Jan-Mar 2010

Lessons for the IT Services Sector

Human capital is the key ingredient that drives the IT services industry. Despite the double-digit growth number, the revenue growth model of IT services firms, historically based on scaling of firm size, is unsustainable in the long run. Given the increasing salaries and living costs in the “IT cities” of India, it is important for firms to find ways to improve revenues. One way is to enhance the productivity of employees rather than depending only on scale. All major IT services firms invest substantially in employee training. However, the extent of these investments should ideally depend on the returns available. Unfortunately, there is little information available for companies to act on.

To understand the returns on investment from training, we undertook a research project along with our colleagues, Professor Ravi Bapna at the University of Minnesota and Professor Ram Gopal at the University of Connecticut. Our aim was to find the returns from training as it is generally done currently across a representative cross-section of Indian IT services industry. This is not an easy task since the impact of training may also depend upon the unique characteristics of each firm. In order to focus on the impact of training untainted by such firm-specific features, we constructed a panel data of Indian IT services firms for the years 2006-2008. The data included information on firm revenues, number of employees and training investments.

What we find is quite intriguing. In general, the labour input shows dismal returns. Thus, while increasing the number of employees can definitely increase revenues, the per capita revenue decreases as the firm scales up. Scaling up may not provide the best returns because it also increases transaction and coordination costs, resulting in sub-optimal returns. Additionally, to continue to scale up, firms may be recruiting from an inferior labour pool that has lower productivity.

We find that, in general, the revenues of an average firm increase by about 5 percent when it invests in training at an average level. When you consider that the average revenue base of the firms in our sample is about Rs. 200 million, this is quite substantial. Despite the costs of training, there is a considerable gain to the bottom line from training. These results can be further enhanced as firms improve training costs and explore newer methods of training delivery.

While our results are valid for those IT services firms that invest in training, they suggest that investments in training can indeed be the lever that enhances the returns from labour input and improves revenues. As Indian IT services firms foray into products and high-end outsourcing, could training become even more important? Only the future will tell.


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