How Much Longer Will Indian Outsourcers Offer Cost Advantages?

Any discussion on pure IT outsourcing companies like Infosys (INFY), Wipro (WIT), Satyam (SAY) or Cognizant (CTSH) raises one question. How long can these companies offer the benefits of cost savings to their customers?

The focal points are the increasing wage bills for Indian employees and the appreciating rupee. Very few people take into consideration the increase in compensation costs fo US based employees , which is mainly caused by the increase in health care costs in USA. Keeping all the above factors in mind I have tried to create an equation that gives the magic year when this outsourcing cost advantage will be over.

My assumptions:

Salary of a USA based programmer with 10 years experience:
Minimum: $40 / hr (assuming 2000 hrs year (40 hrs x 50 weeks)) = $80,000 / year
Maximum: $60 / hr = $120,000 / year.
Benefits cost including health care = $10,000 / year.

The maximum and minimum amounts are based on the skill sets and the location of job.For instance a mainframe programmer in Ohio may fall in minimum bracket, whereas an Informatica (INFA) guy in California may fall in maximum bracket.

Average compensation = ($80,000 + $10,000 + $120,000 + $ 10,000) /2 = $110,000 / year.

Salary of an India based programmer with 10 years experience:
Minimum: Rs 1,000,000 (Rs 10 lacs / year)
Maximum: Rs 1,200,000 (Rs 12 lacs / year).

The reason difference between min and max figures in India is not much because the weightage for skillsets and location is not that high. Indian IT companies value process knowledge and project management more.

Change in exchange rate: Assuming 1USD = Rs40.00 and a decrease by 5% / year.

Salary increase: Increase in salary for Indian employees is assumed 15%/year. Increase in salary for US based employees is assumed 5% year. The increase for US based employees is more attributed towards the rise in healthcare costs.

click to enlarge

So the magic year is 2017. But this is just a theorotical number. The moment Indian programmers start costing more than 70% of their US counterparts, the selling point for outsourcing will no longer be "cost advantage". The focus will then shift on quality. If Indian programmers will be able to offer superior quality than US based programmers then they will certainly get more business. One thing is certain that the rapid growth of 30% to 40% increase in revenues is going to fade away.

Comments

[DeepakShenoy]

I'm in Bangalore where the "maximum" for 10 years of experience (equivalent to the 120,000 a year salary in say Northern California) is about 20-25 lakhs. (2-2.5million rupees) Your mileage may vary of course.

Also it's not just about quality. The time differences is a huge issue in my opinion. Secondly communication skills vary, and the best communicators (in India) demand and get far higher salaries. Thirdly, process management is great for the lower cost jobs, but innovation is more important for moving up the value chain. We have not yet demonstrated our prowess in that field, at least not in the outsourceable dimension, if there is such a thing.

I don't think you can outsource innovation unless you can outsource ownership as well. Innovation comes from the ability to benefit from the ends, not the means.

IMHO, what will happen is that eventually there will be balance sheet transfers. Meaning a division of a big company gets transferred over to Mr. Wipro or Mr. Infosys. This then generates future cash flow, and then the Indian company can choose to have American Employees, or Indian employees or use people in Mexico, Argentina or Philipines - makes no difference.

Now they're competing with HP, IBM and the like, which are a) more experienced in deal making, b) also have offices in India and other lower cost countries and c) have far bigger balance sheets and deal absorbing leverage.

From a stock perspective this means a hit to P&L upfront, dilutions or fund raising if necessary etc. If they go down this route (they have to, in my opinion) we will have to see how they pan out, since they haven't done this in any significant way earlier.

Another thing is to spend money on a product framework that could be cross-sold among customers. It needn't be a software product - those can't be cross-sold effectively - but could be things like TPA services or wholesale agency networks for insurers, deal syndication for banking (buy prosper.com!) and so on.

This is now an acquisition based process rather than the plain old gimme work and I'll do it. It's more like "We know your process well enough to take it over,manage it, give it to you for cheaper than you pay right now, and even use it to cross sell to others". Different ball game, different rules. We'll see how it pans out.

[Dayanand]

Deepak,
The gist of your reply what I understand is "VALUE ADDITION". I agree with you on that point.It is the oldest business rule that has never changed nor will ever change.In essence, till you bring value addition to your customers they will keep on coming to you.The day you stop it they will go somewhere else.

Till date the Indian consulting companies were bringing the value addition of "LOWER COSTS".But companies like Accenture, previously known as Andersen consulting were established in fifties and developed there expertise in helping the customers in improving their business processes.In fact in those days a consultant was purely hired for those reasons.

<b>FIRST PROJECT BY ARTHUR ANDERSEN :</b> Accenture originated as the consulting division of Arthur Andersen which was founded in 1913 by Arthur Andersen and Clarence DeLany as Andersen, DeLany &amp; Co. Its origin goes back to 1953, when General Electric (GE) asked Arthur Andersen to undertake a feasibility study about payroll processing and manufacturing automation using computers for GE's Appliance Park manufacturing facility near Louisville, Kentucky. Arthur Andersen recommended installation of a UNIVAC I computer and printer, and GE agreed, which is the start of what became the first-ever commercial computer in the United States. Joe Glickauf was Arthur Andersen's project leader for the GE engagement and was responsible for the payroll processing automation, launching the era of data processing. Considered to be the father of computer consulting, Glickauf headed the Arthur Andersen administrative services division for 12 years.

Accenture since its first project fifty years back has mastered the art of improving business processes of its customers , the most important thing to note is that it has taken them decades to master this.The challenge for Indian IT consulting companies is to mirror this achievement in years instead of decades.

<b>WHEN CAN WE SAY INDIAN IT CONSULTING COMPANIES HAVE ACHIEVED THIS THRESHOLD? :</b> The day revenue per employee for Infy or Wipro is same as that of Accenture or HP. We all know its a long way to go....

[sankar.sajith]

Dan,
I think an exchange rate change of 5% / year is on the real high side - a more appropriate one might be like 10% every 5 years. Could you try your estimates based on this? Another way to compare might be to see how the per capita salaries differ between India and US as per your estimates and something like the Goldman Sachs BRICS report - I think the latter would give a different picture. Another point is that very few 10 yr old programmers are reqd - they would move into roles which bill much higher. A few companies like google, startups, telecom/ chip product cos require such talent. The regular IT shops uses more of the 3-5 yr experience folks for programming work.

[Dayanand]

Sankar,
If you see my equation, it boils down to the fact that the USD will change from Rs 40 to Rs 23 in 10 years.This is based on the fact that USD was Rs 16 in 1990 and Rs 40 by 1998. So actually I am still conservative in my approach.

I considered 10 years experienced professional just as a benchmark.The 3-5 exp folks comparison will also be in a similar line.

D

[ratsharp]

outdate way of analysis .. you can generate n no. of scenarios using x combinations of currency and wage inflation..

why dont you take the PV of these benefits ... you will hit upon a new conclusion ( try it)...

no effort made on assuming stochastic currency rates ..or a step function ... try to bring some novelty..try to incorporate cycles in your assumptions

and again .. lots of numbers and information without any conclusion and insight on where are you leading us to ... dont tell me that we shd look forward to a possible event in 2017 ...

[Hiren Doshi]

Dan,

Interesting analysis but it completely ignores the impact of supply emerging from places like China, Vietnam, etc on the ability of Indian programers to demand hikes on scale of 15% yoy until 2107. According to me, China will start pumping out engineers faster than India in the next 4-5 years and by engineers I mean employable engineers capable of handling outsourcing work. This will bring some amount of sanity to this lopsided demand/supply picture and this frenzy of salary hikes will come down to a more reasonable 5-8% avg hikes every year in India.

If China fails to rise up to this occassion, my personal belief is that it will hurt the overall offshore story as the industry cannot continue this growth rates with exisiting salary growths.

[sparad]

Money does flow to the cheapest marketplace. As India elevates itself, wages will go up. This is the first issue.

The second issue is there is more frustration in American companies and employees due to the lack of good English skills - verbal and written, as well as cultural differences (such as saying "yes" when asked questions).
This is also shifting some companies to not offshore or hire those who cannot communicate well.

So, China will acquire more positions (it's cheaper) and, if enough people

[User 159440]

• Muzza
Mar 03 05:54 AM
You guys know nothing. I have managed Infosys, Tata and Wipro for clients and I manage a small Indian company for my own work.

The truth is you will never get an Indian programmer with 10 years experience on your project. There are hardly any of them around. Nearly every Indian IT person we get on our projects has only 2 to 4 years IT experience. Team leaders have 3 to 5 years IT experience and project managers have 4 to 7 years IT experience. That’s not 4 to 7 years project management experience that’s 4 to 7 years experience in the IT industry in total.

This lack of experience makes these people much less reliable, much less flexible and much less value than there local competitors with twice as much IT experience.

Yes they do get paid 10,000 rupees + 10,000 rupees per year of experience. So on average our people are getting paid 40,000 to 50,000 rupees per month. This works out to be $12,000 US dollars salary per annum.

Now the crazy thing is that the large Telco I work for pays more for Indian resources from Infosys, Tata or Wipro than it would pay for much more experienced local resources.

For example we pay $500 US dollars a day for off shore resources and $950 a day for onshore resources. Based on 200 working days a year this is equivalent to $110,000 per annum for an offshore resource and $210,000 for an onshore resource.

No wonder Infosys has a 45% profit margin. It's amazing that it's not much higher. These Indian companies must be incredible inefficient compared to there western competitors.
I guess this means that these Indian companies can afford to absorb the price increases from rising labour costs and from rising Indian currency for many years simply be becoming a bit more efficient every year.