Indian Outsourcers Should Look At Rural Talent

According to recent Forrester research, technology spending in the United States is expected to grow 8.4% in 2010 and global market IT spending is projected to rise 7.7%. But, while IT spending may be better, the $60 billion Indian IT industry has a tough challenge in maintaining margins. The sector earns the majority of its revenues from the United States, and with the rupee growing stronger against the dollar, margins are being hurt. The Indian rupee appreciated 4% over the dollar in the quarter ended March after registering a 5% gain in the previous year. Additionally, with the job market opening up, players are resorting to double-digit salary increases to retain offshore staff and are taking a hit on their margins; the increasing costs are making traditional outsourcing a less attractive alternative. As I wrote in my Forbes column today, Indian IT majors should look very seriously at rural and small-town outsourcing, and soon.

Despite these recession and currency pressures, the largest player in the country, Tata Consultancy Services (NSE:TCS), saw quarterly revenues grow 18% over the year to $1.69 million, aided by a volume growth of 4% for the quarter. Net profits grew a significant 60% over the year, driven by the strict cost control and utilization improvement measures adopted last year. TCS ended the year with revenues up 5.4% to $6.34 billion.

In line with analysts’ expectations, TCS has announced wage increments. For the year, it plans for an average of a 13% increment for its offshore employees and 2%–4% increments for the onsite major markets. The salary increases are expected to lower margins by nearly 2.5%.

TCS is not worried about the pricing pressures. During the previous quarter, prices improved by a marginal 0.05%, and the company is hopeful that they will continue to improve in the coming quarters.

The company has yet to see the European market recover. While the United States, the UK, and emerging economies are doing better, much of the rest of Europe still seems to be lagging. Additionally, TCS is worried by the currency headwinds faced by the euro.

TCS recently announced a global engineering service partnership with Rolls-Royce, the global power systems company. As part of the agreement, TCS will support Rolls-Royce’s strategy to expand its engineering services in India. TCS will set up an engineering center to support the Rolls-Royce design and engineering requirements in India.

Improving utilization has been a critical task for the outsourcing industry in the past year to maintain and improve margins. TCS has one of the best utilization rates of its peers and for the quarter significantly improved utilization levels to 81.8% excluding trainees and 74.3% including trainees.

The stock is trading at Rs 785, approximately $17.60, after having touched a 52-week high of Rs 845.90 ($19.00) earlier last month.

Infosys too managed to surpass market expectations. Revenue for the Q4 grew 16% over the year to $1.3 billion and exceeded the Street’s target of $1.27 billion. EPS of $0.61 for the quarter also beat the market’s expected $0.58 and recorded growth of 9% over the year. The company ended the year with $4.8 billion, recording 3% growth despite the previous year’s recession. EPS for the year came in at $2.30 compared with $2.25 earned a year ago.

To control creeping attrition, Infosys has announced an offshore wage increase of 13%–17% and an onsite wage increase of 2%–3% over the year. These increments are expected to lower margins by nearly 1.5%.

Infosys also believes that the period of pricing pressure is now over. The company reported a 4% decline in prices last year and a 1.5% decline in the last quarter. But most of its price negotiations are now over, and things aren’t expected to worsen.

Infosys plans to handle margin pressures by continuing the strategy of improving employee utilization. The company is looking to improve productivity by 2% during the year, in addition to exercising additional cost control and pricing leverage. Infosys ended the year with 113,000 employees and a utilization rate of 77%.

Meanwhile, business continues to grow. The company recently announced a three-year deal with Microsoft to run Microsoft’s help desk and software application support across 450 locations in 104 countries. To support the growing business, Infosys plans to hire nearly 30,000 employees in the current year. I see no reason why these 30,000 new hires cannot be located in the hundreds of small towns all around India, instead of putting further pressure on the already crazy-congested metropolitan areas.

The company projects Q1 revenues of $1.33 billion–$1.34 billion with EPS of $0.55–$0.56. The market was expecting revenues of $1.29 billion with EPS of $0.56. For the fiscal year, the company projects revenues to grow 16%–18% to $5.57 billion–$5.67 billion with earnings improving by 9%.

The stock is trading at $61.89, taking the market capitalization to $35.2 billion. In reaction to the results announcement, the stock touched a ten-year high of $63.73 earlier this month.

Like its competitors, HCL Technologies had an impressive quarter. Q3 revenues grew 21% over the year to $685 million. Net income grew 78% over the year to $76.6 million.

HCL had strong growth across all geographies and services. During the quarter, the company announced a partnership with software provider nMetric to help automotive manufacturers improve factory operations through intelligent shop floor solutions. It also tied up with Wellogic, a software solutions provider for the healthcare community. As part of the agreement, HCL will work with Wellogic to provide interoperability and health records management solutions to improve the efficiency of care delivery across the global healthcare industry.

The Axon acquisition seems to be doing well, and HCL announced a go-to-market partnership with NextLabs, a provider of policy-driven information risk management solutions. The partnership aims to “[bring] information risk management software and consulting expertise to companies operating in complex, highly regulated environments such as the utilities, aerospace, defense, travel and transport industries.”

Like peers, HCL has focused on improving utilization trends. The utilization for the quarter was 76.2% for employees including trainees, compared with 76.4% a quarter ago and 74.1% a year ago. Excluding trainees, utilization improved significantly to 79%, compared with 77.9% a quarter ago and 74.8% a year ago.

The stock is trading at Rs 373.90 ($8.40) after having touched a 52-week high of Rs 388.90 ($8.75) earlier this year.

The digital nature of the IT outsourcing industry means that unlike in the manufacturing industry, customers can change relatively easily to another service provider. Indian players have been counting on labor arbitrage for a while to attract customers. But this benefit is gradually waning. As guest author Tony Scott has been showing in his recent series on outsourcing, outsourcing as an industry will continue to exist and grow owing to the benefits it will always offer. However, there is no reason to believe that companies will not moved outsourced operations from India to other countries; indeed, some have already done so. It remains to be seen how the current Indian giants handle the imminent global shift. As of now, none seems to be doing anything significant to lead the transition.

My two cents: Look at the vast, untapped potential of rural and small-town India, where the majority of the population lives.