The second quarter results of Tata Consultancy Services (TCS) and Infosys, delivered on Thursday and Friday, should be seen as the beginning of the end of the Indian IT services business model, where labour arbitrage and linear growth in hiring and revenue went hand in hand. In the future, we will see more discontinuous growth, more acquisitions in the value-added platforms, consulting and products space, and a sharp downturn in manpower growth. Our IT Goliaths have to make the transition from overgrown and overfed kids to lean and mean adults.
Formally, TCS reported a year-on-year revenue growth of 5.2 percent in dollar terms and Infosys 8.2 percent; the dollar value of business is the only one that counts, for the exchange rate can move hither or thither. In terms of guidance, while Infosys did better than expected, its revenue guidance for the rest of fiscal 2016-17 was down to 8.2-9.2 percent in dollar terms.
But the CEOs’ statements, despite some upbeat elements, tell us that the going ahead will be tough. TCS’s N Chandrasekaran said: “It has been an ‘unusual Q2’ for TCS. Growing uncertainties in the environment is creating caution among customers and resulted in holdbacks in discretionary spending this quarter.” Infosys’ Vishal Sikka talked about being “focused on strong execution in Q2 with our core IT services business showing good progress on the strength of our innovation and operational initiatives. While we continue to navigate an uncertain external environment, we remain focused on executing our strategy and increasing momentum of our software plus services model.”
The operative phrases are “unusual Q2” – which is likely to become less unusual in the coming quarters. And Sikka’s takeaway comment is “uncertain external environment”, when the reality is not the uncertainty, but the certainty of a shift in client demand away from ordinary manpower services.
While Chandrasekharan said he was confident that the setback of Q2 was “temporary”, Sikka seemed to suggest (rightly) that the future would be a different place. “Longer-term, I believe it’s increasingly clear that our industry’s future lies in evolving from a cost-based, people-only model, to one in which people are amplified by software and AI (artificial intelligence), and are freed to innovate in areas that are strategic to our clients’ future.”
Put simply, this means the days of linear growth by adding staff for offering plain vanilla IT support services are going to taper off. The future will be hard-fought, one where productivity and intellectual property will have to be acquired and deployed to gain markets or even retain existing ones.
The Indian IT industry is facing the classic dilemma portrayed in Clayton Christensen’s book, Innovator’s Dilemma: When new technologies cause great companies to fail. The dilemma is this: when existing revenues are so good and the margins fat, why should TCS and Infosys make investments in technology and ideas that will destroy margins and the very basis of today’s prosperity and high share valuations? While the Accentures and IBM were forced to automate and offer consulting to beat the TCSes and Infys, the Indian behemoths raked in the moolah and failed to speed up on technology.
As Andy Mukherjee wrote in his column for Bloomberg, “Indian software companies' outsize revenue growth is a thing of the past.” While this may be too sweeping a judgment, the problem he points out is real. “A slowdown alone wouldn't have stopped the Indian industry if it had been able to embrace "SMAC" - or social, mobile, analytics and cloud-based technologies. But the vendors wasted so much time defending their legacy business of writing code for and maintaining purpose-built enterprise applications that they failed to make a mark in the new digital world.”
This too is a very sweeping judgment, for both TCS and Infosys have been trying to up skills and technology in cloud computing, Artificial Intelligence (AI), and automation. But their global rivals have already had a head start precisely because they did not have a low-cost arbitrage market to milk for easy money. Hard realities made harder competitors out of IBM and Accenture. Mukherjee points out that while the big three of Indian IT (including Wipro) had 50 percent more employees working on digital tech than Accenture, their revenues were 40 percent lower. Clearly, Indian IT is trying to throw more people at the problem than automation.
This is, of course, changing, as all three are playing catch-up on automation, robotics, et al, and their head count growth is slowing down.
While TCS reported gross hirings of 22,665 in the second quarter ended September 2016, net hirings were only 9,440. In other words, TCS lost or bid goodbye to more than 13,000 employees. Its total headcount was at 3,71,519, and it is doubtful if we will see much growth beyond 4,00,000-4,50,000 at the limit. Infosys is already peaking employee strength in the range of 2,00,000 plus. In the first quarter, the three IT majors below TCS and Infosys – Wipro, HCL Tech and Tech Mahindra, who are yet to report results for the second quarter - actually saw employee totals reduce. Headcount shrinkage is already happening.
The following is what we should expect to see in the coming years:
One, a sharp deceleration in manpower additions, with new hirings happening more onshore and less offshore in order to be closer to clients and to vault over protectionist sentiment in the largest markets.
Two, a binge of acquisitions, and a reduction in cash surpluses. As on 30 September, Infosys had nearly $5.34 billion in cash or liquid assets; this will come down sharply as the company pays out more to investors to keep them happy while buying critical skills, technologies and marketshare through acquisitions. Ditto for TCS and Wipro.
Three, employee attrition of the involuntary kind will accelerate, as companies seek to replace staff with low skills with automation. Wipro is said to have developed an AI platform called Holmes, which is “a rich set of cognitive computing services for the development of digital virtual agents, predictive systems, cognitive process automation, visual computing applications, knowledge virtualisation, robotics and drones.” Shorn of the gobbledygook, Holmes will replace 3,300 engineers. It will also be sold to Wipro's clients.
HFS Research, a US firm, says that automation will lead to the loss of about 6.4 lakh low-skill IT jobs, and create 1.6 lakh higher paying jobs in their place.
Clearly, automation is going to change India IT forever. It will create a new binary class structure where there will be a very highly paid IT elite, and a reducing but still large complement of lower-wage pool facing an uncertain future.
President Obama’s National Science & Technology Council has said as much in a recent report on the impact of AI in many spheres. “AI’s central economic effect in the short term will be the automation of tasks that could not be automated before. Analysis by the White House Council of Economic Advisors (CEA) suggests that the negative effect of automation will be greatest on lower-wage jobs, and that there is a risk that AI-driven automation will increase the wage gap between less-educated and more educated workers, potentially increasing economic inequality.” (Read the full report here)
This is Indian IT’s future – a future of IT haves and IT have-littles.