It has been almost a year since Infosys, India's second largest and most respected software company, announced its full-year results. The company, under pressure due to the slowdown in technology spending, projected a 12 per cent earnings growth that was much lower than what most analysts and investors had expected.

This underperformance on analysts' and investors' expectations led to the stock losing substantially on the bourses, taking the entire market down on April 10, 2003. Subsequently, Infosys lost around 37 per cent on April 10 and 11. However, if one takes a closer look, it was not Infosys that had failed to meet investors', or for that matter analysts' expectations.

Rather, it was the latter (investors and analysts) that had failed in their judgment of the pressures the company had been facing at that time.

Note: Returns are calculated on Rs 100 invested on April 1, 2003

Coming back to the present, since global economic recovery seems to be showing signs of sustenance, and that there is a pick-up in technology spending, and that billing rates seem to have stabilised, the investing community is again building up huge expectations from Infosys. And the company has, over the past three quarters, not disappointed them either.

For instance, the company has reported sequential revenue growth of 6.1 per cent, 4.9 per cent and 8.9 per cent in the three quarters of this fiscal respectively. Over that, Infosys' management revised its earnings projections in December to 29 per cent growth over FY03 earnings. This was much above than the 12 per cent growth that the company had earlier projected in April 2003.

There is, however, another point that the above graph indicates. It is the sequential growth in the employee base that has been much larger than the sequential growth in revenues. The base that stood at 15,356 at the close of FY03 presently stands at 21,089. And the company plans to take this base to over 23,000 employees when its reports its FY04 numbers.

While Infosys, over the past years, has proven its capabilities on the scalability front, i.e., managing growth, what concerns us is whether it would be able to sustain growth as it gets bigger and bigger in size.

Infosys is building up the employee base, investing consistently in building up its infrastructure (development centres, marketing and distribution network), and this is all in the anticipation that it would get enough work to justify its investments. Before moving further, we need to understand one critical factor that affects Infosys, or for that matter any software company.

Growth in revenues for a software company is dependent either on higher volumes of work (for which the company needs to continuously invest in manpower and supporting infrastructure) or on a rise in billing rates. Now, due to increasing competition and oversupply situation, the billing rates are likely to be stagnant, or improve marginally only for high-value services.

Thus, it leaves software companies with only one, or probably two ways of growing larger in revenue terms – adding to their employee base and moving up the software value chain. However, even offerings that are higher up the value chain tend to get commoditised as more and more companies develop competencies in a wider gamut of domains.

Thus, this leaves companies like Infosys with only one way of growing larger in size – by going aggressively after higher work volumes, and thus adding to its employee base.

And this is exactly what the company is doing at present. It is increasing its workforce by leaps and bounds solely in anticipation of larger deals to come its way. While there is almost no large deal worth mentioning (apart from the one from Telstra) for FY04, whether Infosys will manage to get such deals in FY05 is a matter of high speculation.

Some quick calculations show that to grow to a size of $3 billion in revenues, from the current $1 billion, Infosys would need around 55,000-60,000 employees. And that is huge by any means.

However, if the company were able to carry on with its capabilities on the workforce management, delivery and execution fronts, it would be a remarkable journey, for a remarkable company. But long-term investors need to keep in mind the fact that the journey from here will have a different complexion from that seen earlier.

Managing a large work force and the resultant expectations with it will be the essential features of Infosys' growth from now on. While history suggests that Infosys has managed growth successfully, history can indeed be a bad teacher! Hence, caution is advised.

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