Business Accent

Outsourcing: perception vs reality

The opportunities presented by outsourcing are considerable, but so are the challenges. A commentary by someone in the thick of things

Anil Kini

When the first software code was written nobody could have predicted that the year 2000 would shake the IT world to its foundations. The world woke up with an unknown, unseen, and imaginary threat of Y2K looming over it. The need of the hour was to update computer systems so that they would continue to run as 2000 dawned and beyond.

During the same time, India, one of the largest English-speaking pools possessing a highly educated young population, was trying to establish a foothold in the IT industry. It was a natural choice of companies, mainly those in the United States, to see if they could tap the resources of the Indian software industry to counter the immediate threat of Y2K. That was Indian IT’s first break.

Worldwide enterprise IT expenditures soared from $175 billion at the decade’s start to more than $525 billion in 2000. It was the first time that India started dating the US.

Post-Y2K, the IT world placed its biggest bet ever on e-commerce (dotcoms). This failed miserably, and the dreams of hundreds of entrepreneurs were shattered. However, the world of IT discovered a few gems from the experience, and one of these was the existence of low-cost, highly-skilled Indian labour.

The need of the hour

The economy fell flat on its face in 2001. To run enterprise systems, especially legacy, CRM and ERP became an expensive and unwieldy affair. With labour alone accounting for nearly 75 percent of the cost of software development, finding talented staff, nurturing them and keeping them permanently on the payroll appeared to be a liability. Most CIOs in the US and Europe had been forced to change their IT policies and adopt strategies to curb in-house IT spending.

Their response to this crisis was to lay-off their in-house IT talent and hunt for third-party vendors who could support their enterprise systems by either co-locating to the company’s own premises or by offering remote support.

IT leaders soon realised that using resources from countries such as India and China would help them save on IT spending by nearly 50 to 70 percent.

It was not an employee-friendly policy, but little attention was paid to the protests that followed. The process of laying off in developed countries and shifting jobs offshore to countries where labour was cheap started simultaneously.

McKinsey predicts that IT offshoring will result in net savings to the American economy of $390 billion by 2010. $24 billion of outsourcing contracts will be signed in 2006.

Asian countries such as India, China and Taiwan offer a formidable combination of low wages and regular supply of skilled resources geared up to tap the huge market for offshoring.

Indians specialised in custom application maintenance and distinct management practices. They began to offer a range of software services and consulting.

Destination India

India’s pool of young university graduates (those with seven years or less of work experience) is estimated at 14 million.

As of December 2005, over 400 Indian companies had acquired quality certifications with 82 companies certified at SEI CMM Level 5, making India the top in terms of certifications worldwide.

A recent survey by Nasscom found that almost two out of five Fortune 500 companies outsource some of their software requirements to India. More companies are going offshore to develop and maintain their software. GE, Bank of America, Target, and American Express, for example, have formed partnerships with Indian IT firms or started their own development centres. The reason is obvious: this approach saves time and money. Moreover, it is steadily growing more attractive. Last year, North American companies alone spent $114 billion on in-house software development, contracting, and purchases—and these costs will only go up as additional basic business processes are conducted over the Internet.

In 2004-05, the Indian offshore IT and business-process-outsourcing industry will generate approximately $17.3 billion in revenues.

Offshoring economics

• It’s the exchange rate. The exchange rate of the Indian rupee vis-à-vis major currencies such as the US dollar, UK pound sterling, and the Euro are wide and continue to be so. As long as the exchange rates undervalue the rupee, this cost advantage will continue. Although recent years have seen a trend in rupee appreciation against the US dollar and other major currencies, it is likely that the appreciation will be slow and steady over the long term, and it is unlikely to alter the economics of the offshore model.
• Lower cost of living. Although India is in a post-liberalisation era, basic commodities still enjoy government protection and inflation is under control, hence there is room for salaries in India to become more competitive in response to competition from other countries.

Coming of age

After realising cost savings and growth in revenue, there is a gold rush to outsource software work to Indian companies. American and European establishments moved to outsource their in-house work either to low-cost countries, primarily India, or to open development centres to achieve further control over costs. It has been found that 80 percent of IT services or help-desk jobs are already being performed remotely.

The global outsourcing of IT and BPO services has grown nearly three times over the last five years. So far Indian vendors have managed to corner the lion’s share of outsourced business. That said, a recent study revealed the surprising fact that India could bag only 10 percent of the global outsourcing pie. In 2006-07 itself, around $50-70 billion worth of contracts are in the pipeline, either to outsource or for renewal.

The Indian IT-BPO industry stretches itself to accept challenges and gain a large share of the growing outsourcing business by expanding operations beyond the metros to counter the crumbling infrastructure and scarcity of IT professionals in the big cities. IBM’s headcount in India that currently stands at 38,500 professionals will increase by another 50,000 over the next 12-15 months (source: www.rediff.com). Accenture, with around 20,000 people in India, is targeting a base of 50,000 professionals in South-East Asia by 2009. The top three domestic majors (TCS, Infosys, and Wipro) plan to add another 60,000 people over the next 18 months.

It is expected that the Indian software biggies will make more acquisitions in India and abroad to move up the value chain, and that they will acquire domain expertise. Companies will offer end-to-end solutions from business consultancy to help-desk. They will even offer near-shore support by providing support from nearby countries (e.g. Canada for US clients).

Remote management

As IT vendors get ready to offer services of superior quality at a low cost and on demand, organisations have changed their outsource strategy to split a deal across several IT vendors to minimise risk and get a competitive price. It is advisable to renew contracts at a frequency of 3 to 5 years to ensure that vendors compete among themselves in service provisioning.

Vendors need more specialised leaders to handle contract management. These outsourcing leaders will be the link to CIOs in the client companies. On the part of the client, it needs to do more than merely outsource. These leaders have to perform a multi-purpose role of negotiator and collaborator, and provide leadership to an offshore team.

So where is the problem?

• Low-value job. During the early days of outsourcing it was commonly perceived that the way to go was to choose jobs that were repetitive in nature. Low-business-value maintenance tasks were offloaded to vendors. This was principally because business leaders were not fully aware of the capabilities of these vendor, their skills and strengths, or simply not confident about their ability to deliver the goods.
• Cultural differences. For many years, India among developing countries remained aloof from westernisation, hence there is a cultural barrier hindering us from picking up outsourcing momentum. Clashes between different languages, cultures, and work practices can make collaborating with a client a formidable challenge.
• Know the business. Indian techies were good in following ‘what they were being asked to do.’ It was common to find displeased American and European clients finding that sending work offshore did not always bring value to business. One reason was a mismatch between the IT capabilities of client companies and those of the offshore vendors.
• Communication. With client and vendor teams being located thousands of miles apart, voice communication remains a critical tool to carry out daily business. Oftentimes, cultural difference and an absence of professionalism prevent a vendor from rising to the occasion.
• Different time zones. As Indian vendors started supporting clients located in other countries across time zones, it became imperative to offer support to their clients in their time zones for services rendered. It has always been seen as a challenge to provide after-office-hours support, a problem further exacerbated by poor infrastructure.

Setting aside the top IT and management schools, the quality of education in other educational establishments hasn’t kept pace with the times; the curriculum is often out of date and unsuited to current market needs.

A large portion of the population of engineering graduates are attracted to foreign jobs as they are looking for better opportunities and an assured financial future.

Indian entrepreneurs and multinationals are setting up shop, ensuring that the demand for experienced resources stays high. Today, everyone is engage in poaching talent rather than building it from scratch. Naturally, keeping salaries high to lure talent is ‘bad in the long run.’

Wage differential

Rising wages leading to high levels of attrition are worrying factors not only for Indian IT leaders but also for major US clients. Almost everyone is on a hiring spree, with multi-million dollar deals about to be signed in the near future. It’s almost imperative to have the right talent at the right time. The upshot of all this is that each one is engaged in talent poaching.

Soon, average wages in the IT sector will reach a threshold. However, there remains a wide gap between Indian and Western wages, so it may take a decade for parity to be established. Almost all IT companies have concentrated their operations in a handful of cities, hence the demand and supply equation of talent remains inversely proportional.

The story of Indian IT is mainly written by private players with little government support. While the government is adamant in emphasising its role in creating a conducive atmosphere, the reality is that the infrastructure is worse than bad, that the telecom sector growth to support corporate initiatives is happening at a snail’s pace, and that this growth is principally focussed on adding individual subscribers.

The Indian state needs foreign direct investment, but entrepreneurs often face embarrassment in accompanying foreign delegates from crumbling airports to swank company headquarters.

Ensuring a secure future

• Collaboration rather than competition. As everyone needs skilled resources to grab outsourcing deals, a wage war is underway to attract talent by any means. It is not impossible to collaborate with competitors where each player can leverage the other’s domain and industry experience. The advantages are two-fold. They can bid together to claim a strength that neither possesses alone instead losing a deal by flying solo, and most important of all avoid compromising on the profit margin which usually gets hit when both players would otherwise be competing. It is a clear win-win situation.
• Innovate, not replicate. Offshoring often ends up replicating the same model that already exists at the client’s end. On the face of it, it does save money for the client because of the wage differential. In the long run however, it doesn’t add value to the client’s business. Beyond transition, it is transformation that can play a greater role in realising business goals. Indian talent often goes to waste merely doing things rather than innovating. The client should encourage and vendors should propose the best model that will work in the long run to sustain the client’s revenue growth. This is possible only when the client sees a vendor as a partner and allows him to make the decision rather than seeing him purely as a service provider.

Global and local

Tier-1 Indian companies are seen making outsourcing deals valued in the range of $200-300 million. It is global IT majors such as IBM and Accenture that continue to dominate mega, multi-geography deals. This is mainly because of their capability, global presence, and the ability to offer infrastructure support in addition to services under one roof. The primary challenge of India’s leading software houses will be to expand beyond the country’s borders by building worldwide networks capable of providing advanced services—both in distant, low-cost locations and in the customer’s home country.

One should not hesitate to say that Indian companies must shift their headquarters from India. That’s the only way to make them truly global entities.

Spreading wings into emerging countries will force companies to adapt their recruiting and training skills. It may take Indian companies several years to build skills and brands worldwide. To manage a global presence, these organisations will need leaders who are effective across organisational and national boundaries.

It is also important to generate the friction that shapes and sharpens learning when people of different backgrounds and skills collaborate on real problems. Clear performance targets, an unconstrained environment for finding solutions, and the sharing of prototypes across organisational boundaries generally produces the most beneficial results. Processes must be developed with the help of new generations of information technology to ensure that innovations are disseminated across the network.

What India should do

• Know your customer. Know his problems and business imperatives. Make sure that the product or service you are providing drives his business objectives further and solves his problems. It actually takes a lot to achieve this. It requires that people currently supporting various client businesses should be in touch with customers beyond just the IT task at hand. They must unleash technologies that can help solve complex problems, integrate various loose pieces, and grow the client’s business. Establishing a comfortable level of mutual trust and confidence with the customer is a crucial exercise. This can be cultivated through improved visibility and authoritative participation in industry events and conferences. People should come to be recognised as respected authorities in their area of business.
• On demand. The business scenario is changing faster than the time it takes to design a solution. The future belongs to those who can conceive fresher ideas and solutions. An organisation today needs to be innovative, to which end it must offer an environment where creative people can deliver results and make continuous improvements. Innovating requires a number of inputs; one needs to be aware of the market situation, identify trends, keep pace with emerging technologies, and effectively use this knowledge to come up with solutions before competitors can.

Things India should avoid

Today, India clearly dominates the IT outsourcing arena. It has a few superior characteristics when compared to its nearest rival. Competition is wide but the runner-up is far behind India. It is natural to enjoy today’s success and assume that tomorrow’s business is assured. However, the environment is changing rapidly, clients expect more from their vendors, and they often bring more players to the deal to get competitive prices. To counter this challenge, vendors need a different strategy that can provide steady results. To remain alert and not get carried away with today’s successes is imperative.

There is a need to invest in resources and employees. Training is a weak area. Beyond academic education, which itself is often not paid sufficient attention, investment in role-based training and building domain skills should be taken up as a priority. This will help Indian techies communicate with clients in their own business language.

Product development is quite low vis-à-vis application services. Today’s business faces many problems and different practices to perform the same function. The Indian presence across geographies and businesses in all industries gives Indian companies the opportunity to offer streamlined processes with easily adoptable products. Indian IT leaders should take risks in product development rather than stay content in enjoying the safety of services.

Services follow products. The client is not aware of where there is room for improvement to minimise long operation cycles and arrest revenue leakage. Re-engineering services is an unexplored area that needs immediate attention and sustained effort.

References
Statistics compiled from The McKinsey Quarterly and National Association of Software and Service Companies (Nasscom) of India.

The author may be contacted at anil.kini@in.ibm.com