STRATEGY: Getting a Fix on Growth

IT-enabled services (ITeS) in India have registered a growth of about 46
percent this year, and generated a revenue of $3.6 billion. It is expected that
this sector will touch $57 billion by 2008, employ more than four million and
contribute about seven percent of India's GDP. Though the growth prospects of
ITeS industry seem to be bright, recent anti-outsourcing outcreis in the US, and
withdrawal of contracts by companies like CapitalOne, Lehman Brothers, and Dell
indicate the complexity of the issues facing it.

We will try to take a comprehensive look at all the factors that affect the
growth of ITeS . The figure illustrates the factors that affect ITeS industry's
growth, highlighting the existence of all major cause-and-effect links, and
indicating the direction (cause è effect) of each linkage. The relationship is
considered positive (or negative) based on whether a change in the causal factor
produces a change in the same (or opposite) direction in the effect factor.

Positive Growth Factors

Positive growth factors include 'wages'. Lower wages reduce production
and operating costs and hence, increase the 'propensity of companies to
outsource' manpower intensive call centre and back-office operations. Offshore
services are identical to those they replace-and at times better, since
offshore workers, enjoying higher-than-usual wages, tend to be motivated. Also
in favor of India is the large number of 'trained manpower' helps reduce
market wages and provides cost advantages. India produces more than three
million graduates every year and many speak good English.

This model depicts the major cause-and-effect linkages of factors in ITeS growth

Mostly, outsourcing is done to reduce production costs, provide operational
flexibility, and lessen the fixed investment for carrying out non-core
supplementary activities of the organization. However, there are also 'transaction
costs' involved as businesses try to find the best outsourcing partner in the
global market. Transaction costs refer to the effort, time, and costs incurred
in searching, creating, negotiating, monitoring, and enforcing a service
contract between buyers and suppliers of services. Production costs often can be
up to six times as high as transaction costs. However, organizations consider
both costs while deciding on outsourcing. In some occasions, businesses
outsource even core services internally, with the main objective of reducing
production costs. The transaction costs are negligible in this case. Examples
include companies such as Prudential, AXA, Dell, and GE setting up their own
captive ITeS centers in India. Another way to reduce transaction costs is for
companies to acquire third-party call centers and convert them to captives.
However, for companies outsourcing their supplementary services to third
parties, the transaction costs can be substantial, which in turn reduces their
propensity to outsource. Normally, companies have vendor-management teams to
monitor the outsourcing centers. Lower the transaction cost, higher the
propensity to outsource to Indian companies.

The 'mature Indian IT industry' has a positive effect on outsourcing
decisions, as the cheap and skilled local programmers can develop low-cost
software for the ITeS industry. Of late, customers of outsourcing contracts have
become particular about the quality of services rendered. As 'job quality'
increases, propensity of companies to outsource to India also increases.

The available trained manpower, especially in various vertical domains,
improves the quality of job handled. This also enables ITeS companies to move up
in the value chain. Starting with medical transcriptions and simple call center
operations, ITeS sector in India now handles complicated back-office operations
for financial, legal, insurance, telecom, and other domain knowledge-specific
industry segments. This increases the value of contracts.

Researchers have also indicated that firms see success of 'adoption of
outsourcing by competitors' and imitate them. Such imitative 'jump on the
bandwagon' behavior results in more companies going for outsourcing.
Competitors who have adopted the Indian ITeS industry, act as country referrals
resulting in increased market access.

The Negative Factors

These are factors that impede the growth of this sunrise industry. Currently
160,000 people are employed in ITeS in India. However, as the industry grows,
available technical manpower level will become smaller. Decrease in supply of
skilled manpower will in turn increase the wage levels and this may work as a
dampener of growth. This is shown as a negative cause (ITeS revenue) and effect
(trained manpower level) relationship in the diagram.

The attrition rate in the industry is also very high due to poor working
conditions (like night shifts), and relatively lower wages. Attrition decreases
the available manpower level and also has an indirect impact on wages as the
companies have to provide better wages and amenities to retain their employees.
As ITeS operations grow and mature, employees of remote operations, armed with
information about global job opportunities and compensation levels, may
eventually bid up the price of their skills, reducing the cost advantage that
the companies currently enjoy. Hence, the positive link from 'ITeS Revenue'
to 'Wages' in the diagram.

Though wage levels in India are lower, cost of infrastructure such as telecom
bandwidth prices and electricity tariffs are typically higher. This tends to
reduce the tendency to outsource. One way to offset these high infrastructure
costs is to use these as intensively as possible. The time difference between
the US and India facilitates round-the-clock shifts for optimum utilization of
capital and lower operating costs.

Data protection and security plays a critical role in the ITeS industry for
maintaining confidentiality of the data handled. Data security certifications
and compliance is required for various services. Examples include Gramm Leach
Bliley Act for financial services, and Health Insurance Portability and
Accountability Act of 1996 (HIPPA) for the healthcare industry. Lax privacy laws
in India are a cause for concern, especially for healthcare organizations
planning to outsource. Only adequate privacy and security protection by ITeS
centers will enable companies to move up the value chain.

With increase in size of contracts, outsourcing countries experience 'job
losses' in certain sectors, which then leads to the formulation of
anti-outsourcing laws. The recent US Omnibus Spending Bill is one example. It
has resulted in withdrawal of some of the ITeS outsourcing contracts from India.
These anti-outsourcing laws have a negative effect on outsourcing contracts.
External media also plays an effective role. With the Western media crying out
loud about job losses, companies will think twice before finalizing outsourcing
contracts.

There is also competition from other countries in securing ITeS outsourcing
contracts. Based on location and people attractiveness, countries such as
Ireland, UK, Australia, Singapore, Hong Kong, China, Philippines, Netherlands,
and Mexico are strong contenders for the global ITeS market. The main driver for
India has been low wages. However, Philippines and China could pose the
strongest competition to India in this.

Nurturing Growth

Attractive 'native tax laws' of a country can be a boon for growth of
the ITeS sector. For example, the Indian government's decision to fully exempt
the export earnings of this sector, till 2010, from paying taxes will have a
positive effect on the industry's growth.

Given this comprehensive view of ITeS growth, the major stakeholders such as
the ITeS companies, IT companies, government, policy makers, and educational
institutes should strive to nurture the positive effects and mitigate the
negative effects to sustain the growth of this evolving industry.

Dr V Sridhar and Dr Sangeeta
S Bharadwaj Management Development Institute, Gurgaon