Global sourcing has become critical to successful sourcing strategies for most Global 1000 companies. As such, organizations are taking a longer-term, strategic perspective on global sourcing. As corporations focus on deriving the optimal value from their decisions. Information Technology Outsourcing (ITO) and Business Process Outsourcing (BPO) are significantly impacted by offshore and ‘near shore’ re­sources.

A number of corporations are currently engaged in rationalizing their service providers and enabling deeper inte­gration of their various operations.

TPI conducted a survey of corporations to determine the drivers for their sourcing decisions, their experience with outsourcing and off shoring and to identify the concerns and issues they face as they mature in their deployment of global sourcing.

This study, named the State of Global Service Delivery (SGSD) was the first statistically significant study in this space and was more than a mere opinion poll or a show of hands. Some insights that emerged from the SGSD study are very relevant to the Indian context.

Organizations follow a distinct and predictable path along a ‘maturity curve’.

An organization’s level of experience combined with multiple characteristics is a key indicator of global service delivery operational success, behaviour and effectiveness.

Corporations fell into clear and identifiable groupings depending on their experience with global service delivery (GSD). Their ability and willingness to leverage India and other offshore destinations were directly impacted by their prior exposure to global sourcing and their level of success with it.

As companies mature in their use of GSD, they experi­ment with the number of offshore locations they used. Al­most all of the firms with more than five years of experience used up to four different countries to source their services.

Also, there is a far higher ratio of resources working at a customer site, most likely at a significantly higher rate, than optimized scenarios would suggest. It is not surprising that companies that are more experienced in global service deliv­ery are more comfortable with a larger proportion of offshore staff.

However, it is important to note the ratio of offshore to onsite is far less aggressive than typically promoted by the service providers.

All this speaks to a need to have a truly global approach to the delivery of services rather than an India centric ap­proach.

Indian heritage providers

The Indian services scenario is evolving and as it ma­tures, Indian heritage providers form an increasingly large part of it. While aggressive global corporations were early adopters of the offshore model — setting up captive research and development and business process centers in India—it is the growth of the Indian heritage provider in the past five years that has truly changed the landscape of the ITO and BPO services economy in the country. Indian heritage pro­viders are now competing globally and attempting to offer their customers global solutions.

Indian heritage providers, operating from a smaller base, are steadily gaining in their share of the worldwide outsourcing market based on Total Contract Value (TCV). In the last quarter of2006, India-based providers have seen TCV shares increase from slightly more than one per cent in 2004 to 4.3 percent of the broader market (transactions over $ 50 million). This is a quadrupling of their share, albeit off a small base. In particu­lar, they account for a large part of the applications-related outsourcing market, and the latest information suggests that their market share in this space is over a quarter (26 per cent) of the value of large sourcing transactions concluded in 2006.

We see Indian heritage service provider firms are com­peting on more and larger Application Development and Maintenance (ADM) contracts and winning some outright, but more often portions of the whole transaction. In the mega deal space (transactions over $ 1 billion) though, we are yet to see any significant erosion of the share of contract value en­joyed by the traditional ‘Multi-National’ providers in this space.

Competition from multinationals

In India, large U. S. Europe based ‘Multi-Nationals’ (serv­ice providers) such as IB EDS, Accenture and HP have moved aggressively to provide global solutions. Indian heritage com­panies (service providers such as TCS. Wipro and Infosys) face increasing competition in their core business areas with the pricing gap closing steadily.

The majority of the business of the Indian heritage pro­viders is still in the ‘staff augmentation’ area where they pro­vide technically adept workers to their clients. Very little is in the project space or from large scale transactions with pre­dictable annual revenue streams. These firms have reached a point where they are at a fork in the road.

They now need to either stick to their strengths of being the world’s best offshore technology firms (regardless of the country they deliver their services from) or move into an arena where they try to look a lot more like the full service firms that provide the full spectrum of consulting, technology, and business process work for their clients.

Favourable trends

There are three trends that tilt the worldwide balance in favour of offshore service providers – smaller contract val­ues, reduced capital contributions and increased use of glo­bal service delivery or offshore. About half of the transactions TPI advises on have a growing global services delivery (or offshore) component.

As the offshore component in deals grows, Indian serv­ice providers will increasingly leverage their offshore deliv­ery capability to gain market share. However, with global cli­ents looking for truly mature global delivery, only those who can leverage their cost competitiveness from multiple off­shore locations while maintaining their margins at the same time will succeed.

There has also been a noticeable surge in the number of contract renegotiations of large sourcing deals, and these trends are likely to continue. Also, about 325 global deals have been or are coming up for renewal in 2006 and 2007, representing over a fifth of the active contracts. TPI has been tracking about $100 billion worth of outsourcing contracts due for renewal in 2006 and 2007, of which 72 per cent was held by the big six- the likes of Accenture, ACS, CSC, EDS, HP, and IBM. That said, these restructurings probably do not represent a large opportunity for a massive shift in market share incumbents win these renegotiations in almost 90 per cent of the cases.

Challenges and response

The Indian IT and BPO industry is witnessing some trends that have an implication for its competitiveness and for service providers operating here. Some of these are more easily addressable than others.

Attrition rates: As widely discussed and reported in the media, the attrition rates (turnover of staff) faced by the In­dian ITO and BPO industry are high. These attrition rates still need to be seen in the context of a booming economy.

When benchmarked with the dotcom boom in the U.S., or even contact centre attrition in the U.S., the current attri­tion rates in India do not seem alarming. Most discussions of attrition in India are around voice processes where it can be 50-80 per cent. Service providers are taking measures to con­trol attrition but these need to be re-assessed comprehensively to determine their effectiveness in controlling attrition and managing its impact.

Shortage of trained manpower While much has been said about the ‘unsuitability’ for employment of more than 85 per cent of India’s graduate pool, this is not as dire as made out to be. Service providers and other industry partici­pants are rising to the challenge of providing training to the young emerging workforce – witness the recent investments made by firms such as Infosys, Wipro, and TCS in their train­ing facilities.

Wage increases: Annual salary growth in the past three years has been estimated variously between 8 per cent and 15 per cent in the ITO and BPO sector based on service provider announcements. BPO salaries are growing slightly faster than ITO salaries. However, the average salaries at the entry-level have not increased significantly in the past three years. These fresh graduates are the engine of the off shoring boom. Com­pared to the western markets where lower percent increases still translate into significant costs, the small base of Indian salaries means India will continue to have its labour arbitrage advantages for some years yet.

Delivery locations on the rise

With the maturing of service delivery capabilities in In­dia, a number of companies are now setting up offices in smaller cities in preference to Mumbai, Delhi, and Bangalore, According to NASSCOM, a quarter of India’s BPO firms now have a presence in cities like Kolkata, Jaipur and Rajkot – all cities that have not traditionally been known for their IT and BPO strengths. This move is driven by the search for lower costs (rentals are lower by half of Tier I cities and people costs are lower by 40 per cent) and the need to access larger talent pools – this latter being especially true for BPO firms. Corporations that are setting up captive offshore centers in India still seem to prefer to go to Tier I cities or the larger Tier II cities – preferring ready access to middle management and quality educational institutions catering to these cities.

Some of the service providers, especially those of Indi­an heritage, have explored Tier II cities and have even had measurable success in Tier III cities.

Changing delivery models

As clients mature in their experience with offshore outsourcing, they tend to rationalize and reassess this strat­egy as their spending on offshore services increases. As a part of such a realignment of their strategy, they are likely to en­gage service providers on a limited multisourced approach, reorganize their internal operations to better manage these relationships, and restructure some of their spending with offshore providers to more traditional multi-year, risk-shar­ing arrangements.

India-based providers often operate below the $50 mil­lion contract threshold, which defines the broader market. This is because they frequently use master framework agreements, which have small up-front contract values but allow them to compete and grow “from the inside.” These service provid­ers benefit from this “penetrate-and-radiate” approach, which helps them gradually gain scale and capabilities for the time being, while preparing them to compete for larger contracts over time. It also earns them a foundation of client relation­ships from which to grow, and valuable industry domain knowledge. The ‘Multi-National’ service providers have no­ticed this trend and are now becoming increasingly aggres­sive in competing for smaller initial relationships with a possi­bility of long term upside.

There are benefits for both providers and clients in this outsourcing model which is an alternative to the large trans­action. The providers gain experience and an “inside track.” The clients gain flexibility and limited financial obligation to providers. Clients can multi-source, leveraging individual service provider strengths and minimize their risk by signing backup contracts if the main providers fail to meet contractual terms.

Companies are demonstrating an increasing trend toward the      multiple operational models as they pass through stages on the ‘Maturity Curve’, as demonstrated in the ad­joining table.

Captive centers still viable

Another insight that emerged from the SGSD study is an important consideration in the Indian context, namely, the accelerating growth and acceptance of the captive centre as an operational model. A captive centre is a subsidiary of a parent in the sourcing country and is often the route chosen by customers who want to establish services capability in In­dia or in another destination.

In addition to its heritage of structuring and negotiating transactions on the ‘buy side’, TPI advises clients on their sourcing strategy; the recommendations could vary from fully owned captive operations to fully outsourced deals. A range of options exist in between reflecting corporate preferences and stage in the ‘Maturity Curve’.

It is the experience that the captive centre approach to global service delivery will serve as a pain point for service providers. The captive centre has been viewed as a threat by these firms, including by Indian heritage providers. To date, their response has been to sell against the concept stating those that venture down this path will never reach acceptable pro­ductivity and there are many hidden costs. Much is made by service providers of the shutting down of one or two small captive centers by their parent companies. But these are in­stances based on individual circumstances of the parent and not an indication of a large industry-wide trend.

Based upon the results of this survey and the fact that there are over 380 captive centers in India, there is no evi­dence to support that the captive model is not a viable one. Companies will continue to consider captive centers as an option in future with an ever-increasing portion selecting this operational model.

The location debate

Locations that help service providers optimize their cost base and strengthen their ability to source personnel have al­ways been in demand. India is the first and currently the largest offshore sourcing destination – the drivers for India being the use of English, the quality and scale of its qualified la­bour pool, its relative cost advantage and the maturity of its firms providing such services.

India will face greater and more serious competition in the next few years from other countries offering similar serv­ices at a competitive cost-value equation. Some of the coun­try’s advantages are less sustainable than others, but India will be the dominant sourcing destination for some time to come -largely because few other emerging locations can of­fer corporations the ability to scale up their operations in the next two to three years.

India’s key long-term advantage is its young labour force – it is (and will remain for some time) one of the youngest countries in the world. A third of India’s population was be­low 15 years of age in 2000. In 2020, the average Indian will be only 29 years old, compared with 37 in China and the U.S., 45 in Western Europe, and 48 in Japan. These youngsters form the backbone of India’s outsourcing industry.

Except for language and factors of cultural affinity, the competition from other countries will be restricted to low end services. ITO and BPO services activity in India have slowly increased in the sophistication of the work content. For ex­ample, while earlier most BPO work was around the clerical elements of finance and accounting, we now see activity that can be described as Knowledge Process Outsourcing – in­volving a lot more judgment and knowledge of the custom­er’s industry domain. Continuing to increase this sophistica­tion will allow India to keep its edge as the prime location for delivering such services.

China, not a threat

China is quickly moving ahead on enhancing its com­petitiveness in the services sector. India does have a head start compared to China in services, and a lot depends on how quickly the latter gains traction with western world clients. Its proximity in geography and language to large markets such as Japan and Korea gives it a natural advantage, and that is one reason why several large service providers are setting up shop in China, or increasing their presence there. In addition, China has a huge local market that is of interest to a number of global firms. As consumers and suppliers of services evolve, the role of locations per se will become less of a focal point. There will also be situations in which customers will prefer delivery from their own countries.

The centre of gravity of the sourcing world is shifting from the developed countries to the emerging countries. The game is now about how best to leverage the dynamics of an increasingly globalised world – for both service providers and customers.