WNS's Margins Improve w/ Automation and Outcome-Based Pricing

Meaning

WNS began operations as an internal-service unit within British Airways in 1996. After separating from British Airways in 2002, WNS began to operate as a Business Process Outsourcing (BPO) company servicing several clients including insurance companies, British Airways, and a few other diversified companies. Four short years later, WNS publicly listed its equity ownership on the New York Stock Exchange in the form of ADSs (American Depository Share) at a 1.1-billion-dollar valuation.

Over two decades, WNS has expanded across geographies and services through both organic growth and heavy acquisition. At its current depressed stock price, WNS is a 2.4-billion-dollar company by market cap but has been as high as 4.2 billion dollars just one year ago. WNS does about $1.3 billion in revenue annually, up from about $200 million in 2006 when it first became publicly available for trade.

How WNS makes money: Formerly characterized as a Business Process Outsourcing (BPO) company, WNS now self-identifies as a Business Process Management (BPM) company, reflecting its shift from simply executing low stakes outsourced tasks to fully managing many companies’ key business processes and partnering with clients to identify areas of improvement. With its shift towards a BPM business model, WNS services its clients as both a technical consulting and executionary firm – WNS identifies aspects of its clients’ businesses that could be improved, executes the necessary steps to improve those business functions, and ultimately owns that business function moving forward on behalf of the client. Clients are incentivized to use BPM companies due to their economic competitive advantage – most BPM employees are industry experts who live in low-cost-of-labor areas like India, the Philippines, and Sri Lanka. Because employee labor costs are the major expense for consulting firms, WNS charges rates that are advantageous for the client while also profitable for WNS.

For example, if an airline struggled to manage the complex moving aspects of their frequent flyer loyalty program, WNS could take on the process, transform it to be better functioning and more simplistic to operate, and continue to operate that process on behalf of the airline on a long-term contractual basis.

Initial client relationships are developed as new clients seek to improve or outsource a specific process, usually to achieve cost savings. Those relationships generally continue over a multi-year basis as WNS contracts with the company to operate the associated business function. Cross-selling is also common among WNS’s clients which leaves WNS managing multiple business processes on behalf of its clients, generally on a long-term basis.

WNS’s uses five different pricing models to contract with clients:

1.     Full-time-equivalent (FTE): Based on engaged headcount. This is the typical pricing model followed by accounting, law, and consulting firms which derives its fees by charging the client for the number of hours worked by employees at various charge rates.

2.     Transaction: Based on the number of transactions processed (insurance claims handled, emails responded to, etc.).

3.     Subscription: Monthly billings based on contractually agreed upon rates.

4.     Fixed price: Based on the delivery of a pre-defined service.

5.     Outcome: Based upon contractually predetermined rates associated with specific results received by the client.

• Example: for every dollar saved in process X, WNS will receive 30 cents.

Over the last decade, FTE, Subscription, Fixed Price, and Outcome pricing models have increased in the share of revenues while Transaction based contracts have shrunk in revenue share. WNS’s management team has repeatedly expressed intent to move away from FTE models where possible and more into Outcome and Transaction based models to better align its incentives with their clients – FTE models set WNS’s incentives at odds with their client while an Outcome-based models are more conducive to lucrative results for both parties.

WNS serves many Fortune 500 companies across nearly every industry with Insurance, Travel & Leisure, and Healthcare being the three largest by revenue share. Overall, WNS’s client base is well diversified across industries as represented by the 40% of revenue attributed to industries outside of WNS’s top three industries. Some of the common services WNS offers to each of these top three industries include:

• Insurance (27%)
  • Underwriting support and analytics
  • Claims management and analytics
  • Financial modeling
  • Finance and accounting
  • Technology support
  • Data mining and management
• Travel and Leisure (17%)
  • Crew scheduling and rostering
  • Finance and accounting
  • Loyalty programs and customer analytics
  • Cancellations and complaints
• Healthcare (16%)
  • Receivables management and collections
  • Collection analytics
  • Finance and accounting
  • Medical information management
  • Big data platform development

There are a few risks facing WNS’s business model:

1.     WNS could see a significant slow-down or decline in revenues if major countries like the US or the UK broadly shift away from using off-shore business services. That shift could be caused by social pressures or by government regulation and/or tariffs on such services.

2.     The increased use of automation technologies, including AI and generative AI, could decrease the dependence of clients on WNS’s BPM services as currently administered.

3.     Employee expense is the highest cost to WNS, so any significant wage increases in India could prevent WNS and other India-based BPM companies from sustaining their competitive advantage over North American and European based consulting firms and may reduce profit margin.

Moat

WNS and its management team have executed well over the past two decades and have consequentially seen returns on capital consistently in excess of 10% (10-year avg. of 14%). Ultimately, WNS and other well-run BPM companies benefit from a Switching Cost moat.

High switching costs act as a “barrier of exit”. As companies analyze the benefits of switching from one product or service to another, the costs may outweigh the benefits. Certain industries or products/services naturally benefit from such an advantage and thus experience relatively low customer/client turnover. While execution and operational excellence are still important, high switching costs relieve the pressure of commodity-like products or services. For example, if you regularly purchase gasoline for your car from gas station A, but gas station B’s gas is equally formidable, you’d likely have no issue jumping to gas station B if it was equal or slightly lower in price-per-gallon. However, if you had to undergo extra expenses to use B’s gas, like changing your cars gas tank, you would elect to simply continue purchasing from station A – the benefit of saving a few cents a gallon simply would not be worth the relatively high cost of replacing your gas tank (not to mention the high level of inconvenience such a process would be).

High switching costs are evident in the BPM industry – usually it is simply too expensive for a company to switch from one BPM provider to another. Additionally, if a client company did see a positive ROI by making the switch from one BPM to another, electing to allocate the required capital in place of investing the same capital in more exciting projects or acquisitions would be relatively unattractive to many management teams. Winning new customers in the BPM industry involves an intense and lengthy period for the client to offboard an internal business process so that the BPM provider can take it over. That same hurdle acts as a switching cost which causes clients to remain sticky. When asked about the risk of competitors beginning to compete on price with the introduction of more automation-technology into their services, WNS’s management team responded saying,

• “From a technology and an automation perspective, we’re all capable of delivering certain levels of automation. The reality is, if you’re successfully executing, if you’re delivering value and if you’ve moved into core mission critical operations, clients don’t want to move their work. And they’re not going to move it for an additional 2% or 3% [in savings].So, we certainly can have discussions and negotiations about productivity improvements and unit pricing with contract renewals and moving relationships forward, but the reality is this is a comfort and confidence business. And if you’re exhibiting the right kind of behavior, if you’re delivering domain knowledge and value to your customers, people aren’t going to take walk away from you on pricing.”

A few quarters later, WNS’s CEO stated the following,

• “Approximately 95% of WNS’s revenue is recurring in nature, highly visible and backed by long term contracts. Because the functions we manage are mission critical to the clients’ day-to-day business, any decision to change partners or bring [outsourced] work back in house can be very risky and expensive for clients, or potential prospects.”

WNS, like other BPM companies, typically inherits and adopts a business process from its clients under multi-year contracts. The initial costs to transfer a crucial process to a third party is already time and cost intensive which acts as an entry hurdle as previously explained, but during the long contract period, WNS deepens relations with its client and frequently cross-sells into other services/processes. WNS’s services consequently become an integral component of the client’s business. This further increases the client’s costs to switch away from WNS.

WNS’s strong switching cost moat protects it against the aforementioned risks:

• Deglobalization: While companies will likely continue to deglobalize their supply chains for centralized control over manufacturing and shipping efforts and to avoid tariffs and social pressures, the effort to apply that to business processes is less vital and more complex. The costs to bring many of these processes in-house would require a large investment in workforce increases, system implementation, and training costs. Furthermore, the arguments to move away from off-shore BPM companies don’t carry the same weight as other globalized operations – the services provided by WNS are procedural, not an integral part of supply chain management.
• AI and Generative AI: While many of the services provided by BPM companies can and will certainly be replaced or altered by artificial intelligence, there will also be many opportunities created for WNS through AI. WNS has begun to actively consult with clients in implementing AI technologies to improve processes and efficiencies. AI will enable WNS to operate more efficiently themselves. While total revenues could certainly decline due to the implementation of AI, profitability should not decline as WNS can carry a leaner workforce while still producing effective results by leveraging AI. WNS has had a multi-year goal to transition away from Full-time-equivalent pricing models and towards out-come and transaction pricing models. The implementation of AI would not affect revenue production under the latter two pricing models while potentially increasing the profitability of such contracts. In this case, AI would act as a tailwind for both revenue and profitability. The bottom line on AI’s effect on WNS is that in the worst case scenario it could reduce sales growth but will also improve profit margins, meaning overall levels of net income should continue to grow at a good rate.
• Employee Wage Increases: India’s average wage is expected to increase at a rate of about 9.4% annually over the next five years. The average wage increase in India over the past 10 years has been 9.6%. While an average annual growth rate of 9.6% is very high, it hasn’t affected WNS’s profitability over the last decade as they have maintained stable gross and operating margins of about 35% and 13%. Clearly, WNS has been able to pass these increased labor costs on to their clients. Additionally, AI could act as a tailwind in this area.

As a byproduct of WNS’s business model, the company becomes a domain expert in specific industries and sub-industries. This actually functions as a flywheel effect for WNS. For example, if WNS is able to contract with one pharmaceutical to outsource some of their basic processes, WNS will develop trust with the pharma client over time. As that trust is built, WNS will likely cross sell the client into different services which are more niche or industry specific. At this point, WNS becomes a more attractive partner for a second pharma company. After servicing and transforming processes for the first and second pharma client, WNS appears even more attractive for the third pharma client, and the process continues.

Though not as strong as the Switch Cost Moat, this Flywheel Effect acts as a competitive advantage within the BPM industry and enables WNS to win clients away from its direct competitors. WNS’s management team consistently refers to its unique business model within the BPM industry as the company focuses on developing deep industry-specific knowledge while leaving the simpler processes, like customer service call center operations, to its competitors.

Management

Keshav Murugesh is 60 years old and has been leading WNS as CEO since 2010. About 14 years ago, Keshav was approached by someone from WNS to lead the company. Initially, Keshav had little interest as he had recently taken the CEO role at his then current company, Atmos Syntel, a publicly traded IT services provider. Ultimately, Keshav caught glimpse of the potential at WNS and across the BPM industry. Murugesh is a chartered accountant in India and began his career as an internal auditor with an Indian conglomerate. Prior to acting as CEO at Syntel, Murugesh held several different leadership roles at Syntel including CFO and COO. Murugesh is under contract with WNS through August of 2025.

Since becoming CEO at WNS, Keshav has introduced the vertical business model of acquiring expertise across various industries to serve companies within those industries at a deeper level rather than offering only basic surface-level services applicable across all industries. Along the way, WNS has transformed from a business operations outsourcing company to a collaborative transformation company which partners with clients to reshape their business processes to become more effective and efficient, driving client profitability. In 2010, WNS did $582 million in revenue at 4% operating margins to yield $24 million in operating profit. 13 years later, WNS posted $1.3 billion in revenue at 12% operating margins, yielding $153 million in operating profit.

Keshav Murugesh’s compensation levels reflect his leadership in the industry as he typically takes home more compensation relative to company profits than the average CEO amongst competitors. However, Keshav’s total annual compensation has remained relatively flat over the last five years at about $3 million while WNS’s operating profit has risen. In contrast, since 2018, competitor CEOs have seen their compensation packages increase at an astounding 19% per year while operating profits have risen only by 9% per year and share price has crept up by only 6% per year. Furthermore, Murugesh appears to be extremely aligned with shareholders. The CEO has close to 70% of his personal net worth tied directly to WNS’s stock. Despite a changing industry, Murugesh clearly believes he and his team are set up to succeed.

In terms of capital allocation, Keshav and the rest of the management team have always prioritized M&A activity as they seek to expand the value and service offerings of their business. The team consistently seeks to increase its level of domain expertise in each industry to which it provides services. Additionally, Keshav commonly allocates capital to share repurchases, though not at a level which is high enough to both offset share-based compensation (employees and management receive stock annually) and significantly reduce the overall diluted share count.

Murugesh lives by a motto: “to be successful, you should surround yourself with people who are smarter than you.” Whether or not Murugesh’s supporting cast is “smarter” than him is debatable and irrelevant. He clearly respects his supporting cast’s opinion as made evident by the fact that he heavily involves his CFO, Sanjay Puria, and David Mackey the VP of Finance/Head of Investor Relations during quarterly conference calls. While Murugesh remains active in the calls, he encourages Mackey to field most of the questions and frequently echoes Mackey’s words. Murugesh brought several individuals over from Syntel when he became CEO, including both Puria and Mackey. Furthermore, Murugesh remains extremely bullish on WNS’s prospects in earnings calls. In our current era of automation, Murugesh makes it clear that he is extremely confident in the company’s ability to seek change as a welcome challenge which will be successfully conquered as it has been in prior years.

Thesis Catalysts

• Maintain gross and operating margins at or above 31% and 12% respectively over the next 2-3 years. Adjust for impairment write downs and don’t worry about revenue growth.
• Begin expanding margins in fiscal years 2027+ after adjusting to an automated world – this will drive growth in earnings assuming revenues at least remain constant.
• Begin seeing a transition toward more “Outcome” based pricing beginning in the second half of calendar year 2025 which leads to higher value contracts and thus improves profitability.