Wage inflation shadow on IT firms’ cost edge

In their quest to retain top talent and reduce attrition, domestic IT firms are running the risk of losing their cost advantage with salaries now getting closer to those in the US. Analysts point out the basics of the outsourcing business are margins and if they get squeezed, the business loses its lustre.

The problem may get accentuated because of the big talent gap that exists in the IT ecosystem and is expected to grow.

According to Nasscom’s Tech Talent report, the talent demand-supply gap in 2021 was 21.1%. Though this may be the lowest among the top IT locations, the tech body has forecast the gap would widen sharply as there is a divergence between the talent available and the skills required.

Nasscom has estimated that the demand-supply gap for digital talent will increase 3.5X to around 1.4-1.8 million jobs by 2026.

Little wonder, all major IT companies have been doling out hefty hikes and revising entry-level salaries as also tweaking promotion policies.

Broadly, the top five IT companies which were offering hikes in the range of 6-8% to the lower-end performers in select skillsets in the digital space have now hiked this slab to 12-15%, according to head hunting firm Xpheno.

HCL Technologies, for instance, recently revised entry-level salaries to Rs 4.25 lakh per annum, from Rs 3.50 lakh per annum earlier for new recruits.

To retain top talent, IT major Wipro has now decided to review performance on a quarterly basis rather than annual. Around 70% of employees seen to be high performers stand to benefit from this move. “We doubled our fresher intake for FY22 compared to previous year. Our plan is to double this again in FY23. We have decided to increase the frequency of promotion cycles for 70% of our colleagues from junior bands,” Wipro CEO Thierry Delaporte said after the company’s January-March earnings.

Similarly, Infosys plans to hike average salaries by around 12% against 7-8% earlier.

“While there is an increase in costs due to hiring in some areas, our focus on growing talent from entry-levels, reskilling existing talent as well as gaining efficiencies through automation and better utilisation of resources has largely balanced the equation,” Richard Lobo, executive vice-president, head HR, Infosys, said. “However, we do see a wage inflation in the short to medium term keeping in mind overall skill shortages, increased demand as well as inflation in the economy. We are gearing up our talent management practices so that we can continue to gain efficiencies and operate at an optimal level in terms of costs,” he added.

Infosys hired 85,000 freshers in FY22 and has guided to onboard at least 50,000 more in FY23. It has also rolled out a wider deployment of its stock incentive programme to encourage staff to stay.

The IT firms are resorting to such incentives because attrition levels are rising. If the January-March numbers are seen, the attrition rates across the top four IT companies — TCS, Infosys, Wipro and HCL Technologies — increased by anywhere between 110 basis points and 220 basis points on a sequential basis.

“Though companies have guided for attrition to stabilise ahead, we believe it is likely to stay elevated as past trends suggest that attrition is usually higher in a post wage hike quarter,” analysts at ICICI Securities wrote in a report.

“Further, rising attrition has led companies to undertake increased retention costs adding pressure to margins. To offset the same, companies have started hiring more freshers to ensure pyramid rationalisation,” the report added.

The companies are surely trying to protect their margins through some other measures. One such step is moving to smaller towns and cities where the salary levels are lower. “The cost of tier-2 talent is significantly lower than having the talent operate out of tier-1 cities with no compromise on productivity,” Neelesh Gupta, director, Deloitte India, said. According to Gupta, moving to tier-2 cities would ensure that the Indian IT firms do not lose their edge to markets like Philippines or Thailand.

Tech Mahindra says that it is already reaping dividends of this approach. “We are hiring talent from new areas, setting up physical centres in tier-2 and tier-3 cities to diversify talent, and are also leveraging the gig workforce as talent can be found anywhere. New positions are filled based on ‘best-fit’ talent to deliver outcomes without any location constraints,” Harshvendra Soin, global chief people officer and head – marketing, Tech Mahindra, said.

Prasadh MS, technology specialist at Xpheno, said: “The base of the pyramid for the IT firms has widened with increased hiring, however, the billing rates to customers would not have changed in a significant way because these are long running contracts. Unless companies trigger the clause of employees cost of living adjustments, revision in existing contracts will not be possible in long-term contracts. So, companies’ ability to charge remains the same, but where the companies would have possibly enjoyed a 40% margin, it would be say 10% less now as that would go towards the increased cost of employees.”

According to Prasadh, IT firms cannot pass on this cost to the client because it will make them lose their cost advantage. So, they will absorb these cost increases with a 3-4% drop in margin, rather than lose their cost positioning by trying to claim it from the end customers.