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Introduction: TCS and Infosys have announced their intent to hire at least
50,000 and 35,000 employees respectively in the next fiscal (FY12).
However, we believe that these preliminary indications have little meaning.
We analysed the gross employee addition numbers of Infosys and TCS over
the past six years and conclude that initial gross addition targets enunciated by
companies and their final gross employee addition are rather weak leading
indicators of revenue growth or business momentum. At best, they indicate
how firms feel about the present demand environment but they do little
to predict future demand.
• As an example, consensus expectations of ~25% revenue (USD) growth for
Infosys in FY12 indicate that growth in net employee headcount should be
~20-25%. Taking 20% net addition (as the gap of 5% can be explained by
non-linearity and improving utilization) and attrition of 15%, gross addition
in FY12 should stand at 35% of current workforce (20% net addition + 15%
attrition) implying a gross employee addition of at least 47,000 in FY12 (a
good 35% above Infosys' preliminary indication).
• To further corroborate our point, we note that around the same time last year
(April 2011), both TCS and Infosys indicated that they would hire about
30,000 employees in FY12. Going by current trends and YTD FY11
performance, TCS and Infosys look set to close out FY11 hiring about 70,000
and 48,000 employees respectively (gross) in FY11, significantly eclipsing
initial indications so as to render preliminary indicators almost meaningless.
Moreover, continual, upward revisions of employee addition in the course
of the year represent really more of catch-up with demand especially
short-term project-oriented demand (as against annuity demand).
• More is still more in Indian IT. In the absence of meaningful non-linearity in
the business model, in two-three years from now, both TCS and Infosys will
need to step up hiring to be able to recruit ~100,000 employees. This ask rate
grows in step with revenue growth - a daunting proposition. Firms that can
give an indication of doing more with less – i.e. hire relatively fewer
resources than their growth rates would suggest through effective non-linearity
may well fetch a sustainable valuation premium (for more see our detailed
thematic piece dated 14th Dec, 2010 on non-linearity: “New Engagement
Models (or non-linearity) is fast becoming a reality in Indian IT - TCS leads
this evolving game so far”).
• Conclusion: Investors should not place undue emphasis on gross employee
hiring targets of companies. We believe that there is as much a possibility of
firms significantly understating their employee addition targets in the current
environment as there is of overstating them during a downturn. We believe
that the stock market values Indian IT stocks looking almost solely at the
demand environment and much less by companies’ enunciation of
employee addition targets in the beginning/course of the year.
• Stay OW on Indian IT. The all-round nature of continued, buoyant IT
spending coupled with the ability of large-cap Indian IT names to expand their
addressable market explains our continued preference for large caps. TCS
(OW) and Wipro (OW) remain our top picks in the sector.
The past (prior to FY11) is an indicator of how firms can get
it wrong
The gross addition numbers of Infosys and TCS over FY06-10 have been in a
rather narrow band: FY06 and FY07 were buoyant years for the industry; late
FY08/FY09 was a difficult period, while FY10 showed a pick-up in the second half.
In other words, even as FY06-10 has witnessed considerable business cyclicality
(from upturn to downturn to subsequent upturn), gross employee additions
have been in a rather narrow band, suggesting that the gross-add metric has not
been a responsive, leading indicator of business momentum or change in
business momentum. Please see Figures 1-2 which lay out the gross employee
addition numbers of TCS and Infosys over FY06-10.
Gross employee addition is not a responsive, leading
indicator of business momentum
Gross additions (in absolute numbers) depend on several significant variables that
undermine its being a predictor of business momentum. They include:
1) Proportion of shorter-term project-oriented business to annuity business in
the overall revenue mix. This mix shifts towards short-term project demand in
the midst of an upturn in demand and away from it at the beginning of downturn.
2) Rise in attrition – this means greater replacement hiring.
3) Size of the existing employee base and the proportion of IT versus BPO in
it. IT and BPO have significantly different dynamics (particularly in per-capita
revenues and attrition)
4) Proportion of IT versus BPO (or infra management) employees in the gross
new employee addition mix.
5) Fresher to lateral ratio as offers to freshers are normally made well in advance
at the colleges, removing the advantage of just-in-time hiring. Just-in-time hiring
better reflects current state of the business than advance hiring.
6) Significant shift in onsite-near-shore-offshore mix as TCS has demonstrated
throughout FY10. In FY11, this mix for TCS has stabilized.
7) Utilization to some extent is a determinant in the short term.
We explain each of the factors as follows:
Proportion of project-oriented business to annuity business
For the larger companies such as TCS/Infosys, anecdotally there is a welldistributed
revenue mix (~50:50) between the shorter-term project-oriented
business and longer-term annuity (>12 months). However, this distribution can
change in short order on an incremental basis with the turn in the demand
environment. New business for existing and new customers that is project-oriented
responds to short-term spikes in demand during an industry upturn which companies
may not necessarily be able to predict. In turn, this reflects in difficulty to hire in
advance for such demand.
Conversely, in the beginning of a downturn, the revenue mix shifts away from
shorter-term project oriented demand towards annuity demand. (Note: annuity
demand typically has a higher representation of application management; infra
management, BPO and support for enterprise package implementations). Thus, any
hiring keeping a certain amount of short-term project-oriented business in mind
can be overdone if this demand turns down (as it must during the initial stages
of an industry downturn).
Rise in attrition – this means greater replacement hiring
• The higher the attrition, the greater the replacement hiring. So, in today’s
environment of increased attrition (the quarterly attrition numbers of Infosys and
TCS work out to be 18-22% on an annualized basis versus 11-13% eight quarters
ago), firms hire more just to backfill. Additional backfill hiring alone, in this
environment, translates into nearly 3-5% of the existing employee base, to
compensate for increased (though now moderating) attrition.
Size of the existing employee base and the proportion of IT versus BPO
employees in it
• By the end of FY11, TCS could have close to 200,000 employees with about 75%
in IT and the rest in BPO (25%) (as per our estimate). The ‘normal’ attrition rate
at a company-wide level is about 15% (combining 11% in IT and about 25% in
BPO). Simply applying this attrition rate of 15% to the employee base of 200,000
means the departure of ~30,000 employees over the next year. In other words,
TCS’ initial 50,000 gross addition target in FY12 really translates into a net
addition of only 20,000 (i.e. about 10% of the existing employee base, which we
would regard as rather conservative in light of 25%+ revenue growth
expectation). TCS’s enunciated gross employee addition target is thus
significantly understated in light of the expected 25%-plus revenue growth
for TCS and others in FY12.
• Also, this number of 30,000 employee attrition incrementally goes up as TCS’s
employee base increases (estimate of 200,000 as of Mar11). Thus, we believe
gross addition should not be seen in isolation and needs to be anchored in the
context of the size of the current employee pool.
Proportion of IT versus BPO (or infra management) employees in the
gross new addition mix
• BPO as a service line fetches much lower per-capita revenues than IT Services
while also suffering from much higher secular attrition. For Infosys, per-capita
revenues in BPO is about US$15-18,000 per year, less than half the per-capita
offshore billing for IT-Services. Also, this service line has seen attrition rates of
20-25% in difficult times; today, this is upwards of 30%. In other words, nearly
a third of today’s BPO employees (in numbers) will have to be hired next
year to just stand still from the net employee strength standpoint. It is stark
that Infosys’s indicated gross hiring in BPO (8,000) is today about 22-25% of
overall indicated hires (35,000) even as its revenue contribution is just 6%
• So, if gross hiring includes a greater weight towards BPO, it means two things:
(a) incremental revenues from such employee addition will be proportionately
lower given the much lower per-capita revenues of BPO; (b) attrition in the future
is also likely to be higher on a company-wide basis because the attrition of BPO
is normally more than twice that of IT Services, necessitating even greater
backfill going forward, further undermining the predictive power of gross hiring.
We can draw the same conclusion for the IT-versus-infra-management mix for
HCLT’s employee base as well, where per-capita revenues (excluding material
pass-through) are noticeably lower in HCLT’s infra management than in IT
Services while attrition is also palpably higher. In other words, the greater
proportion of BPO/infra management in the total IT/BPO/Infra
management hiring mix further undermines our looking to total gross
additions as a demand momentum predictor.
Offers to freshers – normally made well in advance, removing the
advantage of responsive, just-in-time hiring
• The freshers tend to comprise at least 70-75% of the gross addition mix, thus
lowering the cost per employee (this has been a well documented success for
TCS and Infosys; particularly for Infosys, see Figure 6).
• But this comes at a price: the offers at the campus are usually made in the
penultimate year of the students’ course tenure, 9-15 months ahead of the
expected period of joining. The environment can change quite unpredictably
in short order (for better or for worse) after the offers have been made. This
rather long time lag makes gross employee addition targets (in so far as they
pertain to campus offers) even less reliable indicators of business momentum, as
Infosys and TCS found out in the wake of the Lehman bankruptcy.
• That said, Nasscom, the industry body, has co-coordinated the action of most
(if not all) large, relevant IT companies in visiting the campus in the
students’ final year of college for CY10/FY11. If that continues in the future
as well (and is not an exception for CY10/FY11), then just-in-time hiring
may continue in fresher recruitment.
Significant shift in onsite-near-shore-offshore mix
• The industry saw a sharp shift in business offshore in FY10, triggered by the
downturn (TCS exemplified this shift much better than anyone else in the
industry, see Figure 7). Using employee addition target numbers (even net of
attrition) to derive prospective revenues is misleading if there has been or is
likely to be a significant shift in onsite to offshore and near-shore, as this deflates
the prospective revenue picture (recall that per-capita onsite billing tend to be
more than double per-capita offshore billing).
Utilization to some extent is a determinant in the short term
• Infosys today operates at well below optimum utilization (73% including
trainees), unlike peers such as TCS and Wipro that operate at much higher levels
(76-77%). Infosys, with slack in the system, faces less urgency to hire than its
peers and enjoys somewhat greater operating leverage, while utilization remains
sub-optimal. However, we believe with a return in business momentum, such
differences in hiring numbers attributable to varying utilization will even
themselves out in a matter of couple of quarters. Infosys’s utilization can improve
3-5% points before even keel returns (and this can happen over two quarters of 5-
6% Q-o-Q revenue growth). So, while Infosys enjoys greater operating
leverage (in other words, revenue flow with marginal costs and less hiring
urgency) in view of its currently lower utilization, we believe this is a shortterm
advantage.
Net addition as % is a slightly better business momentum indicator
In our view, a better though less-than-ideal demand strength predictor than
gross addition is net employee addition (organic) as a percentage of existing
manpower base (see Figure 8 below), as this metric is normalized for both
size and attrition – the two key variables that, in particular, we have shown
undermine the predictive power of gross hiring in forecasting business
momentum. Further, it would be better if this metric were adjusted for steadystate
utilization, which we have not done.
Will “Less be More” in Indian IT?
More is still more in Indian IT. In the absence of meaningful non-linearity in the
business model, it seems that in two-three years from now, both TCS and Infosys
will need to step up hiring to be able to recruit ~100,000 employees – and this ask
rate will continue to grow in step with revenue growth - a daunting proposition, in
our view. Firms that can give an indication of doing more with less – i.e. hire
relatively fewer resources than their growth rates would suggest through effective
non-linearity may well fetch a sustainable valuation premium if most other cost
optimization levers are already exhausted (for more see our detailed thematic piece
dated 14th Dec, 2010 on non-linearity: “New Engagement Models (or non-linearity)
is fast becoming a reality in Indian IT - TCS leads this evolving game so far”).
Conclusion
We believe that treating gross addition targets as a proxy for business (revenue)
momentum or demand is misplaced. Gross addition depends on many more
variables, as we have shown in the report. We believe that there is as much a
possibility of firms significantly understating their employee addition targets in the
current environment as there is of overstating them during a downturn. Monitoring
the demand pattern more than supply indicators is advisable as this drives stock
prices. We believe that the market values Indian IT stocks looking almost solely
at the demand environment and much less by company enunciation of employee
addition targets in the beginning/course of the year.
Stay OW on Indian IT. The all-round nature of continued, buoyant IT spending
coupled with the ability of large-cap Indian IT names to expand their addressable
market without compromising profitability explains our continued OW ratings on
TCS, Wipro and HCL Technologies. TCS and Wipro remain our top picks in the
sector.
India Equity Research Reports, IPO and Stock News
Visit http://indiaer.blogspot.com/ for complete details �� ��
Introduction: TCS and Infosys have announced their intent to hire at least
50,000 and 35,000 employees respectively in the next fiscal (FY12).
However, we believe that these preliminary indications have little meaning.
We analysed the gross employee addition numbers of Infosys and TCS over
the past six years and conclude that initial gross addition targets enunciated by
companies and their final gross employee addition are rather weak leading
indicators of revenue growth or business momentum. At best, they indicate
how firms feel about the present demand environment but they do little
to predict future demand.
• As an example, consensus expectations of ~25% revenue (USD) growth for
Infosys in FY12 indicate that growth in net employee headcount should be
~20-25%. Taking 20% net addition (as the gap of 5% can be explained by
non-linearity and improving utilization) and attrition of 15%, gross addition
in FY12 should stand at 35% of current workforce (20% net addition + 15%
attrition) implying a gross employee addition of at least 47,000 in FY12 (a
good 35% above Infosys' preliminary indication).
• To further corroborate our point, we note that around the same time last year
(April 2011), both TCS and Infosys indicated that they would hire about
30,000 employees in FY12. Going by current trends and YTD FY11
performance, TCS and Infosys look set to close out FY11 hiring about 70,000
and 48,000 employees respectively (gross) in FY11, significantly eclipsing
initial indications so as to render preliminary indicators almost meaningless.
Moreover, continual, upward revisions of employee addition in the course
of the year represent really more of catch-up with demand especially
short-term project-oriented demand (as against annuity demand).
• More is still more in Indian IT. In the absence of meaningful non-linearity in
the business model, in two-three years from now, both TCS and Infosys will
need to step up hiring to be able to recruit ~100,000 employees. This ask rate
grows in step with revenue growth - a daunting proposition. Firms that can
give an indication of doing more with less – i.e. hire relatively fewer
resources than their growth rates would suggest through effective non-linearity
may well fetch a sustainable valuation premium (for more see our detailed
thematic piece dated 14th Dec, 2010 on non-linearity: “New Engagement
Models (or non-linearity) is fast becoming a reality in Indian IT - TCS leads
this evolving game so far”).
• Conclusion: Investors should not place undue emphasis on gross employee
hiring targets of companies. We believe that there is as much a possibility of
firms significantly understating their employee addition targets in the current
environment as there is of overstating them during a downturn. We believe
that the stock market values Indian IT stocks looking almost solely at the
demand environment and much less by companies’ enunciation of
employee addition targets in the beginning/course of the year.
• Stay OW on Indian IT. The all-round nature of continued, buoyant IT
spending coupled with the ability of large-cap Indian IT names to expand their
addressable market explains our continued preference for large caps. TCS
(OW) and Wipro (OW) remain our top picks in the sector.
The past (prior to FY11) is an indicator of how firms can get
it wrong
The gross addition numbers of Infosys and TCS over FY06-10 have been in a
rather narrow band: FY06 and FY07 were buoyant years for the industry; late
FY08/FY09 was a difficult period, while FY10 showed a pick-up in the second half.
In other words, even as FY06-10 has witnessed considerable business cyclicality
(from upturn to downturn to subsequent upturn), gross employee additions
have been in a rather narrow band, suggesting that the gross-add metric has not
been a responsive, leading indicator of business momentum or change in
business momentum. Please see Figures 1-2 which lay out the gross employee
addition numbers of TCS and Infosys over FY06-10.
Gross employee addition is not a responsive, leading
indicator of business momentum
Gross additions (in absolute numbers) depend on several significant variables that
undermine its being a predictor of business momentum. They include:
1) Proportion of shorter-term project-oriented business to annuity business in
the overall revenue mix. This mix shifts towards short-term project demand in
the midst of an upturn in demand and away from it at the beginning of downturn.
2) Rise in attrition – this means greater replacement hiring.
3) Size of the existing employee base and the proportion of IT versus BPO in
it. IT and BPO have significantly different dynamics (particularly in per-capita
revenues and attrition)
4) Proportion of IT versus BPO (or infra management) employees in the gross
new employee addition mix.
5) Fresher to lateral ratio as offers to freshers are normally made well in advance
at the colleges, removing the advantage of just-in-time hiring. Just-in-time hiring
better reflects current state of the business than advance hiring.
6) Significant shift in onsite-near-shore-offshore mix as TCS has demonstrated
throughout FY10. In FY11, this mix for TCS has stabilized.
7) Utilization to some extent is a determinant in the short term.
We explain each of the factors as follows:
Proportion of project-oriented business to annuity business
For the larger companies such as TCS/Infosys, anecdotally there is a welldistributed
revenue mix (~50:50) between the shorter-term project-oriented
business and longer-term annuity (>12 months). However, this distribution can
change in short order on an incremental basis with the turn in the demand
environment. New business for existing and new customers that is project-oriented
responds to short-term spikes in demand during an industry upturn which companies
may not necessarily be able to predict. In turn, this reflects in difficulty to hire in
advance for such demand.
Conversely, in the beginning of a downturn, the revenue mix shifts away from
shorter-term project oriented demand towards annuity demand. (Note: annuity
demand typically has a higher representation of application management; infra
management, BPO and support for enterprise package implementations). Thus, any
hiring keeping a certain amount of short-term project-oriented business in mind
can be overdone if this demand turns down (as it must during the initial stages
of an industry downturn).
Rise in attrition – this means greater replacement hiring
• The higher the attrition, the greater the replacement hiring. So, in today’s
environment of increased attrition (the quarterly attrition numbers of Infosys and
TCS work out to be 18-22% on an annualized basis versus 11-13% eight quarters
ago), firms hire more just to backfill. Additional backfill hiring alone, in this
environment, translates into nearly 3-5% of the existing employee base, to
compensate for increased (though now moderating) attrition.
Size of the existing employee base and the proportion of IT versus BPO
employees in it
• By the end of FY11, TCS could have close to 200,000 employees with about 75%
in IT and the rest in BPO (25%) (as per our estimate). The ‘normal’ attrition rate
at a company-wide level is about 15% (combining 11% in IT and about 25% in
BPO). Simply applying this attrition rate of 15% to the employee base of 200,000
means the departure of ~30,000 employees over the next year. In other words,
TCS’ initial 50,000 gross addition target in FY12 really translates into a net
addition of only 20,000 (i.e. about 10% of the existing employee base, which we
would regard as rather conservative in light of 25%+ revenue growth
expectation). TCS’s enunciated gross employee addition target is thus
significantly understated in light of the expected 25%-plus revenue growth
for TCS and others in FY12.
• Also, this number of 30,000 employee attrition incrementally goes up as TCS’s
employee base increases (estimate of 200,000 as of Mar11). Thus, we believe
gross addition should not be seen in isolation and needs to be anchored in the
context of the size of the current employee pool.
Proportion of IT versus BPO (or infra management) employees in the
gross new addition mix
• BPO as a service line fetches much lower per-capita revenues than IT Services
while also suffering from much higher secular attrition. For Infosys, per-capita
revenues in BPO is about US$15-18,000 per year, less than half the per-capita
offshore billing for IT-Services. Also, this service line has seen attrition rates of
20-25% in difficult times; today, this is upwards of 30%. In other words, nearly
a third of today’s BPO employees (in numbers) will have to be hired next
year to just stand still from the net employee strength standpoint. It is stark
that Infosys’s indicated gross hiring in BPO (8,000) is today about 22-25% of
overall indicated hires (35,000) even as its revenue contribution is just 6%
• So, if gross hiring includes a greater weight towards BPO, it means two things:
(a) incremental revenues from such employee addition will be proportionately
lower given the much lower per-capita revenues of BPO; (b) attrition in the future
is also likely to be higher on a company-wide basis because the attrition of BPO
is normally more than twice that of IT Services, necessitating even greater
backfill going forward, further undermining the predictive power of gross hiring.
We can draw the same conclusion for the IT-versus-infra-management mix for
HCLT’s employee base as well, where per-capita revenues (excluding material
pass-through) are noticeably lower in HCLT’s infra management than in IT
Services while attrition is also palpably higher. In other words, the greater
proportion of BPO/infra management in the total IT/BPO/Infra
management hiring mix further undermines our looking to total gross
additions as a demand momentum predictor.
Offers to freshers – normally made well in advance, removing the
advantage of responsive, just-in-time hiring
• The freshers tend to comprise at least 70-75% of the gross addition mix, thus
lowering the cost per employee (this has been a well documented success for
TCS and Infosys; particularly for Infosys, see Figure 6).
• But this comes at a price: the offers at the campus are usually made in the
penultimate year of the students’ course tenure, 9-15 months ahead of the
expected period of joining. The environment can change quite unpredictably
in short order (for better or for worse) after the offers have been made. This
rather long time lag makes gross employee addition targets (in so far as they
pertain to campus offers) even less reliable indicators of business momentum, as
Infosys and TCS found out in the wake of the Lehman bankruptcy.
• That said, Nasscom, the industry body, has co-coordinated the action of most
(if not all) large, relevant IT companies in visiting the campus in the
students’ final year of college for CY10/FY11. If that continues in the future
as well (and is not an exception for CY10/FY11), then just-in-time hiring
may continue in fresher recruitment.
Significant shift in onsite-near-shore-offshore mix
• The industry saw a sharp shift in business offshore in FY10, triggered by the
downturn (TCS exemplified this shift much better than anyone else in the
industry, see Figure 7). Using employee addition target numbers (even net of
attrition) to derive prospective revenues is misleading if there has been or is
likely to be a significant shift in onsite to offshore and near-shore, as this deflates
the prospective revenue picture (recall that per-capita onsite billing tend to be
more than double per-capita offshore billing).
Utilization to some extent is a determinant in the short term
• Infosys today operates at well below optimum utilization (73% including
trainees), unlike peers such as TCS and Wipro that operate at much higher levels
(76-77%). Infosys, with slack in the system, faces less urgency to hire than its
peers and enjoys somewhat greater operating leverage, while utilization remains
sub-optimal. However, we believe with a return in business momentum, such
differences in hiring numbers attributable to varying utilization will even
themselves out in a matter of couple of quarters. Infosys’s utilization can improve
3-5% points before even keel returns (and this can happen over two quarters of 5-
6% Q-o-Q revenue growth). So, while Infosys enjoys greater operating
leverage (in other words, revenue flow with marginal costs and less hiring
urgency) in view of its currently lower utilization, we believe this is a shortterm
advantage.
Net addition as % is a slightly better business momentum indicator
In our view, a better though less-than-ideal demand strength predictor than
gross addition is net employee addition (organic) as a percentage of existing
manpower base (see Figure 8 below), as this metric is normalized for both
size and attrition – the two key variables that, in particular, we have shown
undermine the predictive power of gross hiring in forecasting business
momentum. Further, it would be better if this metric were adjusted for steadystate
utilization, which we have not done.
Will “Less be More” in Indian IT?
More is still more in Indian IT. In the absence of meaningful non-linearity in the
business model, it seems that in two-three years from now, both TCS and Infosys
will need to step up hiring to be able to recruit ~100,000 employees – and this ask
rate will continue to grow in step with revenue growth - a daunting proposition, in
our view. Firms that can give an indication of doing more with less – i.e. hire
relatively fewer resources than their growth rates would suggest through effective
non-linearity may well fetch a sustainable valuation premium if most other cost
optimization levers are already exhausted (for more see our detailed thematic piece
dated 14th Dec, 2010 on non-linearity: “New Engagement Models (or non-linearity)
is fast becoming a reality in Indian IT - TCS leads this evolving game so far”).
Conclusion
We believe that treating gross addition targets as a proxy for business (revenue)
momentum or demand is misplaced. Gross addition depends on many more
variables, as we have shown in the report. We believe that there is as much a
possibility of firms significantly understating their employee addition targets in the
current environment as there is of overstating them during a downturn. Monitoring
the demand pattern more than supply indicators is advisable as this drives stock
prices. We believe that the market values Indian IT stocks looking almost solely
at the demand environment and much less by company enunciation of employee
addition targets in the beginning/course of the year.
Stay OW on Indian IT. The all-round nature of continued, buoyant IT spending
coupled with the ability of large-cap Indian IT names to expand their addressable
market without compromising profitability explains our continued OW ratings on
TCS, Wipro and HCL Technologies. TCS and Wipro remain our top picks in the
sector.
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