The New Economics of Outsourcing

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India's Cost Differential Fast Eroding

Contracts are written in dollars, and as much as 60% to 80% of Indian service providers' revenue is in U.S. dollars, but more than half of their costs are incurred in rupees, according to an October report from Forrester. Indian outsourcing powerhouses like Wipro are feeling the squeeze. They've strived to cut costs, and now they're raising prices to keep margins from narrowing further. "We are relentlessly driving for higher pricing for our services and have seen price increases from our customers in the range of 3% to 6%, and our new customers are coming in at around 5% higher than our average," Wipro Chairman Azim Premji said on a conference call with investors on Jan. 18.

Duke University professor Arie Lewin estimates that the benefit of doing business, from a labor-cost point of view, in such locales as Bangalore, India, will disappear for some companies in three to four years. That's due to a combination of dollar depreciation, wage inflation, and other costs. Others say it will take longer. "Costs are escalating, so the level of labor arbitrage isn't as great as it used to be, but that's not to say labor arbitrage is disappearing, nor will it disappear in the next 10 years or so," says Sid Pai, partner and managing director of TPI India, a sourcing advisory firm.

Indeed, while costs are increasing in India, the country is generally less expensive than Latin America and most other locations, especially for companies that don't require high-end software developers. The average annual salary for an IT worker in the U.S. is about $75,000, according to a late 2007 report by Alsbridge, an outsourcing consulting firm. In India it's about $7,779 and in Argentina, it's slightly higher at $9,478. In Brazil, the annual wage jumps to $13,163, and in Mexico it climbs to $17,899. "The bottom line is that there aren't great alternatives with the scale, quality, price structure, and the lack of risk of India," says Stephanie Moore, vice-president at Forrester.

Spreading Out Work In Several Nations

Even Lopez acknowledges that Latin America can't approximate India's scale. Mexico, for instance, has about 500,000 IT workers and graduates an additional 65,000 each year. Last year in India there were more than 1.6 million IT workers employed; an additional 495,000 graduate each year, according to NASSCOM, an IT trade group in India. Instead, Lopez envisions Mexico and the rest of Latin America acting as a complement to India and other offshore locations.

Recognizing that it may not be a good idea to locate all outsourcing in one country, or even a single region, many companies spread work among several sites. On Mar. 31, Royal Dutch Shell announced a $4 billion outsourcing arrangement. The oil company awarded about one-fourth of the total to Electronic Data Systems (EDS), which over five years will handle computing services for 150,000 users in more than 100 countries. The bulk of the work will be done in 4 places, the Netherlands, Britain, Malaysia, and the U.S. While EDS has thousands of workers in India and some of the work could possibly be done there, the company is actually hiring 1,000 workers in Malaysia for this project, an EDS spokesperson says.

Increasingly, companies want a provider that can nimbly shift tasks and labor among its own global network of work centers. "The real question, if you're going to sign onto somebody for five to seven years, is do they have a vision for how they're going to move work around the network," says Kevin Campbell, group chief executive for outsourcing at Accenture (ACN). With more than 40 centers, Accenture has the ability to shift work as market demands change (BusinessWeek, 4/23/07).