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We have long been impressed with the ability of Indian outsourcing firms to hire enough new employees to sustain their tremendous growth rates. As we noted in May 2006:

Think about it. A company that already had a large number of employees (17,050 at March 31, 2005) grew its employee base by 57 per cent in one year. Plus, if the 11 per cent annualized turnover the company experienced in the latest quarter is typical (by our recollection it seems on the low side) that means they would have lost 2,400 employees to attrition during the time (11 per cent of the average number of employees during the year.)

So to add 9,700 employees the company had to hire 12,000. Almost 50 new hires every working day. Even if they hire a quarter of all applicants that means interviewing 200 per day. And if they want to grow another 50 per cent next year they will have to hire 75 new employees each workday this year. By all accounts there are plenty of graduating software engineers in India to hire. But that is still one heck of a logistical exercise. And someday it will be too much to handle and the company will trip up.

If we had to point to one specific risk factor as being Cognizant’s greatest, it would be managing all of that growth. We don’t think it will happen this year, but it could. Or, just as likely, they could continue to coast for several more years. And in the meantime, it is a nice problem to have.

Since then, the stocks have continued to soar.

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Unfortunately, the “one specific risk factor” has also grown in importance. Infosys (NYSE:INFY) turnover rose to 12.9% in the third quarter, and Cognizant (NASDAQ:CTSH) said it was something management was monitoring. Now, based on Infosys’ fourth quarter report, “monitoring” may translate into “watching it get worse.”

Infosys Faces Quality Problems In Staff

Can there be problems when a company is surging a wave of plenty with $1 billion in cash? Apparently, yes.Infosys Technologies may be rich and hiring by the thousands, but has to compete with giants like IBM and Accenture in wooing engineers and programmers, and staff attrition is a looming problem.

The company’s attrition rate rose to 13.5 per cent in the latest October-December quarter compared with 10 per cent during the same period last year. But not all of them left on their own.

About 1.3 percentage points of the 13.5 per cent attrition are attributed to poor quality of work by trainees who could not match up to expectations.

Despite the recent rally, P/E multiples have remained near their recent averages (the stock price rise has been backed by fundamentals.) However, at the current rates of attrition, the recent growth rates will soon prove unsustainable.

Source: Indian Outsourcing's High Growth is Unsustainable at Current Attrition Rates