Indian IT firms open up to cloud, seek to ramp up spending next year 68/

Indian IT services companies are building up dedicated divisions for providing cloud-related services to clients as larger enterprises are slowly preparing to move part of their operations to cloud. Analysts are of the opinion that many big enterprises, which are reluctant to move to cloud owing to security concerns, have started to adopt hybrid cloud (combination of public and private cloud).

Even global research firm Gartner has predicted that total spend on IT services is likely to grow by 5.5 per cent to touch $1.08 trillion in 2020, which will be mostly driven by companies' cloud-related spending. It also predicted that outsourcing deal sizes in the cloud space is likely to be larger next year.

"While new-age digital firms and small & medium enterprises have migrated to cloud, many large firms including government bodies have not done so owing to security concerns. However, this is slowly changing," said Pareekh Jain, founder of Pareekh Consulting and IT outsourcing advisor. "Pentagon's $10 billion cloud contract to Microsoft, and IBM's buy of Red Hat indicate the demand uptick in the cloud space."

In October this year, the US Department of Defence (known as the Pentagon, which is the name of its headquarters) has outsourced a $10-billion cloud contract to Microsoft for providing enterprise-level, commercial Infrastructure as a Service (IaaS) and Platform as a Service (PaaS) to support its various operations. Given the demand uptick, IBM has acquired Red Hat, a leading hybrid cloud provider, for $34 billion this year to cash in the emerging demand in this area.

"For years, the industry has speculated that there would be a huge wave of cloud migration business, which did not materialise as firms kept their legacy estates where they were. However, this is now changing as firms come to realise that they can't continue with their digital transformations with legacy infrastructure," said Peter Bendor-Samuel, founder and chief executive officer (CEO) of global IT outsourcing consultancy firm Everest Group.

Last month, HCL Technologies has set up a dedicated business unit for Google cloud with over 1,300 professionals. The company plans to expand the team count for this division to around 5,000 professionals in the next few months. "Not only HCLT, but many vendors also have a dedicated cloud services practice. Most large system integrators have cloud-specific units. For example, Accenture has a cloud business unit for Google too, as do TCS, Infosys, Atos, and many more," said Hansa Iyengar, senior analyst at London-based Ovum Research.

Cloud Journey

* Organisations who shied away from moving to cloud are now doing it proactively

*Last Oct, US Defence Dept outsourced a $12 billion worth cloud contract to Microsoft

* Deal sizes in this space is becoming larger

* HCL Tech has set up a dedicated division for Google cloud

* IBM’s $34 billion acquisition of Red Hat aims at enhancing its cloud presence

* Gartner estimates most IT spends in 2020 to be driven by cloud software, services

Scarcity of talent likely to hit IT companies' forecasts for FY20

Cost escalation owing to scarcity of talent and more frequent use of temporary workers on onsite locations, especially in the key US market, is likely to affect the growth of IT majors in FY20.

Indian IT services firms such as TCS and Infosys have announced a record number of deal closures in the past couple of quarters. The delivery of these projects is expected to take off during this financial year.

According to analysts, the growing attrition, as in the case of Infosys, and rising sub-contracting costs, reported by industry leader TCS, are some of the factors likely to affect the projects, dragging the growth as well as profitability of the sector. In Q1FY20, TCS, even with its industry lowest attrition numbers, reported the highest ever sub-contracting share of revenue. “We’ve taken very strong measures, and some of the attrition here is what we call involuntary attrition and some of the attrition is also for individuals who will leave to go to graduate schools or for higher education, and that is somewhat seasonal,” Infosys Chief Executive Officer, Salil Parekh, had said while addressing concerns around the high attrition of 23.4 per cent reported by the company in the June quarter compared to 20.4 per cent in Q4FY19.

Higher costs from strengthening the sales team, setting up overseas development centres, sub-contracting expenses (7.5 per cent of revenue) and recruitment in overseas locations led to a 320 basis points YoY decline in EBIT margin for Infosys. “Considering, this is a seasonally high attrition quarter, an attrition rate in excess of 23 per cent is very high (for Infosys) which could impact project delivery at some point,” wrote Harit Shah, analyst, Reliance Securities in a note to investors. Further, cost escalation owing to scarce digital talent and higher onsite hiring can lead to execution risks and further margin pressure for the company, noted Shah.

Higher cost of services are likely to pull down Ebit margin for the Bengaluru-based company to 21.5 per cent in FY20 and, thereafter, improve to 22.6-22.8 per cent in FY21-22, said Neerav Dalal, research analyst with Maybank Kim Eng Securities.

On the other hand, even with 11.5 per cent attrition rate, TCS is likely to see the cost pressures increasing due to local hiring and spends towards contractual staff in the US. In Q1, TCS reported their highest ever subcontracting costs at 8.4 per cent of the revenue. Both TCS and Infosys have been steadily increasing local hiring in the US by roping in local staff who command a higher salary package.

“While the US campus hires command over $70,000 (typically), we see a sharp wage inflation for modestly experienced local (US) resources, with professionals with three years’ of experience potentially commanding 25-30 per cent higher pay than when they started out. Thus, we are not sure that local onsite pyramid can be built out nearly as effectively as offshore (India-based) pyramid,” wrote Viju K George, analyst with JP Morgan.

Consequently, George notes that TCS is likely to struggle to hit the low-end of its 26-28 per cent target Ebit margin band unless rupee offers adequate support. Margin pressure is going to a big challenge for other companies in this space as well.