The outsourcing boom in India is raising political hackles in the United States and other developed economies. But, as Kamalakshi Mehta reports, the economics are simply too good to resist. This boom still has a long way to go. It is truly the face of the future – both for India’s bright young IT generation, and for companies striving to remain globally competitive

Suspended from the ceiling of America Online’s call centre offices in Bangalore are multi-hued boards urging employees to “say please” and to “start with an enthusiastic greeting”.

Hindi pop music and a mini cricket pitch add to the collegiate atmosphere and help the employees – all graduates in their 20s – to work through the night answering calls from AOL customers in the United States.

Some of the employees have impeccably honed American accents. Some concentrate on speaking clearly. All strive to be courteous. This is not always easy: “Joe” is hung up on by an irate caller who takes issue with the fact that he is being forced to speak to someone in India. “Probably a labour unionist,” quips a colleague.

Offshore call centres have proved extremely controversial in the United States and United Kingdom, but they could be just the tip of the iceberg. The business process outsourcing (BPO) and IT related services sector – of which call centres are a part – is set to explode as the search for cost-competitive brainpower drives transactions offshore.

Business consulting firm McKinsey & Co estimates that offshoring is growing at 30% a year and will reach $200 billion in the next five years. And India, with its low-cost economy and English-speaking professionals, has grabbed a lion’s share of the business – about 70%.

However, with pressure on margins and competition from other low-cost countries like Malaysia and the Philippines on the rise, India must go beyond simple back-office and software application work. The country can retain its competitive advantage only if it goes up the value chain by leveraging its intellectual capital.

And this is beginning to happen. There is widespread recognition that a business model based solely on cost arbitrage cannot sustain itself over the longer term. “The cost benefit won’t be neutralized, but the industry is moving away from just cost. There are huge changes in productivity,” says Som Mittal, president and CEO of Digital GlobalSoft, a Hewlett-Packard company, and chairman of Nasscom, the National Association of Software and Service Companies.

In the BPO business, which typically involves low-specialization tasks, a shift in pricing from a seat-based model to a transaction-based model could enhance the value on offer, says Tiger Ramesh, head of the BPO arm of iGATE Global Solutions.

“It happened in the manufacturing industry, it will happen in services,” he says. “Only those firms that can help their customers alter their cost structures on the fly will succeed.”

For example, insurance companies can avoid fixed back-office processing costs by outsourcing their claim processing work to a third-party BPO vendor with insurance expertise. If the vendor can develop a technology platform for processing claims, it can take that platform to a number of insurance companies and achieve economies of scale, thus bringing down the cost of the transaction.

A percentage of the savings can then be passed on to the customers, who pay only when an actual claim is processed. The customer has fewer fixed costs, and the BPO firm is moving up the value chain by leveraging technology it has developed and to which it owns the rights.

India’s software-services companies such as Tata Consulting Services, Infosys and Wipro are moving aggressively into value-added spheres of work. IT consulting, where the phrase that resonates is “business transformation outsourcing”, is one such area.

“It’s going from being just suppliers of services that customers want to being proactive solution providers which bring to the table significant knowledge of the customer’s technology and business, are able to diagnose some of the customer’s challenges and then work with them to craft appropriate solutions,” says Nandan Nilekani, CEO of Infosys. Indian firms are going head-to-head with the likes of IBM, EDS and Accenture – which are setting up their own outfits in India – and seem to be holding their own. In a nod to Wipro’s business model, IBM recently acknowledged the company as a key competitor in the “business value propositions” space.

As momentum picks up, higher end offshoring is being seen in other sectors. Financial firms like American Express and Citibank have been carrying out transaction processing services in India for a decade or more.

But now the focus is on more skilled work.

JP Morgan Chase is hiring junior level economists at its Mumbai office to carry out economic research; Morgan Stanley is said to be following suit. While this is raising hackles in these firms’ home countries, it seems very likely that the cost-talent equation will prove irresistible. AT Kearney estimates that 500,000 financial services jobs will shift offshore in the next five years.

The infrastructure challenge
While not on the same scale as IT services, IT product development is another area where Indian minds are being tapped. “India is getting better at product design and manufacturing. Companies like ours are creating skills and helping people learn the difference between product development and software application,” says Mittal of Digital GlobalSoft.

A number of US firms have set up shop in India. Texas Instruments is the veteran – its Indian development centre was established in 1985 and boasts 225 US patents.

Semiconductor company Analog Devices has developed at its Indian operations three DSP (digital signal processing) circuits used by popular video and audio brands.

General Electric has set up its state-of-the-art John F Welch Technology Center in Bangalore for research and development. And Intel, whose India Design Center is its largest non-manufacturing site outside the United States, is carrying out software and hardware engineering.

While such captive R&D; units of global firms are expanding the local knowledge base and helping to establish best practices, home-grown companies like Wipro and Infosys are accelerating their own R&D; efforts in the hope that capacity utilization issues will make outsourcing of R&D; services to third-party vendors more attractive.

There is little doubt that the juggernaut of outsourcing cannot be stopped. But a number of obstacles need close attention. A weighty one is infrastructure. While the government has been supportive of the IT industry and is taking steps towards remedying infrastructural bottlenecks, the time lag between promises and implementation could prove costly.

Bangalore’s impressive technology parks would not look out of place in Singapore, but the ramshackle, dusty roads that lead to them are distinctly third world.

Telecommunications have seen gains and power distribution is getting a little more efficient, but the overall effect is negative.

“The major challenge lies in improving the roads and the airports. This causes an embarrassment and is one reason why China consistently projects a better image than we do,” says Azim Premji, chairman of Wipro.

Ironically, talent – India’s strongest selling point – could also prove a challenge as capacity is ramped up. While India produces some 75,000 IT graduates and two million English-speaking graduates annually, a move up the value chain towards high-end work will require larger numbers of experts and experienced professionals.

“If we expand unrealistically, it could be a problem to generate experienced talent,” says S Karthik, managing director of Analog Devices.

True, the outflow of young professionals to the United States is beginning to be reversed as opportunities at home proliferate. And companies like Infosys are seeking to attract foreign professionals in a bid to diversify their workforce and spur innovation. But if the quality of minds is to be India’s trump card, investment in education and retraining remains critical.

Another obstacle could arise in the form of the backlash that is brewing against offshoring. A few months ago, the US state of Indiana cancelled a contract with Tata Consulting Services to process unemployment benefits because of angry protests by unions. In November, customer complaints led Dell to announce that some help desk calls from US corporations would no longer be sent to its Bangalore call centre.

Most industry watchers believe, however, that the economics of offshoring are too compelling to be legislated against. According to a McKinsey report, $1 spent offshore by US companies provides benefits of only $0.33 to the supply country. Direct benefits of $0.67 and potential future benefits of $1.12-$1.14 for each dollar spent accrue to the United States. And aside from the cost factor, the shortfall of workers created by changing demographics in the United States and Europe will drive companies to look for talent overseas.

Industry dynamics will inevitably change in the next three to five years as the Indian outsourcing sector positions itself to stay a step ahead of the competition and rise to the demands of increasingly picky customers. There will be more consolidation at the top and greater specialization lower down the ladder. New opportunities will emerge on the horizon – pharmaceutical research is one that analysts are touting as the next big thing. But ultimately, the true test of the sector will be the impact it has on the country at large.

So far, the outsourcing phenomenon is fairly localized, with Bangalore at the centre and a few pockets scattered across the country. But some point out that those pockets, such as Gurgaon outside Delhi, have been transformed, and that other areas could go the same way.

Fuelling the optimism are predictions of a five-fold increase in the outsourcing sector in India by 2008, accounting for 7% of GDP (up from 3% now), 33% of foreign exchange inflows and employing four million people.

The numbers are still too small to make a significant dent in poverty levels, but the enthusiasm for India’s future is palpable, particularly among the young people. And as NR Narayana Murthy, chairman of Infosys, says: “The young are the redeeming feature of this country. About people of my own generation, I’m not so sure.”