Salary cost vs billing rate

One factor that has perhaps not changed over the past 15 years is the excitement among fresh engineering graduates when they land a software job. And, why not? The Indian IT industry has had an unprecedented influence on Indian society, despite representing about 0.55 per cent of India's overall workforce and about 6 per cent of the organised sector.

The IT Industry has matured over three significant inflection points — the 1997/99 Y2K euphoria, followed by the dotcom bubble in 2001/02 and the global recession in 2008.

The sector being extremely people-dependent, industry salary cost accounts for over 50 per cent of the cost in any IT company. In spite of the fact that salaries were moderated post the dotcom era and the 2008 recession, salaries have gone up significantly over the past 15 years, but the billing rates have remained quite subdued in comparison.

Salary

From an employee perspective, the Indian IT/Software market has provided huge growth potential, both in terms of job opportunities as well as salary. The average salary of a fresh engineering graduate during 1996-98 was in the range of Rs 70,000-90,000 per annum. The fresh engineer salary jumped three-four times by 2005/06 and continues to remain at an average Rs 3-3.6 lakh per annum.

As one gains experience, the salary should ideally be linked to the “role” a person plays and just not to the years of experience. However, due to the lack of a credible alternative, years of experience (YOE) plays a critical role in deciding salaries.

The salary per year of experience was roughly Rs 50,000 to Rs 75,000 way back in 1996/97 and now this has jumped to anywhere between Rs 1.5 lakh and Rs 2.5 lakh depending on the individual's skill level, performance and company. For example, a mid-size IT services company will have to pay a premium of 10-20 per cent as against a well-branded large company.

In the Indian context, the salary leaps by five to eight times within 10 years of experience. Compare this with Europe, where the salary, at best, goes up by 50-60 per cent at the end of 10 years. Such a phenomenal increase in India is possible thanks to the ever expanding market place where the demand/supply is still heavily tilted towards demand. Due to the uncertainty involved in perks such as ESOPs, potential employees look at salary as the single most important parameter.

Due to this rising salary market, the average cost of compensation (ACC) or salary cost from an employer perspective has gone up 2.5-3.5 times over the last 15 years. The ACC was around $300-400 per month during 1996/97. Add to this the cost of recruitment, which has also gone up quite significantly. A recent report from Aon Hewitt indicates a 12 per cent salary increase for the IT industry in 2011. Maintaining the ACC at current levels will be a huge challenge for the IT companies.

Billing rates and Revenue

In the case of small and mid-size companies involved in niche areas such as Telecom R&D outsourcing, the average billing rates have more or less remained stagnant or have gone down over the past 15 years. The average billing rate continues to remain roughly around $15 to $25 per hour depending on complexity. However, among both the mid-size and large-scale generic IT services companies, the billing rates have gone up from about $12-14 during 1996-97 to about $18-20 during 2010-11.

While over 80 per cent of the projects were T&M (time and material)-based projects until the late nineties, over the past few years, the number of fixed-price projects has increased and is about 50 per cent in the large IT companies.

While fixed-price projects carry more delivery risk and penalty clauses, they provide a great opportunity to continuously improve productivity and manage profitability by creating the right resource pyramid (the mix of engineers in the lowest band and higher bands). For example, a 500-member software maintenance project would typically be staffed with over 50 per cent of the engineers in less than three-years-experience range. Fresh engineers with appropriate training would form a large chunk of the junior engineers. The large IT services companies are adding 15,000- 20,000 fresh engineers on an average in 2011.

Large IT companies have witnessed over 50 times growth in revenue over the past 14-15 years. Also, almost all large IT companies have achieved Net margin at over 15 per cent during the past 15 years. However, the mid-segment IT companies have seen decline in profitability and were most affected during the recession period. This is primarily because the mid-segment companies were unable to leverage the resource mix and larger IT companies maintained over 50 per cent offshoring.

What next?

With the increasing salary costs in India and billing rates certainly not going up proportionally, coupled with effective tax rate going up, uncertainty over currency fluctuation, strong competition from low-cost eastern European countries and China, IT companies will be under tremendous pressure to maintain profit margins. Indian IT companies need new and innovative approaches in order to sustain profitability.

The “high value” Consulting Business could be a potential growth opportunity. Consulting business contributes to 3-5 per cent revenue of the large Indian IT companies. For Accenture, a global leader in Consulting, over 60 per cent revenue comes from the consulting business with an average billing rate at least 4 to 5 times higher than the current average billing rates among large Indian IT companies. Although consulting is a high revenue generating business, the key challenge is to get the right skilled resources. The consultants are subject matter experts who possess deep domain expertise.

To sum up, over the past 15 years, the impact of salary cost increase vis-à-vis billing rate and thus on profitability has been quite significant among mid-size IT companies, while larger IT companies have been able to handle the impact through effective pyramid management.

India's IT revenue is expected to grow three-fold by 2020 and thus demand for Indian IT professionals would be high. However, it looks increasingly likely that the Indian IT Industry will move towards single-digit net margin levels over the next decade.

The author is Director, Engineering, Teleca Software Systems India. Views are personal.

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