Operating margins of IT firms to shrink yet again, due to H1-B visa curbs: Report

Facing all time low margins, India's IT services companies could be staring at a further shirking of margins, thanks to H1-B visa curbs enforced by the Trump administration.

Employee expenses and cost per employee for Tier 1 players that includes TCS, Infosys, HCL Technologies and Wipro, rose faster at about 17 percent and about 9 percent on-year in fiscal 2019, respectively, compared with about 6 perent and 3 percent a year before, according to a new report by CRISIL. Employee expenses account for nearly 60-65% of total operating costs.

For mid-tier players, the increase in employee expenses was about 13 percent on-year for nine months ended December of fiscal 2019 as many are yet to declare fourth quarter results, the report noted.

Such an increase in employee costs can be attributed to tightening of visa norms for Indian players, resulting in higher onsite costs for them.

Ever since the US government tightened its H-1B visa policy in 2017, challenges have mounted for the sector. That year, Indian-origin employees were the largest consumers of H-1B visas at 63% of initial employment, so the sudden change meant fulfilling onsite client requirements became tough.

Declining margins

Margins have been declining structurally for the past five fiscals, as billing rates and utilisation stabilise, so rising employee costs will only add to the pressure.

Employee utilisation was high at about 85 percent in fiscal 2019, with only a marginal room for improvement in the future.

Billing rates are expected to remain under pressure, as traditional services become commoditised. CRISIL Research expects revenues to grow by 7-8% in dollar terms for the sector in fiscal 2020, helped by double-digit growth in digital services. Operating margin however is forecast to decline 30-80 bps for the sector in fiscal 2020 as local hires increase for onsite job, who cost 25-30% more than their H1-B counter parts.

Indian IT players have had an offsite-onsite employee ratio of 80:20. Limited staff availability in the US is expected to lead to higher employee costs associated with hiring US locals, CRISIL noted.

Tier 1 players added more than 82,000 employees in fiscal 2019, compared with only 10,000 employees in entire fiscal 2018, which is the highest in past five fiscals.

However, the cost per employee for Tier 1 players rose to Rs 479,540 in the last quarter of fiscal 2019, a sharp 9 percent on-year increase compared with less than 5 percent in the previous eight quarters.

Cost per employee increase

The increase in cost per employee can be attributed to the rising number of onsite local hires and higher (~2x) salaries of employees with digital skills, as the wage hike was only in the range of 6-8% for the employees for the period.

CRISIL noted that employee cost has been trending up for the past eight quarters even though employee addition was muted during fiscal 2018, which can be on account of higher onsite costs for players.

According to CRISIL, the average per hour rate for an H-1B-based employee is ~$33 and that for a locally-based employee is ~$42. So, in general, local talent needs to be paid 25-30% higher wages.

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