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IT budget shock: Global IT services firms continue to struggle

February 9, 2024
in Business
IT budget shock: Global IT services firms continue to struggle
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The growth trajectory for the sector hinges on several pivotal factors that need more clarity, including the recovery of discretionary spending and the influx of revenue from new large-scale contracts.

The global IT services industry is at a significant crossroads, with the explosive growth of generative AI and deepening economic uncertainties reshaping its future.

Recent financial reports from major global IT services firms have highlighted a concerning slowdown in the industry that could persist, signaling potential changes to hiring and spending plans.

Cognizant Technology Solutions announced a full-year revenue forecast below expectations. Tata Consultancy Services experienced its slowest profit growth since 2020 in the December quarter, and Infosys failed to meet its quarterly profit expectations.

These developments, along with broader market reports, have cast a shadow over the growth prospects of the IT services sector. Boston Consulting Group (BCG) has said that C-suite executives across the world are prioritizing cost management in response to ongoing economic, financial, and geopolitical uncertainties.

Structural changes and impact of AI

Analysts point out that the noticeable downturn in growth expectations is likely to persist due to major structural changes in the US.

This includes a significant reevaluation of large ticket items, influenced by developments in 2023 around generative AI, according to Sanchit Vir Gogia, chief analyst and CEO at Greyhound Research. Amid considerable hype and discussion, AI continues to receive significant investment from many companies.

“The economic slowdown is now apparent,” Gogia added. “However, there could be new growth opportunities if the US government decides to invest heavily in infrastructure development and silicon chip production. Such initiatives could stimulate the surrounding ecosystem, though there’s currently no certainty around these prospects.”

Although there are efforts to boost industries such as semiconductors, there is much uncertainty about when the impact may be seen. This means that the market can expect to experience a period of softness, with large-scale deals potentially facing longer completion times.

Hiring to take a hit

In light of prevailing economic pressures, particularly affecting user industries such as BFSI, technology, and telecom, numerous leading organizations are implementing workforce reduction strategies, pointed out Thomas George, president of Cybermedia Group and CMR.

“Since the beginning of this year, there has been a discernible increase in announcements related to layoffs,” George said. “The industry data from Layoffs.fyi, a platform monitoring workforce reductions in the tech industry, reveals that 24,584 employees across 93 companies have been laid off in 2024. This contrasts with the 262,595 layoffs recorded in 2023, averaging approximately 22,000 per month, and 164,969 in 2022, averaging around 13,747 per month.”

In response to the current challenges, hiring will be more cautious, emphasizing talent transformation initiatives and upskilling efforts within large and mid-sized IT services organizations. The focus will be to equip the workforce with the necessary skills in emerging technologies to navigate the evolving landscape effectively.

Significantly, this comes just as the entry of generative AI is prompting a shift in service delivery and consumption. AI could necessitate retraining of internal staff to adapt to new technologies. Consequently, the qualities and skills sought in employees are evolving.

“Economic softness impacts both revenue and profit,” Gogia added. “For instance, companies like TCS are mandating office returns and tying annual salaries to it. In challenging times, tough measures are often required. We can anticipate some degree of workforce reduction across companies.”

Recent reports, including those from Gartner, have also highlighted a continuing trend of layoffs in 2024, even though there are early signs of recovery in the industry. 

AI investments not yet mature

The prevailing business landscape and technological advancements have prompted discussions of the wider use of AI and other technologies in the IT services sector.

“Regarding investments in cloud computing, AI, cybersecurity, and related technologies, there’s a significant shift towards productization and platformization,” Gogia said. “The goal is to embed more templated services and products, which can quickly impact revenue and profit margins. This strategy prepares companies for new types of deals and challenges, enhancing their ability to address novel problems efficiently.”

Companies have already made several changes in their approach, offering variable costs with a pay-as-you-go model, said Faisal Kawoosa, chief analyst and founder at Techarc.  “For instance, many of them use solutions from Microsoft, AWS, Google, and the like. All of them offer scalable tech solutions that are cut to size as per the operations. If there is a need, they will continue to add capacity or else scale down and optimize the cost.” 

Interestingly, George pointed out that in the case of Gen AI, only Accenture has openly shared details regarding revenue growth and initiatives. It’s essential to recognize that generative AI technology is still in its infancy when it comes to its application in enterprise-level scenarios, and realizing its potential in most use cases will require significant time.

“Consequently, we anticipate that IT services companies may not experience substantial incremental revenue from generative AI in the immediate term,” George added. “Nonetheless, there will be continued investment in enterprise security and cloud computing. This is driven by persistent cybersecurity threats, breaches, and incidents, as well as the overarching goal of fostering digital transformation and building intelligent enterprises.”  

Expectations in the near term

Looking ahead to 2025, the growth trajectory for the sector hinges on several pivotal factors that need more clarity, including the recovery of discretionary spending and the influx of revenue from new large-scale contracts. Forecasts from CMR indicate an expected growth rate of 6-7% for the segment in FY2025, marking an improvement from the 4-5% observed in FY2024.

“It is anticipated that select companies will surpass the industry average, predominantly fueled by the acceleration of significant contract executions,” George said. “Nevertheless, the outlook for FY2025 remains uncertain, primarily influenced by variables such as the Federal Reserve’s rate cut trajectory. While the full impact of these adjustments on the economy may take time to manifest, they have the potential to stimulate increased discretionary spending among enterprises.”

Nevertheless, Kawoosa highlighted the unique position of the IT sector, noting its relevance in both economic upturns and downturns.

“From that point of view, I expect the momentum to continue, where businesses across sectors would want to see IT implementations not from the point of view of elating experiences but optimizing costs,” Kawoosa said. “However, when this is the requirement, you can’t expect premium pricing from the clients.  This means the IT implementations will see thinner margins and profitability.  But there will be enough business opportunities for consulting-led IT services and solutions providers who can help their clients achieve business and financial goals.”

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