan, China, India, and the Middle East. They are investing in technology and developed Cognizant 2.0, which is a fully integrated global delivery platform based on Web 2.0 technology. They expect to address the challenges of real-time project management and knowledge management across global teams through the platform, as it enables global teams to collaborate virtually and deliver significant time to market cost and IT transformational value to clients.

Cognizant is also investing in emerging high-growth service lines such as the engineering and R&D outsourcing market. Analysts expected a potential market of $200 billion to $220 billion in the years to come. Their recent relationship with Invensys is aimed at addressing this opportunity.

Invensys is a global provider of technology and controls for industrial automation and rail transportation. Their operations management division focuses on automation solutions to improve efficiency, profitability, and safety. Nearly 200,000 manufacturing facilities worldwide use Inventus products. The relationship will likely help both companies expand, innovate, and tap into new markets. Cognizant will deliver the services out of their Indian location in Hyderabad, where they will form the engineering and manufacturing solutions practice.

Their headcount grew by 400 to reach 64,100, nearly 25% of whom are located onsite. Cognizant’s strong onsite presence has helped them get more business — a strategy that is now being adopted by peers. But Cognizant too is looking to improve their rather poor utilization levels. Offshore utilization was 66% during the quarter and utilization excluding trainees was at 70% levels. Onsite utilization was approximately 88% during the quarter. Attrition levels remained at 11%, at par with the industry.

Cognizant raised their guidance and are predicting growth of 11.5% in revenues for the fiscal 2009. With revenues of $3.14 billion, they are expecting EPS of $1.80. Analysts were looking for EPS of $1.54 on revenues of $3.10 billion. For Q3, they are expecting revenues of at least $800 million with EPS of $0.44, higher than the market’s expected $0.39 EPS on revenues of $784 million.

Many believe that Cognizant’s secret to success lies in their business model, which avoids both low-end and high-end outsourcing work. They neither focus on standard call center work, nor on the high-end consulting segment led by Accenture and IBM. They also avoid low-hanging fruit and are thus not lured by labor arbitrage, or projects such as fixing Y2K bugs. This approach enables them to build an adaptable, long-lasting model. Cognizant’s continuous reinvestment might lower their margins, but it helps them keep ahead of competitors in terms of business solutions.

However, they do carry the risk of high dependency on the financial sector, which had caused them concern earlier.

Their stock is trading at $34.43 with a market capitalization of $10.10 billion.

cog

Clients today are looking for reduced prices (estimated to impact 3–5% over the year) while at least maintaining, if not improving, quality standards. Labor arbitrage is losing its sheen, with most companies that paid out huge increments in the earlier years having to curb increments during the current year and resort to sending people on long leave to reduce payroll pressures. Attrition rates have stabilized at 11% levels.

Improving utilization has become a focus issue, and an industry which relied on bench must now resort to optimized staffing. There are still players such as Infosys that prefer keep a big bench in anticipation of being able to use their pool in years to come. But the upcoming end of the tax holiday (the Indian goverment’s tax waiver was scheduled to end in March 2010, but has been proposed to be extended through March 2011) and other pricing and competition pressures will likely put such players under tremendous margin pressure.

Many believe that the current climate will help the Indian IT industry become leaner, more productive, more competitive, and push it adopt a Wave 3 strategy. After all, with margins expected to fall, only companies that can adapt and redefine their models will flourish.

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Dear Ms. Mitra,

Thank you for this wonderful article. It was interesting to get a glimpse of the Indian Outsourcing firms’ strategy. In your opinion, where is IT consulting headed to–towards more outsourcing based on labor arbitrage or away from it?

S Mallik Wednesday, August 19, 2009 at 11:19 AM PT

I just haven’t seen any evidence (plenty of lip-service, yes) that it is moving away from labor arbitrage. It looks to me as though they’re just looking for new markets to practice labor arbitrage at a larger scale.

Sramana Mitra Wednesday, August 19, 2009 at 11:44 AM PT

Thanks. So is it more of a blue ocean strategy of finding new markets rather than moving towards the higher end of outsourcing like IBM’s?

S Mallik Wednesday, August 19, 2009 at 2:20 PM PT

I think it is a rather mundane “finding new geographies” strategy. Nothing Blue Ocean about it.

Sramana Mitra Wednesday, August 19, 2009 at 4:37 PM PT

I think a lot of the talk from the Indian outsourcers is clique d, i think their mindset will continue to remain arbitrage. I don’t think i have seen too many of the people at the leadership level in Indian IT companies with the actual acumen to move away from that model. To do that they will have to break what they have and re-invent it. A lot of the leadership i don’t think has the ability – they are just there because they are a function of the growth that happened in that sector – just sheer timing. The depth of leadership to move to a IP based model in these large outsources just does not exist.

Harsha Friday, August 21, 2009 at 5:19 AM PT

SM

Great summary of quarterly announcements. How about some analysis as well.

regs
ben

ben shiva Tuesday, September 8, 2009 at 12:55 AM PT

The company that Cognizant has partnered with is Invensys, not Inventus.

Siddharth Wednesday, September 9, 2009 at 10:02 PM PT