The skeleton of an IT outsourcing company is the onshore/offshore business model. For example, let's say an application maintenance project involves about 20 programmers. Usually around 30% of the team is onshore (i.e. at the client’s location), and the remaining 70% is in an offshore development center. So about 6 programmers would work onshore and 14 programmers would work offshore. By following this model the revenues should also be split that way.
Satyam (SAY) has disclosed in page 39 of its 10-k report that its offshore and onshore revenues are almost the same. In fact, until 2005 around 58% of revenues came from on-site and 42% revenues came from offshore. Following are a couple of reasons for this:
1. The billing rate of onshore resources is more than that of offshore.
2. There are certain engagements, usually the ones below $1mn, where the entire team of 8-10 people is onshore working independently. These kind of projects tilt the balance of revenues towards onshore.
Following is the breakup of onshore and offshore revenues for the last three years for Satyam:
As Satyam’s offshore revenues increase more than that of onshore, so the gross profits have gone down from 40% in 2003 to around 34% in 2007. This is also supported by the fact that its revenues/employees ratio has decreased from $46,000/employee in 2003 to $36,000/employee. But the cost per employee has very slightly decreased from $27,952/ employee to $24,014/employee.
I wish all other outsourcing companies provided the information that Satyam has provided in its 10-k report. Infosys (NASDAQ:INFY) in its 10-k report has just mentioned that 71% of its billed person months originated from offshore and the rest was onshore. This is around a 7:3 ratio.
Assuming the onshore billing rate of $80/hr and offshore billing rate of around $35/hr (this is just a guess from my experience in working in the IT outsourcing business), if the total billed person months were 1000 and a person on an average works for 160 hrs a month, then the onshore revenues = $80 x 160 x 300 = $3.84mn.
The offshore revenues = $40 x 160 x 700 = $4.48 mn
As the % of billed offshore person months increases, so the revenue/employee ratio has decreased from $48,900/employee to $42,797/employee. And the cost/employee has also gone down from $27,000/employee to $24,600/employee, decreasing the gross profit margin from 44.69% to 42.49%.
From the above two instances of Satyam and Infosys and comparing Cognizant’s (NASDAQ:CTSH) revenue/employee from 2002 ($37,000/employee) to that of 2007 ($36,000/employee), it can be assumed that Cognizant has kept its onshore/offshore ratio fixed for the last five years.