Indian Outsourcers' Inside Threat

As U.S. companies continue to cut labor costs by outsourcing work to Indian IT firms, the outsourcing companies themselves grapple with high rates of attrition, rising salaries and growing competition for talented employees.

The trend is affecting all the Indian information technology firms, and with more U.S. companies -- even outside the IT services sector -- adding headcount in India and competing for brainpower, the issues show no sign of abating anytime soon.

"It's definitely a point in time where execution and HR ... in particular, are going to be very critical," says Julio Quinteros, a vice president on the IT services analyst team at Goldman Sachs. "That's what's going to determine the winners and losers in the space.

"It's about adding business value, and that starts with hiring and training the right type of people and moving them up the curve," he said.

While some are merely keeping an eye on the Indian staffing issues, others argue that their contribution to margin contraction, as well as a more limited room for upside to consensus expectations, increases the risk for a pullback in valuations this year for Indian IT services stocks.

And it seems to have already begun: Since the beginning of May, Wipro (WIT) has fallen nearly 17% to $11.77, and Infosys (INFY) has dropped 10.2% to $70.08, as shares of many Indian companies -- regardless of sector -- have gone into a recent free fall.

"Offshore market demand is tremendous," Bernstein Research IT services analyst Rod Bourgeois wrote in a client note in early May after meeting with a panel of leading offshore companies. "However, we think increasing employee turnover, increasing offshore competition and wage inflation problems will cause margin contraction for the aggregate of the major Indian players this year."

"I think people are going to (be) paying more attention to these margin-related metrics," he said.

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