Indian information technology (IT) services companies need to write a new code to debug rising staff costs, says rating agency CRISIL whose research suggests that operating margins will decline 30-80 basis points (bps) in FY19-20 evey as dollar revenues rise 7%-8%.
According to CRISIL, visa restrictions by the US will begin to bite as the cost of local hires will be 25%-30% more than their H1-B counter parts, cutting into labour arbitrage margins.
Employee expenses, which account for nearly 60%-65% of total operating costs and cost per employee for tier-1 players, rose faster at about 17% and around 9% in FY18-19, respectively, compared with about 6% and 3% a year before. For mid-tier players, the increase in employee expenses was around 13% year-on-year (y-o-y) for nine months of FY18-19 as many are yet to declare fourth quarter results.
Such an increase in employee costs can be attributed to tightening of visa norms for Indian players, resulting in higher onsite costs for them. Ever since the US government tightened its H-1B visa policy in 2017, challenges have mounted for the sector. That year, Indian-origin employees were the largest consumers of H-1B visas at 63% of initial employment, so the sudden change meant fulfilling onsite client requirements became tough.
“To be sure, Indian IT players have had an offsite-onsite employee ratio of 80:20. Employees with H-1B visas have been at the core of their strategy, given that they cost about 20% cheaper than US-based employees. Further, the unemployment rate in the US technology sector was only 1.8%-2.0% in calendar 2018, compared with an overall unemployment rate of 3.8%-4.0%. So, the limited staff availability is expected to lead to higher employee costs associated with hiring US locals,” the ratings agency says.
A deep dive into this issue shows the onsite costs of Indian IT companies would continue to rise and put their profit margins at risk.
According to CRISIL, margins have been declining structurally for the past five fiscals, as billing rates and utilisation stabilise, so rising employee costs will only add to the pressure. Employee utilisation was high at about 85% in FY18-19, with only a marginal room for improvement in the future. Billing rates are expected to remain under pressure, as traditional services become commoditised.
CRISIL Research expects revenues of IT sector to grow by 7%-8% in dollar terms during FY19-20, helped by double-digit growth in digital services. Operating margin is forecast to decline 30-80bps for the sector in fiscal 2020 as local hires increase for onsite job, who cost 25%-30% more than their H1-B counterparts, it added.
“Players can try to optimise onsite costs by resorting to the pyramid model, wherein college graduates are hired at $50,000-$60,000 in a higher proportion and the rest filled with a few domain experts at a higher cost, fewer onsite bench resources, and keeping variable salaries depending on the outcome of projects.
“Focus on moving up the value chain in digital services could also play a role to offset rising employee cost,” the rating agency concludes.