A negative sentiment has engulfed the Indian IT services industry today. Doomsday prophets have had a field day. But if one were to look beyond the hysteria, there are three large themes that are majorly responsible for the slowdown in the IT industry — (1) The technology stack has changed with firms looking at cheaper non-premises solutions aka 'The Cloud' hence, the traditional on-premise implementation and maintenance businesses are being hit; (2) Rise in computing power has heralded a perfect storm in the areas of automation and big data eliminating low level jobs that typically get outsourced and is leading clients to ask for true business impact and not just 'your mess for less'; (3) Rise for the far right in parts of the world and the potential end of globalization leading to outsourcing and outsourcers being viewed as the enemy by the working class and politicians. Having said that, the expectation is that the industry will re-align business models and technology stacks to cater to these changes. Especially around building the capability to lead transformation projects from on-premises to cloud applications, the ability to integrate across platforms and also using the power of RPA to increase internal efficiencies. Most Indian firms have seen a couple of such cycles and should have leaders who should be able to realign their businesses. The tougher question that most are trying to grapple with is the impact of a fundamental shift in the way the West is looking at Indian IT firms.
USA to STEM the Outsourcing of Jobs
If we look towards the West what we see is a growing distrust of the ruling class, increasing gap between the 'haves' and the 'have nots', a fast catching rest of the world and a populace demanding change that is fuelling global economic and social turmoil. Batman fans would remember what Ra’s al Ghul said “When a forest grows too wild, a purging fire is inevitable and natural”. That fire is the rise of protectionist regimes. As part of his campaign, the US President vowed to bring back jobs to the US, Theresa May spoke about brakes on immigration and Macron promised to make France a place of unicorns. Immediately this has meant restriction on the entry of non-nationals in the workforce with tighter immigration laws especially in the technology sector across these countries. Optically such measures sound populist but it remains to be seen what long-term impact they have on their domestic industries.
The US technology industry has grown at an average Y-O-Y of 3% over the last decade. Plotting employment growth against technology numbers for STEM jobs which typically make up the industry numbers, we see a high correlation between the two. By all projections this trend is expected to continue which means the US STEM employment which currently stands at 9.1 million is expected to hit 10.5 million by 2020. So in the next three years the US is looking at a potential generation of 1.4 million jobs. Add to this the fact that 16% of the current workforce is over the age of 55 of which a significant percentage might move out of the workforce by 2020. But the reality of America is STEM unemployment rate which continues to be around the 4.4 % level and has seen a small increase over the last quarter. The sentiment across university campuses is also not upbeat with students finding it even tougher to enter the workforce. So which version does one believe, the one which shows 1.8 million STEM jobs will be created till 2020 or the one which says unemployment continues to grow across US campuses? The answer we think is somewhere in the middle.
A closer inspection of the 1.8 million number split by the nature of the job shows two confl icting stories emerge. Until now non-software related STEM jobs made up 60% of the total workforce. This trend though is seeing a reversal. Of the 1.8 million new created jobs, 850,000 or 47% of these jobs will be software-related. Overlaying this on the US campus graduates enrollment numbers helps build the picture. On an average, only 50% of the total enrolled students complete their degree courses in the US. Which means over the next three years for a requirement of 950,000 non-software-related jobs, the US job market will have 1.8 million projected graduates. While against a projected requirement of 850,000 software-related jobs only 600,000 graduates will enter the job market. This means a gap of 250,000 unstaffed requirement by 2020 in software-related jobs. Add to this a rider around employability, geographical challenges and this number will see a further inflation of 25-30%.
Why the Success of the English Football Team in Qatar Might Be a Window to a US of 2022?
Years back Arsène Wenger, the manager of Arsenal football club managed a team of 11 comprising foreigners. For a football crazy nation whose last major success at an international tournament came back in 1966, this was symbolic of all that was wrong with their football. The question being asked was if a club could field 11 foreign players in a national league, the breeding ground for English talent, how would indigenous talent ever get a chance to develop? This led to a huge hue and cry, consequently the English Football Association, the sport’s governing body brought in a new rule restricting the number of foreign players who could play for a club to a maximum of 16 in a squad of 24. A move to ensure more opportunities for English players had some other unforeseen consequences — (1) This created a sudden inflation in player wages by 16% (highest in Europe), due to a demand side pressure; (2) Money that could have been invested in grassroot level was being spent on higher transfer fees and player wages; (3) Clubs stock piled young players at lower age groups increasing competition in formative years inhibiting their development. The troubling part for England is that none of this has resulted in positive results for the national team on the field.
Now compare this to the IT industry in US, where there is already a gap between demand and supply of skilled talent, and a further restriction on foreign workers is likely to increase the demand side pressure and lead to a similar inflation in wages for the IT workforce. In the long run, this will hit the productivity of firms, altering cost structures. Some of the scenarios that may thus play out could see US based MNCs will move from outsourcing selective jobs to moving complete captive and delivery centres to cheaper geographies. IT products could see business moving to newer innovation hubs such as Eastern Europe and India. As some of these scenarios emerge over the next five years by 2022, it will be interesting to see the strategy adopted by US technology majors. Incidentally, 2022 is also a WC year for England, 15 years post new regulations which could provide a few clues on using protectionist measures to drive growth.
What this Means for India – Will the World Continue to Be Flat?
Traditional Indian companies have been running a 80-20 deployment model. In this model 80% of the headcount sits in the India delivery center and 20% headcount is onsite, split between host (7- 8%) and expat hires (14-15%). If the US President's vision of America or a protectionist Europe does take shape, it will drastically alter this deployment mix by targeting the 15% expat jobs. As a result, we expect dual impacts each with a set of unique challenges:
- Increase in local hiring
- Increase in offshore compensation to compensate
- loss in Employee Value Proposition (EVP)
Increase in Local Hiring
As one of the ways to retain a 20% onsite deployment mix, firms will look to increase local hiring. Local hiring though happens at a premium of 1.3X as compared to expats. This premium translates into an additional payroll cost of 8-11%. Add to this the fact that there is expected to be a sharp wage inflation in the US on account of a widening talent gap and you can see this number go even higher. As a result of this, while in the short run we will see an increase in local hires, in the long run this is not a viable option for Indian IT firms operating on a cost arbitrage model unless they re-invent their operating models.
Increase in offshore Compensation to Compensate Loss in EVP
Until now there has been a synergy in place between Indian IT firms and US/EU clients based on a cost arbitrage model. On their part, Indian IT firms continued to leverage this through systematic pyramid refreshes accentuated by higher tolerance for attrition at mid-levels, supported with liberal campus hiring programs.
This has also led to two universal truths for any non-IIT engineer in India
- Entry level salaries will be below ` 4,00,000 and
- Within 2-3 years of joining you will end up onsite in either US , Europe or Australia which in the employees mind makes up for the low wages to begin with
An individual’s salary sees an increase of anywhere between 2.5 to 1.8 times depending on location and career level. Add to this the draw of a better lifestyle, a social status and this is an offer too good to be true for most. A control on visa and a minimum wage condition at the entry levels will take this proposition away and also impact the delivery models for Indian IT firms. To compensate for this loss in earnings Indian IT services firms will need to re-look at their wage structures. Most global multinational firms which operate in an off shoring model with limited onsite opportunities are operating at higher wage structures than Indian firms to account for this. Indian IT services firms will have to start baking in this salary premium of 20-30% in their budgets along with building greater brand equity to maintain talent attractiveness. While the second option of looking at talent from Tier 3 organizations/campuses does exist it will also cripple the push towards moving up the technology value chain, which the survival of the industry is hinging on.
The wage bills of the pure play services organizations will come under tremendous pressure as the onsite EVP starts to dilute with time. There is some cost optimization that may happen through automation but the size and scale of that will be determined by factors outside their control including social and political reactions to automation.
“What will it take to continue on an accelerated growth path - Money often costs too much”
What stands out from the above discussion is very clearly there is going to be a big impact on the operating margins of Indian IT firms stemming directly from a wage bill inflation of 30-40%. What this then means is that firms will need to look at fundamental changes in the way they do business and establish a client partnership. Up until now technology cycles have lasted 4-6 years, giving firms the time to build capability, customize deployment models, and productize solutions. Now with tech cycles lasting barely 24-36 months firms no longer have the luxury to build capability within the cycle. Entering at the top of the technology curve gives you the early mover’s advantage from a business and talent perspective, the opportunity to partner in giving direction to technology development and the tacit learning/ expertise that comes with it. A firm that wants to position itself as a partner rather than a vendor would hence, need to look at:
- Business managers instead of project managers
- Building capability and COE structures
Building these centres of excellence will not be easy and be a long journey in itself. For the first time IITs and premier engineering colleges in the country will act as mass hunting grounds for Indian IT players. This will also require a big commitment from a cost perspective. An average Tier 1 comes at an additional cost of 1.9X to times that off a Tier 2 candidate. Currently architect/consulting profiles make up to 3% of the headcount in Indian IT services firms while it is difficult to speculate the exact mix required to lead this change, even moving this mix to the 10% mark will mean additional payroll costs of 6-7%.
These are indeed interesting times for rewards professionals as they manage conflicting priorities. As the industry navigates this transition period, revenue growth will be sluggish and the full force of protectionism will see inflation in wage bills hitting productivity. Organizations will also see fundamental structural changes and the need for greater investment to survive. The onus hence, is on rewards professionals to act as business advisors with success hinging on their ability to:
- Re-align rewards strategy to reflect the new business dynamics to allow for a different talent mix, a rapidly changing skill architecture and a younger demographic profile
- Support structural changes by identifying risk and building in controls and policies such as voluntary retirement schemes, severance packages
“It is often interesting, in retrospect, to consider the trifling causes that led to great events.”
In ancient Roman religion and myth, Janus is the god of beginnings, gates, transitions, time, duality, doorways, passages and endings. Fittingly he is also depicted as having two faces, very similar to the predicament that the Indian IT industry finds itself in. Somewhere between transitions, gates, beginnings and endings lies the future. The first part of the story will be played out across the seas. A protectionist America unless backed by structural changes in the education system and incentives will inflate wages and hit profitability of US organizations. For an industry which is still recovering from the crashes of 2000 and 2008 this could lead to hard times. A knock on effect will be felt in India too, only the companies that reinvent themselves will be able to ride the wave. The silver lining could be finally the coming of age of the industry we have been waiting for, truly flattening the playing field.
Jang Bahadur Singh
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