The jury’s in — the back-to-basics strategy is working at WNS. The results of this strategy pop out in its FQ3-14 earnings report. Net revenue increased 5 percent to $120 million. Gross profit increased 16 percent year over year to $45 million. SG&A expense went down four percent. Adjusted earnings per share rose to $0.38, above the consensus of $0.36. During Q3 WNS also signed its fourth-largest deal to date.
When Keshav Murugsh took over the CEO reins at WNS, he instituted a new management team, simplified the value proposition, focused on the arbitrage market and drove a more aggressive sales strategy. It’s a classic back-to-basics strategy, and the market is rewarding WNS in revenue growth, an eye-popping shareholder value and 107 percent year-to-date returns through December 2013.
Many of the Indian service providers are going back to the basics after investing in the products space in lieu of the services space. WNS was one of the first to return to this basics strategy, and Infosys followed closely on its heels with a similar strategy. Like the ABCs are basics for the benefits of reading and writing, the Indian services firms are finding fertile ground in getting back to the basics with increased execution, and the results that follow show customers and shareholders are enriched.
INFY’s December 2013 quarterly report demonstrates that Murthy’s back-to-basics strategy is starting to show fruit with Infosys upping its guidance for both revenue and earnings. Its year-over-year revenue growth of 9.8 percent is encouraging; however, when we compare it to the performance of industry leaders TCS and Cognizant, it is clear that there is still much to do. Put another way, the faster growth of the industry leaders shows that INFY is still losing market share and is far from out of the woods.
At 9.8 percent, INFY’s growth pace is slower than the market leaders and dramatically far from the growth of Cognizant (21.9 percent) and TCS (17 percent). Why the large gap? INFY’s earnings are a bright spot; but once again, when we look more closely, it’s apparent that rupee appreciation — rather than improved efficiencies — is the biggest factor.
Although it’s good to see Murthy’s turnaround strategies showing early returns, we believe they may be short lived and even shift to a disadvantage over time. Here’s why. Murthy’s strategy focuses on investing more in offshore relationships, especially in the commoditized application outsourcing space. It’s likely to bring short-term financial gains, but we believe this move could result in Infosys losing client intimacy. It’s not likely a winning strategy in the face of competition — especially from the leading duo, Cognizant and TCS, which are investing in enriching their onshore client relationships and their consulting expertise.
Losing market share and profits propped up by currency changes … short-term gains but long-term challenges — with apologies to Robert Frost, Infosys has miles to go before it sleeps.
The spooky orchestral background and thriller tagline — “Just when you thought it was safe to go back in the water…” — from the 1978 hit movie “Jaws 2” brings out our primal fears that something can attack us even though all appears to be safe and when we least expect it. That’s what is happening now with H-1B visa reform.
As we predicted in previous blogs, it appeared in July that the chances were slim for immigration and H-1B visa reform to be enacted in 2013. And House Speaker John Boehner’s November 13 statement, “Frankly, I’ll make clear, we have no intention of ever going to conference on the Senate bill,” seemed to put an end to the bill.
But there are threatening sharks beneath the surface of Boehner’s statement. Let’s look at these risks and the timing.
Odds are good for reform occurring in 2014
Boehner wasn’t saying he does not intend to negotiate with the Senate on immigration/visa reform; he was just saying that he plans to take a piecemeal approach to the bill’s language instead of a comprehensive language approach. And instead of using the formal conference process, he will use an informal negotiation process to see where the two parties can reach compromises. He stated, “I want us to deal with this issue. But I want to deal with it in a common-sense, step-by-step way.”
Although it will be done piecemeal, the legislation still will have to go through Senators Durbin and Grassley, who authored the onerous H-1B visa language that targets the Indian service providers.
Because of the high chances of success in a piecemeal approach, we believe there is a 20-45 percent chance that in 2014 Congress will pass into law the proposed legislation with the currently drafted onerous visa provisions.
Politics. Another reason we believe Congress will enact the legislation is that Immigration is one of those rare issues that has strong sentiment in both political parties to get something done, although for different reasons. It has genuine bipartisan support and thus strong alignment of interests, so we believe there is a material chance that legislation will come through next year.
Despite the fact that it’s in the interest of both parties to enact the legislation, the Republicans are key to the outcome. If the Republicans gain strength, we see the legislation going through but shaped more strongly with a Republican bias. If they lose strength, we see legislation still going through but along the current lines of the Senate bill with the onerous provisions for H-1B visa reform. Whether the Republicans gain or lose political ground in upcoming months, it will lead to Congress passing immigration reform.
Our perspective is that the only major threat to the chances for passing the law in 2014 is status-quo politics. If both parties are locked in a standoff, it will negatively impact the chances for passing the law.
Timing. If Republicans and Democrats manage to reach compromises, the House could pass one or more piecemeal bills on immigration reform in February or March 2014. This could lead to Congress voting on the bill after the spring primaries, depending on how immigration plays out in the elections.
Impact on Indian service providers
If Congress does not pass comprehensive immigration reform in 2014, Senators Durbin and Grassley could still push to pass stand-alone H-1B visa reform for high-skilled workers.
Given the political sentiment, pressure is likely to ratchet up for the Indian firms even without a stand-alone bill. They will face an environment of increased scrutiny and have to deal with U.S. Dept. of Labor audits of their visa practices at client firms, higher scrutiny of visa petitions and possible higher risk of rejections, as well as increased scrutiny and due diligence by U.S. firms considering moving work to Indian providers.
Furthermore, you can almost hear the music from Jaws 2 and the shark’s teeth when you think of the ripple effects that are likely from the Infosys investigation into alleged visa abuse. How many times will we hear Durbin and Grassley raise t
he specter of “abuse” of visas? In addition, the U.S. Attorney may launch more visa investigations. And the IRS may decide to pursue INFY for underpaid employment taxes resulting from the provider’s visa practices; this could, in turn, lead to “abuse” investigations of other firms.
With a 20-45 percent chance of Congress passing the immigration with onerous H-1B visa provisions, perhaps the tagline for this continuing saga in 2014 should be from the movie, “The Fly” — “Be afraid. Be very afraid.”
Everest Group’s ongoing analysis of global service providers’ performance revealed some notable market shifts in the most recently reported quarter. We note especially that Wipro seems to be righting its ship. Although its growth previously had lagged its peers and the industry, the last quarter evidenced higher growth.
As the chart below displays, Wipro is now performing as one of the top global services firms.
To what can we attribute this improved performance?
Certainly we need to give some credit to the strategic maneuvers that CEO TK Kurient and Wipro’s executive council made. First of all, they have been implementing a verticalization strategy. They also are focusing on large accounts. We believe these strategies make sense and could well contribute to further growth.
In addition, taking a step further back, we believe that Wipro is reaping the benefit of its concentration in services areas that are recovering — infrastructure and Europe. The industry has seen growth in infrastructure services really picking up over 2013. Also, as Europe recovers from its economic crisis (particularly in the UK, Germany and the Nordics), Wipro’s strong position in Europe allows it to also benefit from this growth.
Considering it’s in the right place at the right time with effective strategies, where will Wipro be in next quarter’s charts?
It’s the time of year when we turn our attention to reflecting on what happened over the the past 12 months and weigh the significance of the year’s events. I think we can showcase 2013 in five primary aspects.
1. Market growth
First let’s think about the market itself. We began the year expecting more robust growth, but I was disappointed in the first two quarters. The developing markets did not sustain their level of growth as in previous years, so we saw a drop-off in the developing markets space.
However, the market has gotten stronger over the year. So taken as a whole, I think it’s disappointing in light of our expectations, but we certainly are finishing with growing momentum. We’re seeing signs of growth in the United States, Canada, UK, Germany and the Nordics.
Net-net, 2013 brought a modestly positive level of growth but didn’t meet expectations.
2. Changing of the guard
This year the differences among the Indian heritage firms emerged more distinctly.
Cognizant and TCS are setting a torrid growth pace.
We have seen the rebound of the smaller firms such as Virtusa and Syntel outperform even Cognizant and TCS.
HCL doubled down on infrastructure and is preparing to try to accelerate its BPO and apps offerings.
TCS seems to have made its growth and platform plan work.
Infosys is going back to its roots in labor arbitrage.
On the MNC side, IBM made strides to close the gap that Accenture had opened up in the transformation space. Big Blue made a commitment to increase its consulting and transformation expertise.
We also saw the rise of the Big Four and significant steps forward by the audit-related consulting and integration practices. The largest of the four, Deloitte, is playing an increasingly prominent role in major transformation. E&Y and PwC are taking steps to join them with PwC buying Booz Allen consulting and E&Y coming out with an audacious growth plan to get to $51 billion by 2020.
Due to these significant differences in both growth and product offerings, the industry players are no longer moving in lock-step.
Furthermore, the industry has almost uniformly taken an increased interest in building industry-oriented offers and verticals and has shifted down that path.
It has been a fairly quiet year for major acquisitions. Although there seems to be plenty of interest in inorganic growth, 2013 did not show big movements in that regard.
4. Impact of cloud
In the past 12 months we saw central enterprise organizations, CIO, CTO and shared service organizations taking tangible steps to embrace the cloud or next-gen models. Although that has had a very modest impact on revenue, it’s clear that they have moved from a “watch” to a “drive” posture. Where previously cloud was almost the exclusive providence of the business stakeholder units, 2013 showed that the enterprise is prepared to take a more active role in those decisions.
Although cloud had some modest impact on the industry in terms of growth, it foreshadows significant changes in the future.
5. Immigration and H-1B visa reform
Immigration reform and its associated H-1B visa reform raised its head and had a bigger impact than we anticipated. Service providers found that it was harder to move talent around globally. It became more difficult to get U.S. visas; and in the iGate-Royal Bank situation it became harder to get visas into Canada. Certainly the thresholds and scrutiny were raised around talent entering the UK and Europe.
The year brought the rising prospect of structural changes to immigration legislation; if enacted in the U.S., Canada and Europe, it would further complicate the free movement of labor. The net result is that it would not destroy the labor arbitrage model, but it would make it more expensive and lower the profit margins for some providers.
There is uncertainty and potential risk around the law, if enacted by Congress, raising further barriers for the movement of talent. Already we have seen two major developments in 2013.
First, the GICs (Global In-house Centers) or captives continue to solidify their situation and incrementally increase their influence in the industry. The industry experienced the normal handful of exits, but there were more than offset by new starts of GICs or captives.
More importantly the past year saw the GICs deepen their value proposition to their parents; they became more self-confident, extended their reach into more important functions and started taking over some third-party management functions that hitherto were executed out of the parents’ domestic operations.
A second aspect of industry change linked to immigration this past year is re-sourcing — moving work from low-cost locations into higher-cost locations. There has been a lot of talk about this. Although we saw little evidence that it happened in a material way in 2013, I think the prospect looms that at least some adjustments will be made.
As the industry matured and can better segment workloads, it is clear that the one-size-fits-all offshore talent factory does not fit every situation. Buyers are becoming more selective about what goes into those talent factories and what work is done domestically or in close proximity to the origination of the work.
The net result of that is, although 2013 did not bring a shrinking of work, we saw a reallocation of work. The actual numbers have continued to grow and increase, but buyers intentionally put more work into a right-sourcing model. So there was a modest overall impact on this in 2013, but it is something to watch in the future.
Of the five areas described, if I were to select the one that likely will have the greatest long-term impact on the industry and greatest impact in 2014, it would be immigration and H-1B visa reform. If Congress enacts the law, it could have a very significant impact on the industry. And if Senator Durban were to get his way with the H-1B visa provisions, it would go a long way toward leveling the cost advantage that the Indian heritage firms have over the MNCs.
Both buyers and providers in the global services industry are scrutinizing how to react to the dramatic depreciation of the Indian currency. Since 2000, the rupee has traded in the range of 40-50 rupees to the U.S. dollar and in recent years was stable at 45. But it depreciated during the last two years and now hovers at 64.26 per dollar — a 23 percent drop against the dollar. Unfortunately, many existing services contracts were signed with pricing based on an expectation of 45 rupees to the dollar.
Never mind that the Indian providers have been able to use the depreciation to offset wage inflation and competitive tensions — customers only envision the ka-ching sound of a cash register when they look at this windfall to providers’ profits. They feel entitled to share in the value created by rupee depreciation. In fact, some buyers have asked their providers for a corresponding reduction in price; and in some instances, particularly where contracts terms have completed, they are succeeding.
But there are unintended consequences for those who ask for the price reduction.
We have observed several providers responding to this challenge by shortening contract lengths. In some instances we’ve seen them unwilling to extend new pricing beyond one or two years.
This is understandable — after all, what goes up must come down. If providers give pricing concessions that are commensurate with the fall in the rupee, they also want to be protected on the upside. The value of the dollar could depreciate, for instance, and the providers would then be in a very difficult situation.
With contract durations of one or two years, buyers need to recognize that their interaction costs will rise and they will spend a lot of time and money negotiating contracts.
None of us is smart enough to know what will happen with currencies; thus, determining contract pricing is complicated. Including specific hedges around currency is painful on both sides because of the uncertainties in the work allocation between offshore and onshore. The current situation with rupee depreciation underlines the absurdity of long-term pricing commitments.
Historically, currency volatility has played to the providers’ benefit because they were able to adjust their scope and pricing through change control. But the current depreciation of 23 percent plays against the providers; such a large shift in FOREX significantly affects their profitability. Given how much FOREX has shifted in their favor, they feel they need to protect themselves if they give up some of that gain. Certainly one means of protection is shorter contracts, and we’re starting to see that trend emerge.
“At times, Indian IT service providers fall behind expectations in new and exciting technology areas that extend beyond the traditional outsourcing paradigm.” – A large MNC buyer of IT outsourcing services
With traditional models of IT outsourcing facing increasing competitive pressures, Indian service providers are looking at a multitude of solutions to drive success and retain competitive advantage. Chief among these are emerging technology solutions from start-up firms. Service providers have realized that to compete and stay relevant in the changing paradigm they have to focus on developing niche and specialized products, boost efficiency, and develop IP. Primary traction themes include data analytics, big data, cloud computing, and enterprise mobility. Niche start-ups with innovative technology solutions help providers augment their existing service offerings.
This echoes the strategy often adopted by multinational technology firms including Cisco, Microsoft, Yahoo!, Intel, and SAP, which back a plethora of emerging firms. Indian providers are now looking to invest and form alliances with ventures in niche domain areas. This is a dramatic shift in the status quo, as Indian IT providers have historically paid minimal attention to start-ups due to their own lack of a proper ecosystem to facilitate such transactions and a fairly low-risk appetite. Yet, of late, they have increasingly set up funds and accelerators dedicated to tech start-up initiatives.
Notable Involvement in Start-ups
Has set up a US$100 million fund to invest in start-ups, besides spotting and funding internal innovation
OnMobile, Yantra Corp
Has established a US$50 million fund exclusively for investments in global technology start-ups
Launched an initiative – i5 Startnet – to scout for firms in cloud, mobility, networking, and vertical-specific technologies
Created a team led by the Chief Strategy Officer to look for start-ups and next generation solutions
Actively picking up stakes in cloud and big data firms
Opera Solutions, Axeda
Formed its Innovation Labs and Co-Innovation Network (COIN) to bring together academic institutions, start-ups, venture funds, strategic alliance partners, multilateral organizations, and clients
iKen Solutions, Perfecto Mobile, Computational Research Laboratories
Set up an emerging business accelerator
Incubated 20 ideas over the past 18 months
Slowly, but steadily, the ecosystem is developing to encourage such start-ups. For instance, in June 2013, NASSCOM announced a program to fund and incubate 25 start-ups to be established by young Indian entrepreneurs. Additionally, it held an event that brought together promising technology start-ups and IT service providers including Infosys, TCS, Cognizant, Wipro, and MindTree. The gathering was an effort to provide young start-ups a platform to showcase their capabilities, connect with leading service providers, and generate investor interest.
Quid Pro Quo
Increasing competitive pressures and changing market dynamics have made Indian service providers truly value innovation, viewing it not just as a buzzword but rather a core operating lever to drive growth. Partnering with start-ups is an effective method of achieving innovative solutions without the allocation of time and resources they can ill-afford. And the mutually beneficial relationship between the two segments can lead to sustainable ecosystem in the long haul.
In September 2008, Satyam, then the sixth largest India-based IT services company, received the coveted “Golden Peacock Global Award for Excellence in Corporate Governance” award. Then, just four short months after this recognition, one of the biggest cases of fraud in the Indian IT service industry came to light, with the firm’s Chairman B. Ramalinga Raju admitting to financial fraud to the tune of ~US$1.5 billion.
The industry was shaken. The company’s stock and fortunes crashed.
Satyam’s much-needed rescue support came from the Indian government and the new Satyam Board, which consisted of numerous stalwarts from the Indian industry. This provided the required handholding to avoid a complete collapse, protect the interest of its employees and clients, and uphold the image of the Indian IT industry. Consequently, a sense of stability was achieved in April 2009 when Tech Mahindra won the bid to acquire a majority stake in Satyam (which was later renamed to Mahindra Satyam).
Since then, the company went through struggles, twists and turns, and finally reached a steady stage under the Mahindra umbrella. Following is an analysis of company’s financials and its stock price movement during its turbulent times and through its last financial year:
The formal merger of Mahindra Satyam with Tech Mahindra in June 2013 made “Satyam” brand history. The combined entity, retaining the name Tech Mahindra, regained ground to again become the sixth largest Indian IT-based service provider, intensifying competition for the industry-wide known WITCH (Wipro, Infosys, TCS, Cognizant, and HCL) group, and turning it into the TWITCH group (with Tech Mahindra being the new addition!). This turn of events strengthens Everest Group’s hypothesis about the possible formation of new groups in the industry (for details, refer to our blog “The Changing Pecking Order and Emerging Irrelevance of the WITCH Group Term”
The new Tech Mahindra, with US$2.7 billion revenue, has laid down an ambitious roadmap to be achieved by 2015, where each digit of this year denotes a meaning:
Reach US$5 billion revenue by 2015
The growth rates in the current economic environment are likely to vary in the range of 5-15 percent. Thus, a target of US$5 billion in revenue, implying a CAGR of 36 percent, is unlikely to be achieved without an inorganic route
Tech Mahindra is backed by Mahindra Group which has acquisitions in its DNA; therefore, a possible buyout cannot be ruled out
Zero differential between its bottom line and the EBITDA of the fastest growing rival
While this is good to appease the stock markets, it appears to conflict with the company’s growth aspiration. An organization chasing huge top line growth should not be constrained with profitability targets in the short term as it must invest in its business
Being number one as the best employer and amongst the best-known companies for corporate social responsibility
The company can become the best employer when its employees are happy. This ties back to the type and amount of work and talent available in the company, and is thus intricately linked to its growth
With the Tech Mahindra Foundation – the company’s dedicated CSR arm – we expect it to achieve some level of success in its corporate social responsibility initiatives
Five focus areas – telecom; manufacturing; mobility analytics, cloud security and banking; network services; and banking, financial services and insurance
Tech Mahindra needs to leverage its telecom legacy to differentiate itself from other India-based service providers. It should also exploit the vast potential in telecom cloud delivery models
All service providers are focusing on the mobility, analytics, and the cloud stack. Tech Mahindra needs to figure out how will it stand out and differentiate vis-à-vis the competition. It may also want to look at industries, such as healthcare, that are going through significant transformation and creating opportunities for the service providers
Do you believe that Tech Mahindra has the mettle to reshape the contours of the India-based technology provider landscape?
As most in the global services industry know, the acronym WITCH stemmed from the fact that the large, India-based, offshore-centric service providers – Wipro, Infosys, TCS, Cognizant, and HCL Technologies – had quite similar delivery models, sales strategies, risk appetite, and growth trajectories, which essentially placed them in a single bucket.
Indeed, stark divergence among this group, as evidenced by Cognizant’s capture of the number two spot away from Infosys (see chart below), is clearly emerging.
Per the latest financial results released by these offshore majors (ending March 31, 2013), TCS and Cognizant continued to outgrow their peers on a yearly basis – both in terms of size and growth – by adding revenue that was higher than, or almost at par with, the cumulative incremental revenue of Infosys, Wipro, and HCL. Their clear vision and strategic bets, as compared to the prevailing internal confusion of the other WITCH players, is paying off.
What is leading to this segregation within the WITCH group?
TCS is continuing to excel on the back of its broad-based growth and aggressive penetration in the European market
Cognizant’s approach of keeping margins lower via a higher investment in sales and marketing spend is fetching benefits
HCL is capitalizing well on the ongoing churn in the industry, and is exploiting the anti-incumbency against the traditional service providers. While this makes HCL’s growth narrow and focused largely on infrastructure services, it’s paying off for a short-term strategy
Infosys and Wipro are struggling with their internal, company-specific issues, (i.e., strategic confusion, weakening brand recognition, legal issues, and senior level exits).
The ultimate questions are:
Will the irrelevance of the collective WITCH term become more visible in the future? Will the different strategic gambles of each service provider lead to huge variances in their success rates?
Will the return of Infosys’ retired co-founder and former chairman Narayana Murthy help it make a comeback to the levels of TCS and Cognizant?
To what extent will the ongoing challenges of a few of the WITCH group players create opportunities for mid-sized players – such as Genpact, one of the key players in the FAO space, and Tech Mahindra (the combined entity) which has credible enterprise applications and infrastructure management offerings – to capitalize on their niche capabilities?
We expect to witness further changes over the next few years in the pecking order in the overall industry, and the formation of new groups cannot be ruled out. This is likely to be driven by inorganic growth, key strategic investments, service provider consolidation, and aggressive sales strategies.
The U.S. Congress took steps last week that bring proposed immigration reform — and associated H-1B visa reform — even closer to passing into law. The Senate Judiciary Committee passed the full bill on a bipartisan vote of 13-5. They also agreed to key compromises that, if passed, raise the annual cap on H-1B visas from 65,000 to 115,000 and remove the provision requiring recruiting American workers before foreigners. It gives a green light to Silicon Valley giants and other U.S. tech firms and squelches the hopes of the large Indian service providers that the language in the reform provisions might be softened. The tech companies now seek to influence six GOP senators to vote to pass the bill out of the full Senate with a large majority, which would increase the odds for it passing in the House.
In addition to the potential impacts we outlined in those blog posts, Senator Hatch last week added an amendment that brings L-1 visas into the net for reform and prevents Indian firms from using L-1s to dodge the troubling aspects of H-1B visa reform. For employers with 15 percent or more U.S. employees on L-1 visas, the amendment states they will be prevented from placing those workers at client worksites. Further, they will be unable to assign L-1 visa holders to “labor for hire” arrangements.
Unless the trends reverse, the legislation will uproot the business models of the large heritage Indian service providers. At stake: increased costs and margin hits along with constraints in placing H-1B and L-1 visa holders on site in U.S. clients’ locations.
Aside from praying that the proposed legislation falls apart in the House, there’s no “silver bullet” for eliminating the negative impacts to the Indian providers. So in this third post in our series on H-1B visa reform we present risk-mitigation strategies and our analysis of the likelihood of those strategies succeeding. We worked closely with Rod Bourgeois of Bernstein Research and Jeff Lande of The Lande Group in developing the thinking in this analysis, which also draws heavily on Rod’s presentation at his 10th annual equity analyst conference. We sincerely thank Rod and Jeff for their insights in this analysis.
What mitigation strategies are available?
Our analysis breaks down the H-1B reform provisions into six major aspects (shown in the blue rectangles in Exhibit 1). With the exception of two aspects, we suggest one or more mitigation strategies (green rectangles) for the impacts to the Indian service providers.
Let’s look at the likelihood of the above mitigation strategies. This is not an exhaustive analysis, but these factors are the primary ones of concern for the Indian firms.
U.S. clients lobby. It is possible that the big U.S. clients of Indian providers might lobby Congress to change the language of the 15 percent ratio of H-1B holders to U.S. employees due to their concerns about significant disruption to their operations and talent access. However, our research indicates this has not happened to date, and we don’t believe it will occur.
Political factors. India’s government could eliminate its protectionist policies limiting the sale of U.S. tech products in India with the hope that, in turn, this strategy would influence Congress to water down the 15 percent ratio provision. However, there is currently no U.S. political force stepping up to help the Indian firms.
In fact, our observance is that it may be more important politically to pass comprehensive immigration reform than it is to avoid bilateral issues with India.
Although the U.S. tech firms were allies of the Indian firms initially in the visa reform debates in order to increase the “pie” of available visas, this is no longer the case. Presumably the reason for their about-face in support is that the proposed higher cap on available visas and greater share of the “pie” of visas going to U.S. firms meets their visa desires. We have observed statements by such tech firms as Microsoft and IBM in support of the Senate’s visa reform provisions and in support of putting pressure on India to change its protectionist policies.
Staffing model alterations. The proposed ban on eligibility to apply for new visas (triggered by a 75 percent ratio of H-1B or L1 visa holders to U.S. employees, with the ratio dropping to 50 percent after FY 2016) limits the access of Indian firms to new visa holders.
If these restrictions become law, Indian firms could respond by increasing their offshore staff or increasing their nearshore staff in locations such as Canada or in U.S. rural areas and low-cost states (e.g., Louisiana, Mississippi, Alabama). We believe their offshore staffing mix is already at optimal levels.
Alternatively, they could hire subcontractors from companies that primarily operate in the United States that are below the visa headcount threshold ratio.
Or they could acquire businesses with high levels of U.S. staff and rebadge them. However, there are well-known risks in achieving return on investment in acquisitions of services firms. But let’s assume Indian firms decide to take this risk. At what point does an acquisition clearly make sense for an Indian IT firm? Where is the break-even point for low-margin work with high headcount? Would it break up the business of some firms into sub-businesses?
We also note that the proposed legislation includes language stating that if 90 percent of an employer’s visa holders have applied for Green Cards, they would be removed from the visa headcount ratio calculation. However, we do not believe this mitigating factor is feasible to pursue.
Higher wages. The proposed reforms require that, for new visa holders, employers pay higher wages for H-1B workers than they currently pay. We assume this also will necessitate higher wages to existing workers, especially since they have more tenure and relevant experience. The only mitigating factor we see for this provision is for the House to draft wage requirements lower than the Senate’s proposed requirements.
Increased application fees. The legislation also increases visa application fees to $10,000 per visa for employers with 50 or more employees if more than 50 percent are H-1B or L1 employees. As a point of reference, a fee of $10,000 on 5,000 visa applications ($50 million) equates to 3.2 percent of Cognizant’s current operating income. Note that 5,000 applications are fewer than Cognizant’s FY2012 level but similar tot FY 2011. The Indian firms could mitigate the expense impact by using fewer new visas.
Another mitigating factor is that the language in this provision could be watered down in the House and/or during conference. However, we believe it will remain in the legislation because Congress needs to raise funds to ensure the bill is cost neutral.
Pass costs through to clients. Another strategy for mitigating the financial impact from visa reform is for the Indian firms to try to pass the costs onto clients by renegotiating contracts and/or raising prices. For reasons detailed in our second blog post in the series, we do not believe this strategy would succeed.
Although the Indian firms will likely need to consider all of the above mitigation strategies; however, as shown in Exhibit 2, we believe the tactics with the highest viability are the tactics for staffing alteration.
Fortunately the top Indian firms have substantial inventories of visas that they can use to mitigate the short/medium-term impact if Congress passes the immigration/visa reform into law.
The BPO side
We believe that building U.S.-based platforms for vertical-specific BPO markets is a viable strategy for growth among the Indian firms as this would add U.S. headcount that would help lower the ratio for visa holders vs. U.S. employees.
In addition, many of the BPO players are in the position to rebadge their clients’ staffs in order to drive a higher ratio of U.S. staff. It’s fairly easy to transfer a visa to another employer; thus the Indian firms could transfer their visa workers to their clients or even to other services firms.
Possibility of joint ventures
We believe an interesting and creative mitigating strategy is for large U.S. or multinational service providers to create joint venture structures with the Indian players. This would ensure that current U.S. clients of Indian firms would not experience major service disruption. It would also enable the U.S. players to organically capture market share that the Indians otherwise would lose due to visa restrictions.
Due to the contentious issue of undocumented immigrants, the comprehensive immigration reform and related visa reform might not be passed into law. Even if enacted, there is still a possibility that the House’s version of the legislation will water down the restrictions in the Senate’s version. However, if it passes into law at close to its current version, the visa reform provisions will cause a seismic shake-up among the Indian service providers that are aggressive users of visa workers.
Stay tuned. We’ll keep you apprised of significant changes in visa reform impact to providers and customers in the global services industry.
Check out Peter’s other blogs on immigration reform here and here.