For almost two decades now, the Indian IT services industry has been a bright spot in the lives of a lot of people - the lakhs of people who got jobs in IT companies, suppliers of products and services to these companies (everything from real estate to taxis to canteen contractors), the businesses where employees spent their earnings and certainly equity investors. A few hiccups aside, IT services companies have generated enormous wealth for everyone. From where we were in 1990, it's a great miracle that such a huge, people-intensive industry has come up in an area where India was an utter no-hoper till then.
But those days may be coming to an end. It looks like the IT industry is coming up against the most serious crisis - one that threatens its very fundamentals. I'm not saying that the industry will disappear, but the business model - and what might be called the employment model - is under its most serious threat ever. Growth will be slower and sometimes non-existent. Profitability will be lower and what will ultimately cause the most disruption is huge parts of the workforce will turn out to be useless.
To understand what is happening now, we have to accept the truth that was always out there - the IT business is not a 'technology' business in any real sense of the word. There is nothing in common between the business that a TCS and an Infosys and a Wipro are in with that of a Google or a Microsoft or an Oracle. Indian IT services consultants are essentially manpower businesses. The only difference between a TCS and a 'manpower consultant' in a town in Kerala or Punjab is that the latter recruits people to drive vehicles and clean buildings in foreign countries, while a TCS or an Infosys hires out people to maintain IT systems and write software. The business is the same - hire cheap labour, contract it out to countries where its more expensive and pocket the difference.
Most of the work is about following the processes - ensuring that servers are running, networks are up, backups are running, users' problems are solved and so on. Some of the work is also implementing 'solutions' like ERP systems at the clients'. For a long time, the IT business was a stable business. Indian workers were inefficient (needed more people to do the same jobs) but a constantly declining rupee and huge differences in wages and living cost meant that clients in the US and Europe still found it worthwhile to send work to India.
The golden years
Within IT companies, enormous growth and low-skill employees meant that a steep 'pyramid' developed. Freshers joined, were put through a rudimentary training process and then put on a project by telling the client that they had some skills which they often didn't. They learnt on the job enough to sort-of justify their billing. Within two or three years, they were promoted to a 'team lead' kind of position, where they would shepherd a handful of freshers, along with doing the actual work. It's people at this level who really produce what the client pays for. Freshers are there mostly to inflate billing while getting trained at the client's expense.
In five or six years, they would be made 'project managers'. At this point, they would stop working and just manage. This model worked because of enormous growth and enormous margins. There would always be a huge hoard of freshers joining and a larger and larger number moving up through the experience ladder. Annual hikes were large by the standards of other industries which could employ engineers. Industry-wide growth also meant that a lot of middle to mid-upper level managers moved jobs rapidly because this was a great way of getting even bigger salary hikes.
Regardless of what stream someone was an engineer from, they would all end up in an IT job during this golden period, which lasted from about 1995 to 2008. This was also the time during which the businesses supplying everything from houses to lunches to IT companies and their employees flourished.
However, from 2008 to 2015, this model has gone awry. The heart of the model was a pyramid of employees. At the bottom was a large number of freshers being paid around ₹3-5 lakh a year. Then there were various layers of middle managers getting as much ₹10 to 12 lakh a year. By 2010, this model has gotten seriously out of shape with far too many people at the middle level. With lower industry growth, there is little natural attrition - people just don't leave jobs. Generally speaking, the middle level doesn't actually produce anything that can be charged to customers, and there are far too many of them now. The other problem is cost. Years of disproportionate hikes have left margins and the room for inefficiency much smaller, even with a much weaker rupee.
Up in the clouds
On top of that, the industry has been hit by rapidly shifting technologies. The accelerating shift to cloud-based infrastructure and solutions has meant a sharply lower need for the kind of work that Indian IT companies have been doing. A large company using solutions like Google for Work, Amazon Web Services and a cloud-based ERP service from SAP needs only a fraction of IT manpower to manage its business. Sure, everyone is not doing so yet but the shift is happening rapidly and is already producing serious dent in growth. Unfortunately, the industry is so configured for growth that even lower growth (let alone actual shrinking) has produced serious business and HR stress.
What needs to be done
The root of the problem is that IT companies were not prepared for the change. Everything about using and managing technology is in constant change and often the changes are delivered in sudden shocks. This is the kind of crisis in which any possible solution has to be centered around downsizing. Indian IT companies need smaller numbers of differently skilled people. That's the elephant in the room. One or two influential companies can avoid talking about it for a while, but sooner or later every company will have to face up to it.
Lower growth and lower margins can eventually be gotten used to, if it stops at that. However, the shift to a completely different kind of IT setup in customer countries could accelerate disproportionately fast. Like everything connected with technology, the only certainty is that their will be sudden disruptive changes.
What will happen to the people?
If employment in the IT industry starts shrinking rapidly, as looks possible now, there will be considerable disruption and unrest. Our labour laws and the culture of our labour movement are designed to worsen problems and not solve them. This might sound unlikely today, and one hopes it doesn't come to pass, but don't rule out unions, red flags and industrial disputes at the gates of IT company campuses.
However, at an individual level there is bound to be stress for a large number of people. It all depends on whether the people who are being pushed out from IT companies have skills that are easily transferable to other sectors and other types of jobs. One notable fact is that even though there has been plenty of noise about the TCS layoffs, these have actually been at a smaller scale than some others in the recent past, notably IBM.
Hiring consultants are unanimously of the opinion that the job market is tighter but still well-calibrated to experience and skills. Even mid-to-senior, highly-paid workers still jump jobs with 20-30 per cent hikes. The trouble arises with those who haven't kept up with skills or have allowed themselves to stagnate; haven't kept up with real, updated technology skills; or have shifted to low-level management jobs too early in their careers.
Still, the impact will be felt. Value Research had predicted this quite early (read our Editor Dhirendra Kumar's July 2012 column here: In IT Services, an Era Has Ended). Here's a quote from that column: For almost a whole generation of young men and women entering the urban employment market, IT services have been a great safety valve. A high-growth industry whose growth is almost linearly related to employment generation was the best thing that could have happened to India in the last two decades. The constantly increasing workforce, with constantly increasing pay cheques, and a constant predilection to spend - it was a wonderful combination while it lasted. However, that was then. Make no mistake, an era is over - that kind of growth is not coming back.
Of course, this problem wouldn't have occurred had 'Make in India' started three decades ago, but perhaps it's still not too late. As we've said earlier, the only real solution is for the growth in the rest of the economy to absorb the overflow.
The message for investors
From an investment perspective, taking a call on the new reality of the IT industry is quite tricky. The heady days of the pre-2008 are certainly gone. The easy conclusion to draw - and many analysts are saying so - is that many or most of these companies will settle down to a staid cash cow phase. However, the only thing predictable about technology is that it's not predictable. It's possible that cloud-based infrastructure and off-the-shelf solutions become so dominant that the current version of the Indian IT industry starts shrinking. It doesn't take long for cash cows to become dogs. The last two decades have been relatively straightforward for IT companies; the real challenge may just be beginning now.