Today in Tech: What sub-contracting to sales ratio tells us; Apple Vs Samsung

Economic Times says IT Services companies, such as TCS and Infosys, are being forced to subcontract more work than ever before in the US, thanks to measures such as higher visa fees and rejection rate. It quotes from a client note put out by Prabhudas Leeladhar (PL), which says Infosys’ sub-contracting cost has doubled to its highest level (3%), and for TCS, it's 5% compared to less than 3% a year back.

Some of these ratios make more sense only over a longer term. The PL report had the numbers for the last 8 years, and they gave a better picture.

One, it's not clear if Infosys and TCS numbers are comparable. TCS discloses a number under 'fee to consultants', and Infosys, 'cost to technical sub contractors'. But there's no break up, and without additional information from management, we will not know the reasons behind quarterly movements. And, there is no way to tell if the two percentage point difference between TCS and Infosys in the recent quarter means the latter has more leeway to use subcontracting as a margin lever.

Two, when you look at the eight year movement of the ratio, what strikes you most is the way it goes up and down. When there is a surge in demand - like there was in 2006-07 - subcontracting as a percentage of sales went up too. And, when there was a pressure on companies to control costs in the aftermath of financial crisis, it reflected on the ratio. In short, it means companies use it as a tool to scale up in good times, and as a margin lever in the bad times.

Finally, the big question is why the ratio went up in the last one year. In its report, PL considered two possible reasons - one, volumes are growing and two, the demand for specialized skills are growing (as reflected in revenue from consulting and system integration) - and found neither explained the spurt adequately. It concluded it could be because of high visa rejection rate.

But, in my view, there are two reasons why visa rejection might not be the reason.

One, during a recent media interaction, Infosys CEO SD Shibulal suggested that the onsite utilization has come down too (and that more people will be assigned to projects when the utilization rate picks up in the US). Now, the visa rejections will tell on subcontracting ratio only when utilization rate has peaked. Till such time, a company would use its own employees to keep the costs low. Visa rejection rate alone does not explain higher subcontracting. It will make sense only after the utilization rate starts going up again.

Two, the conversations with IT executives and reports from firms such as Gartner suggest that there is a huge demand from new technologies such as mobile, cloud and big data. Projects such as these mean not only more onsite work (there's a higher proportion of onsite work at the beginning of a project), but also more people with specialized skill sets (IT Services companies are still in the process of scaling up these capabilities).

In short, while it's true that visa rejection rates are high, and companies feel the need to send a message that they are hiring locally, there is a good chance that the higher subcontracting-sales ratio is actually a positive indicator.