Mind the profitability gap!
CEOs of IT services organisations would easily relate to the graph below. From targets to order book to invoiced revenue to net margins, there is a significant gap at every transition. If we study the financial performance data of IT services organisations, we realise that the quantum of gaps at each transition varies for different organisations. At the end, all these gaps at each stage translate into lower net margins.
In this article, we try to decode the profitability of IT services organisations and try to understand why these gaps exist in the first place. We will also look at some research data which shows that this gap is not inevitable. There are some companies who have managed to minimise them and attain higher levels of profitability.
How much is the gap?
When we talk about over performers and under performers in the IT industry, the questions is, how much is the gap? So, as a benchmark for over performer, let us look at some publicly available data of TCS.
Now let us look at the analysis of publicly available financial performance data of another IT services organisation. Let us call it ABC corp.
If we compare the data, here are some conclusions:
TCS is 205% more profitable than ABC corp.
TCS earned Rs. 3 lacs more from each of its employee as compared to ABC corp.
Effectively, TCS earns 228% more profit per employee as against ABC corp.
If we study the data of even more IT services organisation, we will find that this kind of a deviation is very common. Very few companies manage to operate at profitability levels closer to or higher than TCS. While most of the companies are in a situation similar to ABC corp. Before we go to what’s probably causing this gap, let’s see how would ABC corp’s profit would look like if it operated at the profitability levels of TCS.
First of all, if ABC corp operated at TCS’s efficiency, its profits would go up to 73.7 crores. What is interesting is, these profits would be achieved just by optimising the existing way of functioning and not by adding more people. Even if it decided to retain its actual profit - 35.96 cr from the total projected profit of 73.7 cr, with the additional profit at hand, it will have around 37 cr at hand which can be used for accomplishing so many things - from expanding team and launching new offerings to improve employee retention and enhance the company’s valuation.
The point is, there is a lot of value in there from IT organisations operating at lower profitability levels. Even a slight increase in net margins can help them in a big way. If you are wondering that TCS is more profitable just because it has a benefit of scale, think again. There are much smaller organisations which are equally or even more profitable than TCS. Advantage of scale is just one parameter which determines overall profitability. There are many more which apply equally to small and large organisations.
With this much of background, let us try to understand some possible factors which result in this high gap in profitabilities of some companies as against others.
Balanced pyramids: For IT services organisations, the project cost comprises mainly of the employee cost. These costs can be controlled to a great extent by balancing the project pyramids. Not all organisations have visibility into the pyramid structures and hence, they cannot balance it. Result? A big dent in the project profitability.
Effective resource utilisation: Organisations lack visibility into their existing resource utilisation. They will have no easy way of finding out utilisation of every resource in the realtime. As a result, it is very common to see employees who are on payroll but are not billed to any client or are only partially billed. This will also bring down the profitability of the organisation.
Accountability: Accountability should bot be restricted only on the top. It has to percolate down. How many of your team employees fill up the timesheets accurately and in time? Are your project leads using only as many resource as they need? IT services organisations lack frameworks that help accountability percolate down through different level of hierarchies. Wherever there is a lack of accountability, profitability takes a toll!
Hiring priorities: For IT services companies, talent is the raw material. Imagine, having an order in hand but no raw material. You will have to either pass the order or purchase the material at higher rate or get the substandard materials which will cause a lot of trouble in the future. Majority of IT organisations are unable to get their hiring priorities right because they do not have required visibility. This escalates the hiring costs, increases revenue losses and ultimately affects the profitability.
In short, there is a lot of value for IT services organisations in improving their own net margins. Even a slight improvement in net margins will mean high impact on cashflow, cash surplus and valuation. IT companies need to invest in tools/platforms which can provide them right visibility into their project costs, resource utilisation, hiring requirements and other such critical parameters.