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What Lies Ahead for Offshore IT Service Providers?

Top-line growth? Sure. But margin compression could loom as well.

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All tier-one offshore IT service providers, including  Cognizant (CTSH),  Infosys (INFY),  Wipro (WIT) and Tata Consultancy Services, recently announced their quarterly results, which indicate that growth momentum is gradually picking up for offshore IT outsourcing. Though the economy remains uncertain, there appears to be no pullback in IT spending. Instead, all leading indicators point to a healthy uptick in spending by companies worldwide. While service buyers continue to keep their eye on cost-reduction projects that deliver a quick return on their investments, recent booking trends indicate that companies aren't averse to increasing their budgets for discretionary and longer-term transformational projects. This upward demand trajectory will more likely lead to revenue expansion for offshore service providers in the near-term. However, we believe that, with a multitude of factors in play, increased top-line growth may not translate to improved margin levels. Overall, we expect fiscal 2011 to yield mixed results for offshore IT service providers.

Expect Growth to be Broad Based, Driven by Higher Volumes
After keeping a tight leash on their budgets during the downturn, companies increased their overall IT spending in general--and discretionary spending in particular--during the last few months. The increase in discretionary spending is evident from higher growth numbers reported in the application development service line. Additionally, spending on package implementation, system integration, and consulting--all of which clients consider to be discretionary--reflected an increase during this period. In terms of industry verticals and geographies, all the companies noted that the growth is broad based, and that demand remained strong across all verticals and geographies. Recent developments in Europe haven't had much impact on offshore IT service providers, as their services were mainly targeted towards clients' nondiscretionary services.

Swami Shanmugasundaram does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.