Mid-tier information technology (IT) companies lost more ground than their larger peers in the financial year 2023-24 as vendor consolidation deals by clients have led to a decline in revenue growth, and that too on a smaller base. Although mid-tier companies continued to outperform their Tier-1 peers, the year-on-year (YoY) growth rate halved in FY24.

Lower tech spending by clients due to uncertain macroeconomic situations in key markets has been troubling IT companies in the past few quarters, leading to the tepid performance in FY24.

Experts say that even as vendor consolidation deals are being lapped up by larger companies, mid-tier rivals have borne the brunt. Simultaneously, mid-tier companies are doling out discounts to clients, which, in turn, has put pressure on margins.

Vendor consolidation deals in the IT industry involve clients reducing the number of suppliers to improve efficiency. This often results in deals going to the larger IT companies as they have the muscle power to negotiate better pricing due to their sheer size.

Additionally, spending on new-age technologies such as artificial intelligence (AI) and generative AI has also led to extra spending by these companies to stay relevant, experts say. This is because larger IT companies are in a better position to absorb these shocks as they can draw from their better cash reserves.

Large IT companies are often defined as the top five IT companies in terms of revenue: Tata Consultancy Services, Infosys, HCLTech, Wipro, and Tech Mahindra. Mid-tier IT companies are the ones that follow and include LTIMindtree, Persistent Systems, L&T Technology Services, Coforge, and KPIT Technologies.

Yugal Joshi, Partner, Everest Group, said mid-tier companies are reliant on key clients as they form a large part of their business. “And if anything happens to those clients, it impacts these smaller firms.”

Generally, whenever the vendor consolidation theme plays out, which is the case currently, mid-tier companies have more to lose. “Now, to ensure that their clients do not go to the renewal table, these companies are proactively going ahead and pitching renewals much ahead. And when you do that, you will normally give lots of discounts, which hits your margins,” Joshi explained.

Topline trouble

Revenue growth of the top five IT companies has reduced by almost half in FY24 compared to the last fiscal year. In some cases, the downfall is even steeper because of company-specific issues. For example, Pune-headquartered Tech Mahindra’s dollar revenue contracted by 5 percent against growth of over 10 percent in the previous year.

However, the fall is sharper in the case of mid-tier companies. Persistent Systems’ dollar revenue growth fell by over half to 14.5 percent in FY24 from 35.3 percent in FY23. LTIMindtree’s revenue growth fell over 3 times to 4.4 percent in the financial year just ended from 17.2 percent in the previous year.

KPIT Technologies is an outlier as its growth improved year-on-year to over 40 percent in FY24 from 27 percent. Coforge’s revenue growth declined to 11.7 percent from 15.6 percent, while Birlasoft’s constant currency revenue growth declined to 6.7 percent from 11.5 percent.

Experts say Tier-1 IT companies boast robust order books, with a notable focus on verticals such as healthcare. Amidst a moderation in IT services growth, engineering services emerged as a beacon of hope, registering double-digit growth rates.

Margin mess

Jain also points to a narrative emerging in the form of “anti-incumbency deals”, where mid-tier companies challenge established players for lucrative vendor consolidation contracts. This trend underscores the growing competitiveness within the sector and has led to a drop in margins.

For example, the margins of mid-tier companies such as LTIMindtree, Persistent Systems, Coforge, etc., have reduced. On the other hand, larger companies such as TCS, HCLTech, and even the struggling Wipro improved their margins in FY24.

Gaurav Vasu, founder of UnearthInsight, offers a sobering outlook for the sector's growth trajectory. While tier-1 companies, which drive the lion’s share of revenue, and tier-2 IT companies are both seeing similar trajectories, neither is faring much better grappling with sluggish tech spends and tepid demand, he said.

Vasu said some of Tier-2 companies operating in specialized engineering services, such as Persistent Systems and Cyient, would continue to grow at higher double digits. “Others, like LTIMindtree, Zensar, and Mphasis, would struggle to grow at about 5-6 percent for FY25,” said Vasu.

Nonetheless, he says where the benefit will show is with existing customers for Tier-2 companies. For instance, Citi and Microsoft have been LTIMindtree customers for over 20 years now, if they look for vendor consolidation, LTIMindtree will benefit.

“None of these clients have yet gone for a complete singular vendor consolidation model; they have consolidated to 3-4 vendors. No one is putting all their eggs in one basket,” Vasu pointed out.

To add to their woes, companies are spending a lot on new businesses, from which revenues are uncertain and also impact their margins negatively. “They have to open all their innovation labs and do a lot of things. So, it has become like a treadmill. You have to invest a lot of money just to be in the same place,” Joshi said.

Tier-2 companies have mid-teen margins at best and the reasons for challenges are execution and sector mixes, according to Gaurav Parab, principal research analyst, at NelsonHall. He added that companies with high exposure to financial services, telecom, and high-tech have been the worst hit.

Headcount halts

Although absolute headcount increased for mid-tier IT companies, the YoY growth in headcount has slowed down amidst tepid demand and rising utilization levels. The metric grew over 7.5 percent in FY24, lower than the almost 12 percent growth seen in FY23.

Monitoring headcount changes in IT firms is a vital indicator of future demand that has remained weak in recent quarters. On the other hand, the hiring slowdown is being felt more in larger IT companies, which have seen a historical fall in headcount.

In a comparison of mid-tier companies and larger peers, a percentage is crucial due to the former’s smaller employee bases.

In the financial year 2022-23, mid-tier IT companies, comprising Persistent Systems, L&T Technology Services, Coforge, KPIT, Birlasoft, and Tata Elxsi, together added almost 11,000 employees. And in the financial year just gone by, they had added a little over 8,500 employees.

In contrast, the headcount of the top five IT companies contracted by almost 70,000 employees in FY24 as they did not backfill attrition. The reduction comes after these companies—Tata Consultancy Services, Infosys, HCLTech, Wipro, and Tech Mahindra—reduced their hiring by almost 80 percent to over 56,000 employees in FY23 from a whopping 2,73,000 additions in FY22.

These companies also cite demand challenges and unused bench strength as reasons for the fall in headcount. Indeed, TCS and Infosys reported a drop after almost two decades.

Among these companies, Persistent Systems has witnessed the sharpest drop. It added 961 employees in FY24 as compared to an addition of 4,290 in the previous one. The Pune-headquartered company said it will hire about 850-1,000 freshers in FY25.

However, Persistent Systems closed FY24 with an improved utilization level of 80.1 percent from 78.5 percent in the previous financial year. Rival L&T Technology Services improved the metric by over five percentage points to 86.9 percent in the fourth quarter of FY24. The company did not disclose the full-year numbers for utilization.

Krishna Vij, business head, of TeamLease Digital, said utilization levels have bottomed out, and beyond this, companies cannot utilize the existing employee base. “And (with) the new projects coming in, the outlook is positive, they will have to go back to the market and hire employees across these skills.”

Nonetheless, Vij says overall hiring is expected to increase by 7-8 percent for large IT firms. Off-campus recruitment is expected to increase by about 15-20 percent compared to last year, she added.

Many other analysts believe headcount will start increasing once growth is back. IT companies have been facing tepid demand due to the uncertain market environment in their key markets.