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Outsourcing: Persistent Systems Interview (Part 9)

Posted on Monday, Jun 7th 2010

By guest author Tony Scott

Labor Arbitrage Cost Differentials

Tony: Anand, what is the cost structure differential right now that you are seeing between the United States and India?

Anand: We are still about one-third the cost of doing the same project in the United States.

Tony: And where were you five years ago?

Anand: It has been roughly in that same range. Costs in India have gone up a bit, and the rupee to dollar exchange rate has changed. We have been able to improve our efficiency and put more junior people on projects, so overall we have been able to hold onto that cost advantage.

Tony:  But didn’t you come from one-sixth of the cost of the United States back then, and aren’t you only at one-third now?

Anand: Yes, but it was a very different situation then. We were trying to find esoteric jobs from the United States and Europe and staff those jobs with people who could meet those requirements. It was not a scalable business for us.

Tony: In terms of your cost structure, do you think your labor arbitrage rate will be sustainable over the longer term at one-third of U.S. costs?

Anand: No, it will definitely change, but if we are able to do what we are trying to do in terms of providing our service, then it won’t cost me as much in terms of the manhours necessary to execute a project. Also, I can sell my services differently because of the value I am providing, and then I get a much better price point and margin than I would have compared to executing a project just by providing headcount.

Tony: But if you forget about the headcount because you are providing a turnkey service, I would still think that if you are providing fixed-price bids, that from a customer’s point of view that bid is roughly about a third of what it would cost here in the United States. I think the fundamental question is, how long does this 1:3 ratio continue, when does it become 1:2, and when will labor arbitrage essentially peter out?

Anand: Well, I think it is still five to six years for sure. I don’t see this going away that fast.

Tony: Five or six years more at one-third of the cost of doing the same project in the United States?

Anand: Yes, in that range I think a significant labor rate arbitrage will still be there. But the bigger opportunity is that I think there is no reason that we have to deliver at one-third of the cost.  I think I could get away by charging two-thirds, and ultimately even just as much as people are charging here, based on the value that I can provide – if I can convince customers that it is truly valuable.

Geoffrey Moore has a book called “Dealing with Darwin,” which is about how companies innovate at various points in their evolution. What we have been doing in the past two years or so is trying to ask our client companies: “Where is your product in its life cycle?” and then having a business model that aligns to the particular stage of that product’s life cycle. We find that if you can solve the problem that a customer is trying to solve, you can set a value and pricing equation that’s very different from a pure headcount equation

Tony: Right – then you are delivering value, not labor arbitrage!

Anand: If you are delivering value, then you can get some very different kinds of business models. We are starting to see a lot of interest from customers who are willing to do that with us. We have seen that about 12%–15% of our earnings have started to come from these kinds of deals.

Tony:  What I like about what you are saying is that the value proposition moves out of labor arbitrage and into core competencies.

Anand: Right. What we are saying to companies today is that they can focus on their core business, and we will do the context. As it happens, more and more parts of the software development business are moving into the part I would call context rather than the core. And more of this will happen in the future.

This segment is part 9 in the series : Outsourcing: Persistent Systems Interview
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