The Infosys rally masks a deeper question: Can India’s outsourcing giants survive the age of AI?

Both Bengaluru-based Infosys and its larger rival, Tata Consultancy Service, are facing near-term pressure on profits. TCS reported a 14% decline in net income this week, missing analysts’ estimates. Infosys registered a 2.2% drop.

Last quarter’s turbulence can be chalked up to the impact of India’s new labour codes—employers have been forced to bump up gratuity and other compensation liabilities. The more important question on investors’ minds is about the long-term viability of the sector itself.

Outsourcing companies employ a hybrid model: engineers sent to clients’ offices and factories around the world coordinate with large teams of coders back in India. In the US, the largest market, the Trump administration’s overhaul of the H-1B work visa programme, which now comes with a steep $100,000 fee for new entrants, will raise costs.

At the same time, large orders for enterprise software that have put as many as 6 million coders on the path to middle-class livelihoods are drying up. Some of it is because of the global trade war. Clients are reluctant to invest in technology amid heightened uncertainty. More of the spending is going into so-called agentic AI—algorithms that make decisions and take action.

According to TCS, its AI services revenue swelled in the September-December quarter to $1.8 billion, annualized. “We remain steadfast in our ambition to become the world’s largest AI-led technology services company," CEO K. Krithivasan said after the results.

The ambition may be legitimate, but what if the street is telling the CEO that he doesn’t need 582,000 employees to pull it off?

The outsourcing industry hired aggressively during the pandemic. With face-to-face commercial transactions forced to go online, there was a rush of digitization projects across industries. But just as demand for software services was returning to normal, generative artificial intelligence appeared on the scene.

When ChatGPT made its splashy entrance in late 2022, the consensus prediction was that TCS, Asia’s largest outsourcing firm, would clock about $37 billion in revenue for the financial year ending in March 2026. With less than three months left, the estimate has dropped to $29 billion. A similar story has played out for Infosys.

Whether clients are really able to extract outsize productivity gains from AI is open to debate. But the impact of the new technology on outsourcing firms is more imminent. As some talented engineers become many times more productive using AI platforms like Claude Code, most other programmers will become obsolete.

What to do with the redundant workforce may become a challenge, especially since the services exporters’ track record of boosting employee productivity hasn’t been all that great.

Over the past decade, India’s top five outsourcing companies have managed to raise labour productivity by less than 2% annually because of their squeamishness to put more fixed capital behind human effort: The average value added by an employee has risen to roughly $40,000 a year, from $34,000 in 2015.

The modest gains are going to labour, although not at the entry level where salaries have been stagnant. Profit per worker, in my calculations, has been practically unchanged in dollar terms.

The only way global investors will fall in love again with the outsourcing business is when it can demonstrably extract more productivity per employee. In an AI-dominated technology environment, that might involve more aggressive investment, or bigger reductions in workforce than these companies have delivered so far. (TCS has pruned its headcount by a little more than 5% since June 2023.)

Slimming down will be tricky. Software services have compensated for the absence of job creation by a stunted industrial sector. Politicians are still wooing these employers with free land, hoping they will continue to create elusive white-collar positions.

The optimistic note struck by Infosys’s forecast may have momentarily dispelled some of the despondency. But with New Delhi’s broader economic relationship with Washington at its lowest point in decades, immigration policies in the biggest overseas market could turn yet more unfavourable.

Nor is the tweak in India’s labour code a one-time drag—some of the cost pressure will endure. Add the challenge to coders from cheap AI subscriptions and outsourcing as a business is still in search of long-term viability. ©Bloomberg

The author is a Bloomberg Opinion columnist covering industrial companies and financial services in Asia.