In New Delhi, Feb 24 The IT services sector is set for a major shift as AI reshapes the core business, which will not only increase "cyclicality" but also require a change in talent and operating models, according to a report by Jefferies.
The brokerage warns that AI-driven shifts will likely shrink the traditional "managed services" segment while increasing consulting and implementation services.
Despite a 16% year-to-date decline, the stocks still offer higher downside potential than upside, according to the report.
Jefferies suggests that the "AI impact" is not over, leading the firm to cut price targets by up to 33% in some cases. It has also downgraded some industry leaders, including TCS and Infosys.
It is important to note that in the past few weeks, investor sentiment in the global tech sector, and traditional IT services and software, has become notably cautious as sophisticated models like Anthropic's Claude, designed to assist with complex tasks, evolve from assistants into tools capable of executing them.
"The Nifty IT index has fallen by 14% and underperformed the Nifty50 by 12 percentage points year-to-date. While 3Q results led to earnings upgrades for nearly all IT firms, recent developments in AI have raised concerns about the medium-to long-term growth outlook for IT firms and driven down ratings by 27%," Jefferies said.
This suggests that stock performance will more likely be tied to the longer-term business outlook rather than short-term earnings.
Jefferies predicts a structural change in the business mix.
"While IT firms should remain relevant, the nature of their client engagements is likely to shift towards advisory and implementation, with application managed services (22-45% of revenues) seeing a significant decline in revenue," it warned.
The extent and timing of this decline are likely to exacerbate as AI tools become more advanced.
"Moreover, the rising share of advisory and implementation engagements would not only increase "cyclicality" in revenue growth, but would also require a change in talent strategy and operating models. Such changes in operating models are not easy to implement, and investors must factor this risk into their valuations," according to Jefferies.
Its calculations suggest that at the current market price, stocks are pricing in revenue CAGR of 6-14% for large IT firms and 9-17% for mid-sized IT firms over FY26-36.
"In our view, maintaining the long-term revenue growth trajectory in line with the previous decade is the best outcome for IT firms (case 1)...The worst-case scenario could be a 3% lower revenue CAGR over FY26-31 (15% cumulative deflation), followed by no growth beyond FY31 (case 3)," it said, outlining three different scenarios.
Recent launches from Anthropic’s Claude – including Claude Code, aimed at automating legacy code modernization, and Claude Code Security, an AI-powered vulnerability detection tool – have intensified the debate about whether swathes of labor-intensive, legacy IT services and software layers could soon be automated, even commoditized.
As a result, the conversation on AI has shifted from a narrative of a productivity booster to an imminent disruptor of long-standing IT business models.
This is where investors and analysts are actively debating whether such tools could displace human-led teams across programming, application modernization, legal processes, cybersecurity audits, and other conventional service areas.
The market reaction has been significant – both in India and globally.
Technology heavyweights, such as IBM, suffered significant declines, with shares plunging more than 13% on Monday, marking the steepest fall in over 25 years following claims about Claude Code's ability to streamline the modernization of a legacy programming language.
The plunge raised fresh concerns about the durability of traditional consulting and infrastructure revenues.
Globally, cybersecurity and software firms, including CrowdStrike, Datadog, and Zscaler, too faced pressure as investors tempered growth expectations in segments previously considered relatively insulated from disruption.
In India, major IT services companies such as TCS, Infosys, HCL Technologies, Wipro, and Tech Mahindra witnessed notable sell-offs, dragging the Nifty IT index lower amid fears that AI adoption could structurally reduce demand for conventional outsourcing and managed services.
Analyst opinion remains divided, though guarded – firms like Jefferies have downgraded several IT stocks and cut target prices, citing evolving revenue models and pricing pressures, while others contend that the correction may be excessive.
They contend that enterprises continue to view AI primarily as a productivity enhancer rather than a complete substitute for human capabilities.
A latest note by HSBC Global Investment Research argues that software will be the primary mechanism for the diffusion of AI across the world's largest enterprises.
"Foundation models and vibe-coding are not replacements for software within an enterprise for their main IT platforms," it said, adding that "we see 2026 as the kickoff for monetization within software".
HSBC report further claims that foundation AI models are inherently flawed technically and not suited for "a lift-and-replacement" of major software platforms.
"While there are limited cases where this is appropriate, like an image creation program or small software app, this is not realistic for the majority of high fidelity enterprise class platforms, in our view," HSBC said in its note.