“Deal pricing is so competitive, service providers cannot reduce costs fast enough anymore to maintain operating margins,” said Phil Fersht, CEO of HFS Research.
According to Fersht, to win deals, especially renewing existing contracts, service providers are negotiating as hard as up to 20-30% price decreases.
“Most of the service providers have such poor deal pipelines they are bringing forward renewals with the carrot of 20-30% price decreases. We are seeing this much more across the top tier firms as large deals are in decline. Mid tiers are able to go after smaller deals more aggressively which do not eat into operation margins as much.”
ETtechIn a challenging demand environment, while margins improved in the second and third quarter, a bid to win deals and grab more business weighed on the margins in the final quarter.
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Infosys, the second largest software services firm locally, saw its margins dip to 20.1% from 21% a year ago and 20.5% in the October to December period. Similarly, for its smaller rival HCLTech, the EBIT margins for January to March quarter dipped to 17.6% from 18.2% last year and 19.7% in December.
Even for the full year, Infosys reported a subdued margin of 20.7% dented by headwinds of 180 basis points (bps), of which 100 bps were because of one-time impact of contract renegotiation and rescoping while 80 bps were towards salary and branding costs, Infosys said during its post earnings call. One bps is equal to a hundredth of a percentage point.
Seasonality & Profits
While HCLTech attributed its lower margins to seasonal slowdown and guided conservatively in the 18-19% range with focus on growth, in a post results analyst call, CEO C. Vijayakumar said, “I think software vendors are able to get away with the significant price increase which customers are left with no option…if you have a large
footprint the customer expects more for less and in some areas where they have not really outsourced, they tend to outsource more.”
Meanwhile, TCS’ margins boosted to 26% in the final quarter of FY24 (from 24.5% in Q4FY23 and 25% in Q3FY24) and 24.6% for the full year, up from 24.1% in FY23. Fourth-largest IT major Wipro also improved slightly to 16.4% from 16.3% a year ago and 16% in the previous quarter.
Hansa Iyengar, UK-based research firm Omdia’s senior principal analyst for enterprise IT, attributes the margin stagnation to a confluence of factors. “Initial cost optimization efforts are reaching their limits, and wage inflation, supply chain pressures, and a project mix shift towards lower-margin work are at play here. TCS, the industry leader, seems to have navigated these challenges more effectively,” she said, adding that margins are likely to find a new equilibrium in FY25 as companies adjust to the evolving cost landscape.
The IT bellwether said the improvement was led by improved productivity, better utilisation and reduction in subcontractor expenses.
However, with key margin levers at near optimal levels, scope for meaningful expansion in margins seems low.
The Tata group firm also highlighted that it would see headwinds coming up in the first quarter of FY25 as it will take the impact of increments to employees.
Saturation Point?
As per a recent Jefferies report, further expansion in margins may be difficult, given that utilization levels are near their peak for most IT firms.
Bengaluru-based UnearthInsight points to acquisitions and inorganic bets of Indian IT services firms which are aiding revenues but some impacting margins negatively due to higher onsite mix, average employee costs, compliance costs and higher SG&A (selling, general, and administrative expenses).
Besides the post-covid higher average employee costs continuing to remain high.
“Another impact on the wage bill is investments for Gen AI in two ways. One is through new hires for Gen AI capability and the second is wage corrections for up-skilled / cross-skilled resources,” said Gaurav Vasu, founder and CEO of UnearthInsight.
The significant push towards training and upskilling budget to build future ready talent for newer deals could further elevate the costs impacting margins, he added.
