Outsourcing - The economic inevitability

Threat to BPO is likely from competing countries than US legislation

Outsourcing has become a new word in the IT vocabulary, although it is an old concept in the manufacturing industry, where most large manufacturers of mass produced goods have traditionally used specialised vendors to supply sub-assemblies.

Thanks to the controversy generated in the US about Indian IT companies increasing their business from that country, the temperature on this topic has been raised there in the context of the US Presidential election in November.

In some cases, this has led to irrational propositions and actions like the governor of the state of Indiana cancelling a $ 15 million contract with TCS to process the state's unemployment benefits and awarding it to a US company at a cost of $ 23 million.

Ironically, this action is in line with the sentiments of our own swadeshiwallas who would be willing to pay more and accept much lower quality for swadeshi products.

Till recently, our industrial lobby had enjoyed import bans and high tariff walls to protect lower quality and higher priced swadeshi goods. Now that Americans are adopting the swadeshi mantra, we as Indians should not be surprised!

We should have the confidence that in the end the laws of economics will prevail "" more so in a democratic and profit-oriented society like that of the USA. Therefore, it is wise for the Indian government and industry to maintain a dignified silence and let economic logic take its inevitable course.

It is paradoxical that, although India has had many centuries of trading relationships with European countries "" beginning with Portugal and then with Holland, France and finally with England "" the strength of the business relationship which we have developed with the USA in the last 50 years is much stronger than any of those, especially in the new industries.

Culturally, our businessmen are more at home with American counterparts than with say their German or even British counterparts. This was something to do with the openness of the ordinary American and his lack of pretension.

An American is used to dealing with a polyglot society in his home market "" Hispanics, native Americans, African Americans, Chinese, Latinos, etc. To him an Indian is not a novelty, just another business partner.

On the personal side, his home is open to business guests and when he visits India, he is happy to be entertained at Indian homes and exposed to our extended families.

In contrast, a European will find all this discomforting, even daunting. This relative lack of inhibition on the part of the ordinary American has helped to strengthen US bonds with India "" especially with the younger Indians, who are made to feel very much at home and even Americanise their names and habits.

The fact that the Indians who have gone to the US are from the intellectual class, and not from the working class, has helped to create a far better image of Indians in the US, compared to Europe.

In the last few decades, a large number of Indians have chosen the US rather than the UK for higher studies because of the better quality of education and the availability of financial assistance as well as the facility to work while studying and afterwards.

Many of them have chosen to stay back and work there because of the availability of attractive opportunities and the relatively easier assimilation into American society and culture.

The success of our IT business in the US has a lot to do with this cultural affinity, apart from the proficiency of Indians in the English language.

A typical Indian IT company will have a base in a place like Bangalore and establish its presence in the USA to canvass business. It will initially undertake what is termed as on site assignments.

It will charge anything between $ 50 and $ 100 per hour (or $ 8,000 to $ 16,000 per month) of the consultant's time, depending on the complexity of the work and the experience level of the consultant.

The next step will be for the Indian company to negotiate with the client to have more of the IT work done at its base in India because it will benefit both the client and the IT company. This is what has come to be called offshore work or outsourcing.

The cost to the client will be less than half of what is charged for onsite services (i.e. $ 25 instead of $ 50 / hr). The cost to the IT company will be significantly lower as its consultants are based in Bangalore and not in the US.

Typically, the IT company will aim to have a smaller part of the team in USA and the main task force in India. With modern communications and the Internet, distance has ceased to be an issue. It is this significant saving in cost to both parties that drives outsourcing, and it cannot be reversed by government intervention.

Ultimately, it benefits the US economy as well as Indian companies. A recent study by the McKinsey Global Institute has shown that for every dollar that is spent on outsourcing a business process to India, the US economy gains at least $ 1.12, and this saving benefits the US consumer.

For instance, when X-rays are sent from the US to India for analysis, it directly reduces the cost of healthcare to the US patient. Healthcare costs are one of the major concerns of US consumers today.

The loss of jobs in the US due to outsourcing is another red herring. It is estimated by the same McKinsey study that the US has lost two million jobs in the last 20 years due to global trade, while it has added 35 million net new jobs in just 10 years.

Many more jobs are lost as well as created by new technology in every industry. The impact of outsourcing of IT to India in terms of employment is marginal. If US companies did not outsource to India, they would be less competitive and could well lose out to competition.

This is true of large companies like Ford, General Motors, Citibank as well as of many mid-size US companies.

As US companies have gained more confidence in the reliability of Indian IT, the trend towards outsourcing has increased. Several US companies have set up their own IT centres in places like Bangalore.

Almost one third of the offshore work done in India is done by branches of US companies directly. The other two-thirds is undertaken by Indian IT companies, which earn over $ 10 billion per annum in this business.

Looking ahead, it is inevitable that outsourcing to India will spread to hi-tech manufacturing industries as Indian companies gear themselves up. This is already happening. For instance, a company in Bangalore is supplying miniature transformers for mobile phones to all the large mobile phone companies in the US and Europe.

In another instance, after a worldwide search for outsourcing, General Electric has chosen a company in Bangalore as a source for electronic meters.

All this is based on the cost advantage and design capability of Indian engineers, many of whom are trained in the USA. Several US companies with experience of joint ventures in China, say that it is easier to deal with Indian companies.

First of all there is the proficiency of Indians in the English language. Of course this may disappear in the next decade as the Chinese learn English.

But the other reason is that, unlike Chinese companies in which some government agency is a partner, Indian companies are mostly in the private sector and share the same motives and values as US companies.

In my view, the threat to Indian industry with regard to outsourcing for US companies is not going to come so much from legislation in the US as from competitors from other countries like the Philippines and Vietnam, where the US has special relationships, and from emerging South Asian countries like Sri Lanka and Bangladesh, where too English is spoken.

Indian companies may therefore find it worthwhile to set up bases in these countries to take advantage of their lower costs. We could then see Indian multinationals managing their operations in the USA, India and other emerging countries, that have a cost advantage.