In 2013, when Nationwide Insurance in Ohio chose technology company Guidewire to run its $9 billion worth of business on the latter’s core insurance offerings, it knew it was a big deal. What it did not realise was how difficult it would be to find people to spearhead that transformation. EY, the consulting company, was helping Guidewire understand how Nationwide operated its business so that its engineers could configure the software accordingly. To do that, it needed hundreds of business analysts who understood tech and insurance.

“At one point, EY needed 150-200 business analysts for the project. It was just not able to get them. There weren’t many people available with the required skill set in the market. So it went ahead and hired from anywhere and everywhere it could think of,” said an industry insider, declining to be named since he wasn’t directly involved with the contract. “If it hadn’t found enough people to finish the project, either it would have walked away or there could have been financial repercussions.”

That’s how the tech industry works. You need to forecast specific skill sets that will be in demand, to make sure that you have enough people available. And that is why Indian technology companies apply for H-1B visas in preposterous numbers. So that they have skilled people available in the United States, whenever a new contract comes up. That was the intention, at least to begin with.

“H-1B was put in place to mitigate demand and supply gap from skill set perspective, but companies figured that they could use it for the cost advantage. And that started taking centre stage from H-1B perspective. An analyst in the US, who probably could have gotten the job, lost it because somebody with H-1B was willing to do it at a lower rate,” said Ronak Bhatt, a business transformation principal, who has previously worked as a management consultant with firms like Accenture and Cognizant.

That’s the eye of the storm today.

The Donald Trump administration is hell-bent on making sure that companies are unable to bring cheaper labour to the US.

Last month, California Congresswoman Zoe Lofgren introduced The High-Skilled Integrity and Fairness Act of 2017, which demands that the minimum annual wage for H-1B visa holders goes up to $130,000 from the current $60,000. It also supports a market-based allocation of visas to those companies willing to pay the highest, instead of the prevailing lottery system.

This is neither the first such attempt, nor will it be the last one.

“The reality is $130,000 is higher than what [even] US nationals doing the same thing would be paid. Trump has tried to change the game, making it cheaper to hire a US national. If you want to hire an Indian national, you would actually have to pay a little bit more,” said Sanjoy Sen, a doctoral research scholar at the Aston Business School in the United Kingdom, who was earlier with Deloitte.

The Indian information technology industry is almost sure that this bill is far from being passed. However, if implemented, say experts (and everybody else out there), it will remarkably change the game for IT firms. No less significantly, it will affect their clients in the United States, which may have to shell out more for services. But how?

The deal with on-site

IT services is a shining star in India’s economy. It constitutes 9.3% of India’s gross domestic product and enjoys more than a 45% share in the services export market. It is the largest employment generator in the private sector, providing 3.7 million jobs. Of the $143-billion IT industry revenue in the financial year 2016, $100 billion is estimated to be from exports, according to the software lobby Nasscom. And 60% of that IT export revenue comes from the United States. In contrast, the United Kingdom, the second-largest market, contributes 17% to the total export revenue.

Traditionally, Indian IT firms have provided US companies technical support to operate their back-end systems and applications running on them – which they call infrastructure and application management services. It still is their bread-and-butter and gives them about 50% of their revenue. The rest is distributed among engineering and research and development, enterprise solutions and consulting, business process management and digital engagements – anything to do with social, mobility, analytics, cloud, automation and Internet of Things.

For an infrastructure and application management project, typically, an Indian IT company sends 20%-30% of the people allocated for the job on-site, while the rest of the team supports the project from India. The number of people working on a project varies. A large deal with a large client may have 300-400 people. For smaller deals, the number would be smaller.

In all such projects, on-site presence is integral. Skilled IT workers have to execute at locations where such professionals are either not available or come at a very high cost.

“Realistically, there has to be some element of on-site in a project. For infra and application management deals, it is about coordination. Not all work can be done completely on-site or completely off-site,” said Bhatt. “The mission-critical aspect of a business is never off-site.”

“For example, if you are a US-based telecom company, your US customers are going to call you from 9-5, you will have to run a call centre in India where people actually will work night shift. But sometimes there are critical processes for which you may have to coordinate with your actual business operations team, which works 9-5 in the US. You will have to be physically present over there so that you don’t have to wait for 12 hours to get the issue resolved,” he explained.

He added, “Also, if you are doing a complex project, you would need an on-site presence to get things stabilised. Once all the nuts and bolts are understood, to have more efficiency you would move offshore. Sometimes there are rules and market regulations, which don’t allow clients to move core competencies outside the jurisdiction.”

Sanchit Gogia, chief analyst and chief executive at Greyhound Research, emphasised that the need to have people on-site is more than just technical.

“IT companies are required to have meetings with different stakeholders to implement a business solution,” Gogia said. “Then, there is this trust factor. Clients are also at ease when someone from the company is physically present [and is accountable]. This is also about work environment and change management.”

Then comes the cost part. “IT firms pay an Indian employee around $70,000-$80,000 for a job on-site, but it costs them at least $100,000 to hire a local,” said Sen. “Even after paying these [wage] costs, once you convert services provided into number of hours the Indian professionals work and apply the cost per hour, obviously they are making significant profits on the back of it by billing the client. Overall, they at least make a profit of 25%-30%.”

There is an underlying advantage, too.

In some cases, IT companies would earn more margins when billing a client for a person working on-site, versus what they would make if the same person worked on the same job off-site. Because the clients are billed differently on-site and off-site, acknowledge industry veterans.

For instance, if an IT firm charges its client $100 per hour for a person working on-site for $60 (per hour), the profit would be $40. If the same person is working on the same job from India for $20 (the salary difference for a person working on-site and off-site on the same job is at least 3X), and the client is charged $50 per hour, the IT company would earn $30 on it.

“But, in general, they would try to maintain the same margins,” added Sen. “When the IT companies take the work off-site, though the margins are less, they would make it a volume game. That is, putting in more number of hours so the overall profit goes up.”

Infographics by Nikita Takkar
Infographics by Nikita Takkar

The much-awaited transformation

In the last few years, IT firms have expanded the scope of the work, beyond infrastructure and application management. They have tried to pitch solutions and platforms (software code, which they sell as a package to provide a suite of services), which solve a business problem or offer a business outcome. For example, they may say to clients: If you hire us, we will reduce your supply chain cost by 20%.

Those are advisory or consulting services, where companies like Accenture and IBM do very well. For a consulting engagement, IT companies start at $150-$200 per hour; it is a far superior relationship. In such contracts, where IT companies become strategic partners to the clients, they generally send 50%-60% of people working on the project on-site. But teams are smaller, with 20-30 people on an average.

And as Indian IT companies enter the consulting business, they haven’t reduced their dependence on on-site work, which roughly translates into their dependence on the H-1B visa.

That’s because they need H-1B visas to secure additional business.

Otherwise, they will remain infra maintenance companies for the rest of their lives, said Sen. Consulting not only brings in new business but also more core technical deals.

“On-site, you have more access to the information, which can lead to the downstream projects,” said Bhatt. “You will know what the client’s issues are. The moment you start understanding their problems, you start thinking about other various solutions from the company’s perspective that you can offer them. This is not going to happen to the people at off-site. They will only do the allocated work.”

At the end of the day, it is about creating relationships, because these companies want to increase their revenue from every client over a period of time.

The tug of war

Amidst all this, Nasscom is taking a firm stance against the proposed bill.

“This bill does not address the root cause of the issue, which is a lack of skills. If the objective is to save American jobs, [the bill] does not fulfil the objective by raising the minimum wages,” said Shivendra Singh, head, Global Trade Development. “We will continue to highlight how important the role played by the Indian IT is to the American legislature through the process of the bill.”

The bill, many believe, will hurt the American companies as well.

The impact on Indian IT firms is not as simple as multiplying the number of people on an H-1B visa with the difference between $60,000 and $130,000 to arrive at a consequential number.

“If the regulations get implemented, it would be naive to think that IT companies will deliver the services at the same cost,” said Sen. “In most cases, it would definitely trigger a re-negotiation. This is going to increase cost for American companies at least by 10%. If there was enough resource in America, obviously this would not have happened. But they can’t backtrack on IT because if they did, it would erode their profitability.”

At the end of the day, experts said, it raises costs for everyone. It might also backfire on American companies.

“If the minimum wage increases, there will be a decline in margins of around 100-150 bps [basis points], but Main Street America will see a massive increase in IT costs as compensation will increase in an already resource-constrained market,” said TV Mohandas Pai, chairman, Aarin Capital Partners. “Yes, the big companies in Silicon Valley are willing to pay above $100,000, but they are a small part of the industry.”

Simultaneously, IT firms are evaluating how much actual work could be done sitting in India or nearshore – in locations like Mexico or Brazil.

“Increasing the salary of the H-1B visa will be difficult for Indian IT companies. If such a law comes into force in the US, there could be a possibility that they might hire someone in the US. I don’t think video conference or automation can help a lot,” said Sandeep Ladda, national leader of technology and e-commerce at PwC. On the other hand, Sen argued that overseas acquisitions by Indian IT companies may increase because each of these acquisitions will come with a team of local people.

In the end, it’s a tug of war not only between cost arbitrage and visa pushback, Nasscom and the Trump administration, but also between strategic calls within IT firms themselves. How long would they need H-1B to thrive?

This article is republished with permission from The Ken, a subscription-based news site that publishes one original story every week day on technology, healthcare and business. The article was first published on February 6.