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India IT Services
Tech Bubbles & Pebbles: To bulge or not to bulge?
Bulge is not an unqualified advantage in Indian IT
• The proportion of experienced hires in the Infosys workforce is at an all-time
high providing significant room for margin leverage in CY11 through fresher
hiring for top-tier companies (Infosys/TCS). However, as this note explores,
we believe that the advantages of bulge in Indian IT are somewhat
exaggerated when we look at performance over the longer-term.
• Cognizant (covered by our US analyst Tien-Tsin Huang), the fastest growing
offshore IT-Services company, has operated at a more unfavorable bulge mix
(fresher-to-lateral ratio) than Infosys through cycles. The company is
increasingly making its key relationships with customers outcome-based.
Some of the relationships with its top pharma clients are almost completely of
this nature. To manage this transition to outcome-based relationships (as
opposed to outcome-based projects), a preponderance of low-cost resources
may not be the appropriate action as risk management, productivity
enhancement, analytics associated with managing outcome-based
arrangements needs more experienced resources.
• Greater productivity of the workforce and better use of non-effort based
pricing mechanisms especially in infra-management, BPO and maintenance
render the importance of bulge less important than before. For example, note
the increasing use by TCS of transaction-based pricing in BPO (about 40% of
TCS' BPO revenues) and device/system-based pricing in infra-management
(about 80% of TCS’ infra-management revenues derives from non-effort
based pricing). This might mean that the focus moves to system-based or
person-based productivity and the need to keep and show “higher
billable/available” bench is getting less important.
• Greater verticalisation of solutions to beat commoditization also does not
depend on the bulge as much as other commodity-like services. The BPO
industry is a good example of this. Pure-play BPO providers such as Genpact
and WNS have depended on vertical-agnostic F&A (finance & accounting)
and a younger workforce but are finding the going relatively hard in the
marketplace. On the other hand, a value-added vertical-based BPO strategy
that relies less on bulge (Cognizant) and/or one offering a proprietary
platform-based proposition to run business processes (ADP, Paychex) fetch
much higher per capita profits which sustain despite a less favorable bulge. In
this context, having a unified IT/BPO proposition increasingly has merits.
• TCS’ BPO has a high degree of end-to-end verticalised back office processes
embedded in financial services through the acquisition of eServe (Citibank’s
captive in India). Cognizant accomplished the same with its acquisition of the
UBS India captive. Differentiation along vertical lines is more sustainable and
durable than a bulge-enabled broad brush of horizontal capability.
• Hence, the bulge is a cost management-driver at best. Overly depending on
the bulge may limit the revenue/pricing model of the company and restrict
ability to create differentiation in business mix and in the pricing model.
Firms have to make the trade-off between value-addition from highercost
resources against the relative stability offered by service lines that
lend themselves to bulge. It is dangerous to lean heavily in favor of bulge.
• We think TCS (OW), our top pick, is aptly managing this balance
Executive Summary
It is interesting to note that in the current environment Infosys’ proportion of the
junior workforce (i.e., the percentage of employees with less than three years of
experience) has reached an all-time low. Therefore, the bulge provides a decent
margin leverage in CY11/FY12. But is maximizing bulge always good? Not
necessarily so, as this report explains.
Ironically, lower bulge (or a lower proportion of freshers/less-experienced resources)
is not a bad longer-term outcome for Indian IT, as we believe that long-term
progression in the business model rests on a combination of being consulting-driven,
solution-oriented, non-effort pricing-based and vertical-led. And, the success in
graduating to such a business model may not be determined by today’s operating
margins alone, but the ability to protect these margins over time and deliver higher
per capita profitability.
In our view, protecting margins and boosting per capita profitability hinges less on
bulge and more on creating
• proprietary solutions (if the customer perceives that what is delivered is
differentiated) or
• proprietary delivery and measurement of that thereof (if aspects of the solution
such as pricing, structuring etc. are what the customer perceives as differentiated
as opposed to the solution per se).
Higher margin offshore-dominant services use more inexperienced resources to
boost margins. The past four-five years prior to the downturn saw the Indian IT
services business model progress to envelop offshore-centric service lines such as
BPO, infrastructure services, and testing. These are volume-based service lines that
lend themselves to the use of freshers and non-engineering graduates and, hence,
have readily absorbed the bulge in Indian IT companies such as Infosys during 2004-
08. Some of these offshore-centric services such as testing and infrastructure
management can have higher margins than the overall company average and are
more readily scalable. However, the downside is that the per capita profitability of
such service lines tends to be much lower than the value-added services. Also, they
more readily commoditize being lower hanging fruit. However, it is possible to take
a value-added, distinctive approach as Cognizant has in its BPO or TCS has taken in
its infra-management practice.
The BPO industry is a good example of how bulge per se is ineffective at
defending margins if the revenue/pricing model proposition does not improve.
Pure-play BPO providers such as Genpact and WNS have depended on horizontalbased,
vertical-agnostic F&A (finance & accounting) and a younger workforce but
are relatively struggling currently in the marketplace. On the other hand, a valueadded
vertical-based BPO strategy that relies less on bulge (Cognizant) and/or one
offering a proprietary platform-based proposition to run business processes (ADP,
Paychex) fetch much higher per capita profits which sustain over time despite a less
favorable bulge.
In this context, having a unified IT/BPO proposition increasingly has merits as
(a) deals increasingly get integrated, (b) technology is increasingly needed to reengineer,
consolidate and automate processes, (c) a distinctive sliver of business
functionality (such as sales and marketing analytics) that can be offered on a
standardized basis via BPO platform.
Value-added services fetch higher per capita profits which is relatively more
durable. Build-out of consulting and solutions will need to incorporate more
experience and superior quality skill sets. Such businesses could be lower-margin
with a more-onsite bias, but can still top the ladder of value addition. It is instructive
to note this fact: Accenture’s operating (EBIT) margins are 13-14%, yet its per
capita EBIT is on par with Infosys on a much bigger revenue base of 4x of
Infosys. It begs the question - with the current bulge, will Infosys be able to keep
its per capita EBIT on Accenture's base?
Also, with outcome-based relationships (non-linear relationships) taking hold in
Indian IT we believe that heavy bulge may not necessarily be the way to go. This is
because we believe that outcome-based relationships push productivity to the
forefront and greater experience manages and perfects this culture of productivity
enhancement better than freshers.
Cognizant (covered by our US analyst Tien-Tsin Huang), the fastest growing
offshore IT-Services company, has operated at a more unfavorable bulge mix
(fresher-to-lateral ratio) than Infosys through cycles. On average, its fresher-to-lateral
ratio in the normal years has stood at 50:50 versus 75:25 for Infosys. The company is
increasingly making its key relationships with customers outcome-based. A few of
its top pharma clients are almost completely outcome-based relationships. To
manage this transition to outcome-based relationships (as opposed to outcome-based
projects), a preponderance of low-cost resources may not be the solution as risk
management, productivity enhancement, analytics associated with managing
outcome-based arrangements needs more experienced resources.
Thus, increasing bulge (inexperience) may not necessarily be an out-and-out
good development for Indian IT over the longer-term in the absence of
differentiation in the revenue/pricing/integration model. Especially, if the bulge
builds out discretely in service lines such as BPO, infrastructure management (IM),
and testing where Indian IT companies are yet to crack the code in building
uniqueness, either in their delivery models or in their pricing models. One of the
biggest strands of a multi-thread value addition strategy for Indian IT lies in
achieving a smooth integration of all of these sub-offerings with a common platform
or interface to the customer. This is only possible with embedded value addition in
integration and functionality (thus, higher-skilled resources). Standalone offerings,
drawing on inflated bulge, fall short of doing that.
Finally, in our view, the real economic advantage of bulge is that it affords a stream
of steady cash flows in stable service lines that is ideally systematically harvested in
building traction in value-added, higher-end services. Firms have to make the
trade-off between value-addition from higher-cost resources against the relative
stability offered by service lines that lend themselves to bulge. In our view it is
dangerous to lean heavily in favor of bulge as bulge per se is not a sustainable
competitive advantage.
Conclusion
Increasing bulge may not necessarily be an out-and-out good development for
Indian IT. Especially, if the bulge builds out discretely in service lines such as BPO,
infrastructure management and testing where Indian IT companies are yet to crack
the code in building uniqueness, either in their delivery models or in their pricing
models. One of the biggest strands of a multi-thread value addition strategy for
Indian IT lies in achieving a smooth integration of all of these sub-offerings with a
common platform or interface to the customer. However, the layer of seamless
integration can only come from embedded value addition in integration and
functionality (thus, higher-skilled resources). Standalone offerings (e.g. standalone
BPO), drawing on expanded bulge, fall short of doing that.
In conclusion, the real economic advantage of bulge is that it affords a stream of
steady cash flows in stable service lines that is ideally systematically harvested in
building traction in value-added, higher-end services. Firms have to make the
trade-off between value-addition from higher-cost resources against the relative
stability offered by service lines that lend themselves to bulge. It is dangerous to
lean heavily in favor of bulge (inexperience).
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
India IT Services
Tech Bubbles & Pebbles: To bulge or not to bulge?
Bulge is not an unqualified advantage in Indian IT
• The proportion of experienced hires in the Infosys workforce is at an all-time
high providing significant room for margin leverage in CY11 through fresher
hiring for top-tier companies (Infosys/TCS). However, as this note explores,
we believe that the advantages of bulge in Indian IT are somewhat
exaggerated when we look at performance over the longer-term.
• Cognizant (covered by our US analyst Tien-Tsin Huang), the fastest growing
offshore IT-Services company, has operated at a more unfavorable bulge mix
(fresher-to-lateral ratio) than Infosys through cycles. The company is
increasingly making its key relationships with customers outcome-based.
Some of the relationships with its top pharma clients are almost completely of
this nature. To manage this transition to outcome-based relationships (as
opposed to outcome-based projects), a preponderance of low-cost resources
may not be the appropriate action as risk management, productivity
enhancement, analytics associated with managing outcome-based
arrangements needs more experienced resources.
• Greater productivity of the workforce and better use of non-effort based
pricing mechanisms especially in infra-management, BPO and maintenance
render the importance of bulge less important than before. For example, note
the increasing use by TCS of transaction-based pricing in BPO (about 40% of
TCS' BPO revenues) and device/system-based pricing in infra-management
(about 80% of TCS’ infra-management revenues derives from non-effort
based pricing). This might mean that the focus moves to system-based or
person-based productivity and the need to keep and show “higher
billable/available” bench is getting less important.
• Greater verticalisation of solutions to beat commoditization also does not
depend on the bulge as much as other commodity-like services. The BPO
industry is a good example of this. Pure-play BPO providers such as Genpact
and WNS have depended on vertical-agnostic F&A (finance & accounting)
and a younger workforce but are finding the going relatively hard in the
marketplace. On the other hand, a value-added vertical-based BPO strategy
that relies less on bulge (Cognizant) and/or one offering a proprietary
platform-based proposition to run business processes (ADP, Paychex) fetch
much higher per capita profits which sustain despite a less favorable bulge. In
this context, having a unified IT/BPO proposition increasingly has merits.
• TCS’ BPO has a high degree of end-to-end verticalised back office processes
embedded in financial services through the acquisition of eServe (Citibank’s
captive in India). Cognizant accomplished the same with its acquisition of the
UBS India captive. Differentiation along vertical lines is more sustainable and
durable than a bulge-enabled broad brush of horizontal capability.
• Hence, the bulge is a cost management-driver at best. Overly depending on
the bulge may limit the revenue/pricing model of the company and restrict
ability to create differentiation in business mix and in the pricing model.
Firms have to make the trade-off between value-addition from highercost
resources against the relative stability offered by service lines that
lend themselves to bulge. It is dangerous to lean heavily in favor of bulge.
• We think TCS (OW), our top pick, is aptly managing this balance
Executive Summary
It is interesting to note that in the current environment Infosys’ proportion of the
junior workforce (i.e., the percentage of employees with less than three years of
experience) has reached an all-time low. Therefore, the bulge provides a decent
margin leverage in CY11/FY12. But is maximizing bulge always good? Not
necessarily so, as this report explains.
Ironically, lower bulge (or a lower proportion of freshers/less-experienced resources)
is not a bad longer-term outcome for Indian IT, as we believe that long-term
progression in the business model rests on a combination of being consulting-driven,
solution-oriented, non-effort pricing-based and vertical-led. And, the success in
graduating to such a business model may not be determined by today’s operating
margins alone, but the ability to protect these margins over time and deliver higher
per capita profitability.
In our view, protecting margins and boosting per capita profitability hinges less on
bulge and more on creating
• proprietary solutions (if the customer perceives that what is delivered is
differentiated) or
• proprietary delivery and measurement of that thereof (if aspects of the solution
such as pricing, structuring etc. are what the customer perceives as differentiated
as opposed to the solution per se).
Higher margin offshore-dominant services use more inexperienced resources to
boost margins. The past four-five years prior to the downturn saw the Indian IT
services business model progress to envelop offshore-centric service lines such as
BPO, infrastructure services, and testing. These are volume-based service lines that
lend themselves to the use of freshers and non-engineering graduates and, hence,
have readily absorbed the bulge in Indian IT companies such as Infosys during 2004-
08. Some of these offshore-centric services such as testing and infrastructure
management can have higher margins than the overall company average and are
more readily scalable. However, the downside is that the per capita profitability of
such service lines tends to be much lower than the value-added services. Also, they
more readily commoditize being lower hanging fruit. However, it is possible to take
a value-added, distinctive approach as Cognizant has in its BPO or TCS has taken in
its infra-management practice.
The BPO industry is a good example of how bulge per se is ineffective at
defending margins if the revenue/pricing model proposition does not improve.
Pure-play BPO providers such as Genpact and WNS have depended on horizontalbased,
vertical-agnostic F&A (finance & accounting) and a younger workforce but
are relatively struggling currently in the marketplace. On the other hand, a valueadded
vertical-based BPO strategy that relies less on bulge (Cognizant) and/or one
offering a proprietary platform-based proposition to run business processes (ADP,
Paychex) fetch much higher per capita profits which sustain over time despite a less
favorable bulge.
In this context, having a unified IT/BPO proposition increasingly has merits as
(a) deals increasingly get integrated, (b) technology is increasingly needed to reengineer,
consolidate and automate processes, (c) a distinctive sliver of business
functionality (such as sales and marketing analytics) that can be offered on a
standardized basis via BPO platform.
Value-added services fetch higher per capita profits which is relatively more
durable. Build-out of consulting and solutions will need to incorporate more
experience and superior quality skill sets. Such businesses could be lower-margin
with a more-onsite bias, but can still top the ladder of value addition. It is instructive
to note this fact: Accenture’s operating (EBIT) margins are 13-14%, yet its per
capita EBIT is on par with Infosys on a much bigger revenue base of 4x of
Infosys. It begs the question - with the current bulge, will Infosys be able to keep
its per capita EBIT on Accenture's base?
Also, with outcome-based relationships (non-linear relationships) taking hold in
Indian IT we believe that heavy bulge may not necessarily be the way to go. This is
because we believe that outcome-based relationships push productivity to the
forefront and greater experience manages and perfects this culture of productivity
enhancement better than freshers.
Cognizant (covered by our US analyst Tien-Tsin Huang), the fastest growing
offshore IT-Services company, has operated at a more unfavorable bulge mix
(fresher-to-lateral ratio) than Infosys through cycles. On average, its fresher-to-lateral
ratio in the normal years has stood at 50:50 versus 75:25 for Infosys. The company is
increasingly making its key relationships with customers outcome-based. A few of
its top pharma clients are almost completely outcome-based relationships. To
manage this transition to outcome-based relationships (as opposed to outcome-based
projects), a preponderance of low-cost resources may not be the solution as risk
management, productivity enhancement, analytics associated with managing
outcome-based arrangements needs more experienced resources.
Thus, increasing bulge (inexperience) may not necessarily be an out-and-out
good development for Indian IT over the longer-term in the absence of
differentiation in the revenue/pricing/integration model. Especially, if the bulge
builds out discretely in service lines such as BPO, infrastructure management (IM),
and testing where Indian IT companies are yet to crack the code in building
uniqueness, either in their delivery models or in their pricing models. One of the
biggest strands of a multi-thread value addition strategy for Indian IT lies in
achieving a smooth integration of all of these sub-offerings with a common platform
or interface to the customer. This is only possible with embedded value addition in
integration and functionality (thus, higher-skilled resources). Standalone offerings,
drawing on inflated bulge, fall short of doing that.
Finally, in our view, the real economic advantage of bulge is that it affords a stream
of steady cash flows in stable service lines that is ideally systematically harvested in
building traction in value-added, higher-end services. Firms have to make the
trade-off between value-addition from higher-cost resources against the relative
stability offered by service lines that lend themselves to bulge. In our view it is
dangerous to lean heavily in favor of bulge as bulge per se is not a sustainable
competitive advantage.
Conclusion
Increasing bulge may not necessarily be an out-and-out good development for
Indian IT. Especially, if the bulge builds out discretely in service lines such as BPO,
infrastructure management and testing where Indian IT companies are yet to crack
the code in building uniqueness, either in their delivery models or in their pricing
models. One of the biggest strands of a multi-thread value addition strategy for
Indian IT lies in achieving a smooth integration of all of these sub-offerings with a
common platform or interface to the customer. However, the layer of seamless
integration can only come from embedded value addition in integration and
functionality (thus, higher-skilled resources). Standalone offerings (e.g. standalone
BPO), drawing on expanded bulge, fall short of doing that.
In conclusion, the real economic advantage of bulge is that it affords a stream of
steady cash flows in stable service lines that is ideally systematically harvested in
building traction in value-added, higher-end services. Firms have to make the
trade-off between value-addition from higher-cost resources against the relative
stability offered by service lines that lend themselves to bulge. It is dangerous to
lean heavily in favor of bulge (inexperience).
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