High attrition and Variable pay cut: A tailwind for the IT sector?

Well, let me start by asking you one simple question – “Which sector would you choose to invest in, if you were asked to generate significant returns with minimal risk ?” 

Hold on a second… Let me guess.. It’s gonna be specialty chemicals or FMCG right? But you know that specialty chemicals is not an evergreen sector. And certainly FMCG will not give you out of the world returns. So in turn you might look out for IT stocks. After all, this space has made many millionaires in the world. But, do you know the same sector which is often regarded as Evergreen is facing a tailwind? Let’s find out why?   

Now we all know that IT is a very lucrative business because of its asset light model. Its employees and the client pipeline are the key ingredients for its upswing revenues. But then again, your clients will be of no good if your employees start leaving the organization. And that is when attrition rates come into play and which has been increasing since the day Work from Home started. 

Hold on… We are going too fast… Let’s rewind.

Due to the falling operating margins in the first quarter of FY23, Infosys – the second largest IT firm in India has decided to cut the average variable payout of employees to 70 percent. 

Now what is Variable pay?

You see, a salary is a packaged component which comprises many factors. It includes fixed and variable components. So, variable pay is the incentive companies pay to their employees based on their performance.

But Infosys is not the only company to do so. Before it, TCS and Wipro also reduced variable pay for the April- June Quarter. 

The reason for the squeezing operating margins were the high attrition rates. Attrition rate refers to the number of employees leaving an organization within a given time frame. Now since the attrition rates were high, the IT companies were acquiring talents at a very high premium and were even giving a good raise to their current employees. This dampened their margins at the end.      

In the first three month of the current fiscal year. Indian IT firms on an average spent 57% of their revenues on employee expenses and some IT firms like Infosys passed single and even double digit wages to high performing employees. Over the same period, Infosys had reported attrition levels at 28.4%, while the software services major has increased its employee headcount by 21,000 employees.  

While due to higher pay and other retention policies, attrition increased at TCS as well, it touched 19.7 per cent in the June quarter which was much higher than 17 percent in Q4FY22. During the quarter, the company had a net headcount addition of 14,136, which makes its cumulative total headcount to 6,06,331. Meanwhile, HCL technologies attrition for the same quarter was up at 23.8 percent from 21.9 percent in Q4FY22. Interestingly, Wipro was the only company that managed its attrition rates relatively well as compared to its peers with the figures going down to 23.3 percent from 23.8% in the sequential period. 

So in order to compensate for these soaring attrition rates, Indian IT companies are on a hiring spree where the majority of these recruits are freshers. In Q1FY23, TCS, Wipro and HCL technologies added 15,446, 14,136 and 10966 employees respectively while Infosys recruited the most with a net addition of 21,171 employees.

As per NASSCOM, the demand supply gap for Digital Tech Talent is expected to increase 3.5 times to 1.4 – 1.8 million. Such compensation hikes have impacted margins by 160 basis points and the utilization dipped due to new freshers coming in. The CFO of Infosys – Nilanjan Roy in the Q1 earnings stated that the company is fueling the strong growth momentum with strategic investments in talent through hiring and competitive compensation revisions. He further quoted –  

“While this will impact margins in the near term, it is expected to reduce attrition levels and position us well for future growth”. Infosys stated that these were more like “investments” though with a strong demand scenario, it will look at strong cost cutting measures like better utilization and more automation.

So what happens next?

Even if attrition comes under control over the next few quarters, it will not return employee expenses to pre-covid levels. Most IT companies have 70-80% new employees that have come at a higher cost which will keep the wage bills inflated. Also 20-30% employees are getting back to the offices which in turn require additional spends negating any savings from lower attrition.