Looks like the Indian outsourcing juggernaut may finally be running out of steam. After years of steady growth based on its huge labor cost advantage, the impending global IT spending slump makes it unlikely that India's high-tech outsourcing business will maintain its historical revenue and earnings momentum. That's the takeaway from the recent guidance offered by the sub-continent's top IT outsourcers.
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Global IT Cutback
The first indications of troubled times came from Infosys (NASDAQ:INFY), India's second largest outsourcer. Last week, the company disclosed that it expects revenues for its next fiscal year to decline between 3.1% and 6.7%, which is the first such drop in the company's history. The reduction was prompted by the unavoidable reality that the company's clients, 90% of whom are located in the U.S. and Europe, have materially cut back their IT spending budgets. According to the company's own survey data, clients that account for about 83% of its revenues indicated that they would cut outlays on IT by up to 10%.
Price Cutting Necessary
The impending slowdown in business volumes could also lead to additional pain in the form of price cuts, according to industry heavyweight Tata Consultancy (NSE:TCS.NS). Recently, Tata Chief Operating Officer (COO) N. Chandrasekaran indicated that clients were already negotiating price cuts for the the services they received.
Wipro (NYSE:WIT), the number three outsourcer, managed to beat expectations with its latest quarterly earnings result, but this company also had to concede to client demands for price cuts. It now forecasts revenues to decline in the next quarter. (Explore the controversies surrounding companies commenting on their forward-looking expectations in Can Earnings Guidance Accurately Predict The Future?)
All of these views echo warnings raised earlier by IT research firm Gartner Group, who predicted that the price of IT outsourcing services would shrink by 5% to 20% through 2010.
Increased competition coming from recently rescued former number four outsourcing player Satyam Computer (NYSE:SAY) could add further downward pressure on pricing. Recently brought to the brink as a result of India's largest accounting fraud, Satyam was thrown a lifeline earlier this month when another Indian outsourcer, Tech Mahindra (NSE: TECHM.NS), which is 31% owned by British-based BT Group plc (NYSE:BT), acquired a 31% interest in Satyam. Tech Mahindra intends to boost its holding to 51% in order to obtain a controlling interest via an offer that begins June 12, and includes Satyam's U.S. ADR holders. The company counts Citigroup (NYSE:C) and Cisco (NASDAQ:CSCO) as clientele, and significant concessions may have to be offered by new management in order to keep them onboard.
The Bottom Line
While the weaker Indian rupee, which fell 4% during the first quarter on top of a 19% plunge in 2008, has so far helped prop up revenues and margins, it's unlikely to contribute much from this point forward. Inevitably, all the outsourcers will have to cut costs, and because the key input for many of these companies is human capital, it will involve cutting staffing levels. While reasonable reductions would be seen in a positive light, massive cuts, which now appear more likely given recent overhiring, could serve only to undermine client as well as investor confidence in these businesses.