IT deal closures face delays as clients seek pre-pandemic pricing, discounts

It's double whammy for IT companies as clients ask for discounts amid deal conversion slowdown and demand uncertainty.

Customers of top IT services firms are seeking pre-inflationary rates and pricing concessions for both new agreements and contract renewals, amidst a challenging macroeconomic environment and cuts in discretionary technology budgets.

Even as firms such as Tata Consultancy Services (TCS) and HCLTech have denied that customers were seeking any significant pricing discounts in deal negotiations during their April-June quarter earnings conferences, industry observers said it is one of the key factors for the ongoing uncertainties in demand and delays in deal closures, making it a double whammy for the IT companies.

According to market intelligence firm UnearthInsight, there was a price increase of at least 20-30 percent on transformation deals during the pandemic, a hike that clients are seeking to pare to some extent, due to uncertainty about their growth prospects.

UnearthInsight estimates that discount asks have climbed to 50 percent of new deals but companies are agreeing in 30 percent of the instances, citing cost pressures.

Phil Fersht, founder and CEO of HFS Research told Moneycontrol, “Many renewals are being delayed with clients demanding pre-inflationary prices and some even discounts. Providers have to decide if they can afford to drop their prices to keep fully utilised or stand firm and grind out the current slump.”

At the same time, Peter Bendor-Samuel, founder and CEO of Everest Group, a research and management consulting firm said that despite the increasing pushback from the customers, IT services firms aren't willing to budge.

“There is an increasing pushback against the post-pandemic price increases, this can cause protracted negotiations and along with the economic uncertainty contribute to the slowdown in pipeline closing and the increase of deal delays,” he said.

“At this time we have not seen a significant rollback of the price increases pushed through in the last two years but there is a growing push to claw back some of these increases and no appetite to allow further increases,” he added.

Impact on margins

While it is hard to determine if this has started impacting margins, a look at the first-quarter earnings across the top five Indian IT firms shows a decline in operating margins except for Wipro, whose margin expanded by 112 basis points (bps) quarter on quarter (QoQ). In terms of margins and the usual commentary, Q1 is seasonally a weak quarter for IT firms, as they roll out wage hikes during this period.

Additionally, this time companies saw weakness in several key sectors including BFSI, communications, media and entertainment (CME) and telecom. Tech Mahindra, which gets nearly 40 percent of its revenue from the CME vertical, saw its margins drop by 440 bps QoQ.

UnearthInsight's founder Gaurav Vasu said discounting demands are more pronounced in new deals and with newer clients compared to existing ones.

“In 2020, when the pandemic hit, the services companies already had to do discounting. So the same discounted price continued for some time, then suddenly when the war for talent happened, the services companies went back to the clients asking for some increase in pricing. Now that the inflation pressure too is coming down, this kind of price discounting is happening in three out of 10 deals, especially with new clients," Vasu told Moneycontrol.

But company managements denied seeing any significant ask for pricing discounts so far, analysts said.

“In terms of pricing reductions, there have been some sporadic requirements from different clients but largely the pricing environment remained stable,” C Vijayakumar, CEO and MD, HCLTech, said during the company's recent earnings conference with the media.

TCS CFO Samir Seksaria maintained that the overall pricing environment remained stable for the country’s largest IT services firm, instead, there was a “year-on-year increase in realisation,” wherein prices increased to some extent.

Overall, all the companies guided for slower revenue growth and delays in deal pipeline conversion in the upcoming quarters.

Delays in deal renewals

According to UnearthInsight’s estimates, in FY24, the top five Indian IT companies including TCS, Infosys, HCLTech, Wipro and Tech Mahindra will cumulatively bag between $70 billion and $85 billion worth of order book/total contract value wins. Of this, renewals will account for around 30-35 percent of the total deals.

The ongoing delays in deal closures are happening across sectors and deal sizes with the exception of artificial intelligence, which continues to remain a bright spot given the Generative AI hype, analysts said. But they also expect revival to happen soon as Fed rate hikes and inflation starts to cool down over the next two quarters.

“Deals are pushed out by 45 to 60 days right now. This is due to two factors – a lot of folks decided to take summer vacation in North America which is a rare thing and the markets had not been sure of a recession in North America. Now, they know that the recession is more than unlikely to happen,” said Ray Wang, Principal Analyst and CEO, Constellation Research.

Vasu said $100 million-plus deals have slowed down, and he expects revival to come in largely from public sector and government deals across countries. Hi-Tech and SaaS should also bounce back from Q3 FY24. Manufacturing, BFSI and healthcare are taking comparatively longer to make decisions and even deals which are won have projects getting paused/taking longer to materialise. This trend will continue for the next 4 to 5 months in FY24.

“Long-term tech transformation deals which have a 3-to-5-year execution cycle and completely new-age technologies like Metaverse or experimental tech investment from clients are either on hold or taking 5 to 8 months to close,” Vasu said.

There are a number of complications this year with deal renewals, said Bendor-Samuel. One of them is vendor consolidation, which is underway with large accounts. Vendor consolidation deals in the initial stages are usually resource-demanding and do not really leave good margins; revenue starts rolling in only after certain maturity. Thus, they are complicated to execute, taking more time, and creating a lag in revenue recognition as workloads take time to transition.

Another factor is the increased focus on cost savings which results in more Request for Proposals (RFPs) but longer procurement cycles.

“For the first half of the year, there has been a lot of indecision as firms increasingly prepared themselves for a recession. This made decision-making more difficult and more drawn out resulting in a significant slowing in pipeline closing,” he explained.

Finally and potentially most importantly new deal signings are paired with a significant reduction in discretionary spending often pre-committed in existing contracts, Bendor-Samuel said, adding, “Hence, book-to-bill ratios which are strong stand in stark contrast to revenue recognition which has slowed significantly.”

The book-to-bill ratio for IT companies is a metric used to explain the value of orders received to the value of orders completed.

Tempering inflation

Analysts have started seeing green shoots in most major geographies like North America, expecting the recovery to kick in the next few quarters.

HFS Research has predicted that with the news on inflation running at only 3 percent in the US, a recovery for IT spends could be in Q4 2023.

However, US banks still seem to be weathering a crisis, following the collapse of Silicon Valley Bank and the Signature Bank earlier this year. Global credit rating firm Moody’s on August 7 downgraded ratings of 10 small to mid-sized US banks, adding that it may further downgrade some of the US’ biggest lenders, as the sector reported pressure in profitability in its recent company earnings. BFSI is one of the largest sectors to give business to IT services companies. TCS generates nearly 35-40 percent of its revenue from this sector.

Read: Global banking crisis adds to woes of IT firms, slowdown expected in near term

Ashutosh Sharma, head of research at Forrester Research India, highlighted that the equity markets in North America and India have started to pick up.

“Equity markets have started to pick up in India and North America. Experts are seeing some green shoots appearing, expecting economies to recover and inflation to slow down. It might get delayed by a quarter or two, but there will be a recovery. For the time being, deals are getting pushed out and clients are not opening their purses easily,” he said.

Wang concurred, “Given the recent tech rallies and stock market growth, there is confidence that economic conditions are improving.”