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Outsourcing: Wake-up Call for Indian IT Firms

Fact: Between fiscal years 2001-2005, India's share of global outsourcing for IT has grown from 62% to 65%, and 39% to 46% for IT-enabled services - BPO. And, equally true is the fact that successful models breed competition, as is evident that the Indian IT / ITeS sector has competition on its heels, borne out by the fact that several other locations are in the running as alternate off-shoring / outsourcing options. However, NASSCOM in its 2006 Strategic Review maintains India remains the most preferred off-shore location for outsourcing a broad range of business services, a positive outlook that is based on the following survey results:

The A T Kearney Global Services Location Index 2005 gave a weighted score of 10 to countries, based on their financial structure (4-points), people and skills availability (3-points) and business environment (3-points). India scored highest with a weighted score of 6.87 points, China second with 6.17, Malaysia third with 6.07, and Philippines fourth with 5.78.

In the business environment category, Singapore led the pack with 2.67 points, followed by UK with 2.41 points; Canada came a close third with 2.40. Interestingly, USA came first in the people and skills category with 2.74 points, France second with 2.34 points and India third with 2.14. Philippines let in the financial structure category followed by Ghana with 3.57, then Vietnam with 3.55 and India with 3.47.

As is common knowledge, India's well-known advantage lies in its excellent people skills and a sizeable English-speaking workforce. The number of IT-ITeS professionals employed in India has grown from 8.3-lakhs in fiscal year 2003-04, to over one million in fiscal year 2004-05. And, the industry employee base is expected to reach 129,000 by the end of the current fiscal year. Offshore IT / ITeS / BPO services penetration is estimated at about 10% (McKinsey report 2005), and rising rapidly.

While, the Indian industry is targeting $60-billion worth of exports by 2010, President of India, Abdul Kalam has urged IT professionals to take this figure to $200-billion by 2010. If President Kalam's request is to be met with, it translates into an estimated demand for 850,000 IT and 1.4 million ITeS-BPO professionals by 2010. However, currently there seems to be a shortfall of about 500,000 workers.

If you recall, it is this same workforce that generated an uproar in the US and Europe on the basis of allegations about Indian and Chinese workers purportedly "taking jobs away from the West". With the backlash gradually subsiding, it is worth noting what the author of "The World is Flat", Thomas Friedman, has to say: "In the flat world, there is no such thing as an American job. It's just a job and will go to the most talented and adaptive person."

India, amongst the fastest growing IT markets in the Asia-Pacific region can also lay claim to BFSI (banking and finance), telecom, and consumer durables being early adopters of IT-BPO in the domestic market, currently accounting for nearly three-fourths of the business in this sector.

Valued at $10.2 billion in 2004-04, the domestic IT-ITeS market is expected to exceed $12.4 billion, a rise of nearly 22% in 2005-06. Demand for services in the domestic IT market is predicted to grow by 21%, and projected to cross $4 billion (a CAGR of 1.5% over 2001-05). ITeS-BPO demand in the domestic market is expected to cross $900 million in 2006 (a CAGR of 60% over 2002-06). Though, the current small base will be responsible for attributing to the high growth rate.

The players in this segment are strongly focused on niche areas, such as HR firms providing payroll processing services, and are predominantly focusing on exports including domestic businesses, with perhaps captive needs. For instance, Bharti has outsourced its call centre operations, supporting its mobile services customers across 23 circles, to IBM-Daksh, Mphasis, HTMT, TeleTech. Whirpool has outsourced a range of customer interaction services, including inbound complaint management and queries, outbound dealer calling and its client customer database to Infovision. Air India has outsourced its calls relating to flight information, booking and reservations, hotel and limo bookings, baggage, tele check-in and complaints to Sparsh (Spanco Tele).

Comparing the figures for 2004 and 2005 (with reference to the A T Kearney index), one notes the Indian financial structure figure has fallen by a marginal 0.2 points. However, that of the Philippines rose, significantly, across all three categories. Other countries that pose a potential threat to India saw an overall improvement in their index figures on the whole i.e. Thailand, Chile, Mexico, Costa Rica, Vietnam, Russia and Israel. If Indian firms do not chalk out a strategy to remain ahead of the game by moving up the value chain, these countries may soon offer strong competition for a share of the outsourcing pie.

Lee Dawson, CEO, Southern Water confirms India is an undisputed global offshore leader, but cautions it to move up the value chain to retain its lead. In other words, it needs to outsource commodity items to emerging competitors such as China, Vietnam and Borneo. As well, India has to improve its power situation. "Much of the work is in the East. However, much of the power is in the West." he says in a lighter vein.

Further, India's stress on infrastructure has to move to Tier-II cities as well, since Tier-I cities are reaching saturation point. President Kalam highlighted this in his special address at NASSCOM 2006. "NASSCOM and the government of India should start targeting small and medium ICT industries and encourage a consortium approach for IT solutions." he urged, insisting IT-ITeS companies look at smaller Tier-II cities, besides focusing on Asia-Pacific, ASEAN and African countries.

Rising Wages Mar Cost Advantage

The Indian IT software services sector has been witnessing a steady decline in profit margins - from around 41% in 2001 to 30% till date, attributed primarily to the rapidly-escalating employee costs that swallow almost 50% of the IT sector revenues.

While revenue of top 20 companies researched grew 2? times in the last five years, employee costs quadrupled over the period. Four frontline software services companies i.e. TCS, Wipro, Infosys Technologies and Satyam Computers are on a hiring spree. In the first nine months of the fiscal 2006, these companies added almost 40,000 employees, taking the total addition to 84,000 since fiscal 2004. TCS hired almost 30,000 since FY-04, Infosys 26,000 and Wipro 19,000 since FY-06, while Satyam has added almost 10,000 employees to its fold since FY-04.

Incidentally, the Phase-I results of the Hewitt Salary Increase Survey 2005 states the average increase in the IT sector, across levels is in the range of 16%. Junior levels saw a higher movement in compensation, with the first three levels reporting a double-digit salary increase of 12% in comparison to 2004, which saw an average increase of 8% at these levels.

The revenue per employee in the last five years has steadily declined from Rs. 3.77% per rupee spent on an employee in FY 2001 to Rs. 2.90 in FY 2003, and further to Rs. 2.31 in FY05. In the first nine months of FY06, a rupee spent on employees has generated revenue of Rs. 2.09. Currently, the attrition level is said to be around 35% for the industry as a whole, and varies between 10 and 15% for frontline companies. IT companies always keep a pool of employees (also referred to as benching). Industry estimates of benching stand at 20-25% employees.

NASSCOM, though, believes wage inflation is a market dynamic and the recent hikes in salaries are the result of a short-term mis-match between the demand for, and supply of experienced professionals. A scenario the industry is learning to manage as it matures. Azim Premji, chairman, Wipro, concurs the profits of Indian IT companies will remain in the 25-30% range. "Our profit margins cannot be compared with that of US companies. I always hear people say that our margins are bound to fall. This sector is driven by people resources. I beg to differ that we are losing our cost advantage. If you compare the profit per person in India (around $12,000) and that of the US ($23,000-25,000), you will realise that there is a huge disparity." he says.

India with a population of over one billion people can look at healthcare, tele-medicine, tele-education, thus envisaging a new market through e-business network. It should also nurture at the knowledge process outsourcing (KPO) area where it's making considerable inroads.

Dawson points out knowledge services offer a potential of $17-billion by 2010. If India were to move up the value chain, it could capitalise on engineering design outsourcing, for instance, to shore its revenue, says Dawson. Incidentally, 40% per cent of global engineering design is sourced from India. Besides, environmental consultancy and legal services too offer ample scope for expansion.

Pradeep Udhas, senior partner and COO (advisory services, Middle East and S.E. Asia), KPMG India, says: "We have done great so far. However, the jury is till out, whether India can create a true multi-national platform. We have to learn how to work and manage different nationalities. For instance, if we sublet the outsourced work to China, we should be able to manage Chinese workers. We aren't known for this skill as yet."

Recently, conducting a dipstick (indicative and not authoritative), KPMG surveyed across Indian IT and ITES organisations to determine the "change readiness" in the industry. The change readiness index shows, a high-performing company more likely to be receptive to change compared to average and poor performers. In other words, companies, which have a higher profit after tax and return on capital employed growth are high (84%) on the change readiness index.

Average performers or the median group showed 70% readiness for change, while poor performing companies, in terms of PAT and ROCE figured anywhere between 40-61% on the change readiness index.

The survey also revealed quality of leadership in change-ready companies is of utmost importance. "In our talks, clients often tell us that while the top management of Indian IT-ITES companies are impressive, such is not the case with the middle-level management." says Udhas.

Finally, another way of moving up the value chain would be to reach out to non-customers, creating and capturing new demand and value innovation.

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