Whalesbook
AI's Growing Pressure on IT Costs
AI is changing the Indian IT sector. It's not just creating new business but also lowering the cost of IT services. Analysts now predict that large IT companies could see slower revenue growth by fiscal year 2027. This is because AI efficiency gains are largely going to clients, who are demanding lower prices and higher productivity from vendors. For example, AI can drastically cut the staff and time needed for projects like cloud migration. What once took 500 people 18 months might now need only 50, significantly reducing the revenue earned per project.
Where Value is Moving and What it Means for Stock Prices
Cloud providers like Google and OpenAI are currently covering many AI costs and helping companies adopt these tools. However, this value is expected to spread out. As AI costs stabilize and subsidies decrease, the benefits will be shared among clients, AI model developers, and service providers. Motilal Oswal Financial Services notes that IT company stock prices might not fully account for this shift, posing a risk for investors. This is especially relevant because AI is easier to integrate into new projects (greenfield), where AI-native companies are leading. Traditional large Indian IT firms, which specialize in upgrading older systems (brownfield), face tougher competition.
AI Weakens IT Firms' Competitive Edge
The usual competitive advantage for IT firms, built on deep knowledge of company systems and years of integrating processes, is weakening. AI can now quickly gather and use this kind of information, making it harder for established players to stand out. The market is increasingly favoring AI-native companies that excel in modern technology, challenging the traditional strengths of older IT service providers.
Rethinking How IT Services Are Priced
Companies claiming a shift to 'outcome-based pricing' for IT services need closer examination. Motilal Oswal distinguishes between pricing tied to project milestones and true models where payments depend on proven performance improvements. The latter, a more complex and different business approach, is less frequent. The industry is moving away from contracts based solely on time and materials towards mixed models or those linked to results. This reflects the productivity gains from AI and client demands for costs to match the value delivered.
Why Some See Trouble Ahead for Indian IT Giants
Major Indian IT companies like TCS, Infosys, HCLTech, and Wipro face a fundamental challenge. AI is directly affecting their main income sources, which were built on cheaper labor and standard IT management. While AI opens up new income streams, many firms are finding that AI automation and efficiency are improving faster than they can develop new, high-value AI services. This has led to smaller deals; for instance, projects once worth $100 million are now closer to $80 million because they can be completed faster with fewer staff. Although TCS, Infosys, and HCLTech are seeing AI-driven growth, the overall outlook for the sector in FY27 is cautious, with growth forecasts for some between 1-4%. This is lower than global rivals like Accenture, which expects 2-5% growth for FY26. Stock valuations for Indian IT leaders reflect this difference: TCS and Infosys trade at higher price-to-earnings ratios (around 32x and 29x), while HCLTech and Wipro trade lower (26x and 24x). The Nifty IT index has experienced sharp swings, falling as much as 19.5% in February 2026, its biggest monthly drop in 17 years, due to worries about AI's disruptive impact. The traditional model of offshore services, charging by the number of people and hours, is under pressure as clients increasingly want integrated platforms and results, not just staff. Companies like Accenture have invested heavily in AI, buying many AI-focused businesses and reporting significant GenAI revenue, which outpaces the more partnership-focused strategy of Indian IT firms. The main concern is a long period where AI's cost reduction outpaces new AI revenue, affecting profits and future growth prospects into FY27. The market's reaction, including a nearly 5% drop in the Nifty IT index after recent earnings reports, signals wider concerns beyond individual AI successes.
What's Next for Indian IT?
Analysts expect a phase of moderate growth for the Indian IT sector in FY27. AI's influence on pricing and revenue models will be a key factor. While some predictions show a modest sector-wide revenue increase of around 4.50% by FY27 for large companies, significant challenges remain, including global economic uncertainty and geopolitical tensions. Investors will be watching for details on new service contracts that link pricing to results and announcements about AI-native partnerships. In the short term, value creation is likely to favor AI-native businesses, while traditional IT vendors will face pricing pressure, limiting their growth prospects.