Automation is a double-edged sword for IT vendors as it it can cannibalise existing business although it potentially increases profitability
Bengaluru: For domestic technology firms, investments in automation and smart intelligent platforms will be key to post consistent high growth as the companies’ traditional approaches to improve profitability, including deploying more people on projects, reach historic highs.
For this reason, some experts said failure to embrace these next-generation technologies could make listed companies in the country’s $146 billion outsourcing sector “derate faster than most investors are prepared”.
However, automation is a double-edged sword for these IT vendors as it it can also cannibalise existing business although it potentially increases profitability.
To be sure, since 2011, four of India’s largest IT firms and Nasdaq-listed Cognizant Technologies have made significant productivity gains rather than merely recording higher growth by adding more employees.
However, almost all the gains have been primarily on account of a firm’s ability to improve its utilization rate, which has helped the firms improve its profitability in fixed-time projects.
“It is worth noting that employee productivity improvement over the long-term has been almost non-existent across Indian IT companies,” Abhiram Eleswarapu, an analyst at BNP Paribas, wrote in an investor note, titled India IT Services, on 27 August.
The three largest IT firms, including Tata Consultancy Services Ltd, Infosys Ltd and Wipro Ltd are currently having utilization rates that are nearing the historic highs in the past.
This according to a few experts suggest the next round of profitability will be driven automating a lot of tasks, which will mean companies saving on wage costs to employee who have historically been deployed to undertake basic maintenance work.
“However, we believe there is more upside if companies’ plans to look beyond these traditional levers and focus on more automation and IP (intellectual property) play out. Note Infosys has a fiscal year 2020 aspirational per-employee revenue target of $80,000 (versus the current $51,000). At the target EBIT margin of 30%, that implies a per-employee EBIT of USD24,000, which is almost twice the current level.” EBIT is earnings before interest and tax.
For now, IT firms do not share the gains made on account of automating tasks or using intelligent platforms as the firms believe they are still in early days, with only a tiny number of projects seeing intelligent platforms being deployed.
“Longer term, however, we think falling employee growth is a clear trend and we expect revenue growth to slow significantly in the absence of sustainable per-employee revenue gains. Slower revenue growth has historically led to weaker margins (ex-currency). This double-whammy could derate stocks faster than most investors are prepared for, in our view,” wrote Eleswarapu.
“Certainly companies can further improve their utilization strengths to say close to 90%. But then just a like a Central Bank which would like much ammunition at its disposal in keeping inflation down, IT firms too are waking up to this reality that they have perhaps exhausted or nearing an end when it comes to traditional levers for improving productivity,” said a Singapore-based analyst with a foreign brokerage who declined to be named.
However, some experts said although adopting new-age technologies is the way forward for IT firms, many are also coy to deploy it across enterprises for fear of losing out business.
This can be explained by an example. A $10 million project before automation with 25% profitability might become a $7 million project after automation but with 30% profitability.
“So if service providers go all about advocating automation in all of their existing projects, they might loose 25-30% of their revenue from existing projects. So they are slow in adoption,” said Pareekh Jain, research director of engineering services at HfS Research, the US-based IT outsourcing research firm.
For this reason, executives at TCS, Infosys and Wipro do not want to put a date by when these companies will start sharing gains made using automating tools.
Jain said that since unless clients demand automation from their IT vendors, most software exporters will like to offer these new age tools to only “new customers and some of their existing key accounts”.
“Their approach is to balance out automation revenue cannibalization with growth and decline in margin due to pricing pressure with margin improvement due to automation”.