Outsourcing Firms Might Face Cost Crunch (INFY, WIT)

The three largest firms in the outsourcing business are based in India. The leader is Tata Consultancy Services, followed by Infosys Technologies Ltd. (NASDAQ: INFY) and Wipro Ltd. (NYSE: WIT). Infosys has reported a drop in earnings for its first fiscal quarter of -2.4% compared with the same period last year.

The big hit came from Europe, where Infosys gets 20% of its business. European revenue was down 12%. Business in the US jumped 15% in the quarter, helping offset the loss of business in Europe.

Infosys expects Europe to contribute about a third of its revenue in the long-term, but is not expecting much help in the short- to medium-term. The weak economy in Europe has led to a cutback by financial services groups and consumer goods makers in their spending on IT services. Forrester Research expects that trend to continue throughout the rest of the year and “possibly even beyond,” according to the Financial Times.

Because the company’s contracts with its European customers are paid in euros, Infosys is also getting nicked on exchange rates.

Perhaps Infosys’s biggest cause for concern is the difficulty the company (and its Indian competitors) face in hiring and keeping staff. Beginning in the fourth quarter of 2009, Infosys was forced to look outside India to meet its staffing needs. The industry is being forced to pay higher wages as the Indian economy continues its rapid growth, expected to be around 8% this year.

Infosys employed almost 110,000 people at the end of 2009 and was expecting to recruit another 24,000 by the end of March 2010. That growth was primarily expected to come from overseas, swelling from about 5% to 15% in the medium-term.

And all those people, at least the ones in India, will get paid more. Staff salaries at Infosys rose 8% in 2009 and have jumped 10%-20% since the beginning of 2010.

The cost of rising wages in India parallels the rising cost of wages in China, particularly among automakers. The pay rise in India, though, is going to college-educated, English-speaking staff who are being paid more to begin with than the assembly line workers in China’s auto plants. And as wages rise in China and India, foreign staff looks just as good to those countries’ business managers as China and India once-looked to US companies.

In a bit of good news, Infosys did raise its guidance for the fiscal year. The company now expects dollar revenue to increase 19%-21%, up from April’s forecast of 16%-18% growth.

Infosys shares are trading down nearly 7% today on 4X normal volume.

Paul Ausick