IT firms offshore work to cut costs

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February 05, 2009

IT firms offshore work to cut costs
Faced with budget constraints and margin pressures, Indian IT services
providers such as Tata Consultancy Services (TCS), Infosys, Wipro and
HCL are moving more work offshore (to India) rather than onsite (at
the client’s site) in a bid to contain costs.

The offshore-onsite mix has changed from 70:30 ratio to 85:15. While
this benefits clients who do not want to pay extra in a slowing
economy, it also helps IT companies utilise their bench strength
better. Holding a bench at offshore locations is cheaper by two-and-a-
half times (since salaries are paid in Indian rupees) compared to
maintaining a bench onsite (paid in dollars, euros or pound).

The top four IT firms (since Satyam is now out of the pack till it
restates its figures), note analysts, have increased their offshore
revenue component by 80-150 basis points (bps) to optimise costs.
Moreover, fixed-price contracts have also been increased by 2-4
percentage points (or 200-400 bps) over the quarter because they
deliver better realisations than time and material billing.

For instance, TCS, India’s largest IT software and services exporter,
saw an improvement in operating margins by 53 bps through moving more
work offshore and the offshore mix also improved by 106 bps in the
third quarter that ended December 31, 2008. “In this quarter, we have
achieved an offshore movement of 106 basis points and achieved a good
volume growth of 2.42 per cent and then maintained our pricing,” said
N Chandrasekaran, TCS’ chief operating officer, during an analyst call
after the last quarterly results.

India’s second-largest IT services player Infosys’ offshore volumes
sequentially grew 3.3 per cent, while onsite volumes dropped by 1 per
cent in the quarter. The company is also seeing its offshore revenues
going up as most of enterprise resource planning (ERP) work is done
from offshore now. Moreover, the IT heavyweight feels that telecom
majors in France and Germany have announced budget cuts and hence need
to engage with offshore players.

However, moving work offshore also implies lower margins for IT firms
because the billing rates offshore are almost half that of onsite.
According to Sabyasachi Satpathy, director and co-founder of Mindplex
Consulting, an outsourcing advisory services firm, “There is a
definite rebound towards offshoring and the vendors are cutting down
the onsite work. The reason being that there are not enough projects
and the clients also want to reduce costs. This culminates in the IT
companies taking a hit on their toplines.”

“The margins of the IT companies are hit because their clients heavily
cut down on the discretionary projects. In fact, on a quarterly basis,
the margins are hit 2-3 per cent,” said Avinash Vashistha, chairman
and CEO of research and advisory firm Tholons.

In the the twin challenges of customers looking for price cuts and
stiff competition between vendors chasing fewer deals, analysts say
that cost-cutting will be the foremost driver that will hit the IT
companies’ margins. “Margins can vary between 20- and 30 per cent
depending on the type of the project, its pricing and the vertical
that is being served,” added Satpathy. TCS has increased its offshore
revenue by 1per cent and sees more offshore movements in the coming
quarters. Wipro’s revenue mix from fixed price went up by 440 bps and
offshore mix rose by 90 bps in the quarter.

HCL Tech saw the same trend with realisation in constant currency
going for offshore by 1.5 per cent, while the onsite went down 1.2 per
cent in the quarter (Q2 for HCL Tech) under review. “There is a cost
for knowledge capture, which is called transition and then there is a
cost for moving onsite work offshore or moving from existing vendor
employees to your employees,” said Vineet Nayar, CEO, HCL.

For Infosys, the pricing on reported basis fell 5.8 per cent onsite
and 4.6 per cent offshore and it considers this as one big operational
lever. “This increase in offshoring is not enough for our IT firms as
of the total outsourceable potential, we have explored only 15 per
cent of it. So there is a long way to go,” explained Vashishtha.

Source: Business Standard