Bloomberg BusinessWeek: India: Toward High-End Outsourcing
Indian info-tech companies that once specialized in basic work are now providing high-value tasks such as R&D and business transformation services
In recent months articles in The Wall Street Journal and Forbes.com have postulated that outsourcing information technology work to India was losing appeal. They said that high employee turnover in Indian outsourcing companies and rapid growth had reduced work quality and upset Western customers. These same articles argued that salaries in India were rising so quickly that Eastern Europe, British Columbia, and even Oklahoma would soon become competitive with India. I've just spent two weeks in Indian speaking to top executives at some of the largest outsourcing companies and I believe reports of the demise of Indian outsourcing have been greatly exaggerated.
To the contrary, the Indian outsourcing industry has entered a new era of growth. Infosys (INFY), Satyam (SAY), HCL, and other IT outsourcing majors that once specialized in lower-value tasks such as application maintenance and business process outsourcing are seeing increasing success in providing outsourced high-value tasks such as total IT outsourcing, R&D, and business transformation services. I believe that not even terror attacks and a global recession will deter an impending revival of Indian outsourcing or a reshaping of the industry into a provider of high-value, unique services. Here are six reasons why this is true.
1. Faced with high turnover, rising salaries, and a weak public education system, top Indian companies started investing heavily in workforce education and development. As a result, since 2000, Indian industry made dramatic improvements in the education levels, productivity, and quality of its technical workforce. These companies retrained tens of thousands of low-level IT workers in advanced product design and development techniques to give them more valuable skill sets required to crack higher-value service offerings and fill managerial ranks. These investments have started paying huge dividends. A few years ago, the Indian IT industry relied on experienced managers returning home from the West to fill mid- and high-level management ranks. Now, Indian HR managers say that they prefer to hire local talent rather than returnees.
2. Attrition rates have been remarkably low and are dropping. This is also related to investment in workforce education and development. As Indian IT companies have focused on keeping employees happy and promoting from within, turnover rates at top Indian outsourcing companies have been stable or dropping over the last few years. In 2007, attrition rates at Infosys, TCS, and Wipro (WIT)— three of the largest Indian outsourcing shops—were 13%, 11% and 17%, respectively. These compare favorably with most U.S. technology companies, which are often over 20%. Even the world's leading IT firm, Accenture (ACN) runs an 18% global attrition rate. Several Indian CEOs I have spoken with say that with the worsening global economic downturn, they expect attrition rates to drop into the single digits. In fact, the CEOs were worried turnover rates will be too low. They feel that some turnover is natural and good for the organization.
3. Rising salaries in Indian IT shops are no longer a problem. The global downturn and concerns about job growth on the part of applicants have actually allowed Indian IT outsourcing companies to offer lower salaries for new recruits and to limit increases for employees. Plus, the rupee has dropped 25%. This allows Indian IT companies to provide 25% more services for the same price in U.S. dollars. At the same time, real estate and other business costs have dropped. Keep in mind, these companies were highly profitable even before the rupee's decline. Now they have become much more competitive.
4. Faced with brutal cost-control pressures caused by the global economic downturn, many companies are more desperate to outsource than ever before. Pramod Bhasin, CEO of India's largest business process outsourcing firm, Genpact (G), says that his customers are increasingly asking him to recommend what business functions they should outsource. They are desperate to achieve the 30%-40% cost savings he says his company can offer them. Equally important is the rapid growth in higher-value work being done by Indian outsourcers as companies from the developed world increasingly move offshore tasks that were once considered untouchable core competencies. As a result of this shift, India is becoming a global R&D hub in industries as diverse as aerospace, automobiles, and pharmaceuticals.
5. There has always been a trickle of highly skilled workers returning from the U.S. and Europe to their home countries for family reasons and because they felt homesick. Flawed immigration policies in the U.S., have however created a situation in which there are over a million skilled immigrants and their families in line for a yearly allocation of 120,000 permanent resident visas. There is also a per country limit of less than 10,000 visas. With over 350,000 Indians in the backlog, they are increasingly getting frustrated and returning home. All of the Indian company HR directors and CEOs I have spoken to say that they are flooded with résumés from Indians currently working in the West. They are able to cherry-pick those with the best skills. This influx of skilled labor is giving them the ability to expand services in new areas of finance and technology. With the layoffs occurring on Wall Street and in other industries, the trickle will likely become a flood and this will further strengthen Indian industry.
6. India has been dramatically increasing the output of its engineering colleges, and now quality is improving. In 2004, the country graduated just around 125,000 engineers with bachelor's degrees. In 2007, this number had doubled and will double again by 2011. I have always been skeptical about the quality of Indian engineering education. But after visiting several private colleges and talking to faculty, it is clear that there are dramatic improvements in quality in process at some institutions.
This is not to say that the global meltdown and other factors are not affecting the Indian outsourcers. Vineet Nayar, CEO of HCL Technologies, says the economic downturn has caused some customers to cut projects and reduce outsourcing budgets. But at the same time, he has seen an increase in new deals, particularly projects where the company is offering guarantees of 30% cost savings or sharing risk by accepting payment as a percentage of product sale rather than getting paid for product development. His pipeline for new business is bulging at the seams, Nayar says.
Similarly, S. Gopalakrishnan, CEO of Infosys, has lowered his short-term forecasts, but sees tremendous upside for his company once the economy begins to recover. He has decided to go ahead and add the 25,000 workers he had planned for this year. He says that smaller outsourcing companies could suffer more because they have fewer customers and therefore less flexibility to absorb customer shifts and cancellations in what promises to be a more unpredictable market for services. He also believes that companies like IBM (IBM), Cisco (CSCO), Hewlett-Packard (HPQ), and Microsoft (MSFT), which manage their own outsourcing operations will likely expand aggressively in India once the economy begins to recover.
Regardless, a wholesale exodus out of Indian outsourcing is not only unlikely, but the opposite is more likely to occur as companies on the Subcontinent take the outsourcing industry to a new level of expertise and competitiveness.