Over the past 12-18 months, as growth in the $250-billion software services industry slowed, players like Tata Consultancy Services (TCS), Infosys, HCLTech, Wipro, and Tech Mahindra have been scaling back low-margin subcontracting, or the practice of employing temporary workers at high costs.

Instead, they are focusing on upskilling existing employees, improving billable utilisation, and leveraging generative AI (GenAI) to meet the demands of increasingly complex projects, industry analysts said.

“Recent analysis shows a strategic shift in managing subcontractor expenses among large IT services firms,” said Krishna Vij, business head – IT staffing at recruitment firm TeamLease Digital. “Many companies have reduced these expenses in recent quarters, focusing on strengthening in-house capabilities and optimising cost efficiency. This trend reflects a broader industry response to market dynamics and a push for improved profitability,” she said.

In FY24, subcontracting costs hit their lowest levels in years: TCS at 6.20% of its revenue (the lowest since FY16), Infosys at 7.70% (lowest since FY21), Wipro at 11.50% (lowest since FY16), and Tech Mahindra at 12.60% (lowest since FY19), according to company data.

Subcontracting costs and employee expenses are shown as two different line items in financial statements. This is because salary is generally considered as a fixed overhead while subcontractors are billed on an hourly basis and do not feature in the company’s payroll.

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Companies are driving initiatives around reducing contractors, consolidation of contracting vendors, and tightening approvals for contract versus employee hiring decisions, analysts said.“Subcon (subcontracting) is generally done to access niche skills that normally come at a premium. We expect SPs (service providers) to continue to sharply focus on this cost to drive better margin,” said Yugal Joshi, partner at research firm Everest Group. “Subcon is margin dilutive and most SPs, given lack of growth, are focusing extensively on margin management. However, they also realise there is a limit to this reduction. Moreover, most of these SPs continue to build their nearshore and onshore presence that may further reduce subcon costs,” he added.

Quarterly data shows that TCS and HCLTech progressively brought down their subcon spends to 4.0% and 12.1% of their revenue, respectively, in the April-June period from 6.8% and 13.1%, respectively, in July-September 2023. Infosys and Wipro saw a minor uptick in the June quarter at 8.1% and 11.3%, respectively, from 7.8% and 10.9%, respectively, in the March quarter.

In the first quarter of FY25 ended June, TCS’s operating margin dipped to 24.7% from 26% in the previous quarter ended march, while the rest of the top four players witnessed improvement in margins. Infosys’ operating margin expanded to 21.1% from 20.1% during this period, HCLTech’s to 17.1% from 17.6%, and Wipro’s to 16.5% from 16.4%.

“Over the past 18-24 months, as industry growth has slowed down, there is a big focus by the COO/CFO office on shoring up margins and driving delivery modernisation programmes,” said Somnath Chatterjee, founder of Prismforce, a vertical software provider to the tech services sector. “One of the first levers to pull in such a case is reduction of subcons or replacement with employees with requisite skills. Others are improving billable utilisation while not hampering fulfilment, and reducing G&A (general and administrative) spends,” he said.

The decrease in subcontractor costs is also attributed to a shift towards lateral hiring as supply conditions have eased.

“Enhanced utilisation rates and investments in upskilling have reduced the need for external contractors, contributing to margin expansion and improved operational efficiency,” Vij of TeamLease said.

Analysts said the number of subcon workers in the industry is anywhere between 8%-20% of the onsite employees, especially in the US, which is the largest market for most IT majors.

“Post the stringent US visa regime, to de-risk business and ensure more visa-ready and local resources, and to meet spurt in client demands (often volatile and for niche digital skills), companies increased subcons in the past 5-7 years,” said Chatterjee who is also a former McKinsey partner. This pushed subcon costs “from approximately 5% of revenues to nearly 10-12 % for many IT companies till two years ago,” he said.

Typically, in the US, subcontracting is costlier on an average and they can be at half the gross margins versus revenues from employees, which is a drag to overall margins.

That said, it also offers companies to flexibly scale their business without creating fixed cost structures and meet volatile and niche demand, experts said.

Further, large deals often push IT firms to accept the clients’ incumbent contractors, which the firms try to de-risk over time.

Over the past 12-18 months, as growth in the $250-billion software services industry slowed, players like Tata Consultancy Services (TCS), Infosys, HCLTech, Wipro, and Tech Mahindra have been scaling back low-margin subcontracting, or the practice of employing temporary workers at high costs.

Instead, they are focusing on upskilling existing employees, improving billable utilisation, and leveraging generative AI (GenAI) to meet the demands of increasingly complex projects, industry analysts said.

“Recent analysis shows a strategic shift in managing subcontractor expenses among large IT services firms,” said Krishna Vij, business head – IT staffing at recruitment firm TeamLease Digital. “Many companies have reduced these expenses in recent quarters, focusing on strengthening in-house capabilities and optimising cost efficiency. This trend reflects a broader industry response to market dynamics and a push for improved profitability,” she said.

In FY24, subcontracting costs hit their lowest levels in years: TCS at 6.20% of its revenue (the lowest since FY16), Infosys at 7.70% (lowest since FY21), Wipro at 11.50% (lowest since FY16), and Tech Mahindra at 12.60% (lowest since FY19), according to company data.

Subcontracting costs and employee expenses are shown as two different line items in financial statements. This is because salary is generally considered as a fixed overhead while subcontractors are billed on an hourly basis and do not feature in the company’s payroll.

Discover the stories of your interest

Companies are driving initiatives around reducing contractors, consolidation of contracting vendors, and tightening approvals for contract versus employee hiring decisions, analysts said.“Subcon (subcontracting) is generally done to access niche skills that normally come at a premium. We expect SPs (service providers) to continue to sharply focus on this cost to drive better margin,” said Yugal Joshi, partner at research firm Everest Group. “Subcon is margin dilutive and most SPs, given lack of growth, are focusing extensively on margin management. However, they also realise there is a limit to this reduction. Moreover, most of these SPs continue to build their nearshore and onshore presence that may further reduce subcon costs,” he added.

Quarterly data shows that TCS and HCLTech progressively brought down their subcon spends to 4.0% and 12.1% of their revenue, respectively, in the April-June period from 6.8% and 13.1%, respectively, in July-September 2023. Infosys and Wipro saw a minor uptick in the June quarter at 8.1% and 11.3%, respectively, from 7.8% and 10.9%, respectively, in the March quarter.

In the first quarter of FY25 ended June, TCS’s operating margin dipped to 24.7% from 26% in the previous quarter ended march, while the rest of the top four players witnessed improvement in margins. Infosys’ operating margin expanded to 21.1% from 20.1% during this period, HCLTech’s to 17.1% from 17.6%, and Wipro’s to 16.5% from 16.4%.

“Over the past 18-24 months, as industry growth has slowed down, there is a big focus by the COO/CFO office on shoring up margins and driving delivery modernisation programmes,” said Somnath Chatterjee, founder of Prismforce, a vertical software provider to the tech services sector. “One of the first levers to pull in such a case is reduction of subcons or replacement with employees with requisite skills. Others are improving billable utilisation while not hampering fulfilment, and reducing G&A (general and administrative) spends,” he said.

The decrease in subcontractor costs is also attributed to a shift towards lateral hiring as supply conditions have eased.

“Enhanced utilisation rates and investments in upskilling have reduced the need for external contractors, contributing to margin expansion and improved operational efficiency,” Vij of TeamLease said.

Analysts said the number of subcon workers in the industry is anywhere between 8%-20% of the onsite employees, especially in the US, which is the largest market for most IT majors.

“Post the stringent US visa regime, to de-risk business and ensure more visa-ready and local resources, and to meet spurt in client demands (often volatile and for niche digital skills), companies increased subcons in the past 5-7 years,” said Chatterjee who is also a former McKinsey partner. This pushed subcon costs “from approximately 5% of revenues to nearly 10-12 % for many IT companies till two years ago,” he said.

Typically, in the US, subcontracting is costlier on an average and they can be at half the gross margins versus revenues from employees, which is a drag to overall margins.

That said, it also offers companies to flexibly scale their business without creating fixed cost structures and meet volatile and niche demand, experts said.

Further, large deals often push IT firms to accept the clients’ incumbent contractors, which the firms try to de-risk over time.