Monday, May 22, 2017

The Dark Cloud of the H1-B Fallout for Indian Companies: Layoffs or Reduced Valuations

India's second-largest IT company, Infosys, put out a press release on the 2nd of May, 2017 (link), that it would be hiring "10,000 American Workers Over the Next Two Years and establish four new Technology and Innovation Hubs across the country focusing on cutting-edge technology areas, including artificial intelligence, machine learning, user experience, emerging digital technologies, cloud, and big data."
The first hub, the Infosys press release stated, was expected to open by August in Indiana, which coincidentally is also the home state of the US Vice President, and which would create 2,000 new jobs in the state.
Infosys wasted no time in advertising for jobs in the United States, prominently linking it to its announcement. Nor was there any dearth of tweets on social media site Twitter to give this news more amplification - see this, this, this, this, or this.

While this is certainly good news for the United States and for its President Donald Trump's goal of making American "Great Again", the impact on outsourcing companies like Infosys is likely to be less positive.


If Infosys is hiring 10,000 American workers, then it will have to pay them salaries as per prevailing rates. Even accounting for the relatively low cost of labour in the midwestern state of Indiana, the average annual cost of one American worker is likely to be over US$100,000. This includes the wages and overheads like infrastructure, administrative, and other costs. The figure of $100,000 may well be conservative, but it's a nice, round number to work with. Using these two numbers, we get the figure of $1 billion - 10,000 workers multiplied by $100,000 per worker. One billion dollars a year is what Infosys will end up paying these 10,000 American workers. Keep this figure in your mind while we compute a couple of other numbers.

Infosys' offshore costs, on the other hand, are much lower. While Infosys does not share out these numbers, it would be very surprising if its Indian offshore costs were more than $25,000 per-year per-employee. Given that Infosys and other Indian services companies hire college graduates at less than ₹5 lacs a year (which is approximately $7,500 a year), and that these companies tend to concentrate their workforce towards the younger end of the age spectrum, the figure of $25,000 per-year per-employee is on the higher side. But let's work with this number and keep this also in your head for just a little bit.



So what are the implications of this hiring in the US for Infosys? Let us make some assumptions and see where each assumption leads us.

Net New Hiring.
If we assume that this is net new hiring Infosys is looking at, it means an annual increase of $1 billion in costs. For Infosys to maintain its gross margins of 39% (for FY2016-17), it means it would have to find an additional revenue of $2.56 billion from these 10,000 employees to keep its margins constant (if Infosys earns $2.56 billion from those 10,000 US-based employees, and if its cost for those 10,000 employees were $1 billion, it would mean its gross margins were 39%). To put that number in perspective, an additional $2.56 billion in revenue would mean an additional 24% over its FY2016-17 revenues. Given that revenue growth for Indian services companies has slowed down to the mid-single-digits in recent times, the figure of 24% looks very, very ambitious. And unrealistic.

Workforce Optimization ("Layoffs")
The other option is for Infosys to cut an equivalent number of employees from India. If we take the ratio of 1:4 for the US-to-Indian costs, we arrive at a number of 40,000 employees that Infosys would have to retrench from its Indian operations. That is a huge number, and almost 20% of its existing workforce. It cannot possibly hope to achieve such a drastic cut in headcount without serious domestic repercussions. Even then, it's a Sisyphusian task. If it reduces its workforce, then yes - it reduces its costs, but it also lowers the revenue it would have otherwise earned from those 40,000 (or whatever number it comes up with) workers. So it has to reduce its workforce even more. And so on...
Lowered Margins, Lowered Market Cap
The third option is for Infosys to convince Dalal Street - the financial markets - to live with reduced margins. This could mean either a higher P/E ratio, or a lowered market cap. Will its stockholders, the Board, and its management agree to it? Accepting lowered valuations has its own set of implications for the company, its brand, its ability to hire and retain talent. Clearly, Infosys will accept lowered valuations out of compulsion, and not choice.

Robbing Peter to Pay Paul?
Where will Infosys get the 10,000 new workers from? After all, there is more than one way to skin a cat, as the idiom goes. First, Infosys could move some of its employees from other locations within the United States to the upcoming Indiana and other planned centers. Second, who keeps track of the accounting? I.e., are these going to be 10,000 net new jobs? Are they going to be permanent jobs, or would even temporary jobs created as a result - like in construction - be counted? Is this number of ten-thousand exclusively for technology jobs, or would even administrative, janitorial, and service jobs be included? Third, as per this press release, "Infosys plans to create up to 2,000 new, high-skilled jobs in central Indiana by the end of 2021." Infosys today employs all of 140 people in Indiana, according to the same press release, and will add another 100 new jobs by the end of 2017. These are admittedly small numbers. Yes, there are other centers that Infosys plans to open across the country, but this is only a few hundred new jobs - whose exact nature or skill-level is as-yet uncertain - we are talking about.
A Tax You Cannot Refuse
The cost of hiring these American workers can be seen as a tax. A tax that will be borne by American customers, by Infosys, or by a third-party, or a mix thereof. How so? If Infosys does nothing new, then, as I have outlined in the preceding paragraphs, its margins will suffer, and consequently, its market valuation. This reduced market-cap is a tax borne entirely by Infosys and its shareholders. If, on the other hand, Infosys is able to pass on these new costs to its customers, then the customers and their customers in turn pay this tax. In all likelihood, those end-customers would be the American taxpayer. Whether Infosys would be able to ask and get a price premium vis-a-vis its competitors is an open question. In many ways, Infosys are trying to make the best of an offer they could not refuse. The offer was a more-or-less order - threat, if you will - from the U.S. President, Donald Trump, for companies to hire American workers and to manufacture in the United States.

Which way the Infosys wind blows in this matter will be pretty much way the way for the rest of the Indian outsourcing industry and companies like TCS, Wipro, Cognizant, Tech Mahindra, HCL, and even for multi-national software companies with substantial Indian operations, like IBM, Accenture, and others. There will be some real hiring of net new workers in the United States. There will be much public posturing along with willing American politicians who will play along for the optics. There will be some real pain back home by way of layoffs, reduced pace of hiring, lowered wage hikes, and lowered valuations. Sandwiched in all this will be a lot of sound and noise. Any which way matters proceed, the days of labour cost-arbitrage are coming to an end.

Disclaimer: views expressed are personal. I had some inputs on this article from Monty Agarwal.

This article first appeared in LinkedIn Pulse on May 2nd, 2017.

© 2017, Abhinav Agarwal (अभिनव अग्रवाल). All rights reserved.
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