Indian software services firms are experiencing a shift in their scope of contractual work following client expectations of enhanced productivity from generative AI or due to global macro uncertainties. Such contractual revisions can potentially erode margins at these companies, experts say.

At least three top IT firms – Infosys, Tata Consultancy Services, and HCLTech spoke about either changes in the scope of clients’ contracts or passing productivity benefits to clients by doing the same amount of work for lower price in the last two quarters.

While IT firms pass on productivity gains to clients during deal anniversaries, they are currently being asked by clients to add more scope of work during renewals. In a note on HCLTech’s Q1 earnings, Kotak Institutional Equities said, “(Revenue from) IT services declined 1.5% due to the anniversaries of a couple of mega deals in financial services.”

It added the firm’s earnings before interest and tax (EBIT) margin was under pressure in the June quarter since it transferred productivity gains to clients in select contracts.

TCS chief executive officer K. Krithivasan said, during the company’s quarterly earnings call, that customers expect productivity improvements during project renewals. “What they also do at the time of renewal is usually add more scope during renewals to maintain topline neutrality”.

Peter Bendor Samuel, CEO, Everest Group, a consulting and research firm, said, “Firms are clearly asking IT firms to step up productivity gains from genAI. These asks anticipate further maturing and improving of both the technology and the operations which must evolve to utilise gen AI that are well beyond what the tech services firms can currently deliver. Hence, there is a risk that as they agree to these demands, any shortfall will affect profits.”.

“However, there is also the possibility that they may be able to exceed the demands and capture additional profit for themselves. In general, the additional risk is not a good thing for the tech services firms as the current demands require significant investment and carry uncertainty on the tech firms’ ability to deliver,” he said.Experts say productivity gains passed to clients during deal anniversaries is also impacting margins of IT services firms.

Analysts at Nomura noted on HCLTech, “The overall EBIT margin contraction of 50bp was driven by drop in ER&D services margin and impact of annual productivity benefit to clients which was partly offset by business efficiencies and currency movements.”

Pareekh Jain, CEO, EIIRTrend, an engineering insight platform, said “Clients expect service providers to provide productivity gains year on year and especially on renewals. The expectations from clients have increased now because of the excitement of genAI. Traditional productivity levers were process improvement, automation and offshoring, analytics, AI. But now genAI has become a new lever and expected to give a boost to productivity gains.”

While clients are not just adding more work at the same price, they are also reducing the scope of work for some, said experts. Infosys during its March quarter earnings call said, “We had a renegotiation and rescoping of contract with one of our financial services clients, which led to slightly over 1% impact on Q4 revenues. While part of the work got rescoped, over 85% of the contract is still with us.”

Indian software services firms are experiencing a shift in their scope of contractual work following client expectations of enhanced productivity from generative AI or due to global macro uncertainties. Such contractual revisions can potentially erode margins at these companies, experts say.

At least three top IT firms – Infosys, Tata Consultancy Services, and HCLTech spoke about either changes in the scope of clients’ contracts or passing productivity benefits to clients by doing the same amount of work for lower price in the last two quarters.

While IT firms pass on productivity gains to clients during deal anniversaries, they are currently being asked by clients to add more scope of work during renewals. In a note on HCLTech’s Q1 earnings, Kotak Institutional Equities said, “(Revenue from) IT services declined 1.5% due to the anniversaries of a couple of mega deals in financial services.”

It added the firm’s earnings before interest and tax (EBIT) margin was under pressure in the June quarter since it transferred productivity gains to clients in select contracts.

TCS chief executive officer K. Krithivasan said, during the company’s quarterly earnings call, that customers expect productivity improvements during project renewals. “What they also do at the time of renewal is usually add more scope during renewals to maintain topline neutrality”.

Peter Bendor Samuel, CEO, Everest Group, a consulting and research firm, said, “Firms are clearly asking IT firms to step up productivity gains from genAI. These asks anticipate further maturing and improving of both the technology and the operations which must evolve to utilise gen AI that are well beyond what the tech services firms can currently deliver. Hence, there is a risk that as they agree to these demands, any shortfall will affect profits.”.

“However, there is also the possibility that they may be able to exceed the demands and capture additional profit for themselves. In general, the additional risk is not a good thing for the tech services firms as the current demands require significant investment and carry uncertainty on the tech firms’ ability to deliver,” he said.Experts say productivity gains passed to clients during deal anniversaries is also impacting margins of IT services firms.

Analysts at Nomura noted on HCLTech, “The overall EBIT margin contraction of 50bp was driven by drop in ER&D services margin and impact of annual productivity benefit to clients which was partly offset by business efficiencies and currency movements.”

Pareekh Jain, CEO, EIIRTrend, an engineering insight platform, said “Clients expect service providers to provide productivity gains year on year and especially on renewals. The expectations from clients have increased now because of the excitement of genAI. Traditional productivity levers were process improvement, automation and offshoring, analytics, AI. But now genAI has become a new lever and expected to give a boost to productivity gains.”

While clients are not just adding more work at the same price, they are also reducing the scope of work for some, said experts. Infosys during its March quarter earnings call said, “We had a renegotiation and rescoping of contract with one of our financial services clients, which led to slightly over 1% impact on Q4 revenues. While part of the work got rescoped, over 85% of the contract is still with us.”