Average subcontracting expenditure at eight Indian IT companies rose to 11.3 per cent of revenue in the quarter ended September 30, from 10.5 per cent a year earlier, according to data from business intelligence firm UnearthInsights.
Infosys has acknowledged that subcontracting costs, at 8.9 per cent, remain elevated compared with about 6 per cent before the Covid-19 pandemic. The company has said the expense depends on several factors, including utilisation, business growth, the skills required and the geographies in which projects are delivered. “There is an endeavour to bring our subcontractor cost down over a period of time. It had come down and then slightly it inched up again,” its Chief Financial Officer Jayesh Sanghrajka told analysts on a conference call last month.
A one percentage point reduction in subcontracting costs would give Infosys 15-20 basis points of margin headroom, Sanghrajka said. “To that extent, there is opportunity, but it will never come down to zero. So even in the best years, we have been in the range of 5-6 per cent,” he added.
The increase is an immediate pressure on operating margins at a time when IT services companies are already grappling with subdued revenue growth amid macroeconomic weakness and geopolitical uncertainty. Margins remain a closely guarded metric for the sector, particularly as clients continue to scrutinise costs and defer discretionary technology spending.
“Over the past three to four quarters, we have seen subcontracting expenditure rise as more client-site work is executed through subcontractors,” said Gaurav Vasu, founder and chief executive officer of UnearthInsight. Restrictions on H-1B visas and uncertainty over PERM applications are reinforcing the trend, particularly in the US, where companies need access to onsite talent.
Indian IT companies have gradually reduced their dependence on H-1B visas by training and hiring more employees in the US. But a mismatch between the availability of local talent and the skills required by clients persists. When demand rises suddenly, companies often have little choice but to turn to subcontractors, as relocating employees can be a lengthy process. The situation has become more challenging under the Donald Trump administration.
The US government has introduced several measures to tighten the entry of skilled foreign workers through its immigration system. It has also cancelled PERM-related processes, amid allegations that firms sought to bring in lower-cost foreign workers at the expense of US employees.
The financial implications are considerable because subcontracting is generally more expensive than deploying employees on the company’s own payroll. Employee costs and subcontracting expenditure together determine delivery costs, meaning sustained increases in either can weigh on operating margins. UnearthInsight estimates that PERM-related restrictions could compress operating margins by about 20-30 basis points.
Vasu expects subcontracting levels to remain elevated amid the current geopolitical environment, at around 9-12 per cent for tier-one companies and 15-18 per cent for tier-two players. But the scope to offset these costs by shifting more work offshore is limited. Offshoring already accounts for 78-82 per cent of delivery at tier-one companies and 74-80 per cent at tier-two companies, leaving relatively little room for further increases.
Kamal Karanth, co-founder of staffing firm Xpheno, said costs across IT services companies were likely to rise in the near term as they replace employees moving to global capability centres (GCCs) at higher salaries. “Companies are still hiring to counter average attrition of 12.5 per cent. In addition, a lot of AI pilot projects require subcontractors who are more skilled,” he added.
