The Hindu Business Line : ‘Strong rupee was a good thing’

Gordon Coburn is a no-nonsense Chief Financial Officer. Putting an almost abrupt end to an analyst call just because of time-out comes as naturally to him as does admitting he has no idea where the rupee is headed against the dollar. Cognizant’s June quarter results were impressive. Coburn talked to eWorld on a range of issues, from the impact of the sub-prime problem, to some good growth in Europe, to why his company does not hedge against currency risk! Here’s a snapshot.

You plan to add about 10,000 people in the two quarters ending December this year. Are you assuming that the rupee would be stable?

It’s interesting and I get asked this question every time. Where do you think the rupee is going? The answer is: I have no idea.

Our assumption is right in the middle. It’s roughly where it has been hovering currently, at about 40.50, which is what our guidance is based on. Things have settled a bit in the last couple of weeks bouncing pretty much between 40 and 41 to a dollar. It is as good an assumption as any, but for our broad planning, the assumption is 40.50.

Assume that the rupee appreciates further. Your utilisation rates are lower than your competitors’ and you do have some headroom to go up. Is there a certain number you would be comfortable with? Will there be a time when you will be looking at 65-70 per cent utilisation rates, from the current 61 per cent?

As we get larger there are some scale efficiencies that kick in. We have some headroom to grow. Am I leveraging the utilisation for my current size? The answer is no and you are absolutely right about that. I look at utilisation as one of the levers that I can use to offset if the rupee goes against me.

If you start pulling the levers too far, that can impact the ability to match specific skills. We are not there at this point and we have room to take our utilisation up at this point, if necessary.

Can you elaborate on the skill-set mismatch?

When you are growing fast, the next big order that comes through the door can be 200 SAP programmers or 200 .Net programmers. If I carry a very thin bench, I may have the wrong people to be able to effectively service the next order. If you carry a bigger bench, there is a lower risk of carrying the wrong kind of people. If I keep pushing the utilisation further and further up, the first thing that starts to happen eventually is the skill set mismatch.

Our strategy is to keep the right mix of people and to take the utilisation up. If we keep our utilisation lower, there is no mismatch between potential demand and supply.

What happened is quite interesting. I would argue that for Cognizant, the Rupee moving against us in March and April was a blessing in disguise. We were growing so fast and were so focused on our customers and employees that we weren’t necessarily optimising the running of the business. We took global utilisation to about 61 per cent. It made sense when we were smaller. And when you are growing the fastest we obviously needed more people on the bench.

As we moved from a $1 billion to $2-billion company in six quarters, we did not utilise the scale efficiencies in our utilisation. If as a $1-billion company, I needed 300 SAP programmers on the bench, for $2 billion, I do not need 600.

What happened is that we were so busy growing and focusing on our customers and employees that we did not leverage the natural scale efficiencies that were available. The rupee just forced us to look at the mirror and tighten up our belt a little bit and optimise our business.

Given that and leaving aside the rupee and all other external factors for a moment, what is a good bench mark number for utilisation, is it the low 60s, mid-60s, 70’s for the IT services software company, including off-shore and trainees?

Our global utilisation was 61 per cent in the first quarter, 63 per cent in the second quarter ending June and as we go through our third and fourth quarter, we plan to take our utilisation up to 65 per cent, our current target for this year. This continues to be five to ten points below the competition, so it provides us additional room there.

You have added five more clients to your strategic clients list, i.e., clients with a potential to reach $5-$40 million or more in annual revenues. Typically, how much time does it take for a client marked strategic to give you that kind of annual revenues?

The answer is it is all over the place. For instance, there were two companies that we won with a similar profile five years ago. After two or three quarters, one of them reached the $5-million run-rate. The other one, after several years, had only reached a $1-million run rate. There is no similar answer.

In some cases, there will be a steep ramp-up in a few quarters and in others, it may take years to take off. I can only say over the last three years, on an average, clients are ramping up sooner and steeper than they did several years ago. This is what drives it: the wider range of services that we can sell and offshore today has less internal political battles than earlier. Offshore is so well accepted.

When you earmark a strategic client to reach $5 million or more, what are the three parameters you take into account to reach that decision?

Number One is: Do they have the intention to offshore? Second: Is it a top-down initiative? Third: Do they have ability to grow their IT budgets? These are the three things that we consider before identifying a client as a strategic client.

Revenues from servicing banks and financial institutions has grown 49 per cent for the quarter, year-on-year. What effect does the mortgage problem with the sub-prime issue have on you?

Here’s our exposure to BFSI. Forty seven per cent of our revenues come from BFSI, which includes insurance, transaction processing companies, retail banks, credit cards processing companies and investment banks. Out of that 47 per cent, roughly half comes from banking, including commercial and investment banking. The other half is insurance, transaction processing companies and credit card processing companies.

The other statistic is that our exposure to the mortgage segment is approximately 3 per cent of our total revenues and a very, very small piece of that is sub-prime. So, it is obvious that a very small percentage of our revenues is mortgage and we are well-diversified across the entire vertical. Our exposure to mortgages is not material.

I would like to highlight a difference though. If you are doing BPO work for a mortgage, it is likely that the volume could dry up. If there are no transactions, there are no revenues. But if you are doing IT services work and the client slows down for a while, it will perk up later. In the mortgage space, what we are doing is IT.

In terms of whether we are seeing an impact on financial services, the answer is clearly No. We are not hearing anything from the relationship managers working with these clients or from the clients themselves. We also find that clients capitalise a large portion of their application development work. If the clients have a short-term problem because of credit crunch issues, stopping the development work does not help them, because they are capitalising and not expensing them. Where the discretionary stuff gets impacted is where there is a structural change in the client’s business. And since we are doing work with large financial services institutions, we are certainly not seeing that now.

How do 2008 budgets for our clients look like now?

I do not think our clients have started the budget process yet.

To my mind, the broader question is: Does this trigger a recession in the US economy or something goes beyond financial services, which really slows down the overall economy? Offshoring, in general, if you look historically, has not been meaningfully impacted by small increases or decreases in the growth of the economy. If it’s a major recession, and clients say that their budgets are cut so badly that they would stop doing some work for a while, that obviously will not be good for the offshore industry. We are not seeing anything that changes our view of the world.

You talked about rupee appreciation being an opportunity to optimise on your utilisation. Would the same argument hold good for your SG&A scale efficiencies?

It is a part of our business plan to re-invest, over time, all our excess dollars into SG&A. We are at this point investing a lot of dollars into geographic expansion and more into domain expertise.

As a part of your plans to expand available infrastructure, you have increased your budget from $200 million to $300 million. Are there any signs that Cognizant has seen that have made you update your expansion plans so quickly?

We are investing $300 million in 4.5 million sq.ft of fully-owned space in India, which will be in addition to eight hundred thousand sq.ft of space of leased space. We expect healthy growth for Cognizant over the coming years.

After remaining in the 10-11 per cent revenue contribution bracket for several quarters, there appears to be frenzied growth in Europe (15 per cent) for Cognizant in the latest quarter. What is happening there?

You would have to break Europe into UK and Continental Europe. In the UK, we have had a healthy growth for a while. It is Continental Europe that is new to us. Years ago, we said that we can’t address every market simultaneously. We decided to focus on the US and the UK markets and we got that working well. We focused our attention on Continental Europe. We have put in a lot of dollars and moved in a lot of our key people from the US and the UK into Continental Europe. The reason you are seeing this growth now is that we have addressed the untapped opportunity.

Will your billing rates be healthier in Europe, considering that Europe is just starting off and more open to application development work as against application maintenance work in US?

For offshore, the billing rates are similar while onsite rates are higher as onsite costs tend to be higher as well.

Will the onsite-offshore ratio be any different for Europe?

Nearer term in Europe, you may have onsite ratio that is higher than the company average, but on a longer term basis, I do not think it will be materially different.

You do not hedge against currency uncertainty at all. What is your philosophy on this?

While the Indian companies are exposed on their revenues and their dollar expenses, we have no exposure on revenues and our rupee expenditure is less than 30 per cent of our total expenses. Historically, we have not hedged because there is an implied cost to hedging. So far, we have not done since we have a bunch of short-term levers to pull, which has the natural ability to offset.

Your healthcare segment has done exceptionally well in the latest quarter. What are the reasons for this growth?

Only recently, pharmaceutical companies have begun to strategically adopt the use of offshoring. We are seeing pharma companies in the hyper growth mode for offshoring. We work with eight of the top pharma companies in the world. They are one of the later adopters of IT. But once they adopted, they have moved aggressively and we are well positioned as a clear leader in servicing the life sciences vertical. We are in the sweet spot and very excited about this space.

bharatk@thehindu.co.in

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‘Strong rupee was a good thing’