Information Services Group, Inc. (III) Earnings Call Transcript & Summary

Good morning, good afternoon or good evening to everyone on this Second Quarter 2022 ISG Global Index Call. I'm Apur Prasad of HDFC Securities, and I would like to thank the team at ISG for asking us at HDFC to introduce this call today. ISG has been hosting these index calls in the managed services and as-a-services markets for nearly 20 years. ISG works with both enterprise buyers and service providers, so they offer unique insights to key industry trends. I'll now turn the call over to Stanton Jones, distinguished analyst at ISG. Over to you, Stanton.

Thanks, Apurva, and hi, everyone. With me today is Steve Hall, Partner and President of ISG EMEA; Kathy Rudy, Chief Data and Analytics Officer; and Namratha Dharshan, Research Director and Principal Analyst. And ISG Partner, Bernie Hoecker, has also joined us today to talk about some of the challenges enterprises are facing as they move to the cloud. This is our 79th quarterly index call, and we're closing in on 20 years of IT services market analysis. And I'm really excited to let you know that soon, we'll be announcing a new way for you to access some of that analysis and opinion that goes into the index each quarter. So look for more information on that in the coming weeks in the Index Insider. So with that, let's jump into our big 3 thoughts from the quarter. Steve, over to you.

First, contract activity remains strong. Only the third time in the history of the index, the total number of contract awards broke 600 in the quarter. ADM deals continue to rocket with 8 consecutive quarters with over 200 deals and 6 consecutive quarters with ACV over $3 billion. Engineering also remained robust with almost 120 deals worth $1.1 billion awarded in the first half of 2022. This is up over 120 -- 100% from 5-year averages. Labor markets remain tight, with most clients and service providers reporting high demand with problems attracting and retaining staff. The great reshuffle, which Namratha will discuss later in the call, is in full swing. And we see record high attrition on a trailing 12 months basis being reported. We believe attrition is beginning to subside, though, as a record number of freshers are hired across the industry. And on an annual basis, we believe the worst is behind us. However, there continues to be wage pressure across most segments, which will continue to add downward pressure to operating margins. The global economic conditions are impacting reported revenue numbers with gale force FX headwinds. The U.S. Federal Reserve, the Bank of England and the European Central Bank are taking more aggressive stances with interest rates given the rising inflation concerns. U.S. dollar is strong against the euro, pound, Aussie dollar, yen, et cetera, causing weaker top line growth on a reported basis for firms with a strong EMEA or APAC presence. FX will continue to be a headwind with a 300 basis point impact on the overall industry growth figures. On a broader market basis, we saw some softening compared to recent quarters primarily due to weakness in the Chinese tech sector. The overall market was down 7% on a quarter-over-quarter basis, but was up 19% on a half year basis. The managed service market delivered $8.8 billion in ACV for the first quarter, the fifth consecutive quarter over $8 billion. This is a very strong number given the ongoing weakness in the core ITO business. Record numbers are being achieved without the benefit of a historically strong data center business, which is in steep decline. The new market is being powered by applications, engineering and industry-specific BPO solutions, which were all up at least 25% from 5-year averages. Contracting activity also rose 5% with 9 mega deals signed this quarter, the most since the second quarter of 2019. From a half year perspective, more than $17 billion in ACV was awarded to managed services sector, up 8% year-over-year on a half-year basis. The typically robust as-a-service market posted ACV of $14 billion this quarter, the lowest since second quarter of 2021 and the slowest growth rate since we began tracking this market metric. FX impacted the as-a-service market as well for most of the major providers. However, the biggest decline in the as-a-service market was associated with weakness in China, which was impacted by extended lockdowns and tighter regulatory environment for the large Chinese-based tech firms. The strength of the first quarter though was boosted by the half-year ACV to nearly $30 billion and year-over-year gains of 27%, and as-a-service now accounts for 63% of the combined market ACV.

Thanks, Steve. As you mentioned, it's an incredibly tight labor market right now, and attrition really is the #1 issue in the market today. So Namratha, take us through what we're seeing this quarter.

Thank you, Stanton. You're right, attrition is an ongoing challenge, and there is a supply and demand imbalance that persists in the market. The job switching is actively happening amongst experienced hires, which means that the industry is in great reshuffle mode, which is going to have a big impact on our industry. However, our data indicates that most providers hit the attrition beat during the second half of 2021. While providers are reporting a record high attrition on a trailing 12-month basis, as Steve mentioned, on an annual basis, we believe the worst is behind us. Also we observed a lot of increased activity around hiring and retention. There is no doubt that the industry is taking active measures to tackle attrition rates. Let's focus on retention. A lot of measures are being taken to retain talent like evident investments in training, increasing wages, promotions, employee well-being, offering flexible working conditions, stock options and many other perks that are actually being introduced. Also last quarter, we spoke about startups being a competitor to the IT services companies in terms of talent acquisition, but when funding slowing down, startups are significantly slowing down on hiring. And this could be another key influencer for attrition rates to kind of slow down. Speaking of hiring, services industry is bullish on hiring to meet the increasing demands. Now based on some analysis we did for a group of IT companies, around 40% of the workforce in these firms were hired within the last 12 months. Companies have obviously adopted several strategies. They're bringing a lot of innovation on hiring. As Steve mentioned, providers are hiring freshers en masse. They're also investing in training and upskilling them. They're opening centers in Tier 2 cities like Indore, Jaipur, Coimbatore in India. Now this could definitely help a lot of companies to tackle attrition to some extent and find more talent and retain. Interestingly, in my conversations with some of the contact center services providers recently, they're actively investing and expanding their gig employee structures, too. And this has significantly helped them address some of the seasonal demands, tap into domain specialists and also retain talent. Now although hiring is ramping up, great reshuffle is not going away anytime soon. And there will be tremendous pressure on the services company as they compete for talent.

Thanks, Namratha. Kathy, the pricing angle obviously has a huge impact on talent acquisition and retention. So what are we seeing this quarter?

Thanks, Stanton. Sure. We did look at pricing again. And last quarter, we did report that managed service cost unit rates are declining, but slower than in the past. And this includes areas that are flat, and we're still benefiting, obviously, from increased automation. Now this quarter, we're really not seeing anything different, which isn't surprising. Quarter-on-quarter big changes or fluctuations really aren't seen, but we did want to look at if there was anything in the data that was conclusive. We saw that providers are holding study on managed service deals, again, using automation, balancing their onshore/offshore locations for their team members, leveraging a pyramid with junior resources. It's a great time to be a junior resource in India, lots of jobs to maintain the staffing pyramids. And then making sure that they're meeting deliverables obligations and creating great client satisfaction by putting senior resources on top of the deals. This is a mature market. And for managed services, we're also going to always see competition and continue to see smaller players working to gain market share, therefore, holding prices pretty steady. Now on the other side of the equation, you have project worker large transformation, multiyear deals. And we are still seeing increases as high as 15% for some of the very in-demand skills around engineering and cyber. Other skills increasing again at that 4% to 7% range due to a lot of the reshuffle and the demand for labor. And this is seen mainly in India, but as well in other areas or geographies. With inflation, we've also seen increased use in COLA clauses and longer contracts. And we've also seen an increase in outcome and mutual success deals. They're gaining traction, and they help providers move away from conversations just around price to value-driven delivery and true partnerships. We also took a look at the impact of pricing on margins and concluded that pricing increases don't really correlate directly to increased margins. There's other factors that need to be considered to determine the overall impact. We will continue to monitor pricing across managed services and transformation project work to see what's going on and bring you the results next quarter.

Thanks, Kathy. Let's circle back to our contracting results. Steve, let's talk about what we saw in managed services this quarter.

Great. Thanks, Stanton. So ITO in the first half of the year reached nearly $12 billion. Though it fell more than 6% year-over-year, it was the second highest half on record. Only first half 2021 was higher. And if you look at the individual segments, ITO in the Americas declined 8%, EMEA dipped 4% and Asia Pac dropped 13%. ADM awards once again achieved record high ACV of nearly $7 billion, which really help to offset continued weakness in the infrastructure business. Infrastructure in this half fell below $5 billion in ACV, a 15% year-over-year drop, as enterprise clients continue to shift workloads to the cloud and away from traditional managed service providers. All 3 regions really experienced a pullback. Infrastructure deals will continue to decline, and we expect to see additional spin-offs of the infrastructure heavy organizations as we saw with IBM and Kyndryl last year and, of course, with the Atos announcement earlier in the second quarter. The BPO notched its best half ever, with nearly $6 billion in ACV skyrocketing 59% year-over-year. And again, all 3 regions contributed to the success. Particularly, the Americas and EMEA both gained more than 55% year-over-year in the BPO space. Industry-specific BPO had the most positive impact by doubling its ACV year-over-year. Engineering also accelerated significantly. It broke through the $1 billion in first half ACV for the first time ever. Contact center BPO and digital customer experience were also rebounded from the pandemic. There's really strong market demand for digital customer experiences and transformation-based solutions. Also enterprises are transitioning -- continue to transition captive operations and brick-and-mortar contract centers to external service providers. Now if we look at the Infrastructure as a Service, it obtained $22 billion in ACV for the first half of this year, a 30% gain compared to this time last year. But analyzing the segment by quarterly reveals that the second quarter really dragged down the first half with a gain of only 11%. That's the smallest growth rate really since first quarter of 2015. By region, the Americas and EMEA posted excellent growth of 52% and 43%, respectively. But Asia Pac fell 8% mainly because the bottom dropped out of the market in the second quarter of 2022, again, because of the Chinese tech firms that we've mentioned. The big 3 hyperscalers, AWS, Azure, GCP, led the market growth. The chart on the right depicts the growth of the big 3 hyperscalers compared to the rest of the IaaS market. It's clear to see the continued growth of the big 3 and the overall decline in the remaining providers this quarter. Software as a Service produced nearly $8 billion in ACV this half, representing 20% year-over-year growth. All 3 regions contributed to the gain, and the Americas rose 23%; EMEA, 16%; and Asia Pac 14%. So we've previously talked about the wider participation in the SaaS market. The market share of the top 10 SaaS firms has dropped 600 basis points from a prepandemic high of 50% of the market to its current 44% market share, as clients have even more options for industry-specific solutions. So we'll continue to watch this and ideally see a more robust SaaS market going forward. Stanton, do you want to take us through the leaderboard?

Sure. Thanks, Steve. As a reminder, all the providers on our leaderboard earn their spot based on awards made over the trailing 12 months. So we typically don't have a lot of change in our Big 15 category, but this quarter, Wipro moved into the group after signing deals with Petrobras in Brazil and Crédit Agricole in France. And Capgemini won some significant awards at Dassault Aviation, Airbus and Italian bank, B&L. In The Building 15, Genpact won a large ISG-advised transaction with a well-known financial services firm focused on F&A and HR. And The Breakthrough 15 has several new names like Canadian technology firm TELUS International. It won multiple awards this quarter. And as usual, The Booming 15 had quite a bit of turnover. One of the new names is NNIT. It's a Denmark-based provider. They signed a couple of significant awards in the banking and transportation sector this quarter. So one of the common themes amongst many of the providers on the leaderboard that you just saw is using M&A as a way to fill technology gaps and move into new markets. And this is especially important right now as we deal with elevated attrition, as Namratha talked about, combined with a period of really high sustained demand. So as we noted in our first quarter call, 2021 was a record year for IT services M&A. There are over 200 transactions for a total value of nearly $34 billion. Now we don't expect to hit another record this year, though, through the first half of the year, deal volume is down 7% and deal value is down almost 40%, but that's actually where we are today is actually in line with historical norms, as you can see there on the chart. So there is still a good deal of M&A activity underway, and we believe the combination of decreased valuations with increased cash positions from companies and from private equity is likely to mean that M&A remains strong for the balance of the year. And we also think we'll continue to see more examples of services firms spinning off major portions of their businesses in response to really the massive changes and shifts that we see happening in the market today. So for example, E&Y splitting off its audit and advisory businesses. And as Steve mentioned, the recently announced plan of Atos spinning off its cloud applications and security service lines into a new company called Evidian. Okay. So let's go and jump into our regional updates. Kathy, what are we seeing in the Americas?

Looking at the Americas, the combined market ACV remained above $12 billion this quarter, but dipped 2% from the prior quarter. The year-on-year compare was a robust 36%. Looking at the performance of the first half of the 2022 period smooths out some of the kinks that we saw in the global combined market. In a year-on-year comparison, ACV in the Americas in the first half of 2022 rose a solid 29%. Managed services ACV of $4 billion in the second quarter declined 9% compared to the prior quarter and, again, was flat year-on-year. Given that the year-on-year growth averaged about 25% during the pandemic, the flat compare indicate a slowdown. However, the first half of the year shows managed services ACV at an all-time high and 11% above the first quarter. The number of contracts signed in the half also has hit a record high. Looking at as-a-service ACV in the quarter, it topped $8 billion for the first time, a 2% increase compared to the prior quarter and a strong 36% year-on-year. The Q-on-Q slowdown bears watching, although we have seen this before, 3 times, 2020, 2017 and 2014. The half year perspective with the ACV of $16 billion shows growth of 42% year-on-year, but we expect the comps to get much more difficult beginning next quarter. The as-a-service market in the first half of 2022 accounts for 65% of the combined market ACV in this region. Now Steve, do you want to give us the headlines in EMEA?

Thanks, Kathy. And the combined market in EMEA was also really strong this first half. We generated over $7 billion in ACV for the third consecutive quarter, while its year-over-year comparison showed a healthy 18% growth. ACV did slip 2% from the prior quarter. The $15 billion in ACV for the first half of the year marks a year-over-year growth rate of 20%. This is really in keeping with the growth rates during the pandemic, but it's much higher than the 7-year average of 11% in EMEA. Managed service continued its really strong performance in EMEA. Once again, ACV in the quarter surpassed $3.5 billion, as it has in 5 of the last 7 quarters. The nearly $4 billion in ACV posted this quarter was 3% higher than the prior quarter and 10% greater than a year ago. And if you look at it, the Americas and Europe ACV for managed service is really close. I think you said, Kathy, Americas was $4 billion, Europe is $3.8 billion. So they're really on par now as we go forward. Contracting activity was also vigorous. 6 mega deals were inked this quarter, the most in more than 5 years, and ITO deals led the market with ADM accounting for over 60% of the total ACV awarded this quarter. From a region perspective, Benelux, France, Southern Europe posted double-digit growth year-over-year, while DACH and the Nordics both declined. The U.K. also dropped a bit, but still turned in $1 billion quarter for the third consecutive quarter. And since Brexit, the U.K. really only reached that quarterly ACV mark only once a year. So we're seeing a strong recovery in the U.K. Managed services in the first half of the year grew at a slower pace, less than really 8% year-over-year compared to the 24% growth rate that first half 2021 achieved. But more than 500 contracts were signed in the first half, which was really a new high. The as-a-service ACV exceeded $3.5 billion for the fourth consecutive quarter and posted year-over-year growth of 27%. While healthy, that rate is slower than the 40% to 50% year-over-year growth in the past 4 quarters. The ACV of $7.6 billion in the first half of this year marks a 35% increase from prior years and almost double the growth rate of first half 2021. Now as a service accounts for 50% of the combined market ACV in the first half, so you've really seen this shift. Namratha, you want to walk us through Asia Pac?

Thank you, Steve. As you can see, there's a lot of downward trend in Asia Pacific this quarter. But Steve, as you mentioned, much of that decline is due to the challenges in the Infrastructure-as-a-Service industry. We also, of course, spoke to some of our leaders in the Asia Pacific region, and we're not seeing any significant changes in the demand for managed services this quarter. Asia Pacific managed services was down 17%, generating over $800 million in ACV in the second quarter of 2022. This is in comparison to the $1 billion generated in the second quarter of 2021. So this quarter was a tough comparison for the region, which is the primary reason for the decline. However, on the quarterly basis, the second quarter 2022 showed improvement and was the third quarter in the last 5 quarters where ACV exceeded $800 million. Also this quarter, we saw a record high of 76 contracts being awarded. On a regional basis, India and Southeast Asia markets were up significantly year-on-year while ANZ, Japan and China pulled back against difficult year-on-year comparisons. Turning to as-a-service, an ACV of over $2 billion was generated and was the lowest level since the third quarter of 2020. Infrastructure as a Service segment was the primary driver for this decline due to a significant increase in government regulation that impacted the big 4 Chinese hyperscalers. Software as a Service, though, was not significantly impacted by this. And on a half year basis, as-a-service ACV was $6 billion, a 6% dip from the prior year. This is the first time in the Asia Pacific region has basically registered a first half decline. Steve, I'll hand it over to you to walk us through the industry trend.

Yes. Great, Namratha. So our industry trend slide compares to the first half with the same period a year ago. So it's really a half-year view that we're taking a look at, which removes some of the lumpiness. So BFSI was one of the largest verticals generated over $11 billion in ACV. This was a half year record that translated to a year-over-year growth rate of 31%. And recall that BFSI started the year with a quarterly record high ACV, and 2Q did even better. Each of the 3 regions made a really strong showing led by the Americas, which posted a 52% gain in the BFSI sector. Managed services in BFSI performed even better than as-a-service this half. However, as-a-service posted growth over 26%. The Americas had the fastest as-a-service growth rate with 35% gain; followed by EMEA, a 32% rise that made up for the 2% slip in Asia. The as-a-service market now makes up 45% of BFSI's combined market ACV. The manufacturing vertical cuts across a wide range of industries. In the first half of 2022, manufacturing's combined market ACV was $7.6 billion, up 16% over last year, laser focused on supply chain operations, optimization, companies turning to technology to leverage efficiencies and introducing new products at a faster pace. The managed service gains in this vertical came mainly from activity in the America, which rose 7% year-over-year. EMEA was flat, and Asia dropped 38% in manufacturing. As-a-service had nearly $5 billion in ACV, a 29% gain year-over-year, and both the Americas and EMEA had growth rates over 35%, while Asia dipped 5%. As-a-service makes up 64% of the combined market ACV in manufacturing now.

Thanks, Steve. We've talked a lot over the past few quarters about the massive growth in enterprise cloud adoption, but also the downstream impact to service providers as companies shift from data center outsourcing to moving workloads to hyperscale clouds. So Bernie, let's talk about what you're seeing in the market and what challenges enterprises and providers are facing.

Thank you, Stanton. It's a pleasure to join today's index discussion. Now cloud as an IT category continues to drive innovation and value for many enterprises. Earlier this week, I was in New York City at our inaugural site summit. In ISG, we view cloud computing as a delivery platform that is accelerating to a secure, intelligent, connected enterprise that we call XaaS. At our summit, we discuss cloud as a foundational platform from computing that must have these attributes to deliver continual value to enterprises. Now all enterprises leverage cloud technologies. And about 6 years ago, the trend on IaaS spending began to overtake traditional data center spending to the point that IaaS now represents 90% of quarterly ACV. This dramatic shift was driven by cloud as the enabling platform to unleash advanced technologies like AI, machine learning, advanced analytics and even virtual reality. As-a-service platforms have changed the technical and business models of most enterprises. A robust and dynamic cloud strategy is now an imperative to remain competitive in the market. And if done correctly, cloud will also drive efficiency, lower cost and a higher return on new investments. Surprisingly, the majority of enterprise workloads have yet to move into the cloud, and many legacy workloads remain on-premise or in a hybrid model for years to come. Core back-office applications, like ERP, supply chain and financials, were written in legacy programming languages and highly customized over a 20-year period. Converting these applications into modern cloud languages, like Python, PHP and Java, is expensive. It's timely and it requires highly skilled resources. Enterprises must balance multiple factors to set the pace for their cloud migrations. Creating a strong ecosystem of cloud providers will help to assess multiple variables. Things like capital versus operating expense, rationalizing one's application portfolio to determine core applications versus ones that have to be sunsetted. Access to skills is always a challenge, and it's really important to have a robust cybersecurity strategy. In summary, infrastructure will continue to be commoditized at scale, and providers will continue to invest in cloud technologies to remain relevant in the market and maintain their margins. Now there are multiple blockers to executing cloud strategies, I'd like to highlight 3 of them. Currently, general purpose clouds are really table stakes. Clients now demand industry clouds that align to their markets and provide advantage to their end users. Industry clouds must meet specific regulatory and compliance standards based upon the industries they serve. Examples include PCI, FedRamp, HIPAA, GDPR and other compliance standards. Hyperscalers and providers can no longer focus on just the technologies. They must also be ambidextrous and possess industry knowledge and acumen. Cloud strategies are often orchestrated from the business lines versus from the IT or CIO office. And providers and CSPs must pivot to a vertical orientation. Bottom line, providers and CSPs will be laggards if they don't demonstrate horizontal and vertical expertise to address the markets they serve. And relative to cloud acceleration, there are multiple blockers that challenge and hinder cloud adoption, and they frustrate hyperscalers, enterprises and providers. Several key challenges include lack of baselines. Cloud estates are really in their infancy, and there's limited history on cloud consumption and financial modeling. The translation of traditional and legacy IT environments to cloud estates is a new endeavor for enterprises, and most lack the skills to tackle the technical, business and financial aspects of cloud models. In terms of cloud contracts, many of them can be complex and require thoughtful research and examination of the current and future environments. Some enterprises have declared a cloud-first strategy, but have not implemented operational and financial models to manage the consumption of cloud infrastructure and services. Many enterprises have signed multiyear contracts and later realize that they either have underestimated or overestimated their cloud requirements. The outcome can result in budget overruns or penalties not meeting committed spending levels. After multiple migrations, a cloud-first approach is not always a guaranteed alternative. Now enterprises are expanding their cloud estates to multi and hybrid environments. These new models post threats to the large hyperscalers. Enterprises also face challenges as well. 2 of the big ones, security, multi and hybrid cloud estates represent a larger attack surface for cyber criminals and ransomware attacks. And in terms of managed services, hyperscalers must team with the providers on both infrastructure and migration services. Most enterprises and cloud providers do not have the requisite skills to manage these complex environments, and selecting the appropriate providers for your ecosystem is critical. Now providers are critical to a robust and efficient and effective cloud strategy. Our point of view in the 2022 provider lens study demonstrates strong competition among providers, as clients demand partners who can deliver value in a technology business management construct. Leaders in the provider tier demonstrate consistent innovative strength, and they balance their business model to maintain stable delivery at a fair market price. Given the rapid pace of technology, there is fierce competition to enter the leader quadrant and capture legacy workloads that are migrating to the cloud. Hyperscalers and providers understand the need to capture these large workloads to secure significant revenue and profit for years to come. In terms of product challengers, many have robust capabilities that offer strong technology stacks that integrate all layers of the cloud, infrastructure, software as well as platform. Market challengers tend to focus on specific regions or vertical industries to gain a foothold in the market. And it's clear all providers are investing their time and energy with hyperscalers to provide end-to-end turnkey solutions for the client sets they target. A seamless symbiotic relationship with hyperscalers and providers is critical to many enterprise strategies. So Stan, as we close this segment, really, 2 key points to end on. One, cloud computing continues to be a forcing function that enables innovation, agility, speed and advanced technologies to drive a competitive and healthy enterprise. And second, cloud models will continue to evolve for years to come. And a thorough and comprehensive multiyear cloud strategy is an imperative for every enterprise. Back to you, Stan. Thank you.

Thanks, Bernie. So let's close out the call with our forecast. Steve, back over to you.

All right. Well, thank you, everybody, and great updates today. Clearly, we've got a lot of moving parts. And as we summarize what's happened, let's look ahead to the remainder of the year. Managed services was up 2% year-over-year for the quarter against a very challenging compare. At the half year point, ACV is up 8% over first half 2021. ITO slowed noticeably though dragged down by legacy infrastructure ACV. Spin-offs and other structural issues for some leaders may inhibit short-term recovery. Managed services is really relying on ADM for growth, but the comps going forward will still be difficult. The as-a-service market is up 20% in the first half compared to first half 2021. It too is looking at difficult compares going forward. Some leading companies are camping down their expectations due to FX concerns, infrastructure as a Service grappled with poor performance from China's hyperscalers. And really, the Infrastructure as a Service market is really relying on the big 3 to support its expansion. Those 3 firms really accounted for 93% of the ACV this quarter, up 70% in a typical quarter. As for pricing pressures, Kathy did a great job talking through where we were. Some prices can be passed along to the clients, others can't. And as we've talked about before in our index calls, wages and attrition continue to play the market as Namratha laid out. So let's take a look at our first -- our forecast, but let me give the macro view first. So we've entered the year stretched on valuations. We've added rising interest rates and slowing liquidity. The supply chain is still broken in some areas. We have super tight labor markets. The pandemic is still impacting different parts of the world, and China has more lockdowns in a tougher regulatory environment. And of course, we can't forget what's happening in Ukraine and Russia's aggression across Europe right now. Energy prices are through the roof, and currencies are weakening. So those are all adding a lot of headwinds to the market right now. And yet, quite frankly, we're in the middle of one of the highest sustained demand environments I've ever witnessed. Companies want to do more with cloud computing and using technology to improve productivity and lower cost and increase revenue. They want to get closer to their customers and clients through better customer experiences and digital experiences. And so for the second half of the year, we believe the risk will continue to build, and the tech sector market will become volatile. The market has changed, and it's really looking for profitable growth versus growth at any cost. So with that in mind, sort of the macro, the strength of demand, we are going to lower our overall forecast for managed services to 3.5% growth for the full year. We think that the market demand remains high, but given the FX impact and the inflationary concerns, our models indicate 150 to 200 basis points headwind just with FX. The revised forecast still implies, though, an $8.6 billion of ACV per quarter, and we expect minimal impact of spending due to inflation over the next 2 quarters. We're also lowering the full year as-a-service forecast for the remainder of the year from 22% to 18%, as headwinds persist in China. And the segment relies more and more on the big 3 hyperscalers to support market expansion. Almost $1.5 billion in ACV this -- that we saw this quarter due to China significantly impacted those growth rates, and we don't expect the large tech players in China to fully recover this year. So with that, thank you very much. Let's open the call up for questions. And Apurva, would you like to go first?

Thank you for the insightful presentation. Let me take a few questions. I have one on the demand side and enterprise buyer point of view. So how are enterprise buyers responding to the macro risks? And what's your assessment of decision-making time lines and contracting by the enterprise buyers? And if I can tie in another part to this is in this budgetary constrained environment, does the larger multiyear opportunity of modernization of workloads also start to get more selective as it moves up the maturity curve?

Yes. Thanks, Apurva. Really good questions. A couple of thoughts on that. So right now, we're seeing an incredibly high demand environment, probably the highest that we've seen for multiple quarters. But it's really changed as we think through what's happening in the broader market. So as you heard on the call, we think really infrastructure continues to be in a decline as we go forward. But the market is being really led by apps, engineering, industry-specific BPO, analytics. And without using a catch phrase, I'll say all things digital right now because that's truly what's driving the upper end of the market. You're seeing it in the types of services that providers are doing. You're seeing in the types of projects that clients are requesting. We're seeing it in the deal flow that we see, but also in sort of the shorter durations of contracts duration that we see. So really good movement towards that, and that's really being shown. It's just how active the contract activity is. On the second question, there is this shift, as Bernie talked about, maybe I'll hand this over to you, Bernie, on really the migration to the cloud and more complex workloads moving to the cloud. And that sort of continued to drive through that next level of evolution for technology. Bernie, do you want to take that one?

Yes, sure. Many clients took their initial forays into the cloud by lifting and shifting what I'll call applications that are easily delivered. And what we're seeing now that businesses are going into their second foray into migrations is really the back office. It's a lot of the legacy applications, many of which have been specialized or optimized over many years for a specific industry. And those are really tough workloads written in legacy languages, sometimes with skills that are very, very hard to get. And that's an opportunity for all of the providers, but also a big nut to crack relative to getting those migrations going. But that's where we see where a lot of money is going to be spent and a lot of the activity will be. So it is going to be a very exciting time, Steve, to see those migrations and those workloads. They will move over to cloud eventually, but that's going to be challenging for all of us.

Yes, I agree. Apurva, do you have another one?

Yes, yes. I have actually a couple of questions. So my next one's on pricing. Now we do observe more cost optimization, cost takeout deals more on the downstream side. Now how does this trend of higher cost takeout deals tie in with the pricing lever that Kathy spoke about earlier? And do you see any changes in the ability of service providers to pass on price increase as compared to, let's say, how that was at the beginning of the year?

Yes. I think we're going to play index bingo this week because I think what we really predicted was pricing, attrition, macroeconomics were going to be the big thing that we had to talk about on the call. So Kathy, let me turn it over to you and really go through the pricing and what we're seeing on the pricing and how enterprises and service providers are responding.

Right. I think you are seeing pricing pass on to clients or enterprises from the providers in the key areas, like Bernie has been talking about, engineering services, the things that -- cloud migrations, areas where clients really need to move the needle to move their business forward. So if it's tied to improved margins, revenue, broader market share, those are projects that are happening. And if you want to get them done, you're willing to pay more for it. And I think from what we've heard, providers are having an easier time of talking to clients about pricing in terms of value driven in partnerships and the greater macroeconomic conditions. So we are seeing that pricing being passed along. In the more commoditized deals, again, it's competitive, and we're seeing that hold steady. We're not seeing the decreases as large as we've seen in the past. So it's kind of a tale of 2 cities there. So if it's the larger transformation deals, definitely, we're seeing pricing being passed across.

Yes. I think, Apurva, the other aspect of that is -- and this is the one that's probably discussed quite a bit in the market right now. I think we're going to continue to see some downward pressure on margins. I think it's just natural that with the labor challenges that we've had, the increase in costs, some of these costs not being able to be able to pass through to clients. The higher demand, so trying to hire ahead of demand to some degree across the field, we're going to continue to see downward pressure on margins across. I would suspect the next couple of quarters, whether it's 50 basis points to 150 basis points in that range, maybe a little bit higher. We're going to continue to see that. It's just the demand is high, but the clients and what we're seeing at the enterprise level, we're just not being able to push those rates through at the same level. But we are seeing some. There are some good signs there. It's not all doom and gloom on that by any stretch.

Excellent. And which sort of brings me to my next question, which is on the supply side. Now is this expectation of moderation of the demand fulfillment related challenges in the near term, is that a larger reflection of demand moderating? Or is it more of the supply crunch easing as the fresher pool -- the large fresher pool that Stanton talked about, which is a lot of it being net new in the system that starts to turn billable? And at the same time, how do you assess the dependence on subcontractors, which has historically trended higher, but sort of gone up more sharply in recent times to manage the supply crunch?

Yes. It's -- I'll let Namratha and Stan kind of jump in on this one. It's an interesting time because I don't know that we've ever seen a time where demand has been so high in so many areas against what would be perceived really gale force global headwinds, if you will, with inflation, with interest rates, with the pullback. So none of us have really navigated these waters before, quite frankly, as we're seeing. The demand is pushing things up, but I think there is a caution. I think when you look at a lot of the earnings reports, when you listen to a lot of the announcements recently, there is a little bit of a caution. Now we're not seeing that pullback at the enterprise level, but I think it's reasonable to be a bit conservative as we think through that, and that's definitely what we're seeing on the hiring side. We've seen this big push over the last several quarters. We've seen a bit of a pullback this quarter on it. I think Namratha and Stan are calling it the great reshuffle because, quite frankly, what we're seeing is this great reshuffling or rotation of skilled resources around the same community, right? It's -- end of the day, we're pretty small community, and you're seeing that at the mid- and senior levels. That is the lengths on decision-making because, quite frankly, we're seeing that same reshuffle at the enterprise level. But we don't think it's systemic, and we don't think it's a larger trend that's going to impact demand. But Stanton, Namratha, why don't you guys jump in on this one?

Sure. So Apurva, your original question, on the first question, it's the latter. So as Steve talked about, we still continue to see very strong demand. Really, if you think about the supply side here, I mean, ultimately, there is a huge challenge for the industry right now across attrition. I mean if you look at it on a qualitative basis, I've had, I don't know, let's call it, maybe 5 to 6 workshops discussions with large banks over the past few weeks. And in each one of those discussions, they're talking about 30%, 40%, sometimes 50% of the staff that they have, have turned over or have -- they're struggling to fill those roles. So if you just look at it through the lens of an enterprise and what they're facing right now, this is a huge challenge for our industry right now, and it's having a real impact on many, many clients. You can also see that reflected in -- Steve talked about earnings results, right? If you look at what is getting reported from providers on -- which typically are going to report on the last 12 months on an LTM basis, right, the numbers continue to go up. That said, if you look at this -- if you -- the challenge is the providers all report this data. I know you know this, Apurva. They all report it differently, right? In our models, we can normalize the data. And if you start to look at it more about what's happening this quarter and start to project that out on more on an annualized basis, that's the reason that we feel like it's stabilizing. Now the 2 or 3 report providers have just reported, right? We're going to look at that again. But ultimately, we do feel like, over the next 2 to 3 quarters, things are stabilizing. But that's not just because attrition is coming down, like Namratha talked about a lot of the things that providers are doing to retain. Some providers are just getting better at hiring. They're just filling the bucket faster, right? So it's -- ultimately, it's really up to the provider strategy, whether they're keeping water from leaking out of the bucket faster or filling up the bucket faster. But we do think a lot of those things are coming together, which says that's going to stabilize the attrition challenge over the next 2 to 3 quarters. On your question around subcontractors, that's really related to, I think, on our view, Kathy talked a lot about the specialized skills that are in demand around cyber, cloud engineering, data engineering. That's really where a lot of that subcontractor activity is coming in because that's where, as we talked about earlier, a lot of the demand is coming in. Now it does start to feel like providers are ramping up a lot of that bottom of the pyramid and the middle of that pyramid to be able to -- there's huge training initiatives going on inside of organizations to reskill and upskill people to start to decrease that dependence on subcontractors. So will that start to come down? Yes, it will, but it's going to take time as folks get upskilled and reskilled to be able to sub them in for those subcontractor resources.

Got it, got it. And if I can go with one final question. This is around the competitive landscape. As you characterize it between, let's say, The Big 15 versus The Breakthrough 15 and The Booming 15 and of those essential revenue buckets where service providers are present. So do you think -- so number one, how do you -- how would you characterize the relative advantages of some of these buckets? And at the same time, do you see any shift in relative advantage due to any vendor consolidation that potentially takes place now?

Yes. Apurva, I think there's sort of 3 macro trends that are taking place right now. You've got this shift from infrastructure to the cloud. And what does that mean? So you've got a set of providers that fit in that space, whether they're at the building, the booming or the large size, you've got that macro piece. You've got this rise of industry-specific solutions. That's this mixture of BPO, analytics, technology adoption across the entire enterprise. And third, you've got this massive movement for engineering. And engineering skills, as engineering becomes more dominant, whether it's IoT, analytics, Industry 4.0, smart cities, massive influx of technology skills and providers in that. And each one of those 3 macro trends is really driving a different set of competitive advantages for each of those. So it's really no longer just about the size of the firm. It's how they fit within those 3 sort of big macro trends that we're seeing in the market. And so maybe, Bernie, you can talk a little bit about the cloud side because that's the biggie. Now I think if you look at what Bernie said, 90% of the ACV that is awarded on a quarterly basis, now on infrastructure goes to the cloud guys. Well, that clearly means that the support for those industry-specific solutions, how they work with GSIs is going to be a key part of what the success of the GSIs. So Bernie, you want to take that piece?

Yes, sure. Thanks, Steve. One big factor that I think we need to understand and realize, and it's obvious, but sometimes it doesn't come to you, is a lot of clients, especially Global 2000 clients, earn their third and sometimes fourth generation of outsourcing. Now a lot of those decisions are changing with technology, specifically moving those infrastructure workloads to cloud. So you may have the top 10, the top 15 GSIs that, in their third generation with a client on outsourcing, and what's happening is some of those outsourcing contracts, they're being broken up or they're going competitive, which is really making it very challenging for GSIs, but it's also an opportunity for them to take those workloads to the cloud. The other thing that was mentioned is the focus on industry. Now a lot of clients really are looking for what we call industry clouds in ISG, clouds that are really fit for purpose that meet the regulatory and compliance standards for their particular industry. And it's not just moving horizontal applications now to the cloud. It's really making sure you have the right applications for your market and serving those. So those are all challenges for the GSIs, and that's what's driving a lot of the work. And it's going to be an exciting time in the years ahead. Thank you.

Great. Over to you, Stanton.

Great. Thanks, Apurva and Stanton. Let me -- we do have a lot of questions teed up, which is brilliant. I love this new format where we get so many. So let's start going through some of those. And to tell you, what I'm not going to necessarily go in order on these because I want to get the priority ones. The first one is really about the macroeconomic conditions. So I suspect many of us are multitasking this morning. We've seen the CPI report from the U.S. coming out at 9.1% inflation rate for June driven by energy and food, which is what we suspected both up significantly. I think energy was 11% or maybe it was the gas side that was 11%. Food was like 10.4%. So the big question is what's the impact on tax spend, what's the impact on enterprise spend, what does our crystal ball tell us from that standpoint. I think there is going to be caution in the market clearly when the numbers are absorbed. We've already seen multiple announcements and discussions about the pullback with the tech organizations. I think Alphabet announced last week that they were -- or last -- yesterday, maybe late last week, that they were slowing down spending, slowing down some of their hiring. Microsoft had already announced that they were -- Facebook had -- multiple kind of the tech sector had already announced that they were kind of pulling back on the hiring a little bit in anticipation of tax spend going down a little bit. I think on the managed services side, as I talked about in the forecast, we're seeing good demand, but there are these headwinds that we have to deal with. Now one of the headwinds that we're dealing with quite frankly is this FX. And when we brought our forecast down to sort of the 3.5% growth range, there was a big FX component that we spend a lot of time looking at from our models. We tend to do everything on a reported basis without getting into the technicals. And because of where we are with interest rates, because of where we are with inflation, because of where we are with the stronger dollar, we are seeing impacts in a lot of currencies. Now if you think about the market, 40% of the market is essentially in the rest of the world, so call it 60% U.S., 40% -- 35%, 40% across the rest of the world, quite frankly, for the managed services space. So that has some headwinds that we have to get through. When we see demand, though, again, we see that demand really shifting to these other areas that we've discussed. And quite frankly, we think cost takeout is going to be a major issue again or major opportunity as we go through sort of the next 18 months, probably the next 3 to 4 quarters. Part of that is realigning to the reality, depending on what happens at the macro level, but also really thinking through how do we drive more value coming through. Knowing that we've got the digitalization, the digital agenda, client experiences, et cetera, how do you better align that with the economics of the organization? And that's been a big piece. So I guess, if I had my crystal ball, I would say, yes, tech budgets are going to pull back a little bit for 2023. We're not ready to make the call on 2023 yet. We're still pulling everything for the rest of 2022. But I think all of those in this industry are going to look at it and likely pull back a little bit. How that shift settle between the managed services market, the as-a-service market, the software side, et cetera, I think is still a really good question because I think on the managed services side, which is where we're seeing really good demand, I think there's an opportunity, again, with cost reduction, with some of the things this industry does so well to be able to drive that through. Stanton, Kathy, any additional insights on that you want to add?

Yes. Steve, sorry, I had to get myself off mute there. I think, ultimately, I mean, the main message here is that we continue to see really strong demand, and that demand really has shifted. And I think that's the most important message here is that demand is strong. So I'm looking to the questions here. It's kind of reconciling this demand with -- and some of the decreases on a year-on-year or year-to-date basis with what we're seeing and hearing providers talk about, strong pipelines and what we're seeing. The main message here is that demand is really strong, but that demand has shifted. If you think about the chart that Bernie showed, I mean, it's so clear what's happening in our market. I mean, we are full scale moving to cloud and what has really carried this industry for a couple of decades, infrastructure, data center, those types of service lines, that's generally -- it's been kind of flat over the past few quarters, and now it's down, down double digits over the past couple of quarters. So that's really the main message and really what the data told us this quarter is demand is very strong. It's just that, that demand is really in a new areas.

Kathy, anything from you?

No, I think you guys have really said it all. It's -- we are looking back at what we would normally see in the market, and it's not -- it's different. But what we're not -- what we need to focus on is where it's all shifting to. And so forward-looking, I think we're going to continue to see a downturn in the traditional, and we're going to see increasing demand. It's just too tied to the business not to continue to grow, and that's where the demand is going to be.

Yes. Perfect. When I was describing some of the macro trends, the set -- get the macro trend I said was engineering, and we did have a couple of comments on engineering as well in the questions. And one of the questions is, what do we think about some of the niche engineering firms. Now in the Index, we never talk about any individual service providers or GSIs. But I will say from a demand standpoint, engineering demand is skyrocketing. And we're seeing it across all regions, most verticals where it's highly in demand. Now there clearly are some concerns with engineering firms in Eastern Europe associated with the Russian aggression, Ukraine, et cetera. There's been concerns about what's taking place in that area. But we've talked to lots of people. We've seen the demand. It's actually -- the work continues in a big way. Certainly, there's been some pullback, but not in the way that we would have imagined early on. Some of those firms are doing exceptionally well. Some of those firms are going to continue to expand and grow. I think the competition is going to get really hot because everybody sees the trends on what's happening on the engineering side. We've talked about it for a couple of quarters now. I think as that happens, you're seeing more and more firms jump into the engineering. It's specialty though. You can't just throw your name on the door and say you're an engineering firm now. So there are some inherent advantages to being a first-mover advantage, if you will, there. But as we go forward, you're going to see a lot of demand from that side of the market continue to push. And I think it's these other areas that are taking place across enterprises. With everything being digitized, it's actually lifting the boat. So if it was just IT with just these macroeconomics, I think our forecast would be different. I think we would be probably a bit more bearish than what we are. But given that the demand is coming from so many places, we're quite positive. Now I think we are at the top of the hour, so I do need to cut off questions. But let me turn it back over to you, Stanton.

Thanks, Steve. So as Steve said, we're going to go and close out the call. A huge thank you to Apurva and his team at HDFC for hosting the call today. Thank you all very much for being here. As I mentioned upfront, I'll be in touch soon on the weekly insider on how you can get access to more insights behind the Index. And finally, our third quarter Index Call will be on October 13. It's going to be on a Thursday this time. Thanks for joining us, and have a great rest of your week.