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IT Sector: Hiring says it all - Views on News from Equitymaster
 
 
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  • Jun 28, 2012

    IT Sector: Hiring says it all

    The Indian Information Technology (IT) sector has been the darling of investors in the past, and deservedly so. The past decade was the golden period with the Indian IT sector growing ninefold even with a turbulent global economy. NASSCOM (National Association of Software and Services Companies) expects India's IT and Outsourcing industries to cross US$ 100 bn during FY12, double its 2007 size. Clearly, the sector has experienced spectacular growth during the last decade.

    More recently, we have seen pressure on the revenues, margins and profits of Indian IT companies. This is due to the significant weakness and volatility in the US and European economy, both of which are major markets for the Indian IT sector.

    As a result, many IT industry experts seem to be projecting a cautious outlook for the sector. We believe that their pessimism towards the growth of this sector is not baseless, at least not in the near future. Why?

    In addition to the global economic conditions, there are many leading indicators of the IT sector growth. These include deal pipeline, the number of large projects, hiring plans and salary hikes. And currently most of these pointers are not in a good shape.

    Of these, one of the most critical indicators is the hiring outlook provided by companies at the start of a financial year. Hiring outlook is also the surest sign of the management's view on business prospect.

    While fresher recruiting plans remain intact for many big IT giants such as Tata Consultancy Services (TCS), Infosys and Wipro, some companies are delaying the start date for freshers who they had recruited earlier.

    Indications coming from lateral hiring are equally discouraging. Many big software companies are almost shying away from the lateral hiring in the current situation. Lateral hiring is being done in small pockets on an acute need only basis.

    Importantly, companies are now resorting to temporary hiring to cut and manage costs. Relative to permanent hiring, temporary hiring means smaller salaries, no benefits and no liabilities to retain employees.

    This sends us a clear signal that IT companies are not even sure of protecting margins in this prevailing volatile demand environment.

    Another important pointer is salary hikes. IT companies have always been under attrition pressure. To tame that, these companies used to announce handsome salary hikes. But this time, IT companies seem to be in altogether different mood. The sector erstwhile bellwether Infosys has not announced any salary hike in FY13. Instead, its top management got some variable pay cuts. Many companies are giving smaller hikes compared to previous year. TCS is giving an average 8% hike this year, as opposed to 12% to 14% salary increases last year.

    The extreme weakness and uncertainty in the US, European and world markets has resulted in most international clients in these areas not increasing their IT budgets.

    These international clients are in fact under tremendous pressure to cut costs. In fact, given the uncertain environment, these international clients are committing to shorter term smaller projects, and not the previous five years plus larger projects. Essentially, they are delaying their IT spending decisions.

    For Indian IT companies, this short term client view means keeping more employees on the bench without work, and in anticipation of "uncertain" future work. This phenomenon is very noticeable in the falling employee utilization numbers. For example, for Infosys, employee utilization (excluding trainees) dropped from 78.9 in FY11 to 75.6 in FY12, and for TCS from 82.4% in FY11 to 80.64% in FY12.

    These problems and challenges have not surfaced suddenly. We know that the global demand situation has been weak and volatile for quite some time now. However, the management of many companies maintained positive views. Now they are examining different strategies to manage their businesses.

    NASSCOM has estimated an 11%-14% growth for the IT sector for FY13, much lower than the historical Compound Annual Growth Rate (CAGR) of nearly 25% during last decade. Yet, many experts consider that even these much lower FY13 11%-14% growth estimates are ambitious targets!

    Infosys has projected a very pessimistic outlook for the current financial year. The company expects FY13 revenues to growth at only 8%-10%, well below the NASSCOM projection.

    If tepid hiring of freshers, almost muted lateral recruitment, less than ordinary salary hikes, dropping of employee utilization rates, and a surge in recruitment of temporary staff are anything to go by, odds are that IT companies will not perform well in the near future.

    However, we believe that the long term prospect of the IT sector will remain intact. This is because IT penetration worldwide is relatively low, and there continues to be a need to be more and more efficient to compete and survive. And, while the Indian IT sector is facing challenges currently, it is also innovating and offering new products and services.

    While we believe that the performance of IT companies will be uncertain in the short term, the longer term view remains that with the continuing need for information and knowledge, IT will be a critical catalyst for change and development globally.

    And Indian IT companies can return much more than information to investors.

     

     

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