The IT sector’s TWITCH group may need covid bloat relief

The expanded wage bills of our IT exporters are set to weigh very heavily on them as global demand softens

It has been some time since I have written in this space about the Indian information technology (IT) services industry. I am dating myself, but I have been around for all three major economic boom and bust cycles it has faced: the early 2000s’ dotcom bust, the Great Financial Crisis (GFC) of 2008, and the current post-covid crisis. During the dotcom shake-out at the turn of the century, I was a senior executive at an American IT services firm, and the nasty joke in those circles was that the term ‘B2B’ stood for all the Indian-origin software programmers who had been retrenched and were going “back to Bangalore”.

But after the dotcom bust, Indian IT services, despite the sector’s oft-heralded demise, went from strength to strength, as the world realized that it could send work to the worker and didn’t necessarily have to bring workers to the work. This increased what could be safely ‘offshored’ to Bangalore and other cities. Indian IT again did well during the GFC of 2008 and the covid crisis of 2020-21. During the pandemic, however, the industry may have overplayed its hand.

The IT sector is now roundly expected to post a soft quarter, impacted by both the global Christmas slowdown and a worsening macro environment. Apurva Prasad of HDFC Securities, who follows these firms, expects tier-1 firms to post within 0.6% to 3.1% quarter-on-quarter revenue growth, a far cry from the recent past. He sees revenue growth decelerating from an estimated 13.5% in 2022-23 to 8.5% in 2023-24 and the year after that. The IT stock index’s historical outperformance was dragged lower by about 26% underperformance in the past one year. Tier-1 underperformance over the year resulted from both a cut in earnings estimates as well as a price-to-earnings or PE decline (from more than 30 times at the start of the year to less than 22 now), while the mid-tier IT correction was largely a function of a PE decline despite earnings holding up.

When it comes to hiring, Manik Taneja of JM Financial says the blip in demand during the pandemic was a once-in-a-lifetime chance which left IT Services companies with little option but to step up to the plate. He takes the example of ‘TWITCH’ companies (TCS, Wipro, Infosys, TechMahindra and HCL) to make his point. This group added more people during 2021-22 than the cumulative headcount increase seen across all four years prior, i.e., from 2017-18 to 2020-21. And what was true of TWITCH was also true of Tier 2 firms such as LTI-Mindtree, Persistent and a couple of others.

Specifically, for TWITCH, the net new headcount added was just over 20% for the period, which is an astonishingly large figure, given that cumulative headcount addition in the four years prior was only in single digits each year, with some quarters even showing negative growth in headcount during April 2017 to March 2020. This 20% amounted to net positive hiring by TWITCH of over 317,000 employees during the covid financial years. The corresponding number for Tier 2 firms (per JM Financial’s definition) was 26%, or almost 47,000 employees.

There is no arguing that this represents a quantum jump for the industry and explains the reason behind the tech talent supply crunch during the pandemic. While I am constrained to accept that it is only natural that wages for mid-level employees go up in such a scenario, I am still sceptical that the raises needed to be as high as they were. In many cases, it was over double what a transferring recruit was making at a competing firm. In addition, the work from home environment lowered barriers to job switching, with no changes in one’s daily commute or location of work.

IT service companies are now beginning to trim excesses by cutting down on variable pay and by insisting that their workers start making the old trek to the office. These firms will now put in place the tried and tested method of ‘pyramid rationalization’, which is industry-speak for hiring young fresh graduates to replace overpaid mid-level staff.

The industry has kept salaries for fresh IT engineering graduates at around the same level for 20 years, without even keeping up with inflation. This luxury has been afforded to them because of: a) the demographic profile of our country, which has a very young workforce; and b) the rise of colleges geared towards churning out computer programmers to meet the demands of the Indian IT services industry as well as the local set-ups of Western firms that have sought to capitalize on relatively low-wage Indian computer programming talent.

Let us see what pans out during 2023-24. Demand has been softening, and the mid-level bloat that these companies have put on will take some time to work out of the system. Any delay in correcting the bloat will impact performance further. However, the weight-loss programme of ‘pyramid rationalization’ will work, as it has always done in the past.

India churns out hundreds of thousands of fresh computer programming graduates every year, and I have no doubt that they will be nipping at the heels of their overpaid seniors who graduated 3 to 5 years ago.

No 28-year-old is mature enough to understand that a 2X increase in salary is a fishy proposition; it’s simply too good to last. Overconfidence is the wont of the young, and no amount of advice can stand in the face of a job offer that promises a youngster double his or her salary. A painful reckoning for these youngsters with this sector’s reality has just begun.

Siddharth Pai has led over $20 billion in technology transactions. He is the founder of Siana Capital, a venture fund management company focused on deep science and tech in India. These are opinion pieces; the opinions expressed are the author's own and do not represent any entity.

This article first appeared in print in Mint and online at www.livemint.com

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