Despite a challenging global business environment and over 11-month delay in US H-1B visa processing, subcontracting costs at top Indian IT firms such as Tata Consultancy Services (TCS), Infosys, HCLTech, and Wipro have begun to trend downwards, according to their performance reported for the second quarter of FY23, which ended September 30, 2022.
The managements of these companies have maintained a bullish outlook for subcontracting costs to improve further in the coming quarters, which will aid in improving operating margins.
TCS, which had quarterly subcontracting costs of around 7 percent of revenue levels last fiscal year, saw them rise to 9.7 percent in Q1FY23; however, in Q2FY23, it started plunging by 10 bps, reaching 9.6 percent of revenue, according to analyst reports.
HCLTech's subcontracting costs (or overall outsourced services costs) fell from 15.3 percent of revenue in the previous quarter to 15 percent of revenue in Q2FY23 reducing by 30 bps. Meanwhile, Infosys' subcontracting costs fell sequentially from 10.5 percent of revenue to 10.1 percent, a 40 bps correction. Wipro's subcontracting costs fell to 12.9 percent in the second quarter, down from 13.7 percent previously.
It was cited as one of the key levers that helped the companies improve their operating margins this quarter.
During the analyst call for Q2 earnings, Salil Parekh, CEO and MD of Infosys, explained, “…the impact on margin is what is the premium you're paying to subcontractors over employee. So it's just not a mathematical impact of subcontractor costs coming down from 11 percent to 10 percent. By that token, if we say if we can bring down subcontractors to zero, margin can go up by 10 percent. So this is just a premium you're paying to subcontractors which is impacting your margin.”
TCS CFO Samir Seksaria told the media,“Subcontracting costs have started to trend downwards and we expect that to continue. Especially because supply side challenges are easing out and then reliance on subcontractors will trend down.”
Subcontracting costs trends, according to Amit Chandra, Deputy Vice President, HDFC Securities, is very company specific and will depend on the type of deals they win.
“Benefits of subcontracting costs are already visible in Infosys and to some extent in TCS. For instance, Infosys got the Daimler deal, which was a larger deal, where the need for subcontracting was much higher. In comparison, TCS didn’t have any subcontracting-heavy deals yet. That’s why the subcontracting cost share in Infosys is on the higher side due to this one deal,” he told Moneycontrol.
“But at a sectorial level, the benefits of subcontracting costs has still not come in and it’s still early days to say subcontracting costs have started benefiting the margins. Subcontracting is a tool cater to additional demand. And whenever you don’t have that kind of a demand it is very easy to cut subcontracting costs,” Chandra added.
He explained that the need for subcontracting is especially important for time-sensitive larger transformational projects that require immediate action. Other cost-cutting and deal-optimization-related tech projects, on the other hand, will not rely as much on subcontracting.
Mrinal Rai, Principal Analyst at technology research firm ISG, said that companies are now hiring more in offshore locations, echoing Seksaria and TCS' comments about supply side challenges being alleviated by newer deployment and hiring.
“Well, as per latest data we have seen hiring by providers increasing across regions so it could indicate that providers are hiring in those countries instead of sub contracting,” Rai told Moneycontrol.
Companies like HCLTech has been actively hiring employees from its “new frontier locations” including Sri Lanka, Vietnam, Romania, Mexico, Costa Rica, and Brazil.
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