Indian IT cos preparing for possible recession

Indian IT services companies are pulling various cost levers to protect their operating margins. This has come when a possible recession in the United States and many European geographies are creating concerns over a demand slowdown towards the end of this year. To tide over such uncertain economic environment, many IT firms have announced reduction in variable pay out to deferring bonus pay out to mid-level and junior employees. Especially, large firms are creating a cushion to protect margin that has taken a beating in the first quarter of ongoing financial year. In a conversation with the Bizz Buzz, Founder of Pareekh Consulting and EIIR Trend, Pareekh Jain said that the companies are taking proactive measures to overcome all kinds of situations that may arise if the recession strikes. He, however, said that the situation is not that doom and gloom for Indian IT industry, which is known for its resilience. Rather, a recession in the US or Europe may create opportunities in the large deal space for Indian IT firms, he said.

Indian IT firms gained market share during the pandemic as large IT firms like TCS, Infosys, Wipro bagged multiple mega deals from global enterprises owing to the cost pressure. So, a slowdown may create opportunities in the mega deal space, Jain said. He also said that mid-tier companies seemed to be better placed as compared to large firms as of now. However, in case of a full-blown slowdown, mid-tier companies will be impacted more. On hiring, Jain said that the momentum has come down and Indian IT firms are likely to see fall in attrition on quarterly basis going ahead.

We have seen IT firms reducing and deferring bonus pay outs to mid-level and junior employees. When companies like Tata Consultancy Services (TCS), Infosys and Wipro took such decisions, how should one read it? Will it fuel more attrition?

When something is happening across the industry, one shouldn't worry too much. It may happen that attrition may not come down much but the chances of attrition going up are very slim. The concern related to attrition is more or less over from the last quarter. There is a lot of onboarding of freshers with aggressive hiring in the past quarters. So, the concerns over attrition are not that much as of now. Because, hiring by startups and other technology firms has come down. Therefore, companies are taking these measures like reducing variable pay, bonus pay out among others. In turn, hiring has also come down in recent months.

Apart from slowdown fears in the US, Europe as a geography is also going through a lot of economic uncertainty. How is the overall demand environment in these two key geographies? Have any client-specific issues started appearing in the IT landscape?

There are some reports of client-specific issues that we have seen. But what companies are saying is that impacts of slowdown have started reflecting in some pockets. But, there is no specific impact on country level or vertical level yet. Even if the recession comes, it also has some silver linings. Every slowdown gives rise to large cost takeout deals. There are even some discussions around those kinds of mega deals which Indian IT firms had bagged during the Covid pandemic period. If recession comes, those mega deals will also be up for grabs. So, any slowdown will result in reduction of discretionary spends like digital, but subsequently, mega deals will also come.

Operating margins have come down for most IT services companies in the last few years. There seems to be a secular decline in that period. Can we say that the margin profile of Indian IT industry is facing structural issues now?

Despite all the concerns of slowdown, Indian IT industry is very resilient. Companies usually figured it out in two quarters how to cope with an event. Now, companies are doing the scenario planning as many events are impacting the outcome. Investors are looking at structural risks to margin profile. Because if structural change to margin happens, then stock prices of many IT firms will be derated. Given the valuation, any permanent change in margin profile will affect the share prices.

Earlier, the concern related to margin was arising due to supply-side issues. That's why a record number of fresher hiring has happened. Companies were hopeful that margin issue would get addressed with fresher onboarding. However, concerns over demand have also come up.

Given the margin pressure, what are the levers available for Indian IT companies to support margin profile apart from reducing the wage cost?

Offshore is another lever that the companies will look at for supporting margin. Though there is limit to how much it can be raised (given that offshore is already at a high level), but there is scope for 1-2 per cent improvement. Increase in pricing is another lever. There are pockets in which clients are willing to give higher price. Fixed price contract is a lever which IT firms always opt for improving margin. Companies will definitely look at winning more fixed price contracts. Similarly, implementation of more solutions that can be done through lesser number of engineers will also be actively tapped. Moreover, we are witnessing that companies are reducing their marketing spend after an enthusiastic start during the first quarter of the financial year. In some companies, small expenses are being referred to higher ups. Unnecessary travel is also being curtailed. So, companies are taking many short-term measures to support margin. As macro factors are expected to remain uncertain, companies are preparing for that kind of scenario.

However, it is not a doom and gloom scenario. Companies are rather preparing for an uncertain demand environment. If you see the overall portfolio, it doesn't look bad. Also, if global slowdown leads to increased cost pressure, there is a probability that Indian IT firms may increase market share. We have seen that Indian service providers were benefitted from large deal momentum during the Covid pandemic. If the recession leads to such momentum again, domestic IT companies will again be benefitted from it.

Mid-tier companies have been outperforming large cap companies in recent quarters. Do you think this trend will sustain if slowdown drags IT spend by enterprises?

Tier-I companies have balanced portfolio. Large firms are more dependent on large deals. Mid-tier IT companies doesn't participate in such large deals. That is the reason that revenue growth of mid-tier IT firms was better than large caps. Currently benefit is also being reaped by mid-tier companies as they have less exposure to Europe. Also, hiring momentum remained intact in the first quarter of ongoing financial year. Currently, mid-tier IT firms are more optimistic about their growth prospects than large service providers.

There are two indicators that are driving such optimism. Firstly, growth is driven by the orderbook clinched last year. In the first quarter, order book of mid-tier firms remained strong as compared to large firms. Net hiring and net order book have increased during the first quarter. However, in case of full-blown impact, mid-tier IT companies will be impacted much.