The Hindu Business Line : TCS says competition is tougher, but market potential is bigger

Mumbai April 17 The fiscal gone by saw TCS cross the landmark of $4 billion in revenues. A day after the results for 2006-07 were announced, Mr S. Mahalingam, CFO, spoke to Business Line on profit margins, pricing, wage increases, competition and a host of other issues. Excerpts:

Are you consciously driving for higher profit margins?

We don't approach it that way. Of course, some markets - such as Europe - give us better margins, and some of our newer services such as business intelligence and infrastructure services are giving us even higher revenues.

But ultimately, what makes a difference to TCS is volumes. So, if application development and maintenance (ADM) services constitute 50 per cent of our business, then increasing that slightly is more positive for us overall financially than something else that might be a fantastic service but is a smaller proportion of our business.

There is a big advantage in taking work to our global development centres. If we can manage costs we might get 4-5 percentage points on our margins. But with our phenomenal tax advantage, offshoring to India is still unbeatable.

How much does tax advantage in India contribute to margins? Is there a concern that this is an external factor and might not last?

Since we have no tax at our STPIs (software technology parks), that is a 33 per cent savings on profits. On, say, a profit margin of 25 per cent, the India advantage works out to eight per cent on revenues. That is significant but it may or may not continue forever.

However, this could undergo a change if, down the line, China turns out to show better operating margins than India and say, offers similar tax treatment.

That is when the conflict starts. At the moment we cannot envisage a situation like that, as India is high on availability, talent and processes.

Do you see an upward movement in pricing?

We started talking about pricing movements only two quarters ago. Overall, new customers are coming at 5-8 per cent higher than our existing rates and old customers get 3-5 per cent on a blended basis.

Would you go for a large deal only if it is margin-accretive? Or would you prefer a margin-neutral scenario with a predictable stream of income?

Our business model is fairly complex. We are constantly coming up with newer areas and services and are changing patterns continuously. We are pushing services like BPO and infrastructure services because the growth is happening there right now.

In that context, looking at margin strategy - if I am looking at the traditional kind of work, then I would require a hurdle rate. I would say I won't touch any deal that is beyond the hurdle rate.

But if I am starting a new thing such as Pearl (in the UK) and create a big third party administration for them, I might take a very low margin for the first 2-3 years, but during those periods I will do all these kinds of things that will ensure that my margins from the fourth year will be higher than the TCS margin. This is what we call a hockey stick approach.

What about competition?

The nature of competition has changed. It is not just the India-headquartered players that you are competing with. There are many global service providers, but it is not one rupee that you are fighting for, you are fighting for a huge part of the $150 billion of market potential for IT services.

You said that ultimately what makes the difference to TCS is volumes.

We have a number of active customers. So, we still believe that the extent of money our clients spend on outsourcing and the extent of money out of the outsourcing that they spend with us is very minuscule. One can essentially grow volumes in a very significant manner.

Will you be able to maintain to maintain your margins?

I am entering 2007-08 with a better margin than I entered last fiscal (two percentage points higher), which gives me the cushion to absorb salary increases.

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