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Indian Outsourcers Facing Globalization Challenges

Posted on Thursday, Aug 5th 2010

Recent research reports by Forrester predict 9.3% growth in IT spending for the current year. The improved market conditions are resulting in stiffer competition among the Indian players for quality resources. Attrition in the segment has increased despite most companies offering 12%–14% offshore and 2%–4% onsite salary increments. Companies are trying to retain their staff by offering equity-based incentives, offcycle increments and bonuses, retention bonuses, and promotions. To add to their concerns, the rupee remained strong against the dollar, Europe’s recovery is slower than anticipated, and the ten-year tax holiday is coming to an end. The Indian IT players are in for a tough season ahead.

Tata Consultancy Services, (NSE:TCS) the leader in the segment, saw Q1 revenues grow 21% over the year to $1.79 billion. EPS of $0.21 grew 4.9% over the year.

For the quarter, TCS too saw attrition rise to 13.1% compared with 11.8% for the previous year. Its utilization rate remained among the highest, with utilization excluding trainees increasing from 81.8% a quarter ago to 82.6% and utilization including trainees rising from 74.3% last quarter to 74.8%.

The company is focusing its efforts on expanding operations in high-growth markets of Asia Pacific, the Middle East, and Latin America. It is planning to add 40,000–200,000 people during this year as part of these expansion plans. In the longer run, the company plans for these markets to contribute in excess of 20% of revenues compared with the 12% contribution this quarter.

The stock is trading at 52-week high levels of Rs 868.80, approximately $18.80.

Meanwhile, Infosys (NYSE:INFY) saw Q1 margins of $0.57 drop 4% sequentially, despite growing 2% over the year. Revenues rose 21% over the year to $1.36 billion, managing to exceed the market’s projected $1.34 billion.

For the quarter, Infosys reported 15.8% attrition – the highest since 2002 – compared with 11.1% a year ago and 13.4% a quarter ago. Earlier this year, it announced increments of 13%–17% for offshore staff and 2%–3% for onsite staff.

Additionally, bill rates fell 1.6% over the year on a reported currency basis and 0.6% on a constant currency basis. Tax rates also went up from 21% last year to 25.5% as more delivery units saw the end of the ten-year tax holiday.

To improve margins, Infosys maintained its focus on utilization. For the quarter, it reported 73% utilization compared with 69.3% a quarter ago. The company is also increasing its global footprint and is looking to expand its presence across Asia and Latin America, especially in China, Japan, Australia, and Brazil. However, it recently shut its Bangkok back-office operations due to inability to scale up operations. The Bangkok work will be moved to India and China.

Infosys projects full-year sales of $5.72-$5.81 billion with EPS of $2.42–$2.52. The market was expecting revenues of $5.67 billion with EPS of $2.47. For the current quarter, Infosys is aiming for revenues of $1.41–$1.43 million with EPS of $0.59–$0.60 compared with the Street’s estimates of revenues of $1.38 billion with EPS of $0.60.

Their stock is trading at $62.63, close to the 52-week high of $64.50 it touched in June of this year.

Wipro (NYSE:WIT) saw IT Services Revenue grow 14% over the year to $1.185 billion. The segment’s EBIT of $291 million for the quarter grew 26% over the year.

Wipro’s attrition grew from 17.1% in the previous quarter to 23% this quarter. Net utilization, excluding trainees, fell to 81.6% from 83% a quarter ago.

Wipro continued its global expansion plans and recently opened a Seoul office to cater to the region. During the quarter, it tied up with Citibank to take over the ownership of Citibank’s data center in Meerbusch, Germany. Wipro will provide Citibank with facilities management and physical infrastructure management services. This will be Infosys’s first facility in Europe and will help the company cater to near-shore requirements of the infrastructure management solutions segment.

The company projects revenues from IT Services business to be $1.25–$1.27 billion for Q2.

The stock is trading at $13.75 after having touched a 52-week high of $14.84 reached in April this year.

The increasing costs and attrition are impacting margins of the sector, making me reiterate the need for them to expand operations to the still-untapped rural and small-town population of India. Not only will that diversification help to control costs, but it could keep a tighter reign on attrition. The industry has already begun setting up shop outside India to meet the near-shore delivery and the time zone requirements of its customers. Players are expanding centers in China and Latin America. Infosys has declared China to be its next largest center after India, with plans to ramp from 5,000 to 10,000 people based out of China. TCS is planning a similar expansion.

The companies are exploring Latin America to deliver Spanish and Portuguese services while retaining work nearshore. In cities such as Tijuana in Mexico and Cordoba in Argentina, outsourcing centers are able to get up to 70% bilingual staff, thus managing to address language issues.

But the industry is facing growing competition from the rural outsourcing industry of the United States. Taking an approach known as “ruralsourcing,” some U.S. players have set up centers in Missouri, Minnesota, and Arkansa and are able to offer rates that are 25%–40% lower than U.S. urban rates and a mere 17% higher than Indian outsourcer rates. Further, they are able to handle customer issues within the same time zone and maintain information onshore. It is not just the rural sector that is posing trouble. Companies such as West Corporation are able to deliver high-quality services at rates that are 15% lower than traditional brick-and-mortar U.S.-based centers by utilizing their home- based agents. With unemployment rates as high as 14% in Nevada, 13% in Michigan, and an overall 10% in the country, the U.S. outsourcing industry will have enough local resources available to address the market’s requirements and to deliver these services at competitive rates. Further, attrition rates are negligible, and some companies boast of operating at 100% utilization levels.

Indian outsourcers need to set up significant centers in the United States. Doing work out of the United States for U.S. customers will cost them much more. Today, an Indian outsourcer spends nearly half of its revenues on manpower costs and has to ensure a steady training pool to meet up with 13%–16% attrition levels. A rural U.S. employee can cost these companies as little as $35,000 a year. An inexperienced college software graduate in India costs between INR 400,000–600,000 (~$8,500–$13,000). But that recruit will need to be supported by an additional buffer resource who will cost just as much, will be required to handle potential attrition, and will also have to undergo a two- to four-week cultural training training course.

In my opinion, the BPO industry needs to look at hiring in America, onshore, nearshore, as much as possible, but in places where high unemployment has ravaged the economies. And even with IT services, there is still plenty of unemployed or under-employed people in the United States right now that the Indian outsourcers can and should leverage.

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