Indian Outsourcers Face New Challenges

The country's success as an IT destination is under siege due to wage inflation and competition from China and Eastern Europe

While India's IT prowess is undisputable today, the country is also a victim of its own success as it faces wage inflation and competition from Eastern Europe and China.

According to a recent industry report by India's National Association of Software and Service Companies (Nasscom), maturing socio-political attitudes and an appreciation of the proactive efforts by key stakeholders to further strengthen India's value proposition are helping to reinforce its position as the IT outsourcing destination of choice.

Nasscom is confident that India will remain an integral part of any major global sourcing strategy even as businesses around the world are exploring alternate destinations such as Eastern Europe to enhance their multi-country delivery capability.

The reasons for Nasscom's optimism: the growing impact of technology-led innovation, and the increasing demand for global sourcing as more companies choose to focus on their core competencies. And it is confident that India will achieve its target of US$60 billion in IT exports by 2010.

While India is uniquely advantaged to best address these opportunities, they are not lost to others. Timely, coherent and continued action is needed to ensure that India makes the most of these opportunities and maintains its lead, Nasscom noted.

In an interview with ZDNet Asia, Kiran Karnik, president of Nasscom, noted that the availability of well-educated engineers has been instrumental to India's IT success. "The large number of smart people educated in the right discipline has been the single most critical factor."

Nasscom estimates that about 19 million students are currently enrolled in high schools and 10 million students in pre-graduate degree courses across India. While nearly 3 percent of them find jobs in other fields, the rest opt for employment in the IT industry.

By 2008, there will be an estimated 17 million people available to the IT industry.

More importantly, India's high level of English proficiency has helped the country open doors to outsourcing deals from English-speaking countries. In addition, Karnik said in the 1990s, the Indian diaspora in the United States and the United Kingdom has also "acted as a very good bridge between those countries' markets and India".

Strong government support in the form of policies that encourage the growth of the Indian IT sector has also been a key push driver, Karnik said. This includes easing foreign ownership restrictions for local companies, a move that has helped India attract key IT investments.

"The government also had a good long-term vision by putting in place a 10-year plan in 1999, where tax relief is given to export profits," Karnik added. "This gives companies assurances in planning their cash flow and business models."

ERODING COST ADVANTAGE?India has always enjoyed a strong track record of delivering a significant cost advantage, with clients regularly reporting savings of between 25 percent and 50 percent over the original cost base.

Nasscom's Karnik believes this cost advantage--achievable by outsourcing to India--is unlikely to go away for a long time, and he cited several reasons.

First, the absolute cost advantage vis-à-vis other key markets is actually increasing. According to Nasscom, the current 10 percent to 15 percent wage inflation in India amounts to a lower dollar-value increase in the wage bill, compared to the 3 percent to 4 percent average wage inflation in the developed countries.

Secondly, there is still scope to further lower infrastructure and overhead costs among Indian IT companies. "

Despite the reduction in telecoms costs by 30 to 40 percent in the last two years, depending on how much bandwidth you consume, we still have higher costs for telecoms than other countries," Karnik explained. "So, there is still scope for further reduction there."

Also, Karnik said because of India's inefficient infrastructure, Indian IT companies are incurring at least a few percent more in extra cost. "This can't get worse, and will only get better, so there's some scope there for further savings," he said.

Finally, there is scope for further leveraging operational levers to drive efficiencies in the Indian IT organization.

According to an industry benchmarking exercise conducted by Nasscom since 2005, the adoption of internal practices varies across the industry. This suggests that the adoption of industry best practices can further enhance operational excellence in Indian IT companies.

Contrary to concerns of rising wage inflation eroding the sustainability of India's cost-advantage, especially over the past two years, leading players such as Mumbai-based Tata Consultancy Services (TCS) have managed to grow at an above average rate--while sustaining their high levels of profitability, Karnik noted.

"Clearly, this indicates that they have been able to manage their internal resources, including human resources, very efficiently," Karnik said. "They're spending less time on projects and getting more out of their human resources for higher productivity."

TCS' revenues crossed US$4 billion for the first time, for its latest financial year ended Mar. 31, 2007. The company reported a 41 percent year-on-year revenue increase to US$4.3 billion on net income of US$950 million.

S. Mahalingam, chief financial officer of TCS, attributed the sterling performance to "several levers in terms of pricing, offshore leverage and cost controls" to boost its profit margins against the fluctuating Indian rupee.

Currency fluctuations are often not within the control of any company, and this will naturally affect bottom lines.

As Infosys' president, COO and joint managing director Kris Gopalakrishnan alluded, the company's profitability is impacted "not by wage inflation per se, but by wage inflation coupled with an appreciating rupee".

Michael Guilbault, senior analyst at research company Technology Business Research (TBR), agreed. He noted that a 1 percent increase in the value of the Indian rupee versus the U.S. dollar or sterling pound, socks some Indian firms' gross margins with a 5 percent hit because they pay most of their staff in rupees.

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