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Indian IT Industry and the challenges ahead

Jan 16, 2017(17:41)
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India’s Information Technology sector is presently going through a rough patch plagued by various challenges. Last year it was Brexit and automation and recently H1B visa bill underlined the major changes in the industry. There has been a lot of noise about automation taking away the human element that could lead to a reduction in jobs. Close on the heels came H1B visa which further put pressure on margins for the IT companies. These factors are likely to impact the IT industry adversely in the time to come. The industry is stuck between the legacy of business models and newer technologies.

H1B Visa

The H1B visa is used by the Indian IT firms, offering their employees short term work permit in the United States. After the recent rise in the anti-globalization trend and protectionism theme abroad, this facility given to the Indian IT industry in particular has been threatened. Although, IT companies have been denying that there will not be any impact on their business operations, the fact however is far from real. The bill proposed in the United States talks about the hike in the salary of H1B visa holder from $60,000 to $100,000 p.a. and revoking the exemption of having a master degree. This will increase the cost of employee for the IT companies and in turn squeeze the margins. Average employee cost for the IT companies in India is less than 10 lakh (varies between 3 lakhs-50 lakh).

Around 55-60% of the revenue for these IT companies comes from the United States. Over the past few quarters, IT companies have witnessed rise in sub-contracting expenses as a percentage of revenue. Also, the cost of hiring for these companies will increase if only candidates with master’s degree are sent on H1-B visa. 

Automation

IT giants like Infosys, TCS and Wipro have clearly stated that they prefer automation although it is long and challenging.  Infosys CEO Vishal Sikka has warned his employees that their lackadaisical attitude towards value creation will no longer be accepted.  In November 2016, Wipro took the biggest leap towards automation by asking their managers to identify the jobs that do not require human element anymore. The company has already automated its internal functions such as helpdesk and recruitment last year.

The automation process will increase the renewal competition among the IT companies. Projects over $200 billion will be renewed in 2017 and 2018. Any firm not adapting to automation will risk losing out losing project renewals thereby impacting revenues.

On the jobs front, IT companies will shun entry level engineers in the coming years causing disruption in jobs. However, Malcolm Frank, executive vice-president of strategy and marketing at Cognizant has a different approach as he thinks that sacking employees in the wake of automation is a distant reality and will not be happening at least over the next three years.

Even though the companies claim to shift towards digital business, revenue from the recent technologies are not enough to compensate the losses incurred from legacy businesses.

Losing Clients - IT companies derive around 40% of their revenue from banks and insurance companies globally. These companies have now decreased the quantum of work that was previously outsources to IT players in India. The industry does not have a revenue catalyst and major companies are still relying on their legacy as the main source of revenue.  IT industry in India is yet to adapt to the newer technologies like machine learning, artificial intelligence, internet of things, cloud technology and analytics.

Recently, it was reported that Swiss bank giant UBS is considering building a second centre in India. The bank expects to conduct around 60% of its technology and operations work in-house. UBS is the latest organization to do so after financial firms such as Bank of America, American Express and Procter&Gamble have decided to work in –house rather than outsourcing.

Almost all the global financial institutions that outsourced their work to IT companies feel that these companies are reluctant to adapt new technologies. For long, IT companies have abstained from offering automation as well as outcome-based pricing.

Even though companies such as TCS are tweaking their business model adapting to the changes and tackle the headwinds, IT industry growth seem to remain subdued for the current year.

Should we invest in the IT stocks? Considering the above points is investment in IT stocks advisable? Currently, IT stocks, particularly the larger ones look appealing based on valuations. Having said that, with structural changes happening in the industry the valuation can remain cheap for longer period or could become cheaper. Thus, considering the low valuations investing in IT stocks is not a good idea. One must keep a check on the companies which are adapting to changes quicker as they would be the gainers in the long term. So in the coming few quarters, the IT stock would trade in the broad range and could attract selling pressure on rallies. 

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