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A negative sentiment has engulfed the Indian IT services industry today. Doomsday prophets have had a field day. But if one were to look beyond the hysteria, there are three large themes that are majorly responsible for the slowdown in the IT industry. (1) The technology stack has changed with firms looking at cheaper non-premises solutions aka “The Cloud” hence traditional on premise implementation and maintenance businesses are being hit. (2) Rise in computing power has heralded a perfect storm in the areas of Automation and Big Data eliminating low level jobs that typically get outsourced and is leading clients to ask for true business impact and not just “your mess for less” (3) Rise for the far right in parts of the world and the potential end of globalization leading to outsourcing and outsourcers being viewed as the enemy by the working class and politicians. Having said that, the expectation is that the industry will re-align business models and technology stacks to cater to these changes. Especially around building the capability to lead transformation projects from On –Premises to cloud applications, ability to integrate across platforms and also using the power of RPA to increase internal efficiencies. Most Indian firms have seen a couple of such cycles and should have leaders who should be able to realign their businesses. The tougher question that most are trying to grapple with is the impact of a fundamental shift in the way west is looking at Indian IT firms.

Trump to STEM the outsourcing of Jobs

If we turn an eye to the west what we realize is; a growing distrust of the ruling class;; increasing gap between the “haves” and the “have nots”, a fast catching rest of the world and a populace demanding change is fueling global economic and social turmoil. Batman fans would remember what Ra’s al Ghul said “When a forest grows too wild, a purging fire is inevitable and natural”. That fire is the rise of protectionist regimes. As part of his campaign Trump vowed to bring back jobs to the US, Theresa May spoke about brakes on immigration and Macron promised to make France a place of unicorns. Immediately this has meant restriction on the entry of non-nationals in the workforce with tighter immigration laws especially in the Technology sector across these countries. Optically such measures sound populist but it remains to be seen what long term impact they have on their domestic Industries.

The US Technology Industry has grown at an average Y-O-Y of 3% over the last decade. Plotting employment growth against Technology numbers for STEM jobs which typically make up the industry numbers, we see a high correlation between the two . By all projections this trend is expected to continue which will mean the US STEM employment which currently stands at 9.1 million is expected to see hit 10.5 million by 2020. Which meansSo in the next 3 years the US is looking at a gap potential generation of 1.4 million jobs to be filled. . Add to this Compounding this problem is the fact that 16% of the current workforce is over the age of 55 and of which a significant percentage of this population might move out of the workforce by 2020 and this should be .

This should mean good news to the ear of the average American STEM student. b But the other reality of America is a STEM Unemployment rate which continues to be around the 4.4 % level and has seen a small increase over the last quarter. The sentiment across University campuses is also not upbeat with students finding it even tougher to enter the workforce. So which version doeses one believe the one which shows 1.8 Million STEM jobs will be created till 2020 or the one which says Unemployment continues to grow across US campuses? The answer we think is somewhere in the middle.

A closer inspection of the 1.8 million number split by the nature of the job shows two conflicting stories emerge. Up until now Non-Software related STEM jobs made of the 60% of the total workforce. This trend though is seeing a reversal. Off the 1.8 million new created jobs 850,000 or 47% of these jobs will be software related. Overlaying this to the US Campus graduates enrollment numbers helps build the picture. On an average only 50% of total enrolled students complete their degree courses in the US. Which This means over the next three years for a requirement of 950,000 non-software related jobs, the US job market will have 1.8 million projected graduates. While against a projected requirement of 850,000 software related jobs only 600,000 graduates will enter the job market. This means a gap of 250,000 unstaffed requirement by 2020 in software related jobs. Add to this a rider around employability, geographical challenges and this number will see a further inflation of 25-30%.

Why Tthe success of the English Football team in Qatar might be a window to a US of 2022

Years back Arsene Wenger, the manager of Arsenal Football club fielded a starting 11 comprising of foreigners. For a football crazy nation whose last major success at an international tournament came in 1966 this was symbolic of all that was wrong with their Football. The question being asked was if a club could field 11 foreign players in a national league, the breeding ground for English talent, how will indigenous talent ever get a chance to develop? This led to a huge hue and cry, consequently the English Football Association, the sport’s governing body brought in a new rule restricting the number of foreign players who could play for a club to a maximum of 16 in a squad of 24. A move to ensure more opportunities for English players had some other unforeseen consequences (i) This created a sudden inflation in player wages by 16% (highest in Europe), due to a demand side pressure. (2) Money that could have been invested in grass root level was being spent on higher transfer fees and player wages. (3) Clubs stock piled young players at lower age groups increasing competition in formative years inhibiting their development. The troubling part for England is that none of this has resulted in positive results for the National Team on field.

Demand pressures driving inflation in English Player Wages

Now compare this to the IT industry in US, where there is already a gap between demand and supply of skilled Talent, a further restriction on foreign workers is likely to increase the demand side pressure and lead to a similar inflation in wages for the IT workforce. In the long run this will hit the productivity of firms, altering cost structures. Some of the scenarios that may thus playout could see US based MNCs will move from outsourcing selective jobs to moving complete captive and delivery centers to cheaper geographies. IT products could see business moving to newer innovation hubs such as Eastern Europe and India. As some of these scenarios playout over the next 5 years by 2022, it will be interesting to see the strategy adopted by US technology majors. Incidentally 2022 is also a WC year for England, 15 years post new regulations which could provide a few clues on using protectionist measures to drive successgrowth..

Has Protectionism helped England FA?

What this means for India – will the world continue to be Flat?

Broadly speaking while there has been a lot of talk about Trump bringing in stricter visa controls not much as of yet has happened on ground. If Trump’s vision of America or a protectionist Europe does take shape it will have consequences for the Indian IT services businesses. Traditional Indian companies have been running a 80-20 deployment model. In this model 80% of Headcount sits in the India Delivery Center and 20% Headcount is Onsite, split between Host(7-8%) and Expat Hires(14-15%). If Trump’s vision of America or a protectionist Europe does take shape it will drastically alter this deployment mix by targeting the 15% Expat jobs. Resultant we expect 3 knock on impacts each with a set of unique challenges-

(i) Increase in Local Hiring

(ii) Increase in offshore compensation to compensate loss in EVP

Increase in Local Hiring

As one of the ways to retain a 20% on-site deployment mix firms will look to increase local hiring. Local hiring though happens at a premium of 1.3X as compared to Expats. This premium translates into an additional payroll cost of 8-11%. Add to this the fact that there is expected to be a sharp wage inflation in the US on account of a widening talent gap and you can see this number go even higher. Aon’s view is as a result of this while in the short run we will see an increase in local hires; in the long run this is not a viable option for Indian IT firms operating on a cost arbitrage model unless they re-invent their operating models.

Increase in offshore compensation to compensate loss in EVP

Until now there has been a synergy in place between Indian IT firms and US/EU clients based on a cost arbitrage model. On their part Indian IT firms continued to leverage this through systematic pyramid refreshes actuated by higher tolerance for attrition at mid-levels, supported with libeliberal campus hiring programs. This has also led to two universal truths for any non-IIT engineer in India

(i) Entry level salaries will be below 4,00,000 and

(ii) Within 2-3 years of joining you will end up onsite in either US , Europe or Australia which in the employees mind makes up for the low wages to begin with.

A look at wage difference adjustment by PPP will tell you why this is such a huge carrot for any fresh graduate. An individual’s salary sees an increase of anywhere between 2.5 to 1.8 times depending on location and career level. Add to this the draw of a better lifestyle, a social status and this is an offer to good to be true for most. A control on visa numbers and a minimum wage condition at the entry levels will take this proposition awayaway and also impact the delivery models for Indian IT firms. To compensate for this loss in earnings Indian IT services firms will need to re-look at their wage structures. Most global MNCs firms which operate in an off-shoring model with limited on-site opportunities are operating at higher wage structures than Indian firms to account for this. Indian IT services firms will have to start baking in this salary premium of 20-30% in their budgets along with building greater brand equity to retain talent attractiveness. While the second option of looking at Talent from Tier -3 organizations/campuses does exist it will also cripple the push towards moving up the technology value chain.chain, which the survival of the industry is hinging . on.

Global MNC’s Pay a Differential to make-up for lesser number of On-Shore opportunities

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Playing this cost arbitrage game has an inherent risk with low the entry barriers and increased business risksAon’s view is that the wage bills of the pure play services organizations will come under tremendous pressure as the onsite EVP starts to dilute with time. There is some cost optimization that may happen through automation but the size and scale of that will be determined by factors outside their control including social and political reactions to automation.

“What will it take to continue on an accelerated growth path - Money often costs too much” 

Aspirationally most companies will position themselves to choose option 1 which also comes with a 20% increase in wage bill thus hitting profitability. What stands out from the above discussion is very clearly there is going to be a big knock on impact on the operating margins of Indian IT firms stemming directly from a wage bill inflation of 30-40%. What is then means is that Ffirms will need to look at fundamental changes in the way they do business and establish a client partnership. Up until now technology cycles have lasted 4-6 years, giving firms the time to build capability, customize deployment models, and productize solutions. Now with tech cycles lasting barely 24 -36 months firms no longer have the luxury to build capability within the cycle. Leaders will be required to anticipate changes and proactively make technology bets. Entering at the top of the technology curve gives you the early mover’s advantage from a business and talent perspective, the opportunity to partner in giving direction to technology development and the tacit learning/expertise that comes with it. A firm that wants to position itself as a partner rather than a vendor would hence need to look at

(i) Business Managers instead of Project Managers

(ii) Bbuilding Capability and COE structures

Building these centers of excellence will not be easy and be a long journey in itself. Firms will need to invest in a vastly different Talent profile than the one deployed in project delivery. For the first time IITs and Premier engineering colleges in the country will act as mass hunting grounds for Indian IT players. This will also require a big commitment from a cost perspective. An average IITian Tier 1 comes at an additional cost of 1.9x to times that off a Tier 2 candidate. Currently Architect/Consulting profiles make upto 3% of the headcount in Indian IT services firms while it’s difficult to speculate the exact mix required to lead this change, even moving this mix to the 10% mark will mean additional payroll costs of 6-7%. It remains to be seen how many businesses will have the appetite to see this journey through.

These are indeed interesting times for Rewards Professionals as they manage conflicting priorities. As the Industry navigates this transition period, revenue growth will be sluggish and the full force of protectionism will see inflation in wage bills hitting productivity. Organizations will also see fundamental structural changes and the need for greater investment to survive. Onus hence is on Rewards Professionals to act as Business Advisors with success hinging on their ability to

· Re-align Rewards Strategy to reflect the new business dynamics to allow for a different Talent Mix, a rapidly changing skill architecture and a younger demographic profile

· Support structural changes by identifying risk and building in controls and policies such as Voluntary Retirement Schemes, Severance packages

“It is often interesting, in retrospect, to consider the trifling causes that led to great events.”

As a part of the

While we have the easy side of the equation on premiums for the delivery function figured out, the journey towards becoming client partners is only starting. Leaders will need to identify the type of Talent required, the number game and also the affordability of undertaking such a transition

“It is often interesting, in retrospect, to consider the trifling causes that led to great events.”

In ancient Roman religion and myth, Janus is the god of beginnings, gates, transitions, time, duality, doorways, passages, and endings. Fittingly he is also depicted as having two faces, something I find very similar to the predicament that the Indian IT industry finds itself in. Somewhere between transitions, gates, beginnings and endings lies the future. The first part of the story will be played out across the seas. A protectionist America unless backed by structural changes in the education system and incentives will inflate wages and hit profitability of US organizations. atleast in the short term. For an industry which is still recovering from the crashes of 2008 and 2000’s crashes this could lead to hard times. A knock on effect will be felt in India too, only the companies that reinvent itself will be able to ride the wave. The silver lining could be finally the coming of age of the industry we have been waiting for, truly flattening the playing field.

Annual Wages for Landed Employees PPP adjusted ('000s USD)

Year on Year Increase in Employment & GDP (STEM) Local US Hires

Year on Year Increase in Employment

Enrolments in US by Course

Indian IT Services Deployment Models & Salary Differentials