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Is Outsourcing Dying Or Thriving? (Part 2)

Posted on Sunday, Mar 14th 2010

By guest author Tony Scott

It has now been two years since Sramana Mitra’s article “The Death of Indian Outsourcing” was published. Is outsourcing dying – or thriving?

In one sense, outsourcing in India as it was known in the past is on the verge of (and in some cases is already) “hitting the wall.” Pure labor arbitrage-based outsourcing is dependent upon wage rate differentials. While the global economic downturn may have slowed the rate of wage inflation in India, it will return as soon as the world economies return to “normal” – and likely with a vengeance.

This is a big issue for outsourcing companies for which the sole or primary reason for existence is labor-rate arbitrage. The rate of wage inflation in India and current and expected future relative wages in India vis-à-vis the United States, Europe, and other developed countries that are considering India as a place to outsource information technology and business process services is the only significant factor in the ultimate attractiveness – or not – of pure labor-rate arbitrage outsourcing and off-shoring.

As wage rates in India increase, the pure labor arbitrage model starts to fall apart. It is one thing when the fully burdened wage-rate differential between the United States and India is more than 3 to 1, but at a certain point as those wage differentials decline, it becomes less and less attractive to outsource.

Indian outsourcing boosters will cite the fact that India has a huge population and produces millions of new college graduates annually as their rationale for why Indian outsourcing will continue to grow unhampered for the foreseeable future. However, while India does indeed graduate millions of young people annually, many of them do not have the language skills and accent to be effective in outsourcing roles for which English fluency is critical. Several experts estimate that perhaps only 25% of all Indian college graduates have the skills that would be necessary to successfully work in a multinational environment at graduation.

That means that in good economic times when labor demand increases, those individuals who have the academic background and level of English fluency desired by companies that are outsourcing customer interactions will be in even higher demand. In addition, as India grows its own domestic economy, many more opportunities exist for the cream of the crop of Indian university graduates – opportunities that typically don’t require people to work in the middle of the night in India to support clients halfway around the world.

Ten years ago, the idea that domestic Indian companies would be competing for the best and brightest Indian graduates was almost unthinkable. Today, that is no longer the case. This demand for top Indian graduates who can work in either purely domestic or global environments will clearly increase as the United States and world economies improve and as India’s own domestic economy continues to boom. Higher demand without increased supply of talent means that compensation will inevitably – and rapidly – increase.

Beyond issues of wage inflation, there are also many concomitant problems associated with outsourcing: language and communication issues; time zone differentials; high turnover; and something that is often overlooked in the equation – the “hassle factor” of managing something halfway around the world across multiple time zones. This doesn’t even take into account the customer relations issues that many companies faced after they outsourced part of their customer interactions to Indian call centers, for example. It may be hard to put a value on the total experience customers have when dealing with a company’s support or after-sales care, however it is clear that negative impressions of services provided in India have driven many companies to consider alternatives.

Many of those opposed to off-shoring and outsourcing have pushed on this last point. They often put forth the position that the quality of goods or services delivered in India is lower than that in their home country, and therefore companies shouldn’t outsource or off-shore. That’s a valid point in some cases, and when one adds on the price to attract – and retain – top Indian talent, the economic value proposition for outsourcing or off-shoring to India basic services based on pure labor-rate arbitrage becomes less and less attractive for many companies. This is one of the reasons outsourcing centers in the Philippines, Latin America, Ireland, Eastern Europe, Northern Africa and lower wage-cost locations in the United States have been growing, and that is another macro trend that is unlikely to stop.

The bottom line: India’s days as the undisputed place to go for outsourcing based on pure labor rate arbitrage are over. That is not to say that outsourcing based on labor-rate arbitrage is going to die. But it is certainly not going to see the same kind of easy growth in India over the next decade as it has over the past ten years – and there is a distinct possibility that within the next decade, wage-rate inflation in India will eliminate the incentives companies currently have to outsource basic services to India.

This segment is part 2 in the series : Is Outsourcing Dying Or Thriving?
1 2 3 4

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The Indian outsourcing industry is fairly mature and well tiered, having been in existence for over two decades and experienced changing market conditions. While it is true that labor arbitrage as a key value proposition will not work forever, there are many companies that have consciously enhanced their value to customers by focusing on different areas including processes, solutioning and consulting capabilities and also customer relationship focus. On the last point for example, there are companies that have long standing relationships and hence are able to add better value through a deeper understanding of the customer. Even in the mid market, I know of many companies that are trying to stitch together consultative or solution capabilities in select areas, to move away from the pure labor arbitrage model. Also there are companies that are now willing to share risks with the customer. Last, many buyers from the west are now looking at markets in Asia, and the Indian service providers can make themselves really relevant by bringing their local market understanding to the table.

Sudha Kumar Sunday, March 14, 2010 at 3:23 AM PT

Such an ill-informed and parochial article. I can be that Mr. Scott has written this from the top off his head without any research. There are problems and challenges with Indian outsourcing industry but not the way it is made out to be.

Mav Monday, March 15, 2010 at 1:34 AM PT

Except, Tony Scott has been interviewing some of the top CEOs of the Indian outsourcing companies … so you don’t really have any justification for insulting him.

Sramana Mitra Monday, March 15, 2010 at 8:33 AM PT

Most of the Indian IT companies are in IT services sector and very few in products. So, as long as India’s pricing is competitive compared to other countries, we would be in position to sustain.

Guha Rajan Monday, March 15, 2010 at 5:40 AM PT

Mav,

I am very open and interested to hear in more detail why you think this article is “ill-informed and parochial”.

My research has included (as I stated in the introductory article of this series) interviewing the CEOs and senior executives of a number of outsourcing companies. I always happy to learn more, and look forward to hearing about the research you have conducted that would refute any of the propositions I put forth in this segment of the series.

Tony Scott Monday, March 15, 2010 at 12:27 PM PT

Hi everyone,

I can say that this is possible regarding the wage inflation that outsourcers would be less in the next couple of years since the main goal of these companies to face economic regression is the less costs to virtual staff management. Though, as Indian services has come to arise since companies have used India as an outsourcing haven in the past 10 years, it’s just a fair game for them to demand better prices on better services for companies who’ll be looking forward to quality rather than saving and earning more profit in return.

Tyrone Monday, March 15, 2010 at 8:20 PM PT

I worked closely with the leadership at Tata Consultancy Services on their global rebranding in 2005-06, and with IBM Global Services in 2004-5.

The Tata people knew well in advance that their Indian labor arbitrage play would not survive very long. To counter this, they put in place a two pronged strategy

1. find other low-cost markets – Latin America, The Phillipines, Eastern Europe – to source talent

2. move up the value chain to expand beyond low-value outsourcing into IT consulting, industry-specific applications software and other services

One IBM executive said to us “TCS is better than us in every aspect of their business – except marketing themselves” I have no doubt TCS and others will ultimately challenge IBM, HP and Accenture for IT services leadership

Denis Riney

EVP, BrandLogic Corp

riney@brandlogic.com

203.834.0087 x 331

Denis Riney Monday, March 29, 2010 at 11:04 PM PT

Except IBM has products of their own to sell, and their differentiation is not around services only. The game is changing in a way such that the products / services are verticalizing. IBM and HP are already full blown products / services shops. I expect Accenture to become part of Oracle or Cisco.

That would leave the TCS, Infosys and others with largely an undifferentiated story. However good their process is, the real leverage will be in technology, not in process and labor arbitrage.

I have long believed that TCS and others should start buying SaaS companies.

Sramana Mitra Tuesday, March 30, 2010 at 8:37 AM PT

Your point here is confusing. On one hand you claim technology is important and than want TCS to buy SaaS companies. SaaS is but a service platform! In increasingly collaborative world economy that is rapidly converting products to commodity, what will differentiate is solution through services. If Indian players don't invest in vertical solutions (and hence in domain know-how), they will be marginalized. It's difficult to believe that they are so naive now.

BTW, IBM is not a product company anymore. Their focus is services; it's a different matter that they also have products. One reason why IBM has stayed put decades after decades and many of their contemporaries have faded in to oblivion is precisely owing to the fact that IBM transformed itself into a services company!

Snehal Tuesday, June 22, 2010 at 9:35 PM PT

SaaS is a product "delivered" and "charged" as a service. It IS technology, and it is not a business that scales as a function of adding more bodies. That's my point. Vertical or horizontal, SaaS, right now, is everywhere.

And IBM is still VERY MUCH a product company. I cover them every quarter, and am quite aware of their revenue mix. You may want to check it out.

sramana Wednesday, June 23, 2010 at 5:52 AM PT

You are completely wrong regarding IBM as a product company. They've dumped most of their hardware product lines and focus exclusively on end market computer service offerings.

Jamal Tuesday, April 17, 2012 at 9:42 AM PT

The problem is that the industry is tied to a few numbers that are uncertain and increasingly challenged like Loading Factor, Exchange Rate, Billing Rates, Cost/Employee, Revenue/Employee.

Nearshoring is increasing. Though outsourcing will stay but profitability will be challenged and Indian companies may loose cost advantage and thus need to become truly global. Top companies anyways have global footprints. Technology itself will be a competition and thus source of advantage. A level 5 company CEO will surely agree that still productivity variance and gap among people is huge and can be radically improved. So thats the place to innovate!
Identify how to adopt new paradigms and have lean IT, green IT and IP+SaaS orientation to work towards reducing cost through application of technology and for better productivity

The industry need to radically innovate and do it desperately

I see the following possibilities in near future (nxt 5 yrs):
1. Growth thru consolidation
2. Growth through getting into new geographies
3. Emergence of technology and crowdsourcing based hybrid models for higher value at still lesser cost

By the end of 2015 there could be a visible shift towards advantage through technology and relationship mgmt than labor cost.

Sumeet Tuesday, March 30, 2010 at 12:06 PM PT