Wages rising, can the blues be far away?

With salaries up to 15%, good times are back for employees at Indian information technology (IT) services firms, but their employers — the multi billion dollar outsourcing powerhouses such as Tata Consultancy Services and Wipro — are caught between a rock and a hard place.

For, they have to choose between absorbing the pay hike
by sacrificing their envied high profit margins of around 25% or passing on the additional cost to clients in the US and
Europe.

Last week, TCS committed to raise salaries for its nearly 200,000 strong work force by 12-14%. On Wednesday, Wipro more than matched it by offering 12-15% for its 122,000 odd employees.

It is only logical to expect smaller IT firms to offer something similar if not something better as the struggle to attract talent in a market that is heating up, developed world looks to outsource more coming out of the slow down that started in 2008.

In the near term, the rising wage bill - single-largest expense item and up to 60% of revenues for a typical large IT firm - may eat into the phenomenally high profit margins Indian outsourcers now enjoy much to the envy of their global counterparts such as Accenture, IBM or Capgemini.

The long-term view is more grim. Such wage inflation puts at risk the cost advantage of 50% that brings outsourced work to India in the first place.

The bouyant demand scene gives the IT firms some headroom to negotiate pricing increases from the clients, as a means of passing on the higher cost of wage. But they will likely still have to absorb part of the pay hike.

When outsourcing floodgates were opened up in a big way in late 1990s and early 2000 — with the much hyped Y2K — India could deliver outsourced services at one-sixth the cost of getting the same work done in Europe or US. With wage inflation over the decade that has now brought that down to around half the cost of getting it done in the US.

The global financial meltdown that started with the fall of Lehman Brothers in September 2008 had infused a sense of sobriety in pay hikes which used to be rising at the rate of around 15% a year. More enterprises and governments in the US and Europe have taken to outsourcing in search of leaner cost structures, all of which benefited offshoring firms.

As demand for outsourcing services increased, so did the demand for IT workers opening up more job opportunities for them, which forced Indian IT firms to offer higher wages as a way of retaining their talent pool so that they can ride the demand wave without any bumps along the way.

Further, with Indian IT firms enjoying growth of 25-30% in 2010, there is a reasonable expectation from employees for a share of the spoils of the game.

Industry lobby Nasscom representative Ameet Nivsarkar has two counter arguments - efficient utilisation of existing workforce (asset sweating in other industries), and the so called lowering the base of the pyramid - in IT industry that means hiring engineers from campuses whose salaries are much lower than experienced ones.

Also industry can take comfort in the fact that India’s scale and abundant talent pool is not yet matched by any other competing offshoring location. Plus the TCS’s and Infosys and Wipros of the world have room to expand operations into smaller towns like Nagpurs and Coimbatores to keep costs under control.

Still, clients are already seeking to diversify offshoring locations to de-risk putting all outsourced work in one geography (say India) lest if something fails here their work comes to a griding halt.