Dealing with Deceleration: Is TCS on the Right Track?

17 03 2009

 Economic Times has reported that in an internal communication, TCS management has communicated to its employees informing them about deferred promotions, cost cutting and stringent performance appraisals. In another news item which appeared in The Hindu Business Line, the headline news says “TCS asks 1,300 employees to leave.

 

 

 “Around 1,300 employees of Tata Consultancy Services will resign from the company following an bi-annual performance appraisal. The employees being asked to leave will constitute around one per cent of the total staff, numbering over 1,30,000, said a spokesperson for the company.

 

Their leaving the company is not part of any cost-cutting exercise designed to cope with the economic slowdown, she said. TCS’ bi-annual performance appraisal throws up under-performers who are given special training; but if they are not up to the mark in the next appraisal, they are asked to leave.” 

 

These measures may give an impression to the public that TCS is incurring losses or it may be ridden with debt, as is the case with several companies, including some Tata companies. TCS is still a debt-free company and it continues to make good profits. For the HY ended September 2008, TCS reported revenues of $3.1 Billion and net profit of $ 582 million. In the full year, the profits will be over a billion dollars. No small amount. In this recessionary market, it will be hard to find companies, not only in India, but across the world which report a billion dollars in net profits.

 

 

Then why is the TCS management taking such steps. It is what can be termed as ‘deceleration blues’. The Indian IT services industry has got used to growing at the rate of 30-35% per annum and net profit margins of over 20 %. These rates are built into the planning process and the entire industry engine runs to meet this growth. Now suddenly, the assumptions are being questioned. The growth rates for the IT services will not be more than 10-15% p.a for the next two years at least. The margins are under pressure. TCS grew by 17.7% in revenue and only 2.8 % in profits, during H1 2009. 

 

 

The stock markets are already reflecting the new expectations. TCS stock is perilously close to its IPO price of Rs. 425 (Rs. 850 pre 1:1 bonus) after over four and a half years. Aside the relatively liberal dividends of Rs 12 per share, the shareholders have got very little returns, even as the company has grown over two and a half times since IPO.

 

 

Deceleration blues in TCS is quite similar to what Indian economy itself is facing. In an editorial piece in ET, Swaminathan Aiyar said “What’s wrong with 6% GDP growth?”. The problem is India having grown at 9% for four years in a row, growing at 6% is painful. Similar pains are felt when TCS decelerates from 30-35% p.a to 10-15% p.a.

 

 

A quick look at the business model of TCS will help analyze where the pain will be felt and why. In simplistic terms the Business Model is USA-BFSI-ADM-T&M-STP/SEZ- M2. Let me expand the alphabet soup. The key geography in which they do business is USA. The major vertical which contributes over 40% of the revenue is Banking Financial Services and Insurance (BFSI). The service which contributes bulk of the revenues is Application Development and maintenance (ADM). The type of contracts which TCS engages with clients is Time and Material contracts. On these contracts programmers are deployed either offshore or onsite, and billing is done by the hour. For offshore business, TCS has built millions of sq ft of office-space in Software Technology parks earlier and now SEZs. The business grows by manpower multiplication (Msquare). In order to keep this economic engine in motion, tens of thousands of fresh engineers are recruited from all kinds of engineering colleges in their third year itself.

 

 

The major market US is in recession and there are even indications that it may be a depression. Although US $ remains strong, the movement of the currency is very volatile, making the job of the CFO extremely volatile too. The banks are suffering the most. Many BFSI clients of TCS are either merging or on the verge of bankruptcy. ADM is doing fine. TCS has strong delivery capabilities. The company knows that there will always be several old applications which need to be maintained and supported. After ERP has come into mainstream, TCS is using its ADM capabilities to maintain and provide production support to ERP. The onsite business of TCS will be impacted by the growing protectionism in US and difficulty in getting visas. On-site is also expensive. So the focus is shifting off-shore. For offshore business, TCS and other IT companies are in the process of creating office space in SEZs across the country. Now, with the deceleration in business, the need for office space is reducing. 

  

The effect of the deceleration will be felt most in the bottom-most layer of the chain viz. in STP/SEZ and M2. Already, several SEZ projects have been put on hold. Rationalization of office space is being done and rentals are being renegotiated.

 

The braking of the manpower multiplication engine in the largest employer in India will definitely have an impact. It will have an impact not only on the 130,000 employees of the company. But the thousands of engineers who have an offer from TCS but do not have a joining date yet. The thousands of engineers, who are graduating in 2010, suddenly do not know whether they will get placed at all. The biggest employer in the campus suddenly is acting funny.

 

 

Now, the thought that occurs to me is that the stimulus in the form of the changes in the business environment is for all of us to see. But given the strength and the financial muscle the company has, could the response have been different. Look at Tata Motors, even when it incurred huge losses in its last quarter and its Nano project delayed, it proudly goes to the Geneva car show and launches Nano Europa and a sedan called Prima. In the same global IT market in which TCS operates, IBM has launched a new initiative backed by an aggressive advertising campaign “A smarter planet”.

 

 

Behooving an industry leader, TCS would be well advised to look at the downturn as an opportunity to grow beyond ADM. It could use the financial muscle to enter new businesses (not acquiring BPOs like the Citi One). It could once again, revisit the once stated goal of 30% sales through software products, which it ditched, pursuing easy money in ADM services. The downturn also presents an opportunity to attract the best of software engineers in the US to return to India and create the new businesses. TCS attempts at brand building have been very feeble and advertising campaigns have always been done in fits and starts. A consistent advertising campaign like an Accenture or an IBM will be more apt for an industry leader.

As the adage -never waste a crisis – says TCS has an opportunity to set new rules for the game as it is pushed into an uncharted territory. It will require visionary thinking not just reactive measures for TCS to become a game changer.

 

– G. Mohan

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One response

21 03 2009
Raghuvir

I agree with your view that TCS should view this current downturn as an opportunity to grow beyond their current business. This is what perhaps many good companies have done successfully.

However it is equally true that companies should constantly look for ways of doing things more efficiently. That is the only way they can generate the cash needed to invest in the next growth opportunity.

I am sure many good companies get part of this equation right – but it takes a great company to get both sides right. Without doubt, capital or resource allocation is of the most important jobs in a company.

As long as TCS is redeploying manpower between its various opportunities in an optimal way, margins and stock prices will take care of themselves.

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