Eroding India’s “competitive advantage”?

Business Standard on May 03 had an interesting article (posted below) about the erosion of India’s comparative advantage in IT – cheap labour seems not so cheap now. Even if labour is still cheaper than the ‘advanced’ countries’, but then productivity is far lower. Solutions are suggested – off to KPO. Also, “Some feel there is nothing to worry as India is rapidly creating huge economies of scale in IT offshoring, which offset the inflationary pressures of salary increases”. This bubbly boom and bust of BPO – how much does it affect the country’s overall economy – the P(roductive) F(orces)/P(roduction) R(elations)?

BPO`s diminishing competitiveness
Shyamal Majumdar / Mumbai May 03, 2007

The cost-arbitrage benefit may erode if the meagre productivity of IT staff is factored in.

In a survey released yesterday, CLSA Asia Pacific says 40 per cent of India’s information technology employees expect their salaries to rise by 20 per cent annually over the next 10 years. Two-thirds expect at least a 15 per cent growth. While this indicates continued all-round prosperity for IT employees — for example, the IT professionals spend $1 billion annually just on eating out and almost half in the 28-35 age group had an international vacation last year — how does the zooming salary bill impact the competitiveness of India’s outsourcing industry?

The jury is still out on this. Some feel there is nothing to worry as India is rapidly creating huge economies of scale in IT offshoring, which offset the inflationary pressures of salary increases. Many outsourcing companies are implementing large team sizes and long-term projects to help maintain utilisation levels at above 75 per cent.

But there are quite a few other analyst firms which feel by 2010, India may become too costly to provide low-end services at competitive costs. For example, Evalueserve, a leading provider of knowledge process outsourcing services, says Indian salaries have increased at an average of 14 per cent a year. If this trend continues, the cost-arbitrage benefit would get reduced from the present 40 per cent to 25 per cent by 2010.

Or, listen to The Conference Board. The world’s pre-eminent business membership and research organisation has been a longtime supporter of outsourcing and offshoring American jobs to cheap overseas labour markets. It said in a report in 2005 that potentially massive savings in wage and benefit costs will continue to drive the global offshoring movement.

But the same organisation is now questioning the economic benefits of outsourcing. In a study in October last year, the Conference Board said the competitive advantage of low-wage countries is often exaggerated once the meagre productivity of their workers is factored in. The study said the comparative cost advantages of taking your business to low-wage countries such as China or India are often not the bargain they seem when wages are adjusted for low productivity. The manufacturing sector in India and China only pays between 2 per cent and 3 per cent of the US compensation level on average.

But labour productivity in these countries is also far below the US level at 12 per cent to 13 per cent.Though the productivity levels at present exceed compensation levels by a considerable margin — unit labour costs in China and India are on average 20 per cent lower than that in the US — The Conference Board warns that the one critical lesson for businesses that benefit from one-time labour cost benefits when investing in low wage countries is that productivity gains from new technology and innovation have to keep pace with often fast rising wages of skilled and semi-skilled workers. Or the cost advantage begins to erode.

The worry is real. For example, according to Deloitte research, the top 10 per cent of the IT workforce in India has been receiving an average salary rise of more than 40 per cent. In contrast, most IT employees in the US received a salary rise of five per cent or less. Though salaries in the US are still, on an average, nearly 10 times higher than those in India, the gap is sure to diminish over time. One reason for the fast-rising wages is the limited “employable” pool.

The Indian education system is not churning out enough computer science and electronics graduates. For instance, though India’s 272 universities and nearly 14,000 colleges churn out over 25 million graduates, only about 300,000 enter the workforce as engineers. And, out of that, maybe just 30 per cent are suitable for the software and IT services industry.

One way out of the diminishing competitiveness could be to go up the value chain — from voice-based services to knowledge process outsourcing. According to an Evalueserve study, the global KPO market is expected to grow at a cumulative annual growth rate (CAGR) of 46 per cent. Compare this with the prediction for the low-end outsourcing services market. This is expected to have a CAGR of 26 per cent.The high-end KPO opportunities are immense for Indian firms.

For instance, look at some of the figures pertaining to intellectual property research. Drafting and filing of patent applications in the US is quite expensive. A typical application costs about $10,000 to $15,000 to draft and file with the United States Patent and Trademark Office. Cost savings from offshoring even a portion of the patent drafting process can easily save up to 50 per cent of the cost for the end client, according to Evalueserve.


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