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India’s Labor Arbitrage Strategy

Posted on Monday, Mar 3rd 2008

It has been an interesting few days of being on the receiving end of tremendous hate mail due to my widely syndicated and (looks like) read and discussed Death of Indian Outsourcing article.

The article has met and exceeded my expectation in terms of a tool for catalyzing thought and debate. Those of you who have discussed it on this site, thank you for your comments. Those who have discussed it on the rest of the blogosphere, also, please accept my sincere thanks. Forbes and Rediff readers – if you are reading this message, thank you also for both your positive and negative arguments. A debate is interesting only when both sides are represented.

Now.

For those of you who are my regular readers, you know me by now, enough, to know that I am not a negative thinker by any stretch of imagination. My instinct has always been to look for solutions.

This particular piece was preceded by my Sridhar Vembu story, in which I showed readers an example of an entrepreneur who has been creative in seeking solutions to problems. Have any of you stopped to wonder why I published those two stories in that sequence?

My hope is, that with hard-hitting pieces like the Death of Indian Outsourcing, I will be able to raise awareness of the problems that are brewing in India, and catalyze action, solutions.

In public and private discussions, the metaphor that comes up continuously, is that the Indian industry is burying its head in the sand. [Look through the 100+ quotes on Rediff.] It is this attitude that I have chosen to speak against.

I have also chosen to speak against complacence, which I see rampant in the Indian industry.
But with the hope that things will change.

In Sridhar Vembu’s story, there are ingredients of that change.

“Not only that, in India, Sridhar’s operation does not hire engineers with high-flying IIT degrees, thereby squeezing the cost-advantage. No. “We hire young professionals whom others disregard. We don’t look at colleges, degrees or grades. Not everyone in India comes from a socio-economic background to get the opportunity to go to a top ranking engineering school, but many are really smart regardless. We even go to poor high-schools, and hire those kids who are bright, but are not going to college due to pressure to start making money right away. They need to support their families. We train them, and in 9 months, they produce at the level of college grads. Their resumes are not as marketable, but I tell you, these kids can code just as well as the rest. Often, better.”

I have shown in my piece that if a 15%+ salary hike rate continues, India loses its edge. But it doesn’t need to be so. For starters, Indian companies should look at Sridhar’s example and open operations (BPO, KPO, Call-Centers, IT Services Centers) not only in second and third tier cities, and away from Bangalore, Mumbai, Delhi, but also in small towns like Kohima, Siliguri, Jodhpur, and hire and train a population that is not part of the current IT workforce.

Increase supply. Reduce salary levels. This is Economics 101.

Yes it will take time. English training. Accent training. Programming training. Big charter. But, as Sridhar shows, it CAN be done.

I pointed you to Atanu Dey’s RISc model earlier. He suggests a move to a micro-city model, as follows:

“India’s economic growth depends critically on the development of its 700-million strong rural population living in 600,000 villages. The challenge is to manage their transition from a village-centric agricultural-based economy to a city-centric non-agricultural economy urgently.

The total rural population of India can be covered by about 6,000 RISCs each servicing the needs of approximately 100,000 people. By providing a full complement of services, RISC creates a ‘micro-city’ which seeds the formation of a city by drawing to it the population from the surrounding areas. RISC focuses on the development of the rural population, and not on the development of villages which are destined to be extinct anyway.”

I like the model as an alternative to the bursting situation at the cities. My suggestion is to align each of these 6000 RISCs with a major IT employer that can employ at least 5,000 people. Infosys can have 10-20 RISCs, IBM, Wipro, SAP, Cisco, Microsoft, … yes, the low-end work is at risk of being near-shored and smart-shored, but if India can create a compelling case for keeping the jobs in India via strategies like this, the horizon can be extended dramatically.

Atanu’s equation offers an additional 30 Million people – perhaps not very educated people – but
people who can be trained and brought into the workforce, thereby preserving the labor arbitrage advantage for the non-differentiated work.

And, in fact, if the cost-structure is pegged at the right level, and a training methodology can be put in place by these employers, India can also do work for other emerging markets, including Latin America (Spanish speaking, except Brazil, which is Portuguese speaking), and Europe (multi-lingual). And, importantly, India can do work for itself.

Ultimately, India’s population can be an advantage, but the population needs to be “processed” to be turned into an advantage.

In conclusion, I would like to see some serious long-term thinking from India’s IT leaders, instead of this 15% salary hike trend, and Nasscom’s unsophisticated rah-rah “everything is fantastic” analysis.

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SM – I had enjoyed reading your “Death of Indian Outsourcing” article. I believe it was timely and thought-provoking. The Indian IT service providers have gotten caught up in the case of self-adulation, staying within the box, more of the same, etc. and it is time that some serious thought was giving to SUSTAINABILITY. How to sustain their competetive advantage, margins, market share, etc.? How to ensure that 5, 10, 15 years from now, they still have a seat on the table? How to retain people/knowledge talent in a cost-effective manner?

On your comment regarding “increase supply, reduce salary levels”, we all know that this is easier said than done and that returns on these types of initiatives take some time. Alongside, the Indian IT leadership needs to find more creative ways of retaining their employees. The rate of people jumping ships is another factor that is driving the salaries up, along with a few other G&A line items.

Finally, lets keep working the demand side of the equation as well by finding BFC (Better, Faster, Cheaper) ways of serving the customer. Majority of the services coming from Indian IT companies are highly comoditized and they need to start following Sridhar Vembu’s example. This too should help offset some of the rising wages challenges as customers are willing to pay a premium if you are able to demonstrate to them measurable benefits/savings.

Uday Kumar Monday, March 3, 2008 at 1:55 PM PT

Uday,

I like the RISC model also because of its inherent low-attrition nature.

People, if they can find good opportunities, would like to stay close to their families, and within their communities.

Think about a 5000 employee RISC operation of Infosys in Imphal … what is the likelihood that attrition would be anything close to what it is in Bangalore?

If we spread these centers around, I believe, an inherently sustainable model can be created.

The top IT employers in India need to give this strategy serious thought.

Sramana

Sramana Mitra Monday, March 3, 2008 at 3:15 PM PT

Sramana,

Don’t you think there is a place for both process driven service companies and innovation driven product companies. Maybe the service companies will never move up the value chain.

Perhaps the ecosystem required for the latter has not yet matured, but may some time in the future. The service companies will not be the ones to make that transition, remaining good at what they do with other companies with different skillsets, cultures and ideas making the leap and create to create a new value chain which is perhaps less wage sensitive and more value driven.

Also if you look at India, creating something and marketing it involves a certain appetite for risk, investment and forward thinking that is missing in the current climate. Wage arbitrage is safe, a safety zone from which few established Indian IT companies and off shore so called R&D centres have shown little inclination to move.

In the meantime we do have a lot of frustrated engineers who fall for ‘R&D’ job descriptions only to discover 3 months down the line this is a different kind of R&D.

cheers,
Raul

Raul Tuesday, March 4, 2008 at 5:40 AM PT

hi,

I liked reading the article – Death of Indian Outsourcing. The more you dig, deeper is the problem. Indian techies want dollar salaries in India and want the party to continue forever. It is a story of a frog in the hot kettle, which doesn’t want to jump out immediately. While, the going might be good today, there are dark days ahead. Unless Indian companies innovate and think out of box, they can’t continue to grow at 25% per annum.

Marutish Varanasi

marutish Tuesday, March 4, 2008 at 6:32 AM PT

Why have you seemingly ignored to mention the accomplishments to-date of this nascent industry to expand from its roots in Banglore to cities that were once considered tier-2 or tier-3? Chennai, for example, was not the first place one thought to build an IT services business, but it is now home to Cognizant and every major player heavily recruits there.

The “Solution” you espouse is nothing new, but it seems that you want the companies to go from 0-60 overnight. Change occurs gradually. Just as companies are JUST NOW looking to relocate people to tier-2 and tier-3 cities in the US (why didn’t this happen 5-10 years ago), the Indian vendors will do (are doing) the same.

I respect your credentials and expect that you have done some great work in your time, but this article, and your follow-up, are worthy of a political script-writer. Which is another way of saying that it panders to base fears without true analysis. Your reference to the brilliant RISC model makes me chuckle — every VC I’ve ever worked with (many) has an arsenal of these buzz words and “new” concepts to espouse because that is what they think gets funded. In the Services world, innovation is a tough one to pin down (versus the product world where innovation is tangible), so you folks come up with great acronyms to pin on to “new” concepts. Sometimes somebody gets a brilliant idea and even ties to patent or package these acronymic concepts (Unisys’ blueprints, Agility from EDS, etc.) — another laughable idea.

It’s unfortunate that the press picked up on your report — it is as useful and valid as anything NASSCOM puts out on the other side of the aisle.

Gamite Tuesday, March 4, 2008 at 7:54 AM PT

Hi Raul,

Yes, of course there is room for process driven innovation in the services companies. I think, this is also where SaaS is going to kick in, to make the service companies and their processes more efficient.

Also, the thing about process is such that it can be replicated elsewhere on the globe. What’s preventing Infosys and Wipro to set up the same processes in Canada and Philippines? They already are doing this, it’s just that the rate and scale will go up.

The pure “labor” component of this equation is transferable in my opinion. I have no doubt that if they play their game their right, the large IT companies will be able to preserve their value proposition.

But the point is, they don’t need to be tied to India.

Gamite,

I very much like the fact that jobs are moving to second and third tier cities. It is surprising that it has taken so long, but yes, it is happening, and it will continue to happen.

But, even in those second tier cities, it looks like, the competition for trained resources is high, attrition is high, and therefore the salary hike rates are high.

What I am looking for is a more stable model … which I believe will come from a less concentrated situation. My favorite example is Jamshedpur, which was a small town that developed completely around Tata’s steel plant.
That’s roughly what I am looking for in the IT industry … including educational institutions.

Another good example is Microsoft’s choice of Seattle as their headquarter. They did not come to Silicon Valley. And for a long time they had a very stable workforce. The Valley has historically been much less stable.

Besides, there is a huge issue with education in India. By and large, it’s a hopelessly inadequate education system trying to cope with a population that is out of control. The kinds of ideas discussed above are ways of mitigating some of those challenges, and educating a population that will otherwise not be able to access education.

There is a lot of discussion on sustainability and double-bottomline corporate practices in the world right now. I suggest you try to get past your aversion to acronyms and to me, personally, and reflect on the ideas.

Sramana

Sramana Mitra Tuesday, March 4, 2008 at 10:47 AM PT

Hi,

You do touch upon the right points as far as the complacency in Indian IT industry. People are faced not only with the inherent aversion to risk taking, but also innovator’s dilemma. When you have a business growing at 30% per annum and delivering net profits of 25% it is difficult to let go.

However, the assumption around labor arbitrage is wrong. Assume a US engineer costs $60,000 and an Indian engineer costs $ 15,000. Even if the US costs stay at $60,000, all that the Indian gets is a 10% of 15,000. So taking compound growth rate, it would take about 15 years to neutralize; If the U.S salaries grow at 4%, it might be 24 years. Of course, reality is different and this advantage would run out in 4-5 years

Ramesh Wednesday, March 5, 2008 at 1:57 AM PT

Let me give you a bit of a prospective from someone who has been in the US IT industry for almost 30 years. I am also a manager with employees from India on site and in India.

  1. The perspective is dead on about engineers employed today looking for higher wages in the future. The results of the booms of the 80′s and 90′s in the US the were the same. We were looking for higher wages and job mobility. India today is no different, its human nature at work. Top talent will always be in high demand as it is anywhere in the world.
  2. Wages will/are falling in the US. The dollar as noted with other factors will make costs here more competitive with labor oversees. The ratio we had just 3 or 4 years ago was 1:5 now its more like 1:3.
  3. Education is a key there as it is here. However your focus on IT creates shortages in other key areas. Civil engineers booked up for the next 7 years? India outsources quite a bit of its own engineering to France for example. More focus on organic growth with less reliance on exporting India’s talent. The belief that all of India can be the world hub of IT is somewhat naïve of market and political forces.
  4. Every bubble does burst. The internet bubble, the real-estate bubble, the commodities bubble (shortly) does and will burst. India is riding very high as are other countries. Your country world can not look to the United States forever. Political winds can shift and change can come quickly. For example Data Security is becoming more of a national political issue here.
  5. Business will always move to the lowest cost provider. Yes quality is a factor but everyone can claim quality.. Cost will be key.
  6. India’s class and socio-economic problems will continue to hold back the country. Your Micro-city idea is interesting but again to naïve for many reasons will not work on a large scale. Look at China where it works better than any where with low tech manufacturing.

Everyone fears the end of a boom, I see by the tone of these responses India is no different. With every US boom there has been a recession or bust. The same will hold true for India. India must focus more on social and political changes. Stop counting on worlds outsourcing work all bound for India. For example more cars are built in the US today than where in 1980 even with labor costs. Short team there will be more announcements and more large companies moving parts of there staff to India. However the US economy is slowing, energy prices are far too high to sustain growth, the dollar will continue to fall. If some predictions are correct a major correction is taking place. As this occurs the political climates will change. What would a new democrat president do, or another attack n the US??

Ron Wednesday, March 5, 2008 at 9:20 AM PT

Dear Sramana,

As I read your article titled “The coming death of Indian outsourcing”, I was stunned to see that you have said things right on the dot. Having worked for Infosys myself in the past, I have tried to argue myself many a times with people and on forums that they have their business setup all wrong.

Despite having billions of dollars cash in banks, these companies are least interested in investing in technology or Innovation, and would rather hire a few thousand more hi-tech labourers for the same investment and peddle their services at dollar rates.

Now with US economy in recession, dollar in downward spiral and stronger rupee, most of the large IT cos in India are having a tough time with balance sheets. Also other emerging sectors have simply taken the sheen out of IT. All the things you mention like skill shortage, people getting comfy in cubicles are all very TRUE!

Also this year many disruptive technologies will hit the market that will change the way people and coroporates do computing. Many of those technologies can probably wipe out business units within large IT services companies in a few years of time…

I certainly would like to read all the analysis you have written and would like to keep in touch.

I really do appreciate this particular article of yours.

Regards

Nagendra

Nagendra R Setty Wednesday, March 5, 2008 at 12:27 PM PT

Dear Sramana,

I think your article did what you perhaps wanted it to do.. Focus people on the real challenges facing the Indian IT industry today. As someone who has been involved with the industry for over 20 years, I can say that the the challenges you highlighted are real and need to be addressed.

Regards

Ajay

Ajay Wednesday, March 5, 2008 at 4:40 PM PT

Yes it did, Ajay. And I plan to keep pounding on those issues, hate-mails notwithstanding :-)

Sramana Mitra Wednesday, March 5, 2008 at 6:23 PM PT

End of the day..one cant disagree with you.But do think about this from the employee’s shoes.Indian cities are becoming expensive.The small towns still lack basic ammenities that they should have.Why would anyone want to leave a offer in a metro and move in there ?
Yes you can hire from the smaller towns itself and train them.Eventually they would try moving into the larger cities for higher salary.
A lot I think has to be done from the government’s side.The process of getting admission and the quality of higher education is messed up and the cost of higher education itself is increasing alarmingly.Cities cant support the growth anymore.Supply can be increased with a efficient education system,and growth can be distributed by making other locations attractive.Eg :Mysore near Bangalore has taken of a huge extent,but not Hubli,Mangalore or Dharwad .
I attended a informal session organized by few geeks all who were CEOs,CTOs etc of their startups ,few were in Wall street firms and all of them were against Outsourcing for their critical projects.Its scary

Aditya Friday, March 7, 2008 at 9:33 AM PT

Aditya,

Yes, I do think about it from the employee’s shoes. Quality of life is starting to suck in these cities.

I won’t be surprised if one day, Infosys comes to a large number of these employees and asks them if they would like to move to Western Canada.

Canada is very willing to give visas easily and is looking for people. It has a very small population and a very large territory.

What is stopping Infosys or IBM from setting up a 10,000 people operation in Canada, and relocate frustrated employees from Bangalore?

Would the employees want to move? I have the feeling they would!

Sramana Mitra Friday, March 7, 2008 at 10:54 AM PT

Hi,

Point taken. :D ..Just hope conditions improve within India itself to prevent any such arbitrage.

Nice site..shall definitely visit more often

Aditya Friday, March 7, 2008 at 9:08 PM PT

IT..IT…IT, is it all about IT? I agree with Ron above. Why are we obsessed with IT? Looks like everyone, including Sramana has assumed that IT will be the employer of last resort for all Indians. Any economy can thrive only if it is well diversified with good talent pool available in various fields/sectors. But looks like you are suggesting a mass movement where habitants of 6000 towns in India, all learn English language and get employed in IT sector. This sounds like old wine in new bottle – earlier 70% of India was centered around agriculture, looks like in the future, with this obsession with IT, a similarly high percentage will be centered around IT.

Prime ingredient for product development is passion, commitment and ability, which is what has been proved by so many successful open source projects. I would assume that India has the ability but I doubt if that passion/commitment is there. One doesn’t need funding by Infosys or Wipro for doing product development and blaming them for “service mentality” is wrong. If we do this, we are actually looking for scapegoats for our own lack of passion and commitment. Do understand what I am talking about, one should visit the forums of these open source projects where the developers of those products have been around for years and have answered thousands of user queries, in the process making their products even better. Do you have this commitment in India? A lot of people are busy jumping jobs to increase their salaries.

Rather than this, if we teach our youth to pursue their interests, in whichever field it may be, and do a great job at it, rather than pursue careers just for the sake of money, then not only IT products, but products in other sectors will also materialize.

deepak Saturday, March 22, 2008 at 9:39 AM PT

Deepak,

This is a technology business blog, so we discuss IT. We are talking about a pool of 4 Million IT workers, and increasing that pool to 40 Million. India’s population is over 1 Billion. Why should 40 million people working on IT prevent the other parts of the Indian economy to suffer? I fully agree with you that India needs Civil engineering, Mechanical engineering, Agriculture, Textile, and a whole host of other job types, but even if you allocated 10 Million people per job type, it doesn’t add up to much.

On Passion careers vs. Mercenary careers, I cannot agree with you more, that Indian youth are wasting the best years of their lives right now learning nothing, building nothing.

Nothing.

Sramana Mitra Saturday, March 22, 2008 at 11:48 AM PT

Sramana

fab article. really informative. Firstly, thanks for taking time to reply to all the comments!

it will be great if you can publicise your site more and make it known to more young Indian professionals worldover. Their interaction and comments will reflect a clearer and truer insight

Cheers!
raef

raef riad Monday, March 31, 2008 at 3:41 AM PT

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I have discovered the words Labor Arbitrage, and the label I have discovered is what I have been doing for the last four years with my Internet Sites. I am a perpetual traveler of over 10 years and 79 countries. I posted a blog about my experiences with India workers, I invite you to take a look.

I have read many of the comments, however often they seem too lofty and over intellectualized. I have found that working with companies in India is a hazard to my business, while working with individuals is a great benefit.
Andy of HoboTraveler.com in Japan today.

Andy of HoboTraveler.com Saturday, October 4, 2008 at 7:13 PM PT
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