Technology: Job losses-beyond the noise - Kotak

Layoffs at IT companies have received a lot of press over the past four weeks. We believe that these adjustments in staff strength are not materially different from earlier years. The IT industry will continue to be a net recruiter with numbers prudently and continuously calibrated by industry revenue growth. There have been several reasons for slower net headcount addition in recent quarters.

Layoffs at Indian IT companies – seasonal pruning or breaking news?

As per media reports (denied by many companies subsequently), aggregate job losses at seven IT companies (Exhibit 1) would be 56,000, translating into 4.5% of its aggregate headcount. In a now familiar pattern, Indian IT companies let go of 1-3% employees after annual performance measurement. This year, we could see a slightly higher proportion let go (say 2-4%), a difference of scale rather than kind. We believe that slower growth is making jobs more difficult to come by for those who find themselves out of jobs. Expect negative press to continue on this count.

Slowdown in growth accounts for attrition and lackadaisical new hiring

We attribute the slowdown in hiring to four factors.

- Slowdown in growth rates. The growth rates of Indian IT in each of the past four years. Needless to say, growth rates have slowed down though absolute revenues added by the industry remained unchanged. With absolute revenue addition unchanged, the absolute industry headcount addition should have remained unchanged not decline in FY2017. Muted industry net hiring number of 173K (-16%) was a function of an increase in utilization across companies and continued revenue shift to onsite.

- Decline in attrition rate. Attrition which is a direct outcome of a slowdown in growth rates has trended down across companies. Low attrition would allow companies to improve utilization rates and delivery efficiency, especially in fixed price projects. That said, the extended period of low attrition also limits the ability of companies to manage the employee pyramid.

- Utilization rate increase. This is being facilitated through (1) decline in attrition rates and (2) contracts increasingly moving to fixed priced/ managed services, reducing the need for contractual bench necessary in T&M projects.

- Acceleration in localization program, employee reskilling, changes in market place. Indian IT companies have accelerated localization programs by stepping up local hiring and pursuing contracts that involve employee rebadging. This has resulted in an increase in local headcount in client geographies without adding much headcount offshore. Additionally, growth in digital is led, to a large extent, through onsite local resources. Closer home, IT companies are attempting to reskill employees, but not all are reskillable, leading to separations. Additionally, a broad-based shift to agile delivery has resulted in the loss of several positions (especially managerial positions) for Indian IT. In agile development, the project manager's roles are largely retained by clients, and are not outsourced. This has left Indian IT with excess supply of managerial talent as compared to opportunities.

Even as we acknowledge broader industry challenges, we believe that India's IT services industry will be a net recruiter. Industry headcount addition in FY2018 would be similar to FY2017 figures or marginally higher, assuming 8% c/c revenue growth. The industry may not get the same level of improvement in capacity utilization in FY2018. However, this positive would be partly offset by higher local hiring in US resulting in redeployment of several onsite employees (H-1B workforce) offshore. We detail our thoughts on recruitment in key service offerings area.

Expect industry to add over 150K headcount in FY2018

Underlying this assumption is industry growth of ~8% in c/c. This involves absolute revenue addition of about US$9.4 bn (constant dollars). Without any mix change, this should involve headcount addition of 300K (@8% headcount growth) in FY2018E. However (1) automation and (2) continued shift of resources onsite (due to a digital shift) will mean that headcount addition will lag behind revenue growth.

Looking at headcount differently, one can divide the industry headcount into four broad buckets.

- Engineering and R&D Services. This segment is a relatively fast growing with digital as a growth enabler Time to market pressures on new product launch, IoT and replatorming of products for cloud are spawning new opportunities. Additionally, the expansion of captives in India continues at an accelerated pace. We expect 7-9% headcount addition in this segment.

- Domestic IT and BPO. Continued investments in digitization, implementation of GST and growth in the economy will create opportunities in domestic IT and BPO segments. We expect 5-7% headcount addition in this segment.

- IT Services. The real focus of the Street is on headcounts in IT Services exports. This segment constitutes 35% of the overall industry headcount. Automation, digital disruption and pricing pressure are causing immense pressure in this service line. Indian IT will continue to gain a share in traditional service, but the fact remains that the share of traditional services is declining in overall budgets. We expect Indian IT to grow 6-8% in this segment and headcount addition will be 2-3% lower than revenue growth

- BPO is where the real challenge is. The BPO industry employs 1.15 mn people and headcount has grown at 6.1% in FY2017. Nearly 38% of BPO export revenues are from customer interaction services, something that will be automated and taken over by chatbots etc over a period of time. BPaaS in horizontal services such as F&A, HR and select industries will lead to lower headcount. In addition, RPA will also cause significant disruption.

Overall on a net basis, we expect IT and ERD segments to drive headcount addition.

Impact of automation needs to be closely watched

Indian IT is making investments in automation to reduce people effort. Companies are targeting moving to people + software model from largely people-driven services. Indian IT has indicated potential effort savings on usage of AI based automation platforms. For instance, Wipro has set an audacious target to reduce people deployment by 35% select service offerings and is working towards leveraging its AI platform HOLMES wherever possible. Infosys reports FTEs saved during the quarter through automation initiatives. While it is early days for automation and people effort saved numbers are small, it requires a close watch. We expect automation to have significant bearing on headcount addition in the medium term.

Implications of excess supply of talent

The industry will continue to be a net recruiter, but the fact remains that supply of engineers easily outstrips demand. Even in the mid-management level, where the supply of talent used to be constrained is seeing an excess of supply. These factors have negative implications for the engineering talent detailed below (we have discussed this earlier as well).

- Further moderation in wage revision. Wage increase in the IT sector has already moderated to high single digits from low-to-mid teens historically. This could moderate further to mid-single digits. Fresher salaries of Rs325-350K may remain unchanged for the next few years. Excess supply of graduates will feed into the entire pyramid over a period of time.

- Shift to just-in-time recruitment Excess supply will give companies flexibility to recruit in line with requirements. The campus hiring season could be pushed back such that companies have good visibility of requirement at the time of making campus offers. Just-in-time recruitment will drive the following benefits for companies—(1) drive up utilization rates— this is feasible as excess supply will lower attrition rates, and (2) match-up of skill sets with demand. Over time, this could move to on-demand hiring of specific skill-sets.

- Trade unions could emerge in Indian IT. This idea does not seem far-fetched anymore. Unionization may not be in the traditional sense but through common-interest/issue support groups formed on social media platforms like Facebook and Twitter. We note that Indian IT employees have formed a forum FITE (forum of IT employees) and are planning to approach the labor commission to protest against recent layoffs.

Source : Equity Bulls

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