IT firms may take a 1-3% hit on margins as travel resumes

The cost benefits that accrued to software services providers till now due to Covid-19 related travel restrictions may be coming to an end.

Executives at top IT companies signalled a return to pre-Covid-19 margins and revenue while announcing results for the September quarter.

According to estimates, resumption of travel is expected to add to costs, impacting margins by 1-3%. This comes amid a high demand for talent, and the supply crunch is likely to persist for another two or three quarters.

Indian IT services companies have defended their margins aggressively over the past five to six quarters, driven chiefly by cost optimisation due to the suspension of commercial air travel from March 2020. However, work-related commercial travel is expected to resume from the ongoing third quarter.

During its second-quarter results announcement, Infosys chief operating officer UB Pravin Rao said that by November-December the company expects a good deal of flexibility in travel following increased vaccination efforts across key markets like the United States and Europe.

C Vijayakumar, chief executive and managing director of HCL Technologies, also told ET that some of the cost savings from remote working will have to be foregone.

“I would say, half of the cost will come back. Travel will not be the same as what it was. People will travel a lot less so there will be some savings on the operating costs. Of course, it has an impact on the margins, but it will be good to keep the reference point as the pre-pandemic margin levels,” Vijayakumar said.

Most IT companies are encouraging fully vaccinated senior employees to return to offices by December or January.

These companies have, however, reiterated that the cost benefits of working remotely and better pricing efficiency developed over the past year will not be lost completely.

“All IT service firms are going to take a margin hit of 1-3% to account for both increased travel costs and absorbing the current rampant wage inflation,” Phil Fersht, founder and chief executive of IT research firm HfS Research, told ET.

According to IT industry association Nasscom, operating margins expanded by 2 percentage points to a seven-year high of 25% in the previous fiscal year (FY21), mainly due to cost savings from lower travel, favourable onshore-offshore mix (due to lower onsite roles following the Covid-19 pandemic), and lower attrition levels.

Peter Bendor-Samuel, CEO of analyst and advisory firm Everest Group, said 50% of the cost benefit from travel would be lost over the next two quarters and would further erode in the following quarters, though it was expected to stabilise gradually as people had become accustomed to virtual meetings.

“We are seeing strong wage inflation in almost every geography, it is taking some time to pass through these costs to clients, so we anticipate this to negatively affect margins temporarily. However, we anticipate that the service providers have pricing power and will be able to pass along these costs in time,” Bendor-Samuel said.

ICICI Securities said in a report that despite partial wage hikes and supply-side cost pressures, companies like Infosys, Wipro and Mindtree had reported impressive margins during the previous quarter.

A shift towards more offshoring of work and an increase in the utilisation levels have helped margins, but this is unlikely to sustain as travel and work from office resume, it said.

“Barring a few exceptions (Infosys, LTI, Mphasis), we expect growth rate of the industry to revert to pre-Covid-19 levels as the base effect normalises and one-off distortions (retail unlock boost in Mindtree) cease in the post-Covid-19 equilibrium. Supply-side pressures in conjunction with impending cost headwinds like travel/ office resumption should translate into largely lower than pre-Covid-19 margins,” it said in the report released on October 14.