Future Winners and Losers in Global Outsourcing

Transcription

1 Future Winners and Losers in Global Outsourcing Gautam Shirhattikar MBA by The Trustees of Columbia University in the City of New York. All rights reserved. CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS WINTER

2 Executive Summary Over the last five years, Indian IT firms have established a dominant position in the global offshoring market by capitalizing on two natural advantages: access to a large welleducated, English-speaking work force and a low wage structure compared to that of Western countries like the U.S. However, this localized, wage-arbitrage-based business model, which has worked well for Indian firms in the past, is now being challenged on multiple fronts. Other low-wage countries like China and the Philippines have entered the market, leading to severe pricing pressure and a proliferation of supplier choices for customers. At the same time, traditional onshore consulting firms like Accenture and IBM have realized that they can set up their own operations in India and reap the benefits of lower costs without involving local IT players. As a result, the requirements for success are changing rapidly in the global outsourcing industry. Between the onshore and offshore models, it is unlikely that either one will triumph entirely over the other in the long term. Instead, future winners in this space will be decided by the ability to deliver the following competing benefits: (1) seamless integration of a low-cost model with high-value-added, custom-built services; (2) reliance on deep client knowledge and tighter relationships to create unique, organization-specific solutions; (3) establishment of highly efficient global delivery networks that optimize cost, schedule and quality to provide maximum value to clients. WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 1

3 1. Overview of the Global Outsourcing Market The global market for outsourced IT-enabled services is expected to grow from $125 billion in 2000 to $301 billion by the end of 2004 (CAGR of 25 percent) (Scholl 2001), including $135 billion from business process outsourcing (BPO), $85 billion from IT infrastructure outsourcing (ITO) and the rest from application outsourcing activities. 1 North America is the largest consumer of IT services (49 percent), followed by Western Europe (31 percent) and Japan (10 percent) (see exhibit 1). The industry as a whole is highly fragmented, with the top five players holding a combined market share of less than 20 percent. 2 Exhibit 1. Global Consumers of IT Services Latin America Japan 5% 10% Asia Pacific 5% W. Europe 31% North America 49% Source: National Association of Software and Service Companies (NASSCOM). Offshoring currently constitutes about 20 percent of this market. However, since lower costs typically drive the decision to outsource, it is no surprise that offshoring is becoming increasingly popular. For example, total costs for similarly qualified professionals can be as much as 40 percent lower if services are performed offshore (Heeks 1996). Some estimates indicate that offshore outsourcing increased from 12 percent of U.S. IT budgets in 2000 to 28 percent in A number of developing economies are starting to offer an attractive blend of highquality skills and lower costs, making them serious contenders in this space. Foremost 1 BPO refers to the operation and maintenance of noncore business functions like customer service, finance, human resources and R&D by a third-party vendor. ITO consists of activities like network maintenance and backoffice operations. Application outsourcing is the term reserved for activities like content development, engineering design and animation. 2 Comment by Accenture CEO Joe Forehand in IT s Global Itinerary: Offshore Outsourcing Is Inevitable, Computerworld, September 15, Forrester Research, January 2002 (cited by NASSCOM). WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 2

4 among these countries are India, Ireland, China, the Philippines and Russia. Exhibit 2 provides a comparison of the relative strengths and weaknesses of these countries as outsourcing destinations. Exhibit 2. Conditions for IT Outsourcing in Various Countries India Ireland China Philippines Russia Government support H H L H L Labor pool H L M H H Infrastructure L H L L L Educational system H H M H H Cost advantage H M H H M Quality H H L L M Cultural compatibility L H L H M English proficiency H H L H L Source: National Association of Software and Service Companies (NASSCOM). India, the Philippines and Ireland appear to have the best overall resources for success in IT services. While the first two countries have performed well, cost advantage is such a powerful factor that Ireland, which has a highly talented labor pool, is being forced out of the basic IT services market by lower-wage countries like China, which are building new resources in infrastructure and skilled labor. The current status of the ITES sector in each of these countries is as follows. India. Owing to its low labor costs, large English-speaking population and abundant supply of engineering graduates, India has captured the lead in the global offshoring market, with about a 55 percent share (see exhibit 3). 4 Last year, India s software and services exports grew 30 percent, to $12.5 billion 5 and they are expected to quadruple by 2008, creating more than two million new jobs in the IT sector (NASSCOM 2002). After mastering back-office IT services like network maintenance and software development, Indian firms are moving up the value chain to more sophisticated ones like BPO, R&D and consulting. 4 Computerworld Web site, 5 National Association of Software and Service Companies (NASSCOM) Resource Center, Indian Software and Services Exports, 2004, WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 3

5 The rapid growth of the IT sector has spawned hundreds of players of varying sizes and specialties, leading to a fragmented marketplace. However, there are five major players Wipro, Infosys, TCS, Satyam and HCL each with annual revenues in the $500 million to $2 billion range. Below these top players are 10 to 20 mid-tier players, with revenues ranging from $50 million to $500 million. The bottom tier comprises hundreds or even thousands of start-ups and small companies. As the industry moves toward high-end value-added services, the Big Five are developing a reputation for quality and on-time delivery that is allowing them to garner a disproportionate share of new and large contracts. In just the last two years, Big Five market share has increased from 19 percent to 26 percent. This is putting pressure on smaller and mid-tier players to consolidate their operations in a bid to retain competitiveness. Exhibit 3. Leading Providers of Offshored IT Services Russia 5% Ireland 8% Malaysia 5% Philippines Singapore 5% 5% Mexico 8% China 9% India 55% Source: Computerworld. Ireland. Ireland has always been a premier destination for IT services for a multitude of reasons: low taxes, skilled labor, native English language skills and proximity to the U.K. and other European countries. In the early 90s, corporate tax rates as low as 16 percent helped bring significant foreign investment to Ireland. But over the last three years, lower wages in China, India and Eastern Europe have eclipsed Ireland s cost advantages, spurring many global companies to scale back or cancel plans for Irish operations. In response, Ireland has changed its focus in the IT sector from the low-end services market to the higher-end software and R&D segments. This has helped the sector emerge from its recent slump, with 4 to 5 percent growth expected in the coming years. China. Like India, China possesses an abundance of skilled technical graduates and low labor costs. However, until recently, the nation s IT industry was focused on hardware, and the lack of English-speaking professionals was a barrier to entry into Western markets. In contrast, due to its geographical proximity and cultural similarity, Japan has always been a favored destination for China s IT services industry. Lately, the Chinese government has WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 4

6 been lending an active hand to industry in developing the domestic IT services sector. The China-India Software Association, formed in November 2003, is collaborating with Indian IT firms to establish 20 technology parks across China. Large Chinese firms like Legend, the PC giant, are expanding into consulting services through a series of acquisitions and joint ventures. 6 As a result, the Chinese ITES sector is expected to grow from $255 million in 2002 to $1.1 billion in 2006 (CAGR of 43 percent). 7 Philippines. In addition to the third-lowest salary levels among countries that provide offshore services ($234/month), the Philippines has the third-largest English-speaking population in the world. The Philippines are also emerging as a serious competitive force in areas like BPO, software development, animation, transcriptions and engineering design. A private-sector-led group of firms called Outsource Philippines is now collectively marketing the country s BPO services as a brand, a move that promises to heighten competition in that sector. Russia. On a per capita basis, Russia has the third-highest concentration of engineers and research scientists in the world. As a result, the country has carved a niche for itself in higher-level software engineering and R&D. The output of the outsourced software and services sector has grown to $200 million per year. However, a shortage of project management and English language skills, poor telecom infrastructure and the smaller scale of domestic IT firms have prevented Russia from capturing a larger share of the global IT services market. Going forward, as skilled-labor shortages in locations like India are balanced by the rapid development of the talent pool in countries like China and the Philippines, the choice in suppliers will inevitably broaden, and significant geographic fragmentation is likely. 2. Changes in the Global Outsourcing Industry 2.1. Increased Competition Among Suppliers in Low-Wage Countries Until now, Indian IT majors have reaped the benefits of the significant wage differentials between India and Western countries. As an example, the average cost per full-time employee for an India-based BPO operation is only 20 percent that of a similar outfit in the U.S. Similarly, according to Nishith Desai Associates, a tax and legal consulting firm, labor costs (including training and benefits) account for only 33 to 40 percent of a typical call 6 Legend recently purchased a 51 percent stake in Han Consulting and received 71 percent in the formation of a joint venture with AI Software that will focus on the development of IT services for the insurance industry. 7 Alok Aggarwal, The Future of IT Industry in India and China, Evalueserve PowerPoint presentation, May 30, 2003, WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 5

7 center s costs in India, compared to 67 to 72 percent in the U.S. or U.K. (Nishith Desai Associates 2004). Numbers like these have allowed Indian firms to post growth rates in excess of 50 percent over the last three years. However, the resulting boom has also attracted the attention of other countries. PricewaterhouseCoopers estimates that in 2003 alone, billing rates among Indian IT firms declined by 15 percent owing to aggressive competition from China and Russia. 8 While billing rates are dropping, the lack of qualified professionals is making it increasingly difficult for Indian IT majors to satisfy demand from local sources, which is leading to high wage inflation. For example, salaries for Chinese programmers are half those of their Indian counterparts. 9 Indian firms will need as many as 800,000 software engineers by 2005, compared to 340,000 in However, the intake at local technology institutes in 2002 was only 165,000. China, with a total of 470,000 software and hardware professionals, is expected to fill the gap. In spite of these challenges, Indian firms are expected to continue their leadership in this sector for at least a couple of years. The project management and quality control processes that these firms have built are helping them reap huge dividends in terms of productivity and cost efficiency. In contrast, Chinese firms have thin project management capabilities, necessitating the hiring of expatriate professionals at higher salaries on Chinese projects. However, China is trying to rapidly improve its capabilities in this area. For example, the Shanghai Pudong Software Park is accelerating the transfer of process knowledge to local firms by offering free rental space to Indian firms like Satyam Computers. How will the IT services market be distributed on a geographical basis in the future? Over the next decade, the industry is likely to evolve into multiple global centers of excellence, which will garner the lion s share of work in particular service areas based on their unique competencies. The question of which countries and firms will emerge as leaders in this new space depends on their flexibility and willingness to adapt to changing client demand and business conditions. An example of how the proactive development of capabilities can change the dynamics in a given sector is provided by the scenario unfolding in the call center market. Traditionally, the Philippines were the favored destination for call center outsourcing because nationals from that country speak English with an accent that is favored by U.S. and European customers. However, in recent months, Indian call center firms have eroded this advantage through accent neutralization 8 Prachi Verma, Billing Rates down 15% for Indian IT Cos: PwC, Financial Express, December 4, 2003, 9 Indian software staff to cost more than Chinese, Taipei Times, February 8, 2002, WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 6

8 training programs for their employees, which is enabling them to capture the lead in this fast-growing market Offshore Service Operations by U.S. Clients and IT Consulting Firms A number of Fortune 500 clients have realized that they can reap greater cost savings by cutting out the middleman and establishing their own overseas operations. The formation of a foreign subsidiary also allows these firms greater flexibility in scaling up future operations and tighter integration of overseas operations with the rest of the enterprise. The added benefit of establishing an in-house base is the elimination of security and consumer privacy risks that are typically associated with hiring a third-party vendor. In industries like pharmaceuticals, intellectual property protection is also a major issue, since countries like India are still in the process of refining their patent protection laws. All these problems can be avoided by organic expansion. However, while such moves are a smart choice for U.S. clients, they hurt overseas IT vendors on two fronts: they lower the potential revenue base and they raise labor costs by increasing the competition for talent. GE s experience in India is an excellent example of how to execute such a strategy. The company initially entered India in 1992 with joint ventures in its plastics, medical systems, appliances and lighting businesses. However, it soon realized that India s true potential lay in its vast pool of highly skilled manpower. Today, GE has multiple software and R&D centers in India, which saved the company $250 million in 2001 and could ultimately reap annual savings of over $600 million. GE s India operations generated more than $1 billion in revenues and orders in 2003, and its BPO arm (GECIS) employs more than 17,000 people. 10 Global IT services giants such as IBM and EDS are also eyeing locations like India and China with great interest. While these firms are growing globally at 5 percent to 6 percent a year, some of their offshoring counterparts are experiencing growth rates in excess of 50 percent. Moreover, clients are demanding cost savings that match what competitors are offering, which is forcing these firms to develop an offshore presence. As overseas IT firms move up the value chain from software code writing and applications development to more complex assignments like BPO and systems integration, they are encroaching on service areas that were once the exclusive preserve of firms like Accenture and EDS. In response, U.S. companies are aggressively moving into the Indian market through acquisitions, partnerships and in-house investments. For example, IBM recently acquired Daksh, one of India s largest BPO firms specializing in call center operations, for $140 million. The plan is to merge Daksh s localized knowledge of process efficiency with IBM s 10 General Electric Partners with Leading Investors to Transform GECIS, its Global Business Processing Operation, into an Independent Company, press release, November 8, 2004, _1.html. WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 7

9 global leadership in areas like customer relationship management (CRM) and business transformation. With this acquisition, IBM s total strength in India now exceeds 15,000 employees and its local partnerships have grown from 200 to 375. Such moves have helped IBM double its revenues from India over the past three years Pros and Cons of the Onshore and Offshore Delivery Models Until the late- 90s, IT consulting firms like Accenture and EDS dominated the Indian outsourcing industry by providing onshore, value-added services and custom-built solutions that were tailored to the needs of individual clients. In contrast, the new crop of outsourcing firms like Infosys and Wipro derive their primary advantage from high-quality, low-cost delivery of remote services that capitalize on the wage differential between countries like India or China and developed economies like the U.S. To understand the pros and cons of these two models, let us compare the operations of Wipro Ltd., the second-largest IT firm in India ($1.1 billion in revenues in 2003), with those of Accenture, a $17 billion global services giant operating in 48 countries (see exhibit 4). Exhibit 4. Comparison of Accenture s and Wipro s Operations Accenture Wipro 2003 revenues* $11,820 million $1,307 million Geographical breakdown North & South America (48%) Europe, Middle East & Africa (45%) U.S. (52%) India & Asia-Pacific (26%) Services offered Revenue breakdown Client profile Service locations Revenue breakdown along industry verticals Asia-Pacific (7%) High-end: Consulting, Systems integration Medium: BPO Low-end: Application outsourcing, IT infrastructure outsourcing Consulting & Systems integration (70%) Outsourcing (30%) Mostly large clients: 87% of the Fortune Global 100, 66% of the Global 500 More than 110 offices in more than 48 countries Communications & High-tech (28%) Financial services (20%) Government (13%) Products (22%) Resources (17%) Sources: Accenture, Annual Report 2003; Wipro Ltd., Annual Report * Revenues based on an exchange rate of 45 rupees to the dollar. 11 IBM in India, BusinessWorld, May 10, Rest of world (22%) High-end: Consulting, Packaged implementation Medium: R&D services, BPO Low-end: Application development & maintenance, IT infrastructure outsourcing Consulting & Systems integration (15%) Outsourcing (85%) Mostly small clients: 56% under $3 million in services, 70% under $5 million Four major bases, 15 countries total Communications & High-tech (22%) Financial services (17%) Government (7%) Products (38%) Resources (14%) WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 8

10 The first observation we can make is that Wipro s client base is far more geographically concentrated than Accenture s, with over 50 percent of its revenues coming from just one source, the U.S., and less than 22 percent from the rest of the world (excluding Asia). In contrast, Accenture derives almost equal revenues from its operations in Europe and Africa and North and South America. This phenomenon is not unique to Wipro. Exports from Indian IT firms are in general skewed toward the U.S. (see exhibit 5). This is not surprising, since the U.S. market offers several compelling advantages that markets like Japan do not: higher wage differentials, the use of English as a common language and the receptiveness of the U.S. economy to foreign enterprises. The same phenomenon is also evident in the business models of other overseas outsourcing firms. For instance, Chinese IT firms are exclusively focused on the Japanese market due to its geographical proximity and cultural similarities. However, such overdependence on a single market may leave these firms especially vulnerable to demand shocks in that market. An excellent example of this possibility is the current public outcry against outsourcing in the U.S. Exhibit 5. Breakdown of Indian IT Services Exports by Region Region IT Services Spending Exports Relative Dependence* ($ billion) ($ billion) North America Western Europe Japan Latin America Asia-Pacific Total Source: National Association of Software and Service Companies (NASSCOM) ( * Relative dependence is obtained by dividing the percentage of Indian exports to any given region by the percentage of IT services spending for that region. The second difference between the onshore and offshore models pertains to the revenue mix between high-end consulting and systems integration work on the one hand and low- and medium-end services like applications development and IT infrastructure outsourcing on the other. While Accenture derives 70 percent of its revenues from services like systems integration and consulting, a significant portion of Wipro s revenues come from medium- and low-end services like software development and IT infrastructure outsourcing. The latter represent minimal barriers to entry for new players and are increasingly getting commoditized. In addition, overseas outsourcing firms like Wipro are traditionally relegated to smaller contracts that focus on individual pieces of a client s business infrastructure. For example, while the average outsourcing contract is worth $47 million, 70 percent of Wipro s clients buy less than $5 million in services (Wipro Ltd. 2004). In contrast, onshore consulting firms like Accenture and EDS concentrate on multimillion- WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 9

11 dollar contracts that provide packaged, end-to-end services for entire business functions. Though foreign outfits are trying to build a reputation for handling large projects, Fortune 500 clients remain skeptical about transferring mission-critical applications to overseas vendors. Accenture s local presence in multiple countries is a significant advantage in that regard. Last but not least, offshore outsourcing firms differ from their onshore counterparts in the breadth and depth of their service locations across the globe. While Accenture maintains more than 110 offices in 48 countries worldwide, Wipro only recently expanded its operations beyond Indian shores. While it now has 19 offices in 15 countries, its primary base is in India and most overseas offices have fewer than 50 employees (Butler Group 2003). The same is true for Han Consulting and other outfits in China, which are primarily based out of their home countries. Though these firms are younger and at an earlier growth stage than their U.S. counterparts, part of the answer lies in the easy access to local skilled manpower that they enjoy. By concentrating their operations within a single country, Wipro and Han Consulting are losing the opportunity to build a best of breed network that draws upon the unique advantages of several global locations to create more value for clients. In contrast, firms such as Accenture and EDS, which have a significant onshore presence in developed markets, are finding themselves with stranded assets that are globally uncompetitive on a cost basis. As a result, these firms are now rushing to hire thousands of new employees in places like India and China. Though the onshore model provides these firms with an advantage in responding to local demand, it hinders their ability to quickly and efficiently reallocate resources on a global basis. 4. Likely Evolution of the Industry Over the Next Decade The ideal outsourcing model would be one that combines an onshore presence to manage local client relationships with a back end offshore setup that has the scalability and processes needed to maintain delivery excellence. Firms like Cognizant, a leading provider of custom IT services solutions to Fortune 1000 companies, have pioneered this onshoreoffshore model, which seamlessly integrates on-site technical and account management teams with dedicated development centers in countries like India and Ireland. Such an approach ensures active involvement of client personnel throughout the outsourcing process and a tighter fit between the final product and client needs. Evidence that this type of model can work is provided by the fact that Cognizant is growing at a much faster pace than its competitors (60 70 percent versus percent). As onshore and offshore firms collide on a global basis, which scenario is likely to emerge over the next decade? At this stage, most IT firms are embracing the mantra of WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 10

12 end-to-end services and are developing or acquiring internal capabilities to support such a model (e.g., Infosys foray into high-end consulting through its U.S. unit Infosys Consulting, and IBM s acquisition of Daksh, a call center operation in India). Therefore, the future outsourcing landscape is likely to be dominated by a handful of one-stop service giants instead of disaggregated best-of-breed firms that specialize in different industry verticals or business functions. As firms outsource entire business functions to third parties through multimillion-dollar deals, it is likely that the trend toward awarding megacontracts to single firms will continue. However, under specific conditions, coeptition scenarios could arise, where competing firms come together to deliver the best services on individual pieces of a contract. 5. Recommendations for Future Winners in this Space Recent developments indicate that the global outsourcing industry is entering a new maturation phase, in which the emphasis is shifting from pure cost-cutting to a more holistic customer proposition focused on a combination of service quality, value creation and cost. To survive and thrive in this new environment, outsourcing firms need to master the strategies outlined below Moving Up the Value Chain While Retaining Low-Cost Leadership Offshore outsourcing firms like Infosys and Wipro realize that wage-arbitrage-based cost leadership is by itself not a sustainable competitive advantage. Without significant barriers to entry, the arrival of foreign players is placing severe downward pressure on prices at the low end of the IT services spectrum. The answer lies in moving up the value chain to higher-end complex services like IT consulting and systems integration, which offer greater revenue and margin potential. These types of services are highly dependent on individual client relationships, making them less susceptible to poaching from competitors. However, substantial investments are needed to acquire specific industry and domain expertise, which dilutes short-term operating margins and profits. Nevertheless, Indian firms have recognized the need to broaden their portfolio to include more value-added services. A number of firms are establishing consulting operations in the U.S. with an eye toward strengthening local business relationships and gaining a better understanding of how to handle complex, multimillion-dollar projects. In April 2004, Infosys established a new consulting unit in California that will hire 500 of the best professionals from leading U.S. consulting firms over the next three years Infosys to create 500 jobs in the U.S., CNNMoney Web site, April 8, 2004, WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 11

13 The challenge for onshore consulting firms like Accenture and IBM is different. These firms need to realize that simply establishing an offshoring center in India and hiring local people at competitive salaries do not create a competitive advantage. Firms need to gain a proper understanding of local conditions and develop processes that maximize synergies between onshore and offshore locations. Training programs that educate employees about firm values and establish a common culture are critical for maximizing benefits from offshore operations. In fact, the ideal scenario is one in which the unique advantages of the onshore model (one-to-one client relationships, specialized services, etc.) are effortlessly meshed with those of the offshore model (low-cost delivery, productivity gains, etc.). This is impossible without a clear, comprehensive strategy that identifies all outsourcing opportunities and develops a detailed plan to take advantage of them. The first step in developing such a strategy is to create a list of industries with outsourcing potential and figure out their current and future outsourcing needs (see stage 1 of exhibit 6). Exhibit 6. Process for Identifying New Client and Service Opportunities POTENTIAL SERVICES POTENTIAL INDUSTRIES Airlines Finance Automotive Insurance Pharma Consulting BPO Systems Integration Software development Development STAGE 1: OPPORTUNITY ANALYSIS Attractiveness of each industry -function intersection evaluated on the basis of on three criteria: (1) Size of market opportunity (2) Fit with current organizational capabilities (3) Likelihood and nature of competition ITO FUNCTIONAL SUB -AREAS ANTICIPATED CLIENT NEEDS Need 1 Need 2 Need 3 Need 4 Need 5 Operations Information Employee Systems Transfer Security Access Training STAGE 2: GAPS ANALYSIS Client needs matrix is compared against current organizational capabilities to identify gaps. These gaps need to be filled via in -house investments, acquisitions or joint ventures. Scalability WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 12

14 Such an analysis provides deep insight into which industry and domain verticals provide the greatest potential for profits. Once high-potential sectors have been identified, the next step is to proactively determine, through extensive discussions with clients and detailed internal analyses, current and future client needs within that sector (see stage 2 of exhibit 6). Special emphasis needs to be placed on high-value custom services that are difficult for competitors to replicate. The next question is how to bridge the gap between current organizational capabilities and the identified opportunities in high-potential sectors. Both onshore and offshore firms need to carefully assess various options (joint ventures, acquisitions and in-house investments) in this regard. Each of these options has unique advantages and disadvantages. Joint ventures reduce the start-up time for new enterprises in foreign locations and have the added benefit of local expertise. In contrast, in-house expansions eliminate the possibility of culture clashes and integration issues that are typically associated with joint ventures or acquisitions. This is especially important from a momentum standpoint for firms that are growing in excess of 40 percent per year. Once this analysis is completed, firms need to realign their businesses along newly identified industry verticals and functional areas. An example of this kind of strategy in action is Accenture s BPO division, which has organized itself around highly specific services for separate industry verticals: Accenture Business Services for Utilities, Accenture Finance Solutions, Navitaire for Airline Industry Services, etc Operational Excellence: Moving to a Global Delivery Model At first glance, the decision as to which geographical location to use on outsourcing contracts appears to be simple: find the lowest-cost center and send the work there. However, a number of IT firms that have followed this strategy have gotten burned. Locations with the lowest prices are typically ill-equipped to handle the complexity of large IT projects, leading to delays in schedules and costly budget overruns. For example, countries like China and Russia routinely offer labor rates that are at least 30 percent lower than those in India. However, Chinese programmers do not have the same familiarity with English that their Indian counterparts do. The resulting loss of productivity and need to import project managers at high cost sometimes make Chinese destinations uncompetitive overall. As a result, most U.S. clients are looking beyond cost for other value-added drivers such as on-time delivery and quality reliability. Outsourcing vendors need to focus on developing an integrated global network of specialized IT hubs that optimizes, on a project-by-project basis, the three key drivers of IT services performance: schedule, quality and cost. By bringing the unique advantages of multiple service locations and global teams to bear on different components of the same WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 13

15 project, outsourcing firms will be able to provide an unbeatable value proposition to their clients. In establishing a global network, firms need to carefully assess the pros and cons of choosing different geographic locations from a cost-schedule-quality standpoint (see exhibit 7) as outlined below. Exhibit 7. Evaluating Locations on the Basis of Service Parameters SCHEDULE Synergies in time zones Access to client information Scalability Flexibility in responding to changes in demand Superior Performance COST Fully loaded costs Integration costs Intangibles (cost of failure, reputation etc.) QUALITY Project level Organizational level (CMM/PCMM certifications) Satisfaction of client needs SERVICE LOCATIONS Parameter (Weightage) India China Ireland Russia Philippines SERVICE PARAMETERS Schedule Cost Quality (10%) (60%) (30%) NETWORK ANALYSIS Attractiveness of each location is determined on the basis of the above three service parameters. The analysis is repeated for each outsourcing function supplied by the firm. Schedule. The traditional choice between onshore and offshore locations needs to be refined to distinguish between on-site, onshore, near-shore and offshore locations, each of which offers unique advantages from a scheduling standpoint. For projects with shorter time frames, countries like India and China are preferable to locations in Europe and Latin America because the time difference allows project teams to work on an accelerated, 24/7 WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 14

16 schedule, leading to higher productivity and faster results. On projects where the initial scope is flexible or likely to change, the ability to rapidly scale up operations and respond to sudden changes in demand is a crucial factor. Quality. Consistency in quality on a project-by-project basis is just the first step on the quality pyramid. Most offshoring firms have also mastered the second step, which involves the creation of superior project management and people processes (as measured by Carnegie Mellon Institute s CMM and PCMM certifications 13 ) to ensure uniform quality across dozens of global service locations. However, to ascend to the highest level of the quality pyramid client satisfaction firms need to optimize their service locations for quality. For example, to gain a foothold in the high-end consulting market and establish a reputation in front of first-time clients, an offshore firm like Infosys may need to use higher-quality service locations, even if it means sacrificing short-term margins. Similarly, as Infosys scales up to manage complex, multidepartmental projects, it will need to rely on pilot initiatives that build client confidence and test the reliability of new supply locations. Cost. Firms need to understand that hourly wages and total labor costs tell only part of the story. Differences in productivity level (and the associated impact on schedule), opportunity costs of fixing errors and intangible expenses such as the loss of reputation from a poorly handled job are equally important factors. In addition, when multiple locations are being employed on a project, the added costs of integrating the final output from a given location into the overall work product need to be factored into the decision. In optimizing their global network, firms also need to pay special attention to high-fixedcost services like call centers and network maintenance, which are likely to benefit from the economies of scale generated by regional concentration. Conclusion Low-cost leadership and high-quality processes have helped offshoring firms like Infosys and Wipro win the first phase of the global outsourcing battle. As the industry enters a new era of growth, this approach needs to be combined with superior client focus, optimal delivery networks and customized solutions to create future distinctiveness. Firms that succeed in melding the best attributes of the onshore and offshore models will dominate the global outsourcing landscape in the next decade. 13 The capability maturity model (CMM) and the people capability maturity model (PCMM) measure an organization s ability to develop and maintain software and people processes, respectively. Level 5 is the highest certification level in both these categories. WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 15

17 References Accenture Annual Report Butler Group Outsourcing Services Technology Audit: Wipro Technologies. February. Heeks, Richard India s Software Industry: State Policy, Liberalization and Industrial Development. Institute for Development Policy and Management, University of Manchester. Thousand Oaks CA/London: Sage Publications. National Association of Software and Service Companies (NASSCOM) NASSCOM- McKinsey Study Released at the 3 rd NASSCOM IT and ITES Strategy Summit, Hyderabad, India, June 10. Nishith Desai Associates Business Process Outsourcing Legal and Tax Issues. Mumbai, India, January. January-2004-F.pdf. Scholl, Rebecca S The Rise of BPO in Gartner Dataquest Market Trends Report, January 8. Wipro Ltd Annual Report WINTER 2005 CHAZEN WEB JOURNAL OF INTERNATIONAL BUSINESS 16