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Quarter view and beyond
“The revenue growth for top IT services companies is a mixed bag this quarter.”
K. Bharat Kumar
At a press conference earlier this month to announce the company's results, a journalist remarked to Tata Consultancy Services' top management, “TCS somehow manages to show consistent volume growth….”
CEO of TCS N. Chandrasekaran gently retorted, “I am surprised you say ‘somehow'. There is no ‘somehow' here”, suggesting that success didn't come by chance and that working to a plan is key to performance. A look at the revenue and net profit growth figures shows TCS has grown at a pace healthier than its peers among the top 4 among Indian IT services providers, for the quarter ended December 2010. (Cognizant, though larger than HCL Technologies in revenue terms, is yet to announce its December quarter results.)
Siddharth Pai, Partner and MD, of the Indian arm of TPI, the world's largest outsourcing advisory firm, is impressed with TCS' financial performance over the past few quarters. He says that TCS has always been one of the ‘price leaders', like other Indian services providers, meaning that it gives clients what they want at highly competitive prices.
But, he says, the company has also been putting in place additional discipline at the back-end. CEO Chandrasekaran, who has held the reins for just over a year now, has driven this. Asked what he meant by more discipline, Pai says, “It includes things like optimising your assets — your manpower.” So, assume that a company raises rates per hour at the junior levels and reduces them at the middle level. Even if the total cost changes are not significant for the customer, with a large base of junior-level people over time, the company still maintains a rise in margins.
TCS also draws admiration from Chirajeet Sengupta, Director – Research, Everest Group. He says, “TCS has brought in transparency to its dealings — in my opinion it would edge out even IBM in the transparency that clients have with TCS.” For example, in an infrastructure deal, the IT vendor would bring in eco-system partners providing IT services, Data Centre services, tools management and the works. “TCS has cracked the partner ecosystem.” That is, the client would have a very clear view on who brings what to the table.
The smallest among the Top 4 HCL Technologies made a marked change in its approach to profit margins. Long seen as a challenger with aggressive pricing that told on its profit margins, the company said earlier this month that its focus would be on upping margins in the next two quarters.
It gets a few good words from Fred Giron, VP, IT Services at Springboard Research: HCL has been really aggressive on pricing. “They have won large contracts at low prices against stiff competition even from the likes of IBM.”
Given this history of ‘aggressive' pricing, can HCL Tech make customers pay more now? Giron feels that margin levers such as utilisation rates and expenditure under the SG&A head (Sales, General & Adminstration) are easier to manoeuvre, than get clients to pay more.
He especially likes HCL's foray into Africa and India, where it won the Rs 393-crore NIC deal in the insurance space in its earlier fiscal ending June. For the December quarter, its sequential growth in constant currency terms was 10.8 per cent in the Rest of the World, compared with a 5.8 per cent growth each in the US and in Europe.
Thomas Routhier, Research Analyst at TBR, says that HCL had already made a strong play into competitive margins with its peers, but has since fallen as a result of BPO restructuring and its over-investment in lateral hires during 2010. “All the while, they've been quietly and steadily making a name in IT services and poaching rival experienced employees along the way.” (For instance, 70 per cent of the employee intake in the June quarter last year was experienced people.) His take: now that it has a broad base of lateral hires to deliver services, he expects its margins to see a moderate improvement in the near term. However, all this depends on HCL Tech's ability to increase utilisation and drive productivity increases out of employees without losing them to competition, given that industry attrition rates are high — Wipro at about 23 per cent for the December quarter while Cognizant's was around 21 per cent for the September quarter.
Everest's Sengupta agrees that challenges remain for HCL, saying, “HCL has clearly indicated that it was earlier going after revenue growth. Now, its focus would be on margins. It would be interesting to see how it balances a decline in SG&A expenditure while keeping its word on developing deep client relationships. These two normally don't go together.”
Interestingly, Routhier thinks that Vineet Nayar, Vice-Chairman and CEO of HCL Tech, may still have a few cards up his sleeve to keep HCLT's margins on the upward trend while driving revenue growth recently achieved.
Most industry watchers agree that Wipro, despite the recent churn in the senior management — (Azim Premji, the chairman, asked the two joint-CEOs, Girish Paranjpe and Suresh Vaswani, to leave, while inducting another insider TK Kurien to the sole CEO post earlier this month) — has done well on its growth metrics. For starters, it met its own estimates for performance in the December quarter.
Giron says that Wipro, like its smaller peer, HCL Tech, did well in emerging markets, especially in India and West Asia, where Wipro's growth rates on a constant currency basis are at 2.6 per cent sequentially, and 14.8 per cent year-on-year, slightly higher on both counts than its growth rates in the US.
However, he cautions that it could well slip one place from its No. 3 position, if it keeps the same rate of growth this calendar year. Cognizant has gradually caught up with Wipro and in the September 2010 quarter, only $56 million separated the two, from a difference of $375 million exactly two years ago.
Erin Hichman, analyst at Technology Business Research (TBR), defends the company's approach as being strategic to the long-term. “Wipro IT Services is more focused on achieving sustainable long-term growth and is investing in local onsite resources, including mid- and senior-level experienced hires.” He believes that with its focus on the big picture, the company is passing up shorter-term deals that would boost near-term top-line growth.
Metrics for the December quarter
So much for the macro picture: How have the four performed across service offerings, industries serviced and geographies, for the quarter ended December 2010?
The table shows all-round growth. The obvious stand-out is poor performance in BPO, except for Infosys's year-on-year growth and TCS. HCL Tech is undergoing a restructuring in BPO and foresees investments for a further six quarters before it sees significant turnaround in that business.
Asked if companies offering only BPO services are better off, rather than the biggies who have integrated IT-BPO offerings, Pai of TPI says, “Our numbers show there has been weakness in the new contracts in the BPO market for some time. However, I do believe that contract expansion and extensions have been taking place and the beneficiaries are usually the incumbents.”
Could that mean that captives (or arms of, say, financial institutions having back-office operations that service only the parent company) have taken away a chunk of business from third-party players — be they pure-play BPOs or those with both IT and BPO offerings? “There (has been)… growth in captive/shared services work that we have observed over the past few years.”
He adds that while there was still a significant amount of discussion around ‘platform'-based BPO, the promise of IT and BPO convergence really hasn't panned out as yet. After all, he agrees, decision makers for IT and BPO are still different at client organisations.
Meanwhile, all four companies have shown growth in the financial services and manufacturing verticals. TCS and Infosys have seen less-than-healthy metrics in telecom. That is a quarterly glitch that companies are not setting great store by. Chandrasekaran of TCS said, “If you take away India figures, our global telecom business has grown.”
Infosys CEO and MD S. Gopalakrishnan has said that the telecom vertical has been soft in the North American region but that it is temporary. His COO, S.D. Shibulal, said in a TV interview that this year would see pick-up in capital spending in the telecom sector. He also felt that services vendors to telecom would find benefit from the Internet neutrality norms issued by the FCC last year. “The coming year will be better than the last two years for telecom, hopefully,” he said.
On geographic growth, Infosys has lagged peers in Europe. Analysts feel that this could be due again to clients such as BT in the UK declining.
HCL Technologies feels that Japan is ‘suddenly waking up like Continental Europe'. Says Vice-Chairman and CEO Vineet Nayar “There is significant outflow of deals coming from Japan in the engineering outsourcing space — in fact, there is a shift of R&D dollars from China to India which is extremely good for us.”
Then there is (the rest of) Asia which is high on aspirations as they want to increase their share in the global market. So Asia is going strong.
TCS says that major markets have led its growth, like for everybody else. CEO Chandrasekaran said, “India and Latin America have shown decline, primarily because the mix we have in these markets is still not fully annuity-based. They have a lot of discretionary portion as well. And in the December quarter, the project wind-downs have happened and we have not seen growth in these two markets.”
An industry observer who did not wish to be named said, “The revenue growth for top IT services companies is a mixed bag this quarter.
While TCS and Wipro have delivered a strong growth from Europe, Infosys and HCL saw growth driven largely by the rest of the world. Given that Europe still accounts for 15-20 per cent of the industry's revenues, everyone is in a wait-and-watch mode to see if sovereign debt issues result in holding up of budgets from Europe.”
Net manpower addition seems to have stabilised in the 20,000-25,000 range in the last two quarters. Significantly, none of the analysts eWorld spoke to agree that the industry is back to where it was in 2007, before the global slowdown.
Is the war for talent, as Infosys' HR chief T.V. Mohandas Pai, put it a quarter ago, still playing out? Or will the industry be satisfied with the hordes from campus coming out the next academic year and hence poaching of experienced hands from rivals would decline?
John Caucis, analyst at TBR, says, “The war for talent shows no signs of retreating any time soon, but aggressive hiring over the last two quarters may assuage attrition rates for the next 2-3 quarters.” However, he expects attrition to remain much higher than it was during the recent downturn, when many firms saw their turnover rates bottom out below 10 per cent. “I would say most firms will see attrition holding between 14 per cent and 18 per cent, with BPO-centric players such as Genpact seeing average attrition closer to 30 per cent.
With inputs from Moumita Bakshi Chatterjee.
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