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As investors in IT services companies grapple with demand uncertainty, the latest financial results show a disturbing scenario unfolding--a lack of pricing power.
Despite a significant reduction in hiring, lowered subcontractor costs, deferment of pay hikes and optimised utilisation levels, large IT companies managed to eke out only a minor improvement in profit margins in FY25.
At the annual level, FY25 profit margins are still lower than in pre- COVID FY19. IT companies were expected to repair profit margins by extracting better prices during the post-pandemic boom years. However, that did not happen to the desired extent.
Instead, the sector now faces challenges such as sticky costs and renewed headwinds from tariffs, US Dollar depreciation and AI-led technology transformation. Pertinently, their customers' focus has shifted to money-pinching cost efficiency projects. This provides limited scope for profitability improvement for IT services companies.
“Companies will find it difficult to pull back on sales and marketing investments given the need to capture demand in a weak environment. Leverage from pyramid is also a challenge,” warn analysts at Kotak Institutional Equities.
An improvement in revenue growth rates can yield better operating leverage and profit margins. But that scenario looks unlikely in the immediate future. Analysts are not projecting any major acceleration in revenues growth rates anytime soon.
With revenue growth rates and profit margins below pre-COVID levels, the question to ask is why IT stocks are still trading at a significant premium to 2019 valuation levels.
Taking note of the cost pressures and profitability challenges, IT companies began implementing belt-tightening measures. Analysts expect the IT firms to rationalise employee payouts and cap subcontracting costs.
Still, for a structural improvement in profit margins the companies will have to drive deeper changes in their employee pyramids and climb the technology services value ladder. That is a long-drawn-out process that lies ahead of them. Expect some turbulence along the way. Investing insights from our research team
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