The Achilles’ heel slowing Infosys, and Salil Parekh’s turnaround drive

January 2018. As Salil Parekh took the reins of battle-bruised Infosys, he stitched a three-year plan to sell to investors. In the first year, the company would stabilise — something that was much needed after a board battle over corporate governance. In the second year, it would turn around. And then, in the third year, growth would accelerate.The plan did factor in the fact that Infosys would target lower margins. The IT giant ended FY18 with operating margins of 24.3%, within the target range of 23-25%. The target for the next year was decidedly lower at 22-24%, as the plan was to make investments and power growth.Six-and-a-half years on, Parekh’s tenure as Infosys’ chief executive officer and managing director is widely considered a success. But one critical part of Parekh’s plan has still not worked out. Infosys’ margins haven’t recovered. In fact, the target margin is at a new low.However, it is not bothering investors. The company’s stock price has more than tripled since the start of 2018, with consensus recommendation among analysts is a ‘buy’, according to data firm Trendlyne.“Infosys keeps saying that it is committed to higher margins but it neither talks about an aspirational number nor a timeline of when it wants to achieve it. The market was initially bothered about the margin drop but has now got used to the new level,” says an Infosys analyst with a Mumbai-based brokerage.The company had launched a margin-improvement programme designed by McKinsey at the start of FY24, but the salary hike postponement announced last week mirrors pressure on the profitability front. ET Prime takes a look at the continuing issues with Infosys’ margin and why returning to pre-Parekh levels will be hard. medium114679405Slide showInfosys had targeted 22-24% margins in FY19. In FY20, that level dropped to 21-23% to fund further investments that would drive future growth. And there was immediate pushback from analysts.Kotak Institutional Equities analyst Kawaljeet Saluja remarked that Infosys’ margins had been declining for a decade with new reasons given each year. He wanted to know if this was simply a target for FY20 or a new medium-term band.“At the end of the day, every business would have certain investment plans but there are ways and means of generating operational efficiencies or having some pricing power to fund those investments. Does Infosys have any of those levers or should one expect the margin degradation to continue to the medium term?” asked Saluja at the Q4 FY19 analyst call.Parekh replied that the company’s objective was to build a ‘high-margin’ business and that it planned to drive ‘operational strengthening’ as it went through FY20. He said that the company had internal targets to strengthen its margin.At the end of FY20, the Covid virus was rearing its ugly head. For FY21, Infosys managed to retain the 21-23% target and for FY22, the margin band returned to 22-24% only to drop back to 21-23% in FY23, as the impact of the talent battle post pandemic began to hit the industry.For FY24, the margin target hit 20-22%, a new low for the company. And since then, it has stayed at that level.Profitability driveInfosys has taken steps to improve this number. At the beginning of FY24, the company announced that it had hired consultancy McKinsey to suggest ways to improve its margin, a move it titled Project Maximus.IT companies can use short-term methods to temporarily halt margin declines — such as delaying wage hikes. But Maximus was meant to improve margins structurally. It had five pillars and 20 tracks, according to former chief financial officer (CFO) Nilanjan Roy and was being personally looked at by then deputy CFO Jayesh Sanghrajka.At its heart, Maximus targeted the same things all IT companies do to improve profitability. Pyramid optimisation (IT parlance for employing more cheap freshers than expensive senior staff without upsetting clients too much), automation, onshore-offshore ratio having more people in offshore locations with higher margins and improving utilisation.Roy had earlier said that the Maximus programme was not just looking at cost but at the overall portfolio and that the company was going “on offence” to improve margins.This is much needed.Take financial services — Infosys’ largest vertical. Here, the margins have dropped dramatically since Parekh took over and while there was initially faster growth, compared to larger rival Tata Consultancy Services (TCS), that growth differential has reversed in the past two years. medium114679415All is not wellBy the start of FY25, Infosys was still forecasting 20-22% margins and CFO Roy had left, handing over the reins to Sanghrajka. Raising the margins still remained an ‘aspiration’ and a ‘medium-term goal’, though the company posted a 100 basis point margin improvement in Q1 FY25.Infosys has said it was seeing “encouraging” results, especially around areas such as automation and GenAI and value-based selling.But betting on automation and GenAI to improve margins is complicated. Clients expect the benefits of automation and GenAI to flow to them in the form of lower costs. ET Prime had earlier reported that the competition around GenAI deals is driving “irrational” behaviour.In its second-quarter results last week, Infosys signalled that all is not well with its margin-improvement plans. The company said it would split the pay hikes it offers employees into two parts. For FY25, junior employees will get their hikes starting January 2025. So, essentially only one quarter of that salary hike would impact margins. Senior employees would get their hikes on April 1, 2025, pushing the margin impact to FY26.Contrast this with FY24, when the salary hike was effective November 2023.“When a company starts playing with salary hikes like this, it is a clear signal that all is not well on the profitability front. Infosys can do this because even though attrition rose marginally in Q2, it is still not a problem,” said a second analyst with a Mumbai brokerage who didn’t want to be named.Analysts do not appear to be forecasting great improvements in Infosys’ margin going forward either. Brokerages ICICI Direct and KR Choksey are forecasting 22% margin up to FY27.The final cutAt the heart of the matter is something that IT companies have dealt with for years — dropping margins is easy, bringing them back up is an uphill task. Clients dislike paying more money than they need to — they hire consultants who benchmark costs across service providers to ensure they aren’t overpaying.And while new technologies can command premium billing, they come with commensurate costs as experts in new technologies tend to be both rare and located onshore. And clients pay for their investments in new technologies by trying to cut spending on older technologies, which then become commoditised and no longer as profitable.Parekh is rightfully lauded for taking charge of a divided Infosys and managing to stabilise it and grow. Should he manage to complete his initial turnaround plan and grow Infosys’ margins, he will have truly earned a spot in India Inc’s turnaround history.