22. Global Outsourcing – International Business

22

Global Outsourcing

LEARNING OBJECTIVES

After going through this chapter, you should be able to:

  • Define the term “outsourcing” in the context of the modern world economy

  • Examine the different forms of outsourcing

  • Understand the factors that have acted as drivers of outsourcing

  • Review the factors responsible for the emergence of India as a major outsourcing destination

  • Understand the contribution of the IT/ITES industry in the Indian context

The Global Job Shift

New technology parks on the dusty outskirts of India's major cities are buzzing with activity. Inside Infosys Limited's 22-hectare campus in Bangalore, 250 engineers develop IT applications for the Bank of America. Elsewhere, Infosys staffers process home loans for GreenPoint Mortgage of Novato, California. At the offices of Wipro Limited, five radiologists interpret 30 CT scans a day for Massachusetts General Hospital. At the Texas Instrument Incorporated research centre, 26-year-old engineer Dharin Shah talks excitedly about his USD 10,000-a-year job designing third-generation mobile-phone chips. Five years ago, an engineer like Shah would have made a beeline for Silicon Valley—today India has its own silicon valley.

Outside New Delhi at Wipro Spectramind's sandstone-and-glass building, 2,500 young college-educated men and women work the night shift to process claims for a major US insurance company and providing help-desk support for a big US Internet service provider—all at a cost that is up to 60 per cent lower than in the United States. Wipro voice coaches drill staff on how to speak American English for the US customer, while staff with PhDs in molecular biology sift through scientific research for Western pharmaceutical companies.

Similar scenes can be found in dozens of cities across the developing world. In Budapest, Balazs Zimay, an architect, designs dream homes across the world; In Manila, SGV & Co., an accountancy firm, do number-crunching for Ernst & Young's international audits. British banks like HSBC Securities Inc. have huge back offices in China and India; French companies use call centres in Mauritius; and German multinationals, from Siemens to roller-bearings maker Schaeffler Technologies GmbH & Co., are hiring in Russia, the Baltics and Eastern Europe. Countries like Bulgaria, Romania and South Africa, with large educated workforces, are also tapping into the global market for services.

Outsourcing of services is the latest of three big waves that have reshaped the global economy, the first being the mass migration of manufacturing jobs to developing countries two decades ago. This was followed by the exodus of simple services, such as processing credit-card receipts and mind-numbing digital toil like writing software code. The current outsourcing boom looks to be globalization's biggest wave yet.

From drawing up detailed architectural blueprints, slicing to dicing a company's financial disclosures, to designing a revolutionary microprocessor, the Internet and high-speed data networks have allowed an enormous range of tasks to be transferred overseas. In addition, the developing nations often have large and well-qualified workforces. The Philippines, for instance, is a country of 75 million and produces 380,000 college grads each year, meaning that there's an oversupply of accountants trained in US accounting standards. India already has 520,000 IT engineers; the United States produces 35,000 mechanical engineers a year—about half as much as China does. Not surprisingly, Intel Corporation and Texas Instruments Inc. are furiously hiring Indian and Chinese engineers, many with graduate degrees, to design chip circuits.

Dutch consumer-electronics giant Philips has shifted much of its R&D to Shanghai. Brokerages like Lehman Brothers Holdings Inc. and the Bear Stearns Companies, Inc., use Indian financial analysts for number-crunching work. Procter & Gamble Co.’s 650 Manila employees, most of whom have business and finance degrees, help prepare its tax returns around the world.

Architectural work is going global too. Fluor Corporation of Aliso Viejo, California, employs 1,200 engineers and draftsmen in the Philippines, Poland and India to turn layouts of giant industrial facilities into detailed specs and blueprints. Two hundred young Filipino engineers earning less than USD 3,000 a year collaborate in real time with elite US and British engineers, making up to USD 90,000 via Web portals for a multibillion dollar petrochemical plant in Saudi Arabia. The principal Filipino engineer on plumbing design, 35-year-old Art Aycardo, takes home USD 1,100 a month, enough to buy a Mitsubishi Lancer, send his three children to private school, and take his wife on a recent trip to the United States. The Manila operation knocks up to 15 per cent off Fluor's project prices, converting this into a core competitive advantage.

The rise of a globally integrated knowledge economy is a blessing for developing nations, but causes downsizing and unemployment in countries like the United States. However, as agents of economic development in nations such as India, US companies will have bigger foreign markets for their goods and services. Now, American Express Company, Dell, Inc., Eastman Kodak Company and other companies can offer round-the-clock customer care while keeping costs in check. What's more, for decades, immigrant Asian engineers in the US labs of TI, IBM and Intel have played a big, hidden role in American technological breakthroughs. The difference now is that Indian and Chinese engineers are managing R&D teams in their home countries. General Electric Company, for example, employs some 6,000 scientists and engineers in 10 foreign countries. GE Medical Services integrates magnet, flat-panel, and diagnostic imaging technologies from labs in China, Israel, Hungary, France and India in everything, from its new X-ray devices to USD 1 million CT scanners. These large TNCs are reaping the benefits of the best talent in the world.

 

Source: Information from “The New Global Job Shift”, available at http://www.businessweek.com/magazine/content/03_05/b3818001.htm, last accessed on 20 February 2011.

INTRODUCTION

Outsourcing as a business phenomenon has its roots in David Ricardo's theory of comparative advantage and has been a major growth driver for countries such as India, Ireland and the Philippines in the 1990s. In this context, this chapter focuses on:

  • Introduction to the concept of outsourcing
  • Different forms of outsourcing
  • Outsourcing as a global business strategy
  • Implications of outsourcing for both developed and developing nations
  • Outsourcing in the Indian context

The concept of outsourcing is a commonly used term in the context of economies such as India. There is, however, no commonly accepted definition of the term, although the following definition explains the term rather well: Outsourcing is “the act of transferring some of a company's recurring interval activities and decision rights to outside providers, as set in a contract”.1 Alternatively, “outsourcing is the delegation of one or more business processes to an external provider who in turn owns, administers and manages them based upon a defined and measurable performance matrix to improve overall business performance”.2

 

Outsourcing is defined as the act of transferring some of a company's recurring internal activities and decision rights to outside providers, as set in a contract. It is the delegation of one or more business processes to an external provider, who in turn owns, administers and manages them based upon a defined and measurable performance matrix to improve overall business performance.

The genesis of the term may be traced to Ricardo's theory of comparative advantage, where an organization transfers some of its repeated core and non-core business processes to an outside provider to achieve cost reductions, improve service quality and increase shareholder value. The organization is thus able to concentrate on activities in which it has a comparative advantage. The growth of outsourcing is a phenomenon of the 1990s, attributable to the rebounding of the information technology industry, which had slowed down considerably after the bursting of the dotcom bubble in the 1980s. For countries such as India, the basis of the outsourcing phenomenon was the time-tested principle of comparative advantage, helped by factors such as developments in telecom and internet facilities, the existence of a low-cost English-speaking skilled labour force and a geographical distance of 12.5 hours from the United States, which was its principal outsourcer in initial years.

The genesis of outsourcing may be traced to early developments in the automobile industry. In the early twentieth century, the manufacture of a Ford Model T needed 700 different parts and was possible only through large-scale mass production and a high degree of specialization within a single plant. The gains from this were a reflection of Adam Smith's gains from specialization, as specialized workers performed a single task along an automated assembly line while the plant was vertically integrated and produced the car from scratch. As the industry grew and competition increased, so did the demands of the consumer with regard to their expectations from the product. As a result, it was no longer possible to combine mass production and specialization within one plant. The multitude of tasks and skills required organizational and managerial innovations in order to accommodate increased complexity while remaining cost effective. This led to focused attention and in-house production of strategically important tasks and competencies, and the purchase of non-core tasks and competencies from outside suppliers.

Similar developments in the service industries have manifested themselves in the emergence of outsourcing in the present-day context in the form of the transfer of low-cost, low-skill jobs to countries like India, Ireland, the Philippines and even China.

FORMS OF OUTSOURCING

The terms “outsourcing” and “offshoring” are often used interchangeably, although they are not quite identical. In order to understand the terms better, we may classify outsourcing into four main categories using location and control/ownership as distinguishing criteria:3

  1. Captive onshore outsourcing is a shift in intra-firm supplies to an affiliated firm in the home economy.
  2. Non-captive onshore/local or domestic outsourcing refers to the shift in sourcing of supplies to a non-affiliated firm in the home economy.
  3. Captive offshoring describes a situation in which future supplies are sourced from an affiliated firm abroad.
  4. The fourth variant of outsourcing may be labelled non-captive offshoring and refers to the case when the new supplier is a non-affiliated firm and located abroad.

Captive onshore outsourcing is a shift in intra-firm supplies to an affiliated firm in the home economy.

Non-captive onshore/local or domestic outsourcing refers to the shift in sourcing of supplies to a non-affiliated firm in the home economy.

Captive offshoring describes a situation in which future supplies are sourced from an affiliated firm abroad.

Non-captive offshoring refers to a situation where the new supplier is a non-affiliated firm and located abroad.

From an international perspective, the latter two categories of outsourcing, namely captive and non-captive offshoring, are of particular interest. Table 22.1 illustrates the four concepts.

There are also uncertainties of outsourcing. The requirement of delivering an agreed upon quality and quantity of goods and services may be subject to the possession of a certain skill set, equipment and product development techniques in the outsourced destination. For example, BPO workers in India knew how to speak English, but had to learn the American accent to be able to service clients in the United States. Alternately, a task may require a particular software. However, the software may then be rendered useless after it has been used if it is task-specific.

 

Table 22.1 Types of Outsourcing

 

Source: Reproduced with permission from the World Trade Organization (WTO), “Offshoring Services: Recent Developments and Prospects”, World Trade Report 2005, available at http://www.wto.org/english/res_e/booksp_e/anrep_e/wtr05-3c_e.pdf, last accessed on 9 September 2011.

DRIVERS OF OUTSOURCING

The following factors have been the major drivers or factors facilitating the outsourcing phenomenon.

Theory of Comparative Advantage

The theories of comparative advantage and intra-industry trade together explain why a firm outsources certain operations abroad. Trade between countries, which are significantly different in terms of factor endowments, is driven by comparative advantage. Thus, while trade between nations happens because of different factor endowments, trade between countries that are similarly endowed is motivated by a desire to obtain a wider variety of goods and services. The process of offshoring enables countries to exploit competitive advantage as well as obtain a wider variety of goods and services. For example, the offshoring of IT enabled services and business processes is an example of vertical trade within the same industry on the principle of comparative advantage. The offshored services are usually less skill-intensive and capital-intensive than those retained in the home country. Offshored services, whether low-skilled, such as payroll accounting or telemarketing, or high skilled, such as legal process outsourcing, are all sources of cost-saving and driven by a desire to obtain comparative advantage. The use of these services may lead to the final production of commodities such as cars and computers or services such as banking and financial services, and helps to increase the variety of goods and services available for the final consumer.

Concentration on Core Competency

From the firm's point of view, offshoring certain services helps it to concentrate on those functions that are responsible for its core competency. A total business process consists of a multitude of complex tasks and skills, all of which do not have equal strategic significance for the business firm. By outsourcing its non-core business functions, a firm is able to concentrate on those functions and processes that are of strategic significance and value. Outsourcing thus helps a firm to save on costs in terms of both time and managerial capabilities, enabling greater innovation and growth.

Developments in Technology

New networking technologies have made it possible for global companies to seek the lowest cost solutions from anywhere in the world for activities that can be digitized. Companies can outsource their non-core functions such as human resource, finance and management accounting, customer relationship management and IT services to a third party to be able to focus their resources on their core activities and hence reduce their operational costs. Developments in infrastructure and privatization of telecommunication services have further catalysed the outsourcing boom.

Existence of Low-cost, Skilled Manpower

The existence of an educated, low-wage seeking, language and technically proficient labour force has been a major growth driver for the outsourcing industry. India and Ireland's success in attracting offshoring business from the United States and the UK has been partly attributed to their English-speaking workforce. Outsourcing from the other leading industrial countries is much lower to these destinations and more to countries that are closer home geographically and/or culturally. A large share of German outsourcing contracts thus go to Central Europe, and a large share of Spain's outsourcing contracts go to Latin America.

Changes in Regulatory Environment

Improvement in the regulatory environment, such as trade liberalization for imported inputs, lifting of foreign investment restrictions, favourable taxation and low-interest export credits, have been the major driving forces responsible for the growth of the two largest IT traders, namely Ireland and India.

Infrastructural and Institutional Development

It should also be noted that institutional and infrastructural quality at the national level is also a relevant variable to look at. In some cases, notably in India, software technology parks and other special economic zones have excellent infrastructure and effective one-stop shops for sorting out the legal formalities of establishing and running a business, even if the average quality in the country as a whole leaves much to be desired.

 

A firm's decision to outsource depends on the possibility of separation of tasks, standardization and automation, cost minimization, and market size.

FACTORS BEHIND A DECISION TO OUTSOURCE

How do firms decide which activities to conduct in-house and which ones to outsource? The following parameters may help a firm to determine its make-or-buy/outsource decisions:

INDUSTRY FOCUS  |  Legal Outsourcing

Christopher Wheeler, a former assistant attorney general for the State of New York, presently manages a team in NOIDA of 110 lawyers who work at a fraction of the cost that their counterparts would have charged in the United States. His new workplace, Pangea3, is a legal outsourcing firm, located among a cluster of office buildings surrounded by dirt roads.

India's legal outsourcing industry has grown in recent years from being an experimental endeavour to a small but mainstream part of the global business of law. Indian lawyers are being hired by Wall Street banks, mining giants, insurance firms and industrial conglomerates for document review, due diligence, contract management and more. This reflects in the growth in the number of legal outsourcing companies in India from 40 in 2005 to more than 140 at the end of 2009. Revenue at India's legal outsourcing firms is expected to surpass USD 1 billion by 2014.

In order to win new clients and take on more sophisticated work, legal outsourcing firms in India are recruiting experienced lawyers from the West—American and British included—who are coming in droves to benefit from the opportunity. Compensation for top managers is comparable with salaries at mid-size law firms and living costs are much lower in India, making it an attractive option; the added allure of stock in the outsourcing company often becomes the icing on the cake.

Outsourcing continues to remain a highly contentious issue in the West, particularly as law firms have been trimming their staff and curtailing hiring plans, but Western lawyers who have shifted to India are not complaining. CPA Global, a contract legal services company with offices in Europe, the United States and India, hired Leah Cooper, who left her job as managing lawyer for the giant mining company Rio Tinto, to become director of legal outsourcing. CPA Global has a total of 1,500 employees on its rolls, including lawyers from the Bank of America and Alliance & Leicester, a British bank.

Many legal outsourcing firms have offices around the world to interact with clients, but keep the majority of their employees in India, and sometimes in the Philippines. Employees at legal outsourcing companies in India are not to give legal advice to clients in the West under Indian laws. Instead, legal outsourcing companies perform a lot of the functions that a junior lawyer might in a US law firm.

Global giants such as GE continue to go to the experts in litigation and regulatory law around the world, and are willing to pay their huge fees, but not USD 500 an hour for document review and basic due diligence when it can be outsourced to a capable Indian lawyer at one tenth of its cost.

The initial growth of the industry was due to corporations that were pushing legal firms to save money, but in recent times legal firms themselves have begun to embrace the industry. Moving to a legal outsourcing firm, especially in India, is not everyone's cup of tea, given the cultural adjustments involved in it. It is also difficult for some to adapt to the transition of managing and inspiring a team of young lawyers after a career in litigation. For those who stay on, however, the challenge of getting people to learn legal skills and building a team around it is the reason they are able to survive.

 

Source: Information from “Outsourcing to India Draws Western Lawyers”, New York Times, 4 August 2010, available at http://www.nytimes.com/2010/08/05/business/global/05legal.html?pagewanted=2&_r=2&sq=india&st=cse&scp=2, last accessed on 8 September 2011.

Technical and Institutional Separability

An obvious precondition for outsourcing is that it should be possible to separate service tasks. Recent innovations have made it possible to separate service tasks in time and space. This enables any task that deals with the collection, manipulation or organization of information and data to be codified, digitized and separated from other tasks within the firm. This is the basis of outsourcing and has led to the emergence of new information-based services and occupations. Such services and occupations include software developers and IT consultants, search services, and also new types of media and content that have resulted in new opportunities for independent service suppliers.

Standardization and Automation

Information-based services can also be standardized and automated after codification, digitization and separation. Often they can be converted into routine instructions or tasks which can be easily followed. Some of these services include accounting, billing, the payroll and booking. A basic characteristic of these tasks is that they are non-core tasks, and can easily be outsourced to an external agency. The standardization of computer software has also helped many IT services to be outsourced.

Cost Minimization

The make-or-buy decision for a firm is based on being able to minimize costs through the achievement of the right balance between fixed and variable costs. The relevant costs here are production costs and managerial costs.

Fixed costs have an inverse relationship with the volume of production, since they are incurred regardless of the level of output and decrease as the volume of production increases. The outsourcing of services includes the costs of searching for a supplier and negotiating a contract, which are lower in the case of outsourcing than if production were an in-house activity. Variable costs are directly proportional to the level of production and include monitoring and coordinating costs.

Production Costs

If the supplier is a domestic firm, it is quite likely that production costs would remain unchanged, since the factors of production are purchased in the same market. If the activity in question is being offshored to a low-cost location, it may lead to additional gains in terms of lower production costs, but there are also additional managerial costs. The additional costs depend on whether offshoring is being done as foreign direct investment (captive offshoring) or by means of a contract with an independent foreign supplier. In case of captive offshoring, the costs of acquiring local knowledge about laws and regulations and the availability of non-tradable local inputs are some of the additional costs that have to be incurred in addition to the cost of setting up or acquiring the foreign firm.

Managerial Costs

Managerial costs are usually a significant chunk of total cost, and increase more than proportionally with the complexity of the task and the number of tasks being conducted. Many of these costs are fixed and independent of the production volume and hence higher at lower levels of production. In outsourcing activities, these fixed managerial costs are limited to searching for a supplier and negotiating a contract, and are considerably lower than in setting up in-house production. This is the most important reason for outsourcing being an attractive business proposition. Fixed managerial costs differ among different types of outsourcing as follows:

Captive offshoring > Local in-house production > Non-captive offshoring > Local outsourcing.

Managerial costs for activities such as monitoring and coordinating production are variable. These costs are usually lower with in-house production than with outsourcing, and make outsourcing an unattractive proposition. The main sources of variable managerial costs related to offshoring are differences in language, laws, government regulations, currency and usually also geographical distance, as even digitized service providers need some face-to-face communication between the contracting parties.

Market Size

The relevance of market size for the make-or-buy decision was recognized at least as early as the 1950s. Since firms have to attain a minimum operating scale in order to break even, the number of firms that can operate profitably in the market is limited by the size of the market. Further, even within a firm, a minimum scale is needed to fruitfully employ specialists in all tasks and keep them fully occupied. As firms grow, so does the need for the administration to be able to coordinate activities and govern relations between divisions and individuals. Since at some point, the cost of additional administration exceeds the benefits of additional tasks or components being produced in-house, outsourcing is the solution to expanding unit costs. However, a firm can optimally use a network of outside suppliers only if it has a sufficiently large market.

Market size is also related to the risks related to outsourcing. The outsourcing firm must be sure that the supplier delivers the agreed quantity and quality of inputs at the agreed time, whether it is a service or a component. In the absence of prompt delivery, the production process may come to a complete halt and in an environment with just-in-time production systems, this can be extremely costly. Furthermore, if quality is not as agreed upon, it may adversely affect the reputation and brand value of the outsourcing firm. If the market is large and there are a large number of substitute firms available, the chance of finding a good match also improves, as does the possibility of an alternative supplier.

SOFTWARE INDUSTRY IN INDIA

The genesis of an independent global software industry can be traced to IBM's decision in 1969 to sell software separately instead of bundling it with hardware. This gave customers the option of buying their hardware and software from different vendors in the world computer market. A few years later, in 1972, Intel's invention of the microprocessor facilitated the development of powerful mini- and micro-computers, challenging the dominance of the larger and more expensive mainframes that had been in use till then. The availability of more powerful and inexpensive hardware created a simultaneous huge demand for software, and was the beginning of the global software industry.

 

The genesis of an independent global software industry can be traced to IBM's decision in 1969 of selling software separately instead of bundling it with hardware.

The basic difference between high quality hardware and software is that automated capital-intensive operations permit hardware to be mass-produced, but software production in comparison is a craft-like, labour-intensive affair prone to delays and cost overruns with uneven productivity and quality due to a trial-and-error method of trying to achieve goals. As a result, there has often been a software bottleneck as software productivity and quality has often lagged behind that of hardware.

Over a period of time, software engineering developed along the lines of industrial engineering. Software development is a process of structured programming aimed at achieving coordination and control over a team of programmers working on a large project. In recent times, the use of industry-wise certification norms has helped to strengthen the process of development. The growth of the industry therefore depended not only on demand generated for the development of new software, but also for the maintenance of older software. This resulted in the emergence of time-specific and labour-intensive demand that grew in magnitude in the 1990s into a full-blown software industry.

The emergence of the Indian software industry as a global leader requires an understanding of the macro environment in which it has grown and flourished. The globalization of the semi-conductor industry during the 1960s largely bypassed India, which was committed to self-sufficiency and self-reliance within a broader State-dominated strategy of import substitution led industrialization.

INTERNATIONAL BUSINESS IN ACTION  |  Product Development in China

The Neat Company, a Philadelphia-based manufacturer of scanners (NeatReceipts is their best-selling mobile scanner) reached a crossroads in decision-making after several years of strong sales, a growing worldwide customer base and increasing competition: a basic question about whether to continue product development efforts in-house in the United States, or outsource some of these efforts. The company manufactured products based on cutting-edge optical character recognition technology, for which the engineering is complex and demanding and product development cycles are short. But being based in Philadelphia, which is not a technology capital, the company did not have access to a broad pool of engineering talent. Outsourcing product development could potentially lower their development costs and get products to customers faster.

However, the company wanted to keep strategic development onshore, close to its stakeholders, and use an offshore team to add skills that were difficult to hire in the United States. It was wary of outsourcing because of the danger to its intellectual property as well as customer and employee data, and it wasn't sure that its outsourcing partners could deliver high-quality work against an aggressive product development cycle. It also needed to ensure effective integration of an outsourcing partner into an already high-performing team. Once number crunching validated the decision to outsource, the next big question was the choice of outsourcing partner.

The obvious choice seemed to be India—less expensive than recruiting, managing, and retaining a team of US-based engineers, but it was becoming increasingly expensive, with engineering talent on average costing about 75 per cent to 80 per cent of what the company would pay onshore. China in comparison seemed more affordable, with engineering talent costing about half of what it would domestically. Since NeatReceipts competes globally with larger rivals, the cost advantages of outsourcing product development to China were compelling.

The Neat Company faced three major challenges in establishing a product development team there. The first obstacle was the language barrier. Few engineers in China speak English, which is a challenge for any US-based engineering team that needed to interact daily with Chinese colleagues. The second obstacle was that although Chinese engineers are just as skilled as their Indian and US counterparts, being the first generation of engineers, the workforce lacked people with project management experience. This could pose a significant management challenge, given the need for the Chinese team to work autonomously to deliver results. Developing a strategy to manage the 12-hour time difference between Beijing and the Philadelphia headquarters was the third issue.

For their vendor, they finally zeroed in on Symphony Services, a company with product engineering expertise and strong test-automation and quality-assurance capabilities, which helped to improve the productivity of development processes and sped up the time to market its products. Symphony's newly opened China development centre provided access to the growing base of engineering talent in Beijing.

The experience proved to be wise and the language barrier proved to be the least daunting of the challenges. Working closely with Symphony helped identify the right candidates and to secure a team leader with strong English skills. This greatly facilitated communication between the Chinese and US teams and ensured that issues could be resolved before the product development cycle went off-track.

The time difference between Beijing and Philadelphia was addressed by keeping product development plans extremely organized. Managers in the United States were in daily contact with their Chinese counterparts and the entire team met at least twice a week via videoconference to determine where the team stood with regard to product development objectives.

The outsourcing initiative translated into results pretty soon and the Beijing team helped deliver two new products—a NeatReceipts upgrade and NeatDesk desktop scanner within a matter of months. The team also played a central role in developing a robust automated software testing framework; coupled with huge cost savings, it confirmed the business case for outsourcing to China.

 

Source: Information from “Why We Picked China for IT Outsourcing”, available at http://kposervice.wordpress.com/page/2/; http://www.neatco.com/our-company, last accessed on 15 February 2011.

The establishment of the Department of Electronics (DoE) dominated by a scientific community, as part of the broader, State-dominated, autarkic, import-substitution-led industrialization strategy pursued since the 1950s, had an adverse impact on innovation and entrepreneurship. The highlight of the Indian computer policy in the 1970s was forcing IBM to close down domestic operations in 1978. There was no national software industry, although there were sporadic attempts by various State firms to build a commercially viable computer. There were equally unsuccessful efforts at export promotion that contained clauses permitting the import of hardware only in exchange for a guarantee to export a certain amount of software. There was essentially no government policy for the software industry till the 1980s.

The early 1980s witnessed a cautious policy liberalization through strategies designed to encourage private investment and trade. There were two important initiatives taken by the State for the development of the software industry:

  1. The Computer Policy of November 1984 recognised software as an industry for the first time, and also eased conditions for the local manufacture and availability of computers. This made the industry eligible for investment allowances and other incentives, lowered duties on software imports, and made software exports a priority.
  2. The Computer Software Export, Development and Training Policy of December 1986 had the explicitly stated objective of increasing India's share of world software production. It used the “flood in, flood out” strategy to do this—that is, firms in India were provided with liberal access to global technologies to encourage “thousands of small software companies in the country…thereby increasing export as well as local development”.4 Industry was meant to be independent, with the government only providing promotional and infrastructural support. In a nutshell, this policy explicitly opposed the import-substitution-led industrialization strategy and the Nehruvian ideology of self-reliance in the software sector.

In spite of these policy initiatives, exports in this phase were merely limited to “body shopping”, or the practice of providing inexpensive on-site (that is, at customer locations overseas) labour on an hourly basis for low value-added programming services such as coding and testing. The fact that body shopping was officially encouraged was a reflection of the limited understanding of the industry among policy-makers: software was considered a “hi-tech” activity without adequate distinction made between the different stages of production or the corresponding value added.

Later years saw changes in policy that facilitated a better understanding of the industry and led to policy support for local software development. This saw the inclusion of the private sector and its expertise in the industry. Policy-making began to be based more and more on industry feedback, rather than being the outcome of bureaucratic thinking and planning.

In 1988, the National Association of Software and Service Companies (NASSCOM) was formed to promote the interests of the software industry. Subsequent policy measures tried to promote the industry more pro-actively. The clearest instance of this was the establishment, in 1990, of the Software Technology Parks (STPs). As export zones dedicated to the software industry, the STPs offered data communication facilities, allowing firms to offer offshore services, that is, service provision from India, instead of having to work at customer sites overseas. Although STPs were similar in principle to the export processing zones or the 100 per cent export-oriented unit programme under the Ministry of Commerce, the DoE bypassed the ministry's programmes, arguing that they imposed unrealistic export obligations on firms. Instead, the DoE wanted to limit itself to placing realistic shadow prices on the two scarce resources, foreign exchange and skilled labour. Thus, the annual export obligation of 150 per cent of the wage bill was set with an eye on competition from other low-wage countries such as China. Likewise, the decision to provide high-speed data communications facilities required intrusion onto the turf of the Department of Telecommunications (DoT), then a monopoly service provider, in response to industry frustration with its slow and expensive service.

The shift to offshore services in a more liberal economic environment marked the beginning of a new relationship between the Indian software industry and the global market. This change was the direct result of conscious policies directed at the IT industry since 1984 but was facilitated by the indirect benefits from earlier policies in various other domains. The Indian education system, for instance, managed to create a large pool of skilled labour that became a ready resource in an economy plagued by unemployment and underemployment. This created a large pool of low-cost English-speaking workforce available for employment in the IT industry. This labour force was also endowed with programming skills acquired by working on a variety of platforms since the 1970s. These skills were developed in the years following IBM's departure, when local efforts to build a commercially viable computer were unsuccessful, and users had to rely on imports. Since high duties were a disincentive to import, mainframes never had a significant presence in India, and the few that were imported were of various vintages and from various sources.

These advantages were further leveraged by the geographical advantage of the 12.5 hours’ time difference between India with the United States, their main market. This allowed them to undertake offshore maintenance and re-engineering after regular users there left for the day. This meant lower costs and higher profitability for the US employers who paid their Indian employees at a lower rate compared to what they earned abroad. Offshore development also offered the advantage of having most employees under one roof instead of being scattered across customer sites, allowing the firm to have a sound knowledge base at a dedicated location to compete for subsequent projects, and to move employees from one project to another in a critical situation.

It was against the backdrop of such conscious efforts and unforeseen benefits that the STPs helped transform the industry during the 1990s. Software factories emerged in India with the infrastructure, technology, training programmes, quality processes, productivity tools and methodologies of the customer workplace.

Within India, software factories and development centres began sprouting in regions with skilled labour and communications facilities, both of which were available in Bangalore. During the 1980s, prominent domestic firms such as Infosys, India's second largest software exporter by 1999–2000 and the first Indian firm to be listed on the NASDAQ, were among the early trickle of TNCs in India located in Bangalore. They were attracted by the concentration of skilled labour in the region, initially in public sector manufacturing industries and laboratories in sectors such as aerospace, defence electronics and telecommunications, and subsequently replenished by the large numbers of graduates from the engineering colleges of Karnataka and adjoining provinces.5

Thus, the IT industry in India began as a domestic industry and eventually spread to international markets, while the BPO industry started with a strong export focus. The changing policy environment with regard to foreign investment, rising quality of the offshore environment and improved management capabilities all led global firms to increasingly locate development centres within India. The mid-1990s saw the growth of new centres of software development in Hyderabad, Pune, Chennai, Mumbai and Kolkata. Table 22.2 lists major cities on the IT–BPO map of India. It is estimated that while the leaders account for over 85 per cent of jobs in the IT–BPO space, the smaller cities could grab up to 40 per cent share with improvements in infrastructure by 2018.6

India has been a favoured global destination for the outsourcing industry for over a decade and a half. Indian IT companies like Infosys, Wipro, and TCS have scored over their global counterparts like IBM and Accenture as global leaders in the outsourcing market. The Global Services Location Index,7 developed by consulting firm A. T. Kearney, Inc., indicated that India continued to lead as a preferred location in terms of parameters such as financial attractiveness, people and skills availability, and business environment.

 

Table 22.2 Cities on India's IT–BPO Map

 

Source: NASSCOM and A. T. Kearney, “Location Roadmap for IT-BPO Growth: Assessment of 50 Leading Cities”, NASSCOM-A.T. Kearney Study, 2008, available at http://www.nasscom.in/upload/AT_Kearney/Executive_Summary.pdf, last accessed on 25 September 2011. Reproduced with permission from NASSCOM.

 

The Index for 2010 finds Asian countries at the top 10 positions, led by India, China and Malaysia, as well as Indonesia, Thailand, Vietnam and the Philippines. The different strengths of these countries vary, with India scoring high on account of its deep and broad skill base, and Vietnam ranking as the most financially competitive country in the Index. The Middle East and North Africa have emerged as increasingly attractive destinations because of their proximity to Europe and vast talent pool. Egypt ranked as the leader in the region and fourth worldwide, before the recent political unrest began. The United Arab Emirates climbed to the 15th position overall, serving as a regional services hub.

While many European countries were badly hurt by the financial crisis, Estonia, Latvia and Lithuania saw their ratings climb as a result. While hit as severely as many Eurozone countries, they engaged in a process of internal devaluation, cutting wages and expenditures, and as a result were able to offer highly competitive cost structures. The UK also benefited from a sharp drop in wages, and climbed to 16th place in the ratings from 31st place in 2009.

The United States continues as the top customer for outsourcing services, accounting for 63 percent of global IT outsourcing spending, but Canada has seen its cost advantage diminish, and it has fallen in the ranking to 39th place.

Latin America continues to serve the US market well and is expected to grow in importance. This year, Mexico occupied the 6th position on a worldwide basis, leading the region, due to a sharp drop in wages over the year, the increased attractiveness of “near-shoring”, and a well-developed talent pool. Chile dropped to 10th place from 8th, while Brazil was number 12 for the second straight year.

PUBLIC POLICIES AND THE DEVELOPMENT OF INDIA'S SOFTWARE EXPORTS

In 1986, the Indian government promulgated a policy giving “software exports, software development and training” a prominent position in its economic policy objectives.8 In order to address various obstacles to the expansion of software exports, the government introduced the Software Technology Park scheme and established an autonomous society, the Software Technology Park of India (STPI) in 1991. This society is in charge of managing data communication infrastructure facilities and other services such as technology assessments and professional training of software exporters. By July 2004, 40 software technology parks had been set up under the aegis of STPI. Twenty more STPI centres are planned in the next eight years. In March 2004, all STPI centres combined attracted 4,644 units, of which 3,544 were already exporting software. Although STPI centres can be found in 16 Indian states, those of Karnataka, Tamilnadu, Maharastra and Andra Pradesh accounted for three-quarters of India's software exports in 2002–2003.

The main benefits for firms established in STPI centres are:

  • STPI provides state-of-the-art High Speed Data Communication (HSDC) facilities and 35 international gateways
  • Duty-free imports
  • Exemption from payment of local duties
  • Exemption from corporate income tax up to March 2010
  • Single window for government clearance
  • Foreign ownership up to 100 per cent allowed for firms established in STPI centres

These various forms of public support (trade facilitation, infrastructure, a favourable tariff and tax regime, and liberal FDI regulations) have created clusters of software exporters. The increasing importance of STPI centres in India's software exports is best illustrated by the rise in the share of STPI units in India's total software exports. In 1992-93, STPI units accounted for 8 per cent of India's software exports, and 10 years later, when India's exports had greatly expanded, this share has risen to 81 per cent.

DEVELOPMENTS IN THE IT–BPO SECTOR

According to a review by NASSCOM, The IT–BPO sector is estimated to aggregate revenues of USD 88.1 billion by the end of 2011, with the IT software and services sector (excluding hardware) accounting for USD 76.1 billion of revenues.9 It is expected to result in direct employment of nearly 2.5 million through an addition of 240,000 employees, while indirect job creation is estimated at 8.3 million. The growth in this sector is apparent from the sectoral revenues which have grown from 1.2 percent of GDP in 1986, to an estimated 6.4 per cent in 2010.

The contribution of the IT–BPO sector to exports (merchandise plus services) has increased from less than 4 per cent in 1998 to 26 per cent in 2011. Export revenues are further estimated to gross USD 59 billion in 2011, accounting for 2 million employees. The United States continues to be India's largest market, with an increased share of 61.5 per cent. Other important geographies are the emerging markets of Asia Pacific.

The sector's vertical market mix is well balanced across several mature and emerging sectors. Demand is broad based across traditional segments such as banking, financial services and insurance (BFSI), but also new emerging verticals of retail, healthcare, media and utilities.

The IT services segment was the fastest growing among exports, recording a growth of 22.7 per cent over 2010, and aggregating export revenues of USD 33.5 billion, accounting for 57 per cent of total exports. Indian IT service offerings have evolved from application development and maintenance to emerge as full service players providing testing services, infrastructure services, consulting and system integration. The decade of 2010 marked a strategic shift for IT services organisations, from a “one factory, one customer” model to a “one factory, all customers” model. A key aspect of this strategy is the growing customer acceptance of Cloud-based solutions that offer the best in class services at reduced capital expenditure levels.

The BPO segment has grown by 14 per cent to reach USD 14.1 billion in 2011. The year has also witnessed the next phase of BPO sector evolution, BPO 3.0, characterized by greater breadth and depth of services, process re-engineering across the value chain, increased delivery of analytics and knowledge-based services through platforms, strong domestic market focus and small and medium business-centric delivery models. The engineering design and products development segments have generated revenues of USD 9 billion in 2011, growing by 13.6 per cent, driven by increasing use of electronics, fuel efficiency norms, convergence of local markets and localized products.

Domestic IT–BPO revenues excluding hardware are expected to grow at almost 16 per cent to reach 787 billion in 2011. Growth in this sector is driven by strong economic growth, rapid advancement in technology infrastructure, increasingly competitive Indian organizations, enhanced focus by the government and the emergence of business models that help introduce IT to new customer segments. The fastest growth is visible in IT services rising by 16.8 per cent to reach 501 billion, driven by localized strategies designed by service providers.

The domestic BPO segment is expected to grow by 16.9 per cent in 2011, to reach 127 billion, driven by demand from voice-based services, in addition to adoption from emerging verticals, new customer segments and value-based transformational outsourcing platforms. The software product segment is estimated to grow by 14 per cent to reach 157 billion, fuelled by replacement of in-house software applications to standardized products from large organizations and innovative start-ups

The government sector has been a key catalyst for increased IT adoption through sector reforms that encourage IT acceptance, National eGovernance Programmes (NeGP), and the Unique Identification Development Authority of India (UIDAI) programme, which creates large scale IT infrastructure and promotes corporate participation.

GROWTH DRIVERS OF INDIA'S ITES–BPO SECTOR

The factors driving the growth of India's ITES–BPO sector are:

Abundant Talent

India's basic advantage lies in its young population with its English-speaking skills, which is the outcome of its huge government supported and subsidized academic infrastructure. The growth of the IT sector is the result of a combination of initiatives led by the government, the academia and the industry. These initiatives include skill certification at the national level through NASSCOM-conducted NAC (National Assessment of Competence) tests, the establishment of finishing schools in association with the Ministry of Human Resource Development to supplement graduate education with training in specific technological and soft skills, MoUs with education agencies like UGC and AICTE to facilitate industry inputs on curriculum and teaching, and setting up of faculty development programmes.

 

The existence of a large English-speaking labour force, world-class information security environment and an enabling business policy and regulatory environment are the enabling factors of the Indian IT industry.

Sustained Cost Competitiveness

The Indian IT industry is known for its sustained and significant cost advantage, which helps clients report savings rate of 25–50 per cent over the original cost base. This cost advantage to outsourcers to India is due to the availability of highly skilled talent at low wages coupled with the high productivity gains as a result of an extremely competent employee base. Other factors contributing to cost advantage stem from elements like telecom, which come at low rates in India compared to other low-cost destinations.

Continued Focus on Quality

The Indian IT industry has maintained its leadership through consistent process quality and expertise in service delivery. Ever since the industry came into existence, there has been a focus on quality initiatives to align themselves with international standards. This has resulted in the development of robust processes and procedures to offer world-class IT software and technology-related services.

World-class Information Security Environment

A defining characteristic of the Indian BPO sector is its fool-proof security, which is an indispensable element of the global service delivery model. Efforts at the level of the individual firm are complemented by a comprehensive policy framework established by Indian authorities, who have built a strong foundation for an “info-secure” environment in the country. Some of these initiatives include strengthening the regulatory framework through regular amendments to the existing IT Act and its provisions, scaling up the cyber lab initiative, scaling up the National Skills Registry (NSR) and establishing a self-regulatory organization.

Rapid Growth in Key Business Infrastructure

The growth and expansion of this sector has been the result of growth in business infrastructure. The BPO sector has benefited from the declining cost of international connectivity accompanied by significant improvements in the service level. These benefits have been realized not only in the larger urban centres but also in satellite towns and smaller cities. Critical business infrastructure, such as telecom and commercial real estate, are well in place; improving other supporting infrastructure is a key priority for the government. The rapid increases in STPI infrastructure available across the country and the magnitude of investments is proof of government support to the industry and a key factor in its growth.

Enabling Business Policy and Regulatory Environment

The enabling policy environment in India was a vital catalyst during the early phases of growth in this sector. There has been a special emphasis on encouraging foreign participation in most sectors of the economy, and on recognizing its importance not only as a source of financial capital but also as a facilitator of knowledge and technology transfer in the post-liberalization period. The Indian ITES–BPO sector has benefited from these policies, with participating firms enjoying minimal regulatory and policy restrictions along with a broad range of fiscal and procedural incentives.

PROBLEMS AND PITFALLS OF THE ITES–BPO INDUSTRY

The IT industry has boasted annual growth rates of nearly 30 per cent in the past ten years, with revenues now nearing USD 88 billion. The following are some of the problems faced by the industry today:

Appreciation of the Rupee

The rapid appreciation of the rupee against the dollar presents the biggest hurdle for the IT sector as it erodes its foreign exchange earnings. Since its low in mid-2006, it has gained 16 per cent. This has led to reduced earnings and has the potential to turn a profitable asset into a real liability.

Poor Infrastructure

Poor quality of infrastructure continues to be a problem in cities like Bangalore, where workers can spend four hours a day in traffic. Although state-of-the-art technology was used for telecom networks, getting a connection can still take as long as three months. The problem of erratic power supplies forces units to use their own back-ups.

 

Intensifying competition, loss of the low-cost advantage, increasing demand for trained manpower, employee dissatisfaction and high attrition rates are some of the problems faced by the industry.

Increasing Demand for Trained Manpower

Despite the fact that Indian engineering institutions award around 200,000 diplomas each year and produce around 250,000 graduates, the industry continues to face a manpower crunch. The primary reason for this is that most engineers who find place in the industry frequently switch jobs for better pay, making attrition costs among the highest in the world.

Employee Dissatisfaction and High Attrition Rates

Call centres and other outsourced businesses such as software writing, medical transcription and back-office work employ more than 1.6 million young men and women in India, mostly in their twenties and thirties, who make much more than their contemporaries in most other professions. They do, however, face sleep disorders, heart disease, depression and family discord. Most call centre jobs involve responding to phone calls through the night from customers in the United States and Europe, some of whom can be angry and rude. It is monotonous and there is little meaningful personal interaction among co-workers. That can also be true of other jobs such as software writing and back-office work. All these factors have led to an increasingly dissatisfied workforce, especially at the lower end of the job pyramid, which is increasingly viewing work in the IT industry as a job rather than a career.

Intensifying Competition

Although the Indian IT industry continues to have its competitive edge, it has close competitors all over the world. Meanwhile, foreign IT firms have been increasing their scale of Indian operation despite competitive pressures. For instance, in 2002, the six biggest firms—including Accenture, IBM and HP—had less than 10,000 employees in the country; however, by 2010, their combined Indian workforce exceeded 150,000. This has enabled them to rival the Indian firms in scale and cost, while exploiting their stronger brands and international scope.

Future Threats

In the long term, the Indian IT sector will be able to maintain its competitive edge only if it can keep up with technological advancements. Many of the services they now provide will eventually be automated, as is already visible, for example, in software testing. Western firms, meanwhile, increasingly want Indian providers to do more than just keep systems running; they want help in developing new solutions to business problems—for which Indian firms must encourage innovation.

IT VALUE CHAIN

The IT value chain refers to the IT components, processes and services that link customer demand to a final product or service that is able to satisfy the final consumer. Broadly, consulting and IT strategy form the top end of the value chain, followed by application design and development, application management, package implementation and finally, network and telecom infrastructure management, which constitutes the bottom of the value chain. The outsourcing model was originally placed at the bottom of the pyramid and continues to employ the largest number of people. Over a period of time, however, the nature of jobs being outsourced has moved towards more advanced skill sets such as legal, medical, and financial research. Figure 22.1 gives an illustration of an IT value chain.

 

The IT value chain refers to the IT components, processes and services that link customer demand to a final product or service that is able to satisfy the final consumer.

The Indian software industry model has been a model of cost arbitrage. However, like any business model, this model is not sustainable forever. With other low-cost service-providing countries like China, Russia, the Philippines and South Africa quickly catching up, the Indian software industry has to provide more value to their global clients by moving up the IT value chain. Increasing employee compensation, strengthening of the rupee and increasing competition are some of the factors that have forced the Indian software industry to provide more value to their global clients. If they are providing software maintenance or infrastructure management services, they will need to look at providing high-end business and technology consulting, and if they are offering product maintenance services, they must invest in research and development and come up with innovative products.

 

Figure 22.1 IT Value Chain

REGION FOCUS  |  Moving Beyond the Back Office

In December 2006, Mumbai-based Tech Mahindra won India's biggest outsourcing deal to date—a five-year, USD 1 billion contract from British Telecom to provide technical support. Tech Mahindra, in which BT has a 35 per cent stake, bettered a September 2005 deal in which three Indian IT services firms were among five international providers picked by Amsterdam-based financial services company ABN AMRO Bank N.V. for one of the biggest outsourcing contracts ever handed out, beating many big-name global contenders. Infosys Limited, Tata Consultancy Services and Patni Computer Systems Ltd share that USD 2.2 billion, five-year contract with IBM and Accenture. In another corner of India's outsourcing industry, a much smaller firm created a niche “spot market” for knowledge services. Yet another Indian outsourcing service provider built a platform of expertise to provide patent-related legal resolution support services—several notches above the patent writing functions that were considered high-end assignments until recently. These are just a few samples of the dramatic progression achieved by Indian outsourcing service providers in their offerings. Although 65 per cent of India's 180,000 outsourcing services workforce is involved in transaction-intensive services like call-centre support or check processing, the industry as a whole helps its clients save USD 1.5 billion annually.

Another illustration of high-end KPO work is Pipal Research of Chicago, which was founded five years ago. The company employs about 100 analysts, with most of them based in New Delhi. Until recently, the bulk of its assignments came from equity research, fixed-income asset research and asset pricing related work. A year ago, it carved out a division called PipalAnswers, which functions like a “quasi spot-market for knowledge”. These are essentially one-off assignments tailored to service occasional requirements of clients, unlike Office Tiger, which has dedicated long-term client relationships. The new product offers speedy research on tightly focused client requirements such as snapshot insights of rival companies’ ad spends and public relations.

For Genpact, one of India's largest BPOs, the fastest growing sector is the company's USD 150 million analytics business. Similarly, NASDAQ-listed EXL Service has created its own efficiencies across verticals. In insurance, the firm has moved from doing mere data entry work to actuarial services. For utilities client British Gas, it has become a strategic partner in the design of their backend.

The outsourcing industry globally is moving toward more structured transactions, where companies are looking for total outsourced solutions, resulting in different types of models.

 

Source: Information from “What's Next for India: Beyond the Back Office”, Knowledge@Wharton, available at http://knowledge.wharton.upenn.edu, last accessed on 20 February 2011; “Indian Outsourcing Companies Think Strategy Even as Pressure Mounts”, India Knowledge@Wharton, available at http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4552, last accessed 20 February 2011.

MANAGERIAL PERSPECTIVE

The principal strategy that will help the industry to thrive amid a changing environment is specialization and a move up the value chain from peripheral activities to increasingly core activities of clients.

India's initial and obvious advantages in the outsourcing sector, such as labour arbitrage, lower cost of operations and a workforce that is fluent in English, are not sustainable in a growing economy. It is therefore recommended that firms shift their source of competitive advantage to specialized expertise to ensure their success in the long run.

The BPO-as-commodity era is over as work at the higher end of the value chain makes options like the KPO more exciting. Although many Indian BPOs realized early on that their clients would eventually outgrow a need for only the basic bread-and-butter services, their approach to try and provide the additional expertise within their existing infrastructure met with little success. Most knowledge processes—in the legal, engineering and medical fields, for instance—require different corporate cultures and support systems. They also need employees with higher levels of education, who would naturally cost more. It therefore took KPO services some time to evolve, and presently they are in great demand in legal processes, architectural design, engineering design and application development for gaming and mobile devices.

The typical Indian IT firm also needs to diversify from the US market and consider countries like Brazil, China, the African nations, the Middle East and Australia. The presence of firms like GE and IBM in the emerging economies helped them bounce back unscathed from the economic crisis. The unexplored Indian market is also a major opportunity where volumes are high and growing, but margins are low. This is clear from the experience of the three top BPOs in India: Genpact, WNS Global Services and IBM Global Process Services. Genpact was originally a business unit within GE that was carved out as an independent company in January 2005. WNS started life as a captive of British Airways and now has Warburg Pincus LLC as its principal shareholder. IBM Global was originally Daksh eServices, which was acquired by IBM in June 2004.

These are the companies that have dominated the domestic BPO arena, which has shown strong performance over the past few years, growing by 22 per cent in 2010 over the last year, to gross revenues of USD 2.2 billion. Observers expect Indian companies to become more active here, as has happened in IT software and services.

CLOSING CASE  |  Indian Software Industry: The Move up the Value Chain

The Indian IT industry is an established global brand of service companies that have established themselves firmly on the global stage. More than two-thirds of Fortune 500 firms turn to firms such as Tata Consultancy Services (TCS), Wipro Technologies and Infosys Technologies for their IT and business process outsourcing needs.

The saga of software products, however, has been somewhat different. Although many global companies like SAP, Microsoft and Oracle have used India for product development either through their subsidiaries or by outsourcing to Indian technology service providers, there are very few home-grown products. A few Indian firms have developed and commercialised their own products through the licensing model, but there are very few full-fledged software product companies—those that develop and market their own products.

The National Association of Software and Service Companies (NASSCOM) estimates that of India's total software and services revenue of USD 52 billion in fiscal 2008, the software product segment accounted for a mere USD 1.4 billion, with the top 10 companies taking in more than 80 per cent. Recent market indicators suggest, however, that this segment is undergoing rapid transformation and is approaching a new phase of accelerated growth. The following figures bear testimony to this; since 2001, India has produced 371 product start-ups, two-thirds of these were formed in the last three years, 100 in the last year alone. While most of the early players in the Indian software product space focused primarily on the financial and accounting segments, the newer companies are looking at areas such as business intelligence, security and content.

Venture capital investment in the software product segment grew by 43 per cent to USD 156 million. Firms such as IDG Ventures India, worth USD 150 million, has made 5 investments out of 18 in the software product space. Of its total investment of USD 50 million until now, USD 38 million has been in software product firms.

The Indian software industry is expected to get a boost due to a host of factors including a strong and growing domestic market, disruptions in technology and business models, a growing talent base, a now-well-established “India” brand, and increased venture capital funding. Estimates suggest that the total domestic IT market comprising hardware, software, services and business process outsourcing has jumped from USD 8 billion in 2004 to USD 23.1 billion in 2008, and is expected to be among the world's fastest growing markets. Much of this growth will be driven by the small and medium business sector whose specific localized needs are difficult to be serviced by the large TNCs and present a huge opportunity for local business enterprises. The development of “enterprise specific” products helps in organizational learning for other markets at the lowest possible costs.

Industry pundits also suggest that that software products are typically formed in the shadow of early adopters and friendly, sophisticated companies, which were few and far between in India. Now the possibility exists in both the corporate and consumer sides. The emergence of innovative business models, such as those of Bharti Airtel Limited, India's largest mobile services, provide the kind of working environment needed for product development.

Recent changes in delivery models as well as advances in technology also favour Indian software companies. Software as a Service (SaaS), for instance, is a delivery model under which the ownership of the deployment, integration and maintenance of the IT infrastructure moves from the customer to the vendor, making it financially more viable for Indian customers, particularly those in the SMB segment, to opt for software products. The other advantage of the SaaS model is that vendors can spend money on driving innovation instead of spending huge amounts on supporting multiple platforms for different customers. Similarly, service oriented architecture (SOA) is characterized by loosely coupled architecture and ease of integration, making it easy for Indian companies to sell their products globally and for different vendors to act independently of each other.

Cloud computing has the potential to change the software product landscape in the same way that merchant foundries did with chip design in the late 1980s. The emergence of merchant foundries such as Taiwan Semiconductor Manufacturing Company, which manufactured other companies’ chips, separated chip design from the expensive activity of chip manufacturing. This led to a spurt of companies engaged only in chip design, fostering innovation. The emergence of cloud computing could be a similar great leveller for Indian companies.

The challenge of a talent crunch in the area of product management also seems to be getting resolved as a growing pool of professionals with expertise in software products emerge out of multinationals’ subsidiaries, Indian technology service providers and Indian software product companies. The design and development of software products from scratch at multinationals’ subsidiaries in India cause knowledge to pass through these to other firms in the industry.

Firms such as Yahoo! India have been launching a fully “made in India” product every month. Symantec's India centre works on a complete ownership model for products, including Security 2.0, Information 2.0 and File System Analyzer. Google Map Maker is one of the most recent products from Google India. All of these are global products developed through relevant product experience having been acquired within the country.

The weakest link in the emergence of software product start-ups is the dearth of angel funding. Angels play a critical role in identifying and supporting a start-up and building it to a size where it catches the interest of venture capitalists. The United States has 225,000 such angels, among which many support software product start-ups, as against 225 in India in 2008.

Questions

  1. Enumerate and explain the factors responsible for the growth of the software products segment of the Indian IT industry.

  2. What role have changing delivery models played in the transformation of the IT industry?

Source: Information from “India's Software Industry Reboots for an Expanding Market”, India Knowledge@Wharton, available at http://knowledge.wharton.upenn.edu/india/article.cfm?articleid=4326, last accessed on 25 September 2011; “NASSCOM Sees Next Decade as Crucial for Disruptive Growth of Indian Software Product Segment”, available at http://www.zinnov.com/event.php?ev_id=17, last accessed on 25 September 2011; and “NASSCOM-ZINNOV India Software Product Business Study”, available at http://www.slideshare.net/avinash.raghava/nasscomzinnov-india-software-product-business-study, last accessed on 25 September 2011.

SUMMARY
  • Outsourcing as a business phenomenon has its roots in David Ricardo's theory of comparative advantage—it is the process of transferring recurring business activities to a low-cost supplier outside the business.
  • The major drivers of outsourcing have been a low-wage-seeking English-speaking workforce, developments in technology, changes in the regulatory environment, and institutional and infrastructural developments.
  • A firm's decision to outsource certain business processes depends on the ability to standardize and digitize certain functions, cost considerations and market size.
  • The Indian software industry came into existence with the passing of the Computer Policy in November 1984, the Computer Software Export, Development and Training Policy of December 1986 and the establishment of NASSCOM in 1988.
  • Bangalore, Pune, Hyderabad, Chennai and Gurgaon have been important centres of the IT Industry; however, smaller satellite towns are also becoming increasingly important.
  • Key growth drivers of Indian ITES–BPO exports are a talented workforce, sustained cost competitiveness, continued focus on quality, world-class information security environment, rapid growth in key business infrastructure and an enabling business policy and regulatory environment.
  • Major problems of the ITES–BPO industry are an appreciation of the rupee, intensifying competition, insufficient trained manpower, poor quality infrastructure, rising employee dissatisfaction and high attrition rate.
KEY TERMS

 

Captive offshoring

Captive onshore outsourcing

IT value chain

Non-captive offshoring

Non-captive onshore outsourcing

Outsourcing

DISCUSSION QUESTIONS
  1. What does the term “outsourcing” mean? Discuss the different forms of outsourcing in the global economy.
  2. Enumerate the different factors that play a key role in a firm's decision to outsource certain business operations.
  3. List the factors that have acted as drivers in the process of outsourcing in the global economy.
  4. Write a short note on the growth of the software industry in India.
  5. Discuss the contribution of the software industry in the context of the Indian Economy.
  6. What are the key growth drivers of India's ITES–BPO Industry?
  7. Discuss the main problems faced by the IT industry in India today.
MINI PROJECTS
  1. A.T. Kearney's Global Services Location IndexTM (GSLI) (http://www.atkearney.com/index.php/Publications/global-services-location-index-gsli.html) offers a snapshot for both business leaders and policy makers to help them choose among a growing number of offshore locations. The GSLI analyses and ranks the top 50 countries worldwide as the best destinations for providing outsourcing activities, including IT services and support, contact centres and back-office support. Using information from the 2011 report, make a comparative profile of the top five destinations.
  2. NASSCOM provides an overview of developments in India's IT sector. Using resources from the NASSCOM Web site (http://www.nasscom.in/impact-indias-growth), prepare a report on the impact of the IT sector on India's growth for the year 2011.