| India IT Services Examining perceptions (rather misperceptions) regarding wage inflation in the Indian IT industry | ||
We sense the concern from a section of investors that TCS’s above industry wage hikes (~10% offshore, 2-4% onsite) for FY15 have set the cat among the pigeons. The impression seems to be that the rest of the industry (more precisely, TCS’s peers) will be forced to follow suit – else, they (peers) may be compelled to contend with a rise in attrition (the likes of Infosys/Wipro are already battling high attrition)). We do not think so as we believe that TCS is not a price setter for wages in the industry (though we admit that the optics of a headline average wage hike announced by the various firms do tend to grab employee eyeballs). We lay out the points of reality versus perception regarding wages and wage inflation in the Indian IT industry in this note.
· Perception no. 1: Wage inflation in the India IT industry depends on industry growth and inflation in the economy. Reality: Increasingly, wage inflation depends on a multitude of other factors such as (a) the supply-demand situation (at that role/level), (b) absolute base-level wages, (c) company performance (d) attrition, and (e) utilization. Of these five factors, four (b), (c), (d) and (e) are company-specific factors. Increasingly, in an industry marked by polarization in performance, firm-specific factors such as performance, utilization, attrition also play a role in determining the wage-inflation dynamics (very unlike 2003-09 when the players grew in a fairly homogeneous manner).
· Investigating the first of the named factors (i.e. supply-demand situation which is an industry-wide factor) we note that for years now, the demand-supply situation at the entry-to-mid level is heavily skewed in favor of supply. The engineering graduate turnout in the country now exceeds one million per year. The result is that entry-level pay for engineers ranging from Rs0.30 -0.33 million per annum (about USD5,000 – 5,500) has been virtually stagnant for the past four-to-five years. This massive oversupply is now getting evident in the upper levels (above entry-level) as well today - the supply-demand imbalance has moved to higher levels - the industry has aged without adding too many employees in the past couple of years. The supply-demand imbalance is building up over time. Also, it has now become obvious that wage inflation in the industry bears little or no correlation with the inflation in the Indian economy. For the past two years, inflation at the consumer level (or CPI) has been hovering at high single-digit to double digit in % terms; yet entry-level pay is stagnant. Junior-level pay (<3 experience="" has="" modestly="" only="" p="" risen.="" years="">
· Perception no. 2: Wage inflation in the India IT industry depends on what powerful players such as TCS decide. Reality: Unless the large players act in unison or concert, we do not see large players being able to individually influence the wage structure for peers or for the industry. TCS today accounts for ~10% of the industry employee strength. Our view is that 10% is still far too low a threshold to be a price-setter for wages. This % is inexorably rising since 2007 (it stood at just 5.5% in 2007 - see figure 1). But we believe the % bar needs to be much higher for TCS to be an influencer of wages, say this % gets to at least 25% (i.e. TCS’s employee base more than doubling from here as % of industry workforce).
Figure 1: TCS accounts for ~ 10% of total India IT employee base (although this % is rising), this % is not nearly influential enough for TCS to be price-setter for the industry on wages – large players should act in concert/unison to be able to be a price-setter for wages
Source: Company reports, Nasscom, J.P. Morgan
Figure 2: The India IT/BPO industry has had very modest additions over the last two years; just-in-time hiring, rising automation and focus on other productivity-enhancing tools/measures have contributed to this; this combined with the increase in engineering graduates throughput has resulted in a supply glut and a supply-demand imbalance that is building up over time
Source: Company reports, Nasscom, J.P. Morgan
· Furthermore, any discussion of wage inflation cannot be divorced from absolute level of wages (which varies from company to company). For example, theoretically speaking, company A that pays 5% higher on average than its closest peer (Company B) for a particular employee band (within a defined skill-set) can afford a 2-3% lower wage hike than B for two years. We are not suggesting that TCS is making this adjustment from a lower base – our limited point is that any discussion of wage hikes cannot be divorced from absolute wage levels.
· Finally, even if assume TCS’s announced wage hike puts pressure on peers such as Cognizant/Infosys/Wipro to follow suit or else face the risk of attrition, we also tacitly end up making the simplistic assumption that wages significantly determine attrition (which is not the case). Infosys has given two rounds of wage hikes in the past 12 months; yet, this has done little to contain attrition.Based on anecdotal data points, we have no reason to believe that, generally speaking, Infosys/Wipro’s wages/salaries are inferior to TCS’s for comparable employee profiles – yet, TCS operates at markedly lower attrition than these two. Many more factors determine attrition than just wages and wage hikes per se.
· Perception no.3: Average pay rise announced by companies is in a tight range in trying to keep the mass employee base happy. The median pay rise approximates the average pay rise. Reality: Premium is being very clearly defined and accordingly, stark differential in pay rise is getting established for many companies. In CY14, a not insignificant portion of the workforce might only get a token hike of 4-5% at best. But the few proven performers at the top of their group, or those with proven program/project management skills (so critical for delivery at the mid-levels) or those with niche, non-mainstream but very important skills (e.g. in emerging areas such as analytics, mobility) and solution experts are likely disproportionately rewarded (relative to the past).
· Thus, companies are making pay stretch as much possible with the result that variance in pay today is much higher than in the past. Whether this stretch will remain as industry growth comes back remains to be seen. Companies insist that higher variance is here to stay. Also, increasing use of automation in developing tools, accelerators and components is rendering significant parts of the mainstream coding process much less important today. This probably means that that those with purely technical programming skills (say, Java or.Net) will need to re-skill to deserve above-average wage increase. Over time, we progressively see a larger % of the wage bill increase increasingly cornered by fewer resources. Increasingly, technology through automation is appropriating the utility of lower-level or less experienced programmers.
· Conclusions. (1) Wage inflation for a particular role/level responds more to the supply-demand gap in the industry for that role/level. Today, the industry is an excess supply situation for the junior-to-mid levels. This imbalance is building up over time. (2) Increasingly, in an industry marked by polarization in performance, company-specific factors (such as performance, utilization, attrition) also play a role in determining the wage-inflation dynamics for a company (very unlike 2003-09 when the players grew in a fairly homogeneous manner). (3) TCS is still not yet a price-setter in the matter of wages in India. As of today, TCS accounts for just about 10% of the total industry manpower (though this % is consistently rising), not enough to disrupt the market on wages. (4) Any discussion of wage inflation cannot be divorced from absolute level of wages (which varies from company to company). (5) Finally, even if assume TCS’s announced wage hike does put pressure on peers such as Cognizant/Infosys/Wipro to follow suit or else face the risk of rising attrition, we also tacitly end up making the simplistic assumption that wages and/or wage hikes significantly determine attrition (which is not the case). Infosys has given two rounds of wage hikes in the past 12 months; yet, this has done little to contain Infosys’s attrition. Based on anecdotal data points, we have no reason to believe that, generally speaking, Infosys/Wipro’s wages/salaries are inferior to TCS’s for comparable employee profiles – yet, TCS operates at markedly lower attrition than these two. (6) Finally, we see companies introducing much greater variance/dispersion in the wage hike, placing a greater premium on skills and performance they truly value (by grabbing employee eyeballs, a single headline average wage hike tends to mask this gathering phenomenon).
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