Operator: Our next question comes from Toni Sacconaghi with Bernstein. Your line is open.
Toni Sacconaghi: Yes, thank you. I was wondering if you could just comment on operating profit more broadly. I think your target at the beginning of the year was for operating profit to improve 400 basis points, and it came in at 270. I think your target for the fourth quarter was 250 basis point improvement in operating margin and came in at 170. And so — and that’s manifesting itself into a free cash flow number that was lower than you had expected and this year and potentially for next year relative to your $35 billion target. So, you have a dual mandate, Arvind. One is to try and grow mid-single digits and the other is to deliver very strong cash flow, which is impacted by margins. The margin was not as strong this year, and I’m wondering, if you can highlight what was different from your expectations? And what were the challenges in forecasting that and how investors should think about that and free cash flow realization going forward?
Arvind Krishna: Yes. Toni, thanks. So, you’re completely accurate that these numbers are slightly below our expectations from the beginning of the year. I will ask Jim to comment and give you a lot more color on it. But let me first comment on your statement of, we have a double mandate of revenue growth and free cash flow growth, but I want to also be clear, revenue growth has — which manifests itself in client satisfaction, higher NPS from our clients, better consumption of both software and consulting from our clients, which allows them to consume more and more over time is what we are focused on. And it’s an and we have to deliver the free cash flow growth. Jim mentioned in a response to the first question that we were not expecting the business and Russia to get shut down, that impacted it a little bit.
We were not expecting the currency headwinds to be as severe as it turned out to be. That’s certainly impacted. And I’ll acknowledge, an inflation as in wage inflation showed up and impacted our margins in consulting a lot more than we were expecting. Now an answer could have been to not hire people and to not give that but that would have resulted then in lower capacity at the end of this year, which would not have allowed us the confidence into the growth, both in consulting and in software that we are now committing for 2023. So as we balance those, it becomes a business decision to say, we are going to keep going on increasing capacity, which results in healthier revenue and it will result in improving margins, but that flows through into 2023 as opposed to giving it all to us in 2022.
So Toni, that’s kind of how we think about balancing the investments in the business versus a quarterly result. And I’ll ask Jim to comment a bit more on some of the specifics of what you were asking.
Jim Kavanaugh: Yes. Just to put some numbers around this, Toni, you’re exactly right. We entered the year. We talked about a business profile, higher revenue growth company, higher operating margins, strong free cash flow yield. And we had guided at mid single-digit revenue growth, and we guided that four points of operating margin improvement. The two points of external that both Arvind and I have both talked about Russia and currency. By the way, that was about 0.5 point because currency member, as we’ve talked about many times throughout these calls, not only the rate breadth and velocity and change in magnitude that we haven’t seen in about two to three decades, but it impacts human capital-based consulting business very differently than a product technology-based business.
As we talk about human capital is all pretty much a natural hedge because your cost is basically matched with your revenue outside of global delivery. But in a product-based business, our costs like the industry is predominantly US dollar source, and that’s why you’ve seen pressure on the gross profit margin line and the pre-tax profit margin line around our technology base of business. Now underlying that though, I think you’re seeing a fundamental improvement in our margins as we go forward. So about 50 basis points of currency. The remaining 100 basis points was consulting. And we talked about that. That’s been a rate and pace discussion. You dial back 15, 18 months ago, we called a very accelerated demand environment of our clients shifting to digital transformation and journey to cloud.
And starting in the second half of 2021, we made the bet to make investments around skill capability ecosystems, and we opened up the aperture to build extended capabilities inorganically. And we knew as we went through 2022 that we then we’re operating in a highly inflationary environment. And then it became a rate and pace discussion on how quick can you get price margin and optimization and realize through your backlog. And I think we’ve acknowledged that we were pretty slow throughout the year. Now with that said, we finished the year about nine points of margin in consulting. We had nice improvement. We exited fourth quarter at 11-point PTI model that was up almost 200 basis points year-over-year, our first half to second half, we saw an acceleration of three points of margin from about a seven-point operating PTI model to well over 10 points of an operating PTI model.
And most importantly, the green shoots are starting to play out in the fourth quarter. Our utilization of effective capacity, one of the three levers we talked about all year, up three points in the fourth quarter. Our price margins, third consecutive quarter are up year-to-year, and you’re seeing that play out in that operating profit performance. And finally, acquisitions. Now, we’re on a steady state and our acquisitions are back to accretion. So, we see nice green shoots that lead to our guidance in 2023 at the high end of our high single-digit model in consulting on revenue coming off of a very strong 15% growth in 2022 and guiding another one point plus in operating margins going forward.
Patricia Murphy: Thanks for the question Toni. Let’s go to the next question.
Operator: Our next question will come from Shannon Cross with Credit Suisse. Your line is open. Shannon, we’re not able to hear you in conference, please shift the mute feature on your phone.
Shannon Cross: Hi, can you hear me?
Operator: Yes, we can hear you now. You may go ahead.
