Tata Consultancy Services (TCS), India's largest IT services company by far, with a turnover of Rs 81,809 crore in 2013-14 and profits of Rs 19,164 crore, is the toast of the markets. With a market valuation of Rs 4,34,300-and-odd crore as on 17 April, it is India's most valuable company.
It also has over 3,00,000 employees - 300,464 to be exact. Since its business is about throwing more and more employees to provide offshore IT services to companies all over the world, you could say each employee is worth around Rs 1.44 crore.
In 2014-15, it plans to recruit another 55,000 employees on a gross basis. If each employee added is valued at the same level as current ones, TCS will have a market value of Rs 5,11,868 crore by this time next year. Of course, no one can predict the direction of the markets, and so value is not a function of the number of employees added.
The big question is: how long can TCS continue to expand in this linear fashion? Till 5,00,000 employees? Till 7,00,000 employees? Is there no cost to linear growth?
There is. TCS's real problem is not the market, but retaining employees. Last year, it had an attrition rate of 11.3 percent - which means for every 100 employees added, 11 left.
But the actual picture is worse. In 2013-14, it added 61,200 employees gross, but the net addition to staff was only 24,268. This means it lost 36,932 employees during the year for whatever reason.
Its real attrition rate is thus closer to 60 percent - for every 10 employees added in the year, six left. This is not a catastrophe for many leave for their own reasons - further studies, better jobs, motherhood, etc - but hidden in this statistic is possibly an important long-term problem: managing the numbers is becoming a serious problem for TCS.
This is not an issue with TCS alone. At last count, industry No 2 Cognizant had 1,71,400 employees. In 2012, Cognizant had attrition rates of 10.7 percent - not far below TCS's. Infosys, with 1,60,405 employees, and Wipro (1,46,053 employees) have equally high rates and HCL Technologies (90,190 employees) had the worst rate of 16.9 percent in its IT services business.
Though this is not being stated openly in the industry, the chances are that the high attrition rates are the result of size. Beyond a point, very large employee numbers are difficult to manage within one company, with one policy, and without huge additions to management layers, support costs, and overhead bureaucracy.
Eight years ago, when Wipro was a 45,000-employee company, a Wharton professor of operations and information management, Ravi Aron, had asked Azim Premji, Chairman of Wipro, whether the company was not going to face a problem managing so many additions to staff every year. (Read this Knowledge@Wharton article here)
Aron asked: "One of the observations that often is made about service companies - in contrast to product companies - is that businesses based on human skills inherently don't scale gracefully. Beyond a point, the company becomes so large that it is impossible to manage an organisation if it grows to, say, 1,50,000 people. This seems to suggest there are natural limits to growth and asset size. What do you think?
Premji's answer: "I don't see growing to 1,50,000 to 2,00,000 people as an insurmountable challenge. Take a company like Accenture - it has almost 120,000 people now, and they have scaled up by almost 20,000 people in the past two years. That has come about mainly because they have gone to global delivery models. That is doable. After 2,00,000 people, you might have to think laterally about how to grow beyond that point. You have to think about partnership models - how do you manage partners and still have transparency with your customers? That is important, because you are still responsible for the deliverables in the end."
Well, Cognizant, Wipro and Infosys are already approaching 2,00,000 employees - they will get there in one or two years - and TCS has more than exceeded Premji's optimum size by a large margin.
If TCS adds 55,000 employees this year, and the attrition rate stays at 11 percent, it will lose nearly 40,000 people by March 2015.
Right now, it may not matter for business is booming, and the added costs of both attrition and management layers can be passed on to customers, but sooner than later, TCS will face the law of diminishing returns on linear additions to staff.
A few years down the line, TCS could be half a million employees strong - and that size is not always a strength. Several reasons why.
First, as employee strength grows exponentially, managerial staff have to expand. Let's say every 15 employees need one oversight manager. At 3,50,000 employees next year, TCS would nearly 23,000 managers whose main job is not about software creation or coding, but about managing people. Of course, TCS already has these managers, but remember it is a pyramid. These 23,000 managers would need managing themselves. While there is no hard and fast rule that companies can have only so many maximum staff, at some point the pyramid will become difficult to manage.
Second, as staff numbers grow, functions unrelated to customers multiply. Thus support functions like human relations, travel, logistics, concierge services, and teaching and training staff have to be increased (or outsourced). This adds to costs and reduces margins. This year, TCS is setting up a 10,000-seat training centre in Thiruvananthapuram. The company thus has to invest more in making its employees employable.
Third, the larger the number of layers and support and administrative functions, the weaker the company's culture and communication of values becomes. When you are a small company of, say, 100 people, everyone knows the boss and what he wants and what he values. When you are a 3,00,000-employee behemoth, the guy at the bottom does not fully know what the company's culture is, and what its core values are. Of course, companies have structured sessions and training programmes to drill these things into employees, but it's like learning values by rote, not real experience. Communicating a strategy from top to bottom becomes a huge logistical exercise and even then the message would be garbled once it gets to the last man.
Fourth, companies with large staffs tend to develop huge bureaucracies and sub-systems that will demotivate younger joinees. This is a key factor why IT companies have such huge attrition rates. The companies are unable to manage the aspirations and expectations of so many employees. High attrition rates mean higher costs - from recruitment to training to performance monitoring and managerial supervision, not to speak of support costs. Attrition dents margins.
The 2002 annual report of Cognizant had this to say: "Annualised turnover, including both voluntary and involuntary, was approximately 10.7 percent for 2012. The majority of our turnover occurs in India....In addition, attrition is weighted towards the more junior members of our staff. We have experienced increases in compensation and benefit costs, including incentive-based compensation costs, in India
which may continue in the future; however, historically, this has not had a material impact on our results of operations as we have been able to absorb such cost increases through price increases or cost management strategies such as managing discretionary costs, the mix of our professional staff as well as utilisation levels, and achieving other operating efficiencies."
Translated, this means that the business pipeline has been so strong, that many of the costs related to large staffing and attrition got passed on to customers.
When business is booming, these costs don't matter. The inefficiencies of size are passed on. But if business starts thinning, what happens?
The day of reckoning is not near, but companies like TCS will ultimately face the law of diminishing returns with such high levels of linear staffing expansions every year. They may have to consider one of two alternatives: split their companies into smaller client-facing businesses that are more focused and with fewer employees, each free to develop its own culture; or they could expand the non-linear parts of the business like consulting, platforms and solutions.
It's not going to be easy. Infosys rushed into project Infy 3.0 and burnt its fingers. The others stayed with brad-and-butter IT services and made money hand over fist.
But Infosys 3.0 is actually the way to go. The only problem with it was it was badly timed to coincide with the global slowdown, and poorly executed.
Updated Date: Apr 19, 2014 10:37 AM