CFO Bridge Insights October 2023

Charting the Course: Have you got your Facility cost right? Is it optimized?

Overview

Unlike US companies which embraced offshoring to India or outsourcing in a big way in the last 15-20 years, European countries have not outsourced significantly. This can be witnessed in the Geographic Mix of the IT companies revenue which has 60%+ from US and about 30-35% from Europe region and balance from rest of the world.

In the recent years post Covid, the IT industry has been able to prove to the world at large that the work can be delivered seamlessly from anywhere meeting the client requirements. So a strong case for Offshoring to India to gain full cost advantage has been proven beyond doubt. Companies which were hesitant on moving from On-Prem to Cloud pre-covid have started to think differently and explore options.

Now to give a better comfort, a low cost near shoring model is also being explored by IT companies which are set up in Poland, Hungary, Czech, Puerto Rico, Eastern Europe, Spain, Morocco, Costa Rica, Guatemala etc., to clients so that hybrid model of near-shoring and offshoring to India co-exists to make the outsourcing successful.

Needless to say, there are many factors to be kept in mind before setting up operations in various countries and to have optimal traction and economies of scale. Typically facility cost would constitute: Rent & Short term leasing cost of the facilities, Power & Fuel cost , Repairs and Maintenance of Building, equipment and others including establishment costs.

While our focus would be predominantly on the India Offshoring part in this newsletter, we would give some guidance on the onsite or near-shore facility cost management as well.

As always, we value your feedback and comments, so please feel free to write to us.

Facility Cost spend by Major 10 IT companies

Note: Above data is expressed as % of Total Income ; TCS & Wipro break-up not available; data sourced from Annual report of the companies

Annual facility cost per YE employee

In FY23 Persistent and Cyient are clear outliers; TCS, Infosys, LTIM, CoForge are around a range and HCL T, Wipro, Tech M and LTTS are around a similar range. The above would have been influenced by offshore/Onsite mix, % of hybrid working, own- leased-co-working offices etc.,

Note : Since 2019, INDAS 116 and other major accounting standards have defined the methodology for accounting leases which covers right to use of an asset for a period and associated liability for payments. This change has brought in a level playing comparison between own facilities usage vs. leased facilities usage. So if you are undertaking a comprehensive assessment of real estate costs the right to use costs reflected disclosed in the financials may also be looked in. In our comparison we have compared only what is reflected under facility cost and not what is reported under depreciation. Where companies have reclasses this cost under facility cost we have considered and where it is under depreciation the same is not reflected. Kindly take note of this.

Power & Fuel

Infosys, LT Mindtree, Persistent are having this cost in the lower range and other companies are more than twice.

Suggestions:

• Renewal/Low cost energy sources: Many companies are now sourcing renewal energy at lower cost, cutting down on diesel cost. Old DG sets which are inefficient are being replaced.

• Power Subsidy: In some states there are subsidies available, do check if they are availed by your company where possible.

• Granular monitoring of per unit cost trend: It is important that the cost is tracked month on month by various sources of power – State Power, DG Usage, Renewable power etc., separately to know the mix % and cost per unit of usage. By tracking this one will clearly witness opportunities for improving the efficiency. Any aberration needs to be analysed for root cause and be fixed on priority. Do also understand the spend is seasonal with higher usage in summers compared to winters.

• Sub-meters and Optimal usage: It is noticed that many companies have started a hot desk model of working where even though AC can be operated for all the floor, they segregate and switch off the usage if there is no occupancy in some floor. This is one example, there will be many more inefficiencies which can be looked into for optimal usage of power by keeping sub-meters to monitor usage.

• ESG and Green Energy: Many IT companies are giving importance to carbon credit and hence embracing the migration to Green energy keeping the ESG in mind. This helps in scoring brownie points with clients during their visit and in selection of vendors.

Rent & Short Term Leases

Infosys and HCL are quite low compared to other IT companies. This cost could have a comparison mismatch if companies have their own campus, in which case the cost would get reflected as depreciation on building and cashflow impact on investment, refer to the note mentioned earlier on the changes in accounting standard. This change in accounting standard provides for a level playing field to companies that have lesser cash to deploy on campus infrastructure vs. companies which have invested using their surplus cash. In case of near-shore or onsite, one must be judicious in the spend and ensure the occupancy levels are above 90% level too. While offshore may build buffer space.

Suggestions:

• Building capacity of offshore campus: Companies will have to estimate the growth and plan the seating capacity keeping the growth visibility in place. Many times, the bare shell is kept ready and it is converted with near visibility of order/pipeline with full fledged infrastructure.

• Building capacity in Onsite/Nearshore: : Many times the opening of the facilities in Onsite/nearshore comes out of impulsive decision making or client or business compulsions. Be conscious in those decision-making processes and ensure you do not commit long term leases without a firm order in hand. Do have an option for foreclosure with minimal or no additional cost.

• Availing of Grants/Subsidies: Do check with local governments when you set-up facilities whether you can get some grants and do not miss to avail of those and be realistic in your commitments to honour them.

• Tracking of per seat cost and occupancy by location/facility:It is important to ensure that the per seat cost by each facility is tracked. Also track the occupancy of the same through a proper seat assignment process. Take closure action if there is no line of sight for occupancy.

• Leveraging Tier 2/3 and Co-working spaces: It is important to ensure that the cost per seat is optimal and we make it a semi-variable cost using a co-working space where feasible. A co-working space gives the flexibility to expand or contract on the basis of growth.

• Sales Offices: In case of onsite or India presence, if the Sales or Sales PMO needs an office, better to use a Co-working space and also track the occupancy since most of the time Sales team may not have usage of the office space and will be in clients location . Be judicious in this spend.

• Ideal occupancy rates: Typically when planning is done the occupancy of 80-85% with a buffer 15-20% for any unplanned growth is fine. If there is more capacity and underutilization, be conscious of your P&L and take suitable actions to optimize cost.

• Consolidation of facilities: Many times as the organization grew many offices would get created and it is important to consolidate them at regular intervals else there are many associated and hidden costs like, people commuting between offices, additional security and other costs and the economies of scale is lost.

• Effective usage of Floor space, minimal cabins: Most companies have moved to a model with minimal cabins, open office culture, more work space and quiet enclosure for taking calls, meeting rooms of different sizes and with booking process.

• Any dedicated center or Lab for client – charged to clients : Any dedicated center or lab built for the client should be recovered in the pricing and deemed as non-standard seat cost.

• Sub-leasing: Sometimes there may be a situation that an excess capacity is taken and not being utilized or becomes vacant due to client termination of the contract/foreclosure. In such scenarios instead of leaving it vacant and incur cost, it might be worth exploring to sub-lease the space to other companies. So leave enabling clauses in your rent/leasing contracts when you sign up for any eventuality of this nature. At times this can be better than foreclosure.

Repairs & Maintenance and Workstation

This cost could be incurred on the building upkeep and other associated cost of infrastructure and establishment. Barring Cyient and Persistent which are outliers in this spend, rest of the companies are range bound and indicates this cost could be around 0.6% -1.2% of revenue.

Suggestions:

• Spend on modification in leased premises: Many times, IT companies end up creating development centers, Labs, training rooms etc., in case of leased premises and if they are short term leases these costs would be sunk cost. So be judicious in your spend on improvements to the facility. Also sometimes landlords insist on restoring the facility to its original state which can also be an additional cost.

• Design layout: Ensure the facility taken on lease is having the ideal seating space for the nature of work to avoid wastage. There is a difference between IT work and BPO call center seats. Do keep this in mind.

• Access control: Attendance and security protocols need importance and leveraging technology many activities can be improved and also have good user experience on entry and exit both for employees and visitors. Building those protocols can help in security and other controls.

• Avoiding plastic, disposal process , reusable cups: Most companies have avoided or limited paper/plastic cups and chosen to have re-usable cups. Some of the operational cost needs a deeper tracking since value wise it can be small but has potential for cost optimization and hence tracking will have its payback.

• Standard per seat IT cost: A standard seat would have Lan cabling / Wi-Fi hot spots, plug socket - table ( partitioned) with ergonomic chair. It can have a workstation with a desktop or a space for a laptop. It is assumed the desktop or laptop will have standard MS Office configuration and other standard licenses built in including anti-virus. The bundled cost is typically part of the per seat cost when it is used for comparisons. Any non-standard or additional cost is typically charged to clients additionally in pricing , say if we use a higher configuration laptop.

Concluding Notes

• When the annual budgeting exercise is done, do plan the revenue mix and the geographic plan for the seating capacity and dovetail the same with the companies strategy on Work from home and Return to office mix.

• Where feasible try to use the same seats for multiple shifts for better seat utilization

• Do not have multiple offices in a city, better to optimize the same.

• Do not over commit to the client on a facility or location, try to keep it flexible but assure them of a good work environment.

• Leverage any government subsidies/grants where possible and if there are any commitments made ensure they are feasible to achieve and do not over commit.

• When negotiating, try to negotiate a good rental and a good period of commitment if you have a good line of sight and growth.

Overall, if the Facility cost is hovering around 1 – 1.5% then it is within a range, else you may like to see whether the spend is higher in which sub-bucket – Power & Fuel or Rent or Repairs and Maintenance and take suitable action for optimization.

Do also note that with Global Capability centers or Global Captive centers – GCC are growing big time in India in the recent years and Investment banking firms are also betting big on growth of realty business. This can make the leasing costs go up. So watch out for this as well since it can have a bearing on your per seat cost too.