Compiled by: Chhaya Sehgal

The Winning Edge

SQUEEZING THE EMPLOYEE PAY PACKETS During the fourth quarter of financial year (FY) 2007-2008, Tata Consultancy Services Limited (TCS), the largest Information Technology (IT) company in India announced its plans to cut 1.5 percent of the variable component of employees compensation. It clarified, however, that there would not be any changes in the perquisites of its employees. The rapid appreciation of the Indian Rupee against the US dollar over the previous year and the imminent recession in the US economy, which was the biggest market for the Indian IT companies, had put a lot of pressure on Indian IT companies. The announcement came soon after TCS found it unable to achieve its Economic Value Added (EVA) target for the third quarter of the FY 20072008. The unprecedented move by TCS caught the entire IT Industry by surprise. The EVA payment made in advance for the third quarter was to be deducted from the variable salaries in the fourth quarter. The variable component of the salaries of the TCS employees constituted 30 percent of their total compensation, and even went up to 40-50 percent in the case of senior management. The decision came as a shock to many employees and the media gave wide coverage to TCS decision. The employees fears were compounded when TCS showed some 500 of its employees the door in February 2008 on performance grounds. Established in 1968, TCS was the market leader among the Indian IT industry as of 2008. Its revenues for the third quarter of the FY 2007-2008 increased by 5.04 percent to Indian Rupees (Rs.) 59.24 billion and net profit rose by 6.72 percent to Rs. 13.31 billion. In the wake of the appreciating rupee and signs of recession in the US economy, TCS decided to cut salaries since the companys margins were severely impacted. According to S Mahalingam (Mahalingam), Chief Financial Officer (CFO), TCS, Fundamentally the business operates on sound principles. There is an appreciation of rupee, which will definitely have an impact, which the market has priced. The company was also cutting costs to ease the impact on margins by balancing the need to cut travel costs with the need to visit potential clients to boost business. TCS was not the only company facing problems in the Indian IT industry; the industry as a whole, in fact, was feeling the heat. Infosys Technologies Limited (Infosys) and Wipro Technologies (Wipro), the two other major Indian IT companies, were also struggling due to increased wage inflation and salary hikes. According to analysts, the business dynamics of the Indian IT industry had not been good and the wage cut by TCS was an indication that all was not well with the industry. Experts opined that the Indian IT industry was headed for a fall with attrition hovering at around 43 percent. The mounting employee costs would force other IT companies to follow in TCS footsteps, they said. A business analyst at HSBC Holdings plc (HSBC) said that it was not only the IT sector but the whole outsourcing business that had suddenly become sluggish and added that a few more shockers were soon expected. The decision to cut pay was criticized in many quarters. The employees criticized TCS for not being transparent in the compensation policy for its employees. They alleged 1

Compiled by: Chhaya Sehgal

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that TCS had never paid excess compensation to them when the company had achieved better results than the set targets but that it was the first in the industry to cut salaries when targets were not met. There were also concerns that the cut in pay would result in an increase in attrition numbers. The image of TCS as one of the best IT employers in India also came into question. Though some analysts said that the Indian IT industry would sail through the turbulent period safely, some contended that IT employees had to realize that the days of a consistent double digit growth in their salaries were over and that the only option before the Indian IT companies was to look for alternative sources of revenue and to explore new markets rather than rely on the US market alone. THE HR POLICIES TCS gave utmost importance to its human resource function. The company viewed its employees as assets, which had to be utilized efficiently. The TCS senior management constantly kept track of the vast intellectual assets, their skill sets, the status of projects on which they were working, and the number of people available for being placed in other projects. TCS determined its manpower requirements based on inputs from senior consultants, who provided information on changes in technology and the potential demand for new IT skills in the immediate future. This enabled the HR department to plan and schedule recruitment and training programs. TCS took care of every aspect of human resource management, from recruiting to training and career development. The company viewed recruitment as an ongoing process. To fill entry-level positions, the company picked up candidates from college campuses across the country. TCS deployed over 50 senior executives who maintained contacts with leading educational institutions in India. The company combined its aim of recruiting software engineers with the broader objective of improving educational standards in India. It sponsored IT conferences and seminars in these institutes. The company also engaged in reforming the course curriculum and teaching methods for these institutes. TCS was well recognized in the industry for its emphasis on employee training. The company invested a large amount of money on this activity. In late 1997, the company inaugurated a training center in Thiruvananthapuram, Kerala, to impart IT skills in the latest technology to its new recruits. The center had the capacity to train 600 employees at a time. The atmosphere resembled a college campus, providing a congenial environment in which its fresh out-of-college recruits could learn. In 1998, TCS spent 6 percent of its total annual sales on training. Training contributed significantly to the quality of the companys products and its brand image. Praising TCS for its training programs, Radha Krishnan, Chief Executive Officer (CEO), Innova Solutions, a software services company based in Silicon Valley, US said, The training at TCS is no doubt excellent, and that is why everybody tries to lure a TCS engineer. In addition to training, TCS also believed in grooming its employees into consultants and managers. In their first couple of years at the company, employees were put to work on different technological platforms and applications. This was important for

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TCS as technologies and customer needs and preferences changed rapidly. The company did not try to develop its employees as specialists, as it knew that they would become useless once their area of specialization became obsolete. After two years, according to individual performances, the employees were promoted as system consultants. The TCS management provided them with ample to go up the corporate ladder. This approach was different from that of many other IT companies, who stressed specialization of their workforces. The success of TCS HR policies was reflected in the fact that its annual employee attrition rate was 12.6 percent for the FY 2007-2008, the lowest in the industry. Of its employees, 28 percent were women while foreign nationals from 62 different countries, constituted 9.1 percent of its total employee base. The attrition rates in other IT companies stood at 15 percent during the same period. In 2007, Dataquest, one of the leading technology publications in India, ranked TCS first in its list of Top 20 employers in India. The company was recognized after attaining impressive HR scores and employee satisfaction levels. The same year, TCS was awarded the 23 rd rank on the Business Week Top 100 IT Companies. PERFORMANCE-LINKED SALARY STRUCTURE Despite being rated as one of the top IT employers in India, however, TCS had drawn criticism for its compensation structure. According to the employees the salaries were not on a par with the industry standards. TCS was also under pressure to follow the Employee Stock Options (ESOP) schemes followed by its competitors. ESOPs had emerged as one of the most powerful tools for retaining employees. Several industry observers opined that the absence of stock options limited TCS ability to attract the best talent in the industry In a bid to combat these criticisms, TCS came up with the proposal that it would follow a performance-linked salary structure called the Economic Value Added (EVA) model in 1999. With this EVA model, it aimed to give differential pay scales to employees at the same level of the hierarchy based on the performance of the individual and the company. TCS was the pioneer in implementing EVA as a part of its competitive salary structure. EVA determined the compensation based on the value delivered to the employer. It was measured at individual, department, and enterprise levels. According to the EVA model, the total corporate value depended on the performance of business units and the performance of the people in those units. Individually, the employee needed to know his/her contribution to the drivers that enhanced the EVA of a business unit, which in turn would enhance the EVA of the corporation. The main drivers of EVA were revenue, cost, and capital charge. Individuals could contribute to the growth of EVA by acting on the drivers that they controlled. The main revenue drivers were product licensing fees, fees billed for onsite or offsite work, sales, billable hours, response time, and domain skills. On-time delivery contributed strongly to EVA as better delivery cycles increased the orders from customers. Cost drivers were determined both at the individual as well as the department levels, and

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they also included sales & marketing and recruitment expenditure. Project leaders were well aware of EVA targets, the revenue, and cost drivers. After determining the EVA targets, the employees were informed about the ways of attaining them. An individual was expected to work toward improving the entire benefit package consisting of three components like corporate EVA, business-unit EVA, and individual performance. The individual received a percentage of the total EVA based on the improvement of corporate EVA. While paying out incentives to junior level employees, individual performance was given maximum consideration. The units performance was given the highest consideration for middle level employees, and corporate performance was given the greatest importance at the senior management level. TCS offered salaries in a two-tier package structure that consisted of fixed pay and variable pay. Fixed pay amounted to 70 percent of the salary and the variable pay to the rest. The fixed pay, which was not subject to any change on the basis of EVA, was different at different levels, and changed only when the cost of living increased substantially or when the pay scales in the industry went up considerably. Out of the total EVA, every employee got a certain percentage as incentives based on the improvement of the corporate EVA. If the business unit did well, the employee would also get incentives as a part of the business unit EVA. Individual performance would determine the individual EVA. According to Ramadorai, Theres no ceiling on the bonus. It can be equal to the fixed portion of the salary, providing the cell has shown that kind of EVA growth. In order to maintain consistency in pay and ensure that it did not vary much every year, TCS created a bonus bank. The variable pay was paid not immediately but after a certain interval. Initially, a target bonus was allocated that could be paid only after realization of the target, and was multiplied by a factor if the targeted EVA was surpassed. When targets were exceeded, potential bonus was declared and was deposited in a bonus bank. The individual bonus bank had two components; while the first component consisted of a share for corporate performance; the second was for project and individual performance. The amount was accumulated each year but employees could withdraw only up to twothirds of the amount each year. This left some balance in the bonus bank, which was used to maintain compensation levels for employees during lean times. The bonus bank provided a long-term plan and demanded consistent performance from employees. According to Mahalingam, This gives employees an ability to take a longterm view of things. There is no way that employees can go totally wrong in their (EVA) projections. TCS had a clear stand on ESOPs. ESOPs were offered to only a few employees while most of the employees were under the purview of EVA. However, the TCS management believed that the compensation system would be a combination of both EVA and ESOPs. According to Ramadorai, One is not a replacement of the other.

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EVA focuses on value creation and ESOPs provide the commitment as well as rewards over the long term. TCS ANNOUNCES PAY CUTS In January 2008, the management of TCS gave a jolt to its employees by announcing its plans to cut 1.5 percent of the variable component of the total compensation of its employees. The reason cited for this was the companys inability to meet the EVA target for the third quarter of the FY 2007-2008. Considering the cut as a meager adjustment, Pradipta Bagchi (Bagchi), General Manager, Corporate Communications, TCS said, The cut down is just a small adjustment as against the total compensation paid by the company before starting of the third quarter. The variable salary for the third quarter was paid in advance to the employees and the company proposed to adjust the excess amount during the fourth quarter of 2007-2008. The variable compensation for the third quarter amounted to Rs. 3.76 billion while TCS achieved an EVA target of Rs. 2.93 billion. The advance payment to be adjusted in the fourth quarter amounted to Rs. 0.83 billion. According to analysts, the TCS salary cuts were considered as a negative move that gave a warning sign to employees that everything was not fine in the IT sector. Commenting on the wage cut, a Mumbai brokerage analyst said, This can send a strong signal to the employees that revenues have not measured up to internal targets. The cut is small and is unlikely to attract a howl of protests, but employees will get the message that all is not well with the sector. Instead of giving them a shock at the time of annual salary review, the management has sought to lower their expectations of wage inflation through this small cut. The pay cuts gave a jolt to not only the over 0.1 million TCS employees but also to the 7 million IT employees across India. A TCS employee said, It is not about economics but our livelihood. If our income is going to be this uncertain, how can we plan for our future? Moreover, their problems were compounded when the company announced that the salary cut would be adjusted in their allowance after the declaration of the fourth quarter results for the FY 2007-2008. In the release to the employees, TCS said, In Q4, we will follow the same basis of advance payment of Variable Pay as per expected EVA projections at the beginning of 2007-08. When the audited results for Q4 are announced in April 2008, appropriate adjustment in Variable Pay will be made either upward or downward as the case may be. Commenting on this announcement, an employee at TCS said, The company has not given exact reasons for the cut in Q3. Now, it wants us to prepare for the fourth quarter too. This is the first time that the company has cut down the variable allowance. In addition to slashing a part of the variable salary, the pay hikes were also expected to stabilize due to the increase in wage inflation. Commenting on the moderation of wage hikes, Mahalingam said, The average salary hike is about 15 per cent per annum each year. We expect salaries to stabilize. This would broadly depend on 2-3 issues and therefore brings in a variable component. However, the industry is concerned about ensuring margins, it would certainly put more pressure if a similar hike is to be offered this year.

Compiled by: Chhaya Sehgal

The Winning Edge

In an industry where pay hikes of 40 percent were common, Phiroz Vandrevala (Vandrevala) said that TCS pay cut was their initial step to introducing realistic expectations According to a survey by CLSA Asia Pacific, around 40 percent of the employees in the Indian IT industry expected an annual salary hike of 20 percent over the next 10 years. Analysts opined that if this trend of wage hikes continued, India would become too costly and would face difficulties in providing services at competitive prices. It was speculated that other IT companies would follow suit and consider moderating salaries. According to an IT Specialist at Ma Foi Consultants, other companies had also taken cautious approaches. However, Infosys and Wipro said that they did not have any plans to consider the approach followed by TCS. T V Mohandas Pai (Pai), HR Director at Infosys, said, Everybody in the industry is subject to the same market conditions. Whether you cut employee salaries based on business outcomes depends on the business model you follow. As long as we sell on value and not on price, we will remain competitive. Wipro too denied rumors of cutting employee salaries. Pratik Kumar, Corporate Vice President, HR, Wipro confirmed that the company was not considering any such move. Analysts were of the view that the increasing wage inflation could be stabilized by moderating the wage hikes. According to Ganesh Natarajan, apex body, NASSCOM, There is no need to panic and we do not have to revisit salaries. But there has to be a moderation in expectations of salary increases. With the inflation hovering around 4%, it is my view that salary hikes will be moderated around 9-10% from the earlier average of 15%. To add to employees fears, TCS asked about 500 employees whose performance was not up to the mark to leave the company in February 2008. This was based on the performance ratings obtained by the employees in the companys bi-annual performance appraisal system that ranked the employees on a scale of 1-5. According to TCS, If an employee gets a grade of 2 or less during one appraisal cycle, he or she is put on a performance improvement plan which includes additional training as well as assignments on new projects. If at the end of the second appraisal cycle, the employee does not come up to the mark and his or her ratings do not improve beyond 2, then TCS, after proper counseling, disengages with them. Industry watchers viewed these job cuts as a cost-cutting measure by TCS amidst the rising rupee and fears of a recession in the US. THE REASONS TCS cited several reasons for cutting down employee salaries. The major reason for the unprecedented cut in variable pay was its inability to meet the EVA target for the third quarter of the FY 2007-2008. The rise of the rupee against the US dollar was another major concern for TCS. The rupee had appreciated by 12 percent against the US dollar, building tremendous pressure on the companys margins and revenues. Another reason was the slowdown in the US economy that forced IT companies to cut their corporate spending. The earnings and revenues of IT companies were expected to decline since the US was the largest market for the Indian IT industry, accounting for

Compiled by: Chhaya Sehgal

The Winning Edge

around 61 percent of the exports. Commenting on the impact of the US slowdown on the Indian economy, Simon Ormston, Head, Outsourcing market, BT Global Services said, The global economy will be impacted The US is by far Indias biggest market. According to a report by HSBC and Capital Markets (Capital Markets), the US slowdown was expected to lead to a decline in net profit margins and revenues of IT companies in the range of 500 to 1,500 basis points in the fiscal 2007-2008. Moreover, the service tax on rented and leased premises in conjunction with the obligation of minimum alternate tax (MAT) was likely to take a toll on IT companies. According to certain estimates by Emkay Research (Emkay), a service tax of 12.5 percent on rented and leased premises would affect IT companies by 50-100 basis points. The impact of MAT was expected to affect the earnings in the range of 1-6 percent. Amidst the panic about a possible slowdown in the US economy, TCS decision to cut 500 jobs was also viewed as a cost-cutting measure. However, TCS brushed off speculations regarding cost- cutting and said that the employee resignation was part of their appraisal process. Bagchi said, This is not an exceptional thing, it happens every year and it is part of our annual performance exercise. In TCS, everyone has to go through an appraisal cycle where they are rated between 1 and 5 depending on their performance. If in one appraisal cycle anyone is rated below 2, we put them on PIP (performance improvement plan). Under this, they are given extra training. Even after this if their rating is below 2, then they are asked to look for other jobs. Though TCS viewed the US slowdown as a threat, it also said that the slowdown had not affected it much as contracts from new clients and increasing business volumes had helped it maintain its businesses. Vandrevala said, As of now, its business as usual, though of course [a US slowdown] is a threat. However, TCS expressed its concern over the cuts in IT spending by companies due to the US slowdown. Infosys, on the other hand viewed it as an opportunity. Commenting on the US slowdown, Narayana Murthy (Murthy), chief mentor, Infosys, said, The fact that there may be a slowdown in the US means people will become much more concerned over better value for money...We could look at it as an opportunity. Industry watchers opined that there would not be any adverse impact of the slowdown on Indian IT companies. In early 2007, Mitchell D Cohen, Entertainment Leader, PricewaterhouseCoopers (PwC) Global Technology, had said, Indian IT firms will surely work their way out of this slowdown. We do not see much impact. While TCS attributed several reasons for the pay cuts, one of the reasons cited was that it aimed to cut on employee costs as it planned to create more jobs in India. According to Vandrevala, We plan to take more and more work to India. That remains the biggest lever we have to ease costs. Industry observers opined that TCS step toward containing employee costs was a bid to increase its profit margins since its second quarter margins were severely affected by 117 basis points due to the increments it offered to its employees in the first quarter of 2007.

Compiled by: Chhaya Sehgal

The Winning Edge

The DEBATE TCS move to cut employee salaries received severe criticism from some quarters. TCS reputation as one of the topmost IT employers in India took a beating as its decision to cut salaries shocked many of its employees. Many employees even opined that TCS could have cut down on some of its other expenses instead of cutting the compensation of its employees. An employee at TCS said, TCS has grown rapidly and so this news has come as a shock to many, especially the new employees who have left their well-paid jobs to join. Imagine the impact it has on the morale of the employees. If it is just the EVA then why dont they plug other expenses like the travel, magazines, stationery, telephone, and other overheads that are high costs and yet easy to curb? I am sure employees will cooperate, but who would be willing to take the brunt on their salary. Earlier in 2003, TCS had taken a similar decision, causing an uproar in the IT industry when it reduced the variable salaries of employees by 10 percent. This was due to the initial impact of EVA which was implemented in the company from April 1, 2003. The reduction in the variable salary resulted in an overall reduction of the monthly takehome salary for most of its employees. TCS was severely criticized for this move. A few employees alleged that the employees had more at stake this time around as there was actually a 20 percent cut on the variable pay that led to a 10 percent cut on the total salary. Confirming the cut, a TCS spokesman said, The pay cut of 20 per cent was due to internal targets that were not met for the October-December quarter 2007. The recent announcement of pay cuts resulted in employees criticizing TCS much acclaimed TATA code of ethics that boasted of moral and ethical values. A few employees also questioned the National award for Excellence in Corporate Governance bagged by TCS for its corporate governance practices, innovative practices, procedures followed at the Board, and high standard of disclosure and transparency to its stakeholders, in November 2007. The employees decried the fact that a company, which according to them, did not show any transparency in its policies, had bagged the award. The employees alleged that the company never disclosed the EVA target and the way it was calculated. The percentage of the company component, which formed one of the factors for EVA calculation, was never made public. A few employees contended that TCS never increased their variable pay when the EVA targets were more but that it was the first to cut when its EVA targets were not met. Earlier in 2001, when TCS achieved revenue of US$ 1 billion, employees expected some monetary benefit. To their dismay though, all they faced was a heavy cut in their salaries, they said. Expressing their concern over the salary cuts, the employees said that this step only served to demotivate them and spike attrition. Experts opined that in addition to being the leader in the IT industry, TCS USP had been job security and a steady salary structure. The wage cuts were expected to wreck its image. With the retrenchment of 500 employees in 2008, its image was likely to go down further. However, TCS had

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attributed the retrenchment only to its performance appraisal process and said it had nothing to do with the other alleged reasons. Some analysts too were of the opinion that the sacking of 500 employees had nothing to do with the slowdown in the US economy and the rise of the Indian Rupee. They said that it would be a routine exercise in the future as employees who could not keep up with the growth of the company would be asked to leave. Rivi Varghese, CEO of Customer XPs said, As an industry grows higher up the chain, it is but natural that a small percentage of the people will not be able to keep pace with that. So it is a question of expectations not being met. A few employees even considered the TCS pay cuts as part of its IT Cleansing Cycle, wherein the company laid off old employees in a bid to employ new and dynamic ones. The best way was to trim down the wage levels which would indirectly trigger the employee to leave the organization .The employees said that the variable pay cuts were the tactics adopted by TCS to show that they were in line with the industry and market expectations, and to state that TCS still enjoys the industry leading growth. OUTLOOK Despite TCS claim that it would make salary adjustments in the next quarter, the employees remained divided and expected this trend to continue. A TCS employee said, Though the official word is that the situation will be reviewed by March end, we are preparing for a regime wherein we continue with a pruned salary. Further, the pay hikes of employees in the Indian IT industry were poised to become moderate with pressure building on export earnings of Indian IT companies due to the rising rupee and signs of a slowdown in the technology spend in the US due to recession. According to executives and consultants in the tech industry, the average hike for employees was expected to be around 12-14 percent in contrast to the 14-18 percent hikes given in the previous years. Commenting on the stabilization of wage hikes, Natarajan said, A slightly lower wage hike is good for the industry But it is extremely difficult to predict if this will be done during the year. However, according to another report by ECA International (ECA), a London-based HR firm, the hikes in Indian multinationals was likely to increase by 14 percent in 2008. Lee Quane, Hong Kong-based Asia general manager for ECA said, Salary increase in India is expected to be the biggest this year as companies have to keep in mind the inflation for their employees to maintain a good economic stature. Industry insiders were also of the opinion that managing the growth would be a key challenge in the IT industry. Contrary to what the industry insiders had said, the growth outlook for the IT industry was positive. Gartner Inc. (Gartner) estimated that the Indian IT industry was poised to grow to US$ 10.73 billion by 2011. The Vice President of Gartner, Partha Iyengar (Iyengar), said, There is no sign at this point and no evidence of a slowdown (of IT industry) and India will continue to grow at a rate of 25-30 per cent. According to analysts at JPMorgan, TCS margins would increase by 50 basis points in 2008 There were indeed concerns regarding the short supply of skilled manpower for the Indian IT sector. A shortfall in the skilled manpower was expected to the biggest challenge to the Indian IT sector rather than the slowdown in

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the US economy or the rise of the Indian rupee against the dollar. Iyengar said, Only 25 percent of the total graduates in India were employable. Industry experts said that the Indian IT industry should try to reduce its dependence on the US economy and to increase their revenues from other markets like Europe and Asia. A few experts saw a silver lining for the Indian IT industry despite the gloom of a slowdown in the US According to Navi Radjou, Vice President, Forrester Research, Finally, finally, this might force Indian IT providers to turn their attention to the domestic Indian IT market, which they long overlooked.

Case study Questions

Q1. The EVA approach was criticized being non-transparent and totally subjective. Could the company approach it differently? Q2. Is the EVA-ESOP combination really better than a pure ESOP model? Q3. Has this action affected the credibility and image of TCS? Is their reputation now at stake? Q4. If Infosys and Wipro has not slashed employee salaries, does this justify they are better companies?

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