Why Europe may be the bigger problem for Indian IT sector

When TCS announced its quarterly earnings numbers, its 8.4% profit growth and 15.3% growth in revenues in constant currency terms were very impressive. However, behind this façade, there is a much deeper problem that Indian IT companies are up against. That has to do with the way business is changing in Europe. As the other IT results come out, you could see improvement in margins and other parameters, but the Europe business will remain one big overhang for the Indian IT industry. The problem is that this region has become extremely important for Indian IT companies in the last 20 years and could be a challenge.

The problem could stem from the reduce and more measured technology spending by the European companies. For the large players like TCS and others, the European clients account for 30-35% of total sales and that is quite a lot. Now it almost looks certain that amidst rising inflation, impending rate hikes and rising energy prices; most European large companies may look to cut their IT budgets. Apart from the size of the budget cut, there would also be tough negotiation with the IT service providers on pricing and that will squeeze margins.

For now, the war between Russia and Ukraine appears to be only aggravating. Russia has already cut off the Nord Stream supplies from Russia to Europe and that has virtually cut off the oil and gas lifeline of Europe. They are managing from other sources, but this immense shortage of energy products has resulted in a surge in prices. To add to their woes, in the latest OPEC Plus meet, the supplies have been cut by 2 million barrels per day (bpd) and that has also put pressure on these European countries. As the European Central Bank follows cues from the US Fed, things could only get tighter for European companies.

But the bigger problem for the IT companies could also come from their specialization. All of them have become huge but size has come at the expense of agility. The IT outsourcing industry is about helping global companies become leaner and meaner and also reduce the friction at work. However, that is something that consulting firms like Deloitte and Accenture have been doing a lot more effectively compared to the traditional IT companies. The likes of TCS and Infosys will still have a major labour-cost advantage, but that alone may not suffice for big mandates. European companies, starved for ideas, will want more.

Let us also look at how the nature of the IT industry is changing in India. Demand is moving away from implementing technologies from SAP or Oracle at clients’ premises (something our IT companies specialized in). IT service companies like Service Now Inc have seen revenues grow 6-fold on the back of strong demand for cloud-based workflow automation. Similarly, the San Francisco-based Atlassian Corporation has seen sales grow by 8 times thanks to its proprietary cloud-based application for tracking projects. In implementing new-age IT platforms, the Indian outsourcing players are lagging way behind the consulting firms. 

That is the crux of the problem. The fundamental nature of IT outsourcing is becoming less of implementation and more of consulting. Companies want their IT companies to give them ideas and execution to become leaner, meaner and more profitable. That is the challenge that the traditional Indian IT industry is grappling with. That shift may not happen rapidly, but when it does happen, the shift is huge. India cannot miss out the icing on the cake. The slowdown in Europe is a wake up call for Indian IT industry. It is not just how it lives through the slowdown. It is about how it mines the lateral opportunities arising from the slowdown.