HCL Technologies Limited - Revenue Analysis & Operating Metrics 2006-2011

HCL Technologies Limited - Financial Performance 2006-2011

Financial Performance:

• 2009 revenue growth was affected due to global recession and Financial crisis and YoY growth was only 17%. YoY growth picked up again in 2010 ( 24%) and 2011 (31%) 
• Reduced Operating expenses by almost half in 2009 (17% YoY) but again increased according to the revenue growth. 
• Negative YoY growth in net profit in 2008 (-11%) and 2009 (-6%) but profitability significantly increased in 2011 (35% YoY)

HCL Technologies Limited - Geography Mix 2006-2011 

Geography Analysis:

• Dependency on the US market is always high and the contribution reduced in 2011 compared 2010 but still 56% revenues come form the region. Peaked in 2010 with 62% of revenues. 
• Europe is the second largest market but the contribution fell in 2010 but again increased in 2011 and historically HCL had strong presence in Europe. 
• Rest of the world is also increasing compared to previous years and the company is looking to increase further. 

HCL Technologies Limited Vertical Revenue Mix 2006-2011

Vertical Analysis:

• Manufacturing is the core vertical but the revenue contribution has been falling. 
• Financial Services second largest vertical and growth is constant. 
• Telecom is the third largest vertical but revenues have fallen significantly since 2009.  
• Retail & CPG have fallen in 2007 and constant since. Healthcare revenues are constant in last two years. 
• Energy Utilities and public sector have seen constant growth since 2009. 

HCL Technologies Limited -Services Revenue Mix 2006-2011

Services Segment Analysis:

• Custom Application Services is the largest offering followed by Engineering R&D Services. Custom application services saw growth in 2011 and Engineering R&D services fell in 2011 compared to 2010. 
• Enterprise Application services is growing constantly in the last three years between  21-24%. 
• Infrastructure services are seeing significant growth from 15% in 2008 to 23% in 2011. 
• BPO services revenue is falling since 2006 from 13% to 6% in 2011. 

HCL Technologies Limited Contract Type 2006-2011

Time & Material contracts are the most preferred. But the Fixed price contracts are also seeing growth since 2008.

HCL Technologies Limited Onsite/Offshore Mix 2006-2011

Onsite has always been dominant contributor for HCL Tech but since 2009 the contribution significantly increased.

Source: Company Investors Site                               Website : www.hcltech.com/investors

India Outsourcing Industry – Low R&D spend for Non Linear Revenues

Non Linear revenues are essential for revenue growth. Currently non linear revenues account for only 10%-15% of revenues currently for large IT companies and they are planning to increase these revenues to be 20% of total revenues in the next three years and 1/3^rd of total revenues in five years. Research and Development (R&D) spend is key for non linear revenues. Indian vendors have been investing in R&D for some time and they are not investing significant amounts of money. Infosys is the only vendor that has invested in R&D and it’s investing slightly more than 2% of revenue. HCL is investing 1.4% of revenue in R&D. TCS and Wipro are investing less than 1% of revenues in R&D and they are investing 0.3% and 0.7% of revenue respectively. This is far lesser than global players that invest close to 5-6% of revenues in R&D. Indian Vendors have exclusively set up innovation and research labs with close to 600-800 highly qualified and skilled employees working full time for developing new products and services. Chart: 1 is the R&D spends in Rupee Crore. Chart: 2 is % R&D spend to total revenue.

Chart:1 

Chart: 2

Infosys Labs R&D is focused on applied research in software engineering and other areas of Enterprise IT. Finacle R&D unit is engaged in research of developing new technologies in banking domain. New strategic direction ‘Building Tomorrow’s Enterprise’ identifies new trends that are transforming the client’s business. Areas of research include semantic and language tech for information extraction from social media and for customer engagement, cloud computing, software engineering, security &privacy, etc. Research groups have published two books Raising Enterprise Applications- a Software Engineering Perspective and Process centric Architecture for Software Systems and 125 papers in leading journals in 2011.Infosys have an aggregate of 357 patent applications pending in India and US. The USPTO has granted 22 patents. Source: Annual report.

HCL Engineering, R&D Services group offers end-to-end engineering services and solutions in hardware, embedded, mechanical and software product engineering to aerospace and defence, automotive, consumer electronics, medical devices, networking and telecom, servers, storage and software industries. HCL has started a business unit with a dedicated team to focus on Defence, Space and Security. HCL is investing heavily in developing its own IPs and solutions to help customers' impact the overall product ecosystem faster and better. Solutions include a unified communication platform, a remote diagnostic reusable module, telematics and test platforms in multiple verticals. HCLT has partnered with Cisco, and filed multiple patents in the field of Mobility, Banking, etc. Source: Annual report

Wipro’s R&D focus is to strengthen the portfolio of Applied Research, Centers of Excellence (CoE), Solution Accelerators and Software Engineering Tools & Methodologies. In FY 2010-11, company had filed for 7 new patents and from the previous filings, 6 patents have been granted. The technology themes identified were Cloud Computing, Green IT, Social Computing, Information Management, Mobility, Collaboration and Open Source and resulted in creation of several new services like Cloud SI Services, Cloud Originator Services in areas of Mortgage Processing and Green Consulting. Wipro researches actively involved in Government committees to integrate Rupee sign into ICT environments. Source: Annual report.

TCS’ R&D organization is focused on creating intellectual capital for the Company and enabling innovation across the following three dimensions: Supporting the competitiveness of current business across industries and service lines; enabling the creation of new platforms for non-linear business growth; Exploring new areas and technologies for future new business opportunities. TCS has initiated ‘Research Scholar’ sponsorships to benefit research in the IT disciplines in Indian Academia. A number of innovation platforms, contests and awards were launched. The Company also hosted innovation forums in three continents and held over 40 innovation workshops and symposia. TCS’ researchers participated in more than 150 conferences and published close to 200 papers in prestigious journals. TCS increased its Intellectual Property Rights (IPR) significantly. 223 patents were filed in several countries in FY 2010-11. Until now, cumulatively, TCS has filed 448 patent applications of which 68 have been granted. In the current financial year 6 patents have been granted. Source: Annual report.

R&D departments need to further deliver more products and services and Vendors have to increase their R&D spend. They have to increase their collaborations and tie ups with other research and academic organizations and look to recruit more skilled and qualified professionals. Vendors have been trying to increase their R&D efforts and increase R&D contribution but they have not seen significant success. They have to look for ways to increase their R&D spending and also look for more contribution form the R&D department. 

India Outsourcing Industry- Increasing number of Fixed Price Contracts but Time & Materials Contracts still dominate for Major Vendors

The outsourcing contract is critical document in an outsourcing relationship which typically contains: scope of services, assumptions, deliverables, pricing, intellectual property and deliverable ownership, contract duration, service levels, customer responsibilities, Vendor responsibilities, conflict resolution, and termination process. There were 472 outsourcing deals struck in the third quarter of 2011 compared to 516 transactions in the second quarter of this year according to Everest Group. Indian IT Vendors constantly write contracts with clients every quarter. Indian ITO vendors contracts are based on two types of pricing Time & Materials based pricing and fixed Pricing. Most clients still negotiate for T&M or Fixed Price contracts with T&M contracts more than 51-58% of total revenue and rest is fixed price contracts. Fixed-price projects to mitigate the impact of the rising rupee and wage inflation on their profitability.

Time & Material (T&M) Contracts are the major type of contracts done by the Indian IT Vendors. In the initial days of outsourcing of work to Indian Vendors the outcomes were unknown and both vendors and clients were not sure how effectively the work will be done by the resources provided by the vendors. They were not sure about the time and resources required, hence the T&M contracts were the best options. Clients wanted to have control on the resources and track vendor resources including the approval and clearance of time-sheets and the risks totally existed with the client. In the T&M contracts the risk lies totally with the clients. People are thrown at the problem and are billed on hourly basis and there are instances of unutilized resources in this scenario. Projects can be easily ramped up or down according to the clients needs easily. These contracts are best suited when the relationships between the clients and vendors are just starting fresh and the projects or process are new with no significant view of the outcomes and their impact. As long as uncertainty exist T&M contracts will be there and despite the fact some experts believe the golden age of T&M contracts is going to end in next ten years.

Fixed price (FP) contracts are clearly defined and deliverables agreed between client and vendor. Standard IT procedures, periodic reviews of performance and phased billing are other features of FP contracts. Risk is shared between the vendor and clients and vendors have to invest in the relationship and technologies required. This is a rigid model and mid way changes are difficult to make. Clients have to be very careful in choosing the best vendors for significant ROI and the vendors too have the scope on investing on the infrastructure and technologies as they are well aware of the client needs. Both clients and Vendors have to invest in building a relationship. Fixed price contracts are being favored by the Indian ITO vendors as they can efficiently complete the work using lesser resources and do it without much interference from the clients. In the past four years Indian vendors are trying to increase the Fixed price contracts percentage to total revenues as the client IT budgets/spend are being tightened due to the financial crisis, debt crisis and economic slowdown. Indian IT vendors looking to maintain 40-40% of total revenue through fixed price contracts. Fixed-price outsource contract attracts the customers due to immediate cost reduction followed by 3-5 years of cost control. Fixed-price projects are also more short term in nature, while the time and material are long-term contracts that give longer revenue visibility for companies

Tata Consultancy Services Limited

TCS has a higher ratio of fixed prices contracts in comparison to the competition and suggest TCS is undertaking more complex and mission critical end-to-end engagements.TCS has been looking to maintain the fixed price contracts in between 40-50% which they feel is optimal. The recent recession and financial crisis has tightened the client budgets and spends which forced to look for more fixed price as it helps them in controlling the resources and do the work more efficiently. 

TCS also increased the working hours of employees so that they can increase billable hours for T&M contracts. Fixed price contracts also have higher pricing compared to T&M and carry risk for the vendors. Fixed price contracts have to be signed constantly as the existing contracts get completed overtime and if there are no signings for some time then the overall revenue gets impacted. TCS in 2011 is facing such situation where they have seen fall in fixed price signings but confident to overcome as they have good pipeline. Margins also increase with fixed price contracts.

Infosys Limited

Infosys has successfully increased its fixed price contracts since 2008. Financial crisis and subsequent recession forced Infosys to start look for ways to curb the slow revenue growth. The US clients have changed their offshore outsourcing strategy and this prompted Infosys to look for fixed price strategy. But Infosys still have major revenues coming from T&M contracts as most of its clients want to stick with T&M and there are risks involved in fixed price like if the scope of a fixed price bid is unclear, it can lead to cost overruns. The share of fixed price contracts for Infosys in 2010-11 stands at 42% as compared to 28% in 2005-06. Infosys focused on shift to fixed-price contracts as part of the bigger effort to de-link revenue growth from manpower growth and move up the value chain. In long term, Infosys expects the proportion of fixed price bids going up.

Wipro Limited

Over the last 2-3 years, Wipro have increased focus on fixed-price contracts. Wipro has been able to increase the proportion of fixed-price contracts to 45.7% in FY11 compared to just 34 percent in FY-09. Fixed-price contracts ensure better realizations compared to time and material. Wipro is also is aiming to break the “linearity”, or revenue growth linked to the number of people added, and earn better prices through fixed-price contracts. Wipro was also forced to look for more fixed price contracts to overcome the recession. Wipro has in the past couple of years have been signing more fixed price deals as these deals provide revenue visibility and reduce the pricing pressures. 

HCL Technologies Limited

HCL Tech have increased its fixed price contracts to total revenue percentage in 2011 to 42% from 30% in 2006. HCL had move to more fixed-price contracts as it offers more certainty in contract execution and revenue. Fixed-price contracts require greater planning in terms of resource allocation and utilization and definitive timelines of implementation and were more relevant in the turbulent times where clients of HCL are demanding output/outcome-based pricing with service-level agreements. In the last two years HCL has seen good traction in the fixed price deals and it is planning to do more such deals in future.

Discussion Points:

1. Are the Indian ITO vendors doing well on the Fixed Price contracts front?
2. How comfortable are clients with Fixed Price contracts and how to manage risk?
3. What will happen to T&M Contracts in future?
4. What is the optimal balance for T&M and Fixed Price contracts?