Whalesbook
AI's Impact on IT Pricing
The IT services sector is undergoing a major shift driven by artificial intelligence. While overall technology spending is rising, more spending is going to AI infrastructure, software, and platforms. This shift reduces budgets for traditional IT services, causing slower revenue growth and lower profits.
'AI-led deflation' is now a measurable reality for India's IT industry. Kotak Institutional Equities forecasts an annual revenue deflationary impact of about 3.5% over the next few years. This happens as clients, using more AI, demand that AI-driven efficiency gains translate into lower prices on contracts and renewals. March quarter results showed this trend, with many large IT firms missing revenue expectations. Infosys, for instance, provided cautious guidance for FY27, expecting constant currency growth between 1.5% and -3.5%.
Global Tech Spending vs. IT Services
Global technology spending is set to reach $5.6 trillion in 2026, an increase of 7.8%. However, IT services growth is lagging considerably, forecast at 4.2% in 2026. This growing gap signals a structural change where IT services are taking a smaller share of enterprise tech budgets. While overall tech spending grew strongly in 2025 and was expected to accelerate in 2026, IT services growth slowed, indicating that investments in AI hardware are not directly benefiting traditional IT service providers proportionally.
Competition and Margin Pressure
Most large IT companies are operating more smoothly, leading to fiercer competition for deals. Unlike before, when execution challenges among peers allowed stronger firms to grow market share, now stable competitors are all vying for the same business. This intense competition, plus client demands for lower costs, is squeezing revenues and profits. HCL Technologies indicated AI-led deflation in the 3-5% range. Wipro also faces margin pressure on certain deals. Mid-tier firms like Persistent Systems and Coforge, with higher P/E ratios, are seen as better positioned to capture emerging AI opportunities.
A Fundamental Industry Shift
While Kotak sees AI-led deflation as a temporary cycle, evidence points to a deeper, structural change. AI's ability to automate tasks like code generation and testing challenges the traditional model of IT firms growing through lower labor costs. Historically, the sector has adapted to changes like Y2K and cloud computing. However, the current AI wave may require a more fundamental evolution of business models, moving from selling hours to outcome-based engagements and becoming AI transformation partners.
Long-Term Concerns for IT Services
Some fear AI adoption is a fundamental, long-term disruption, not just a temporary dip. AI can automate core services like application and infrastructure management, which make up 70-80% of major IT companies' revenue. This could lead to less demand for traditional outsourced work as AI platforms handle tasks previously requiring many people. Older service models could become outdated. Firms that don't quickly shift to AI services, data strategy, and AI oversight may see profits fall and struggle to grow. IT stock prices might not fully reflect this disruption risk, with revenue erosion estimates varying.
Outlook for Indian IT
Kotak Institutional Equities maintains a Neutral rating, viewing the AI-led pricing impact as a phase that could reverse within two to three years as new AI opportunities grow. Sectors like financial services and energy are showing resilience. Mid-tier IT companies are considered better placed than larger ones to benefit from new AI opportunities. The sector faces a prolonged period of slower growth and margin pressure, with no significant recovery expected for FY2027. Growth estimates for large IT companies are now clustered between 1% and 4%. The Nifty IT index has fallen sharply, but analysts point to the sector's history of adapting to technological shifts, suggesting potential for long-term relevance and market expansion through AI-driven services.