IT’s back to school in profit quest

The near-term demand story of information technology (IT) remains intact but to ride that demand wave without compromising profitability, Indian IT service exporters will need to hire more inexperienced graduates from engineering colleges to keep salary costs down, said analysts.

Based on recent informal poll of IT services firms and enterprises application software maker SAP, Goldman Sachs analysts Julio C Quinteros Jr, Vincent Lin and Snigdha Sharma said in a note on Thursday that IT services around enterprise application software implementation and maintenance is expected to grow at an average of 20-30% in the next couple of years.

On the same day, however, analysts at BNP Paribas said that profit margins are expected to stay flat for most Indian IT firms over the next two years as they haven’t made meaningful investments in research and development to generate intellectual property rights - to de-link revenue growth from headcount growth.

Abhiram Eleswarapu and Avinash Singh of BNP said Indian IT will likely depend heavily on hiring fresh graduates from engineering colleges to be able to lower their salary costs as the workforce grows at a rapid clip to meet growing demand.

“Several colleges have reported record hiring from large IT companies this year, which suggests lower average salary costs ahead and, therefore, reduced margin risks,” Eleswarapu and Singh said. “Despite the popular focus on factors such as utilisation, we believe fresher hiring has historically been the biggest margin lever for Indian IT players.”

India’s largest IT exporter both by revenue and employees, Tata Consultancy Services, has a hiring guidance of 60,000 engineers and is expected to close the current fiscal with about a quarter of a million employees. Infosys has guided to hire about 45,000 employees during the current fiscal.

The BNP analysts believe that such “recruitment muscle” will help these firms in managing profitability going forward.

However, it remains to be seen how much more younger can India’s IT workforce get through such fresh hiring. Firms like TCS said in a recent disclosure that the average age for its 200,000 strong workforce is only 20-something — 28 to be precise.

TCS, first Indian IT firm to make a revenue commitment regarding the so-called non-linear initiatives, said last year that it aims to generate at least 10% of incremental revenues from such offerings by the last quarter of fiscal 2012. Its flagship non-linear initiative called iON — that offers on-demand computing, including hardware and software, to small and medium enterprises — is targeting $1 billion in revenue in the first five years.

Even if the $1 billion claim were to be taken at face value, Eleswarapu and Singh said, the initiative would only contribute about 5% to TCS’ operating profits within that time frame and that is not significant in the bigger scheme of things, according to them. More such non-linear initiatives by other Indian IT firms will likely emerge as a differentiator by the next fiscal, they said.