Outsourcing Is Now Targeting Core Jobs in West

June 14 （Bloomberg） -- When economists debate the merits of outsourcing, they always invoke the early 19th-century thinker David Ricardo and his theory of comparative advantage of nations.

Businessmen's collective memory doesn't go that far back. When chief executive officers decide to move jobs to India, they draw intellectual sustenance from something more recent.

And that modern classic is a 1990 Harvard Business Review article written by C.K. Prahlad and Gary Hamel. It was titled ``The Core Competence of the Corporation.''

Outsourcing, when you apply the model of core competence to business processes, is all about companies parceling out activities that they aren't best equipped to undertake.

If you sell computers, you shouldn't run your own helpdesk. If you are an airline, you mustn't waste your time juggling cash collected in different countries and currencies.

No company needs to tie up resources in managing accounts receivable, or preparing payroll, in-house.

You can buy all these services from third parties, which will either automate them or manage them with cheaper manpower in India, Latin America or eastern Europe.

This offloading of non-core work to specialists has been the main driver for the business-process outsourcing industry, projected to grow 10 percent a year to $618 billion by 2010.

Now outsourcing companies are pushing the frontier, forcing global CEOs to define their core competence more sharply. It's difficult to predict how it will all pan out, though it looks like Western companies may finally be left with processes with minimal labor content. And that will be one of the biggest political challenges developed-country governments will face.

Shrinking Core

As the service providers add depth to their own organizations by hiring engineers, doctors and statisticians, they are now able to do things that a client company has always considered to be integral to its main business.

Nipuna Services Ltd., a Hyderabad, India-based business- process outsourcing company, manages the shop-floor inventory for an automaker in Detroit, creates graphics for an animation studio in the U.K., and handles artwork changes on labels and cartons of GlaxoSmithKline Plc medicines so as to satisfy regulators in various countries.

``Can I do what you do better than you?'' That, says Venkatesh Roddam, the CEO of Nipuna, a unit of Satyam Computer Services Ltd., is going to be the question specialist companies like his will increasingly be asking prospective customers.

Not Just Cheap

The operative word in Roddam's question is: ``better.''

Most economists believe that services outsourcing is only about getting things done ``cheaper.''

They think it is transient and self-adjusting: A rise in the inflation-adjusted exchange rate of the exporting nation will make its cost advantage disappear; the same relative-price mechanism will also increase developed-country exports to places such as India and China. New jobs will be created to replace the ones that are now being lost.

What this argument misses is that the third-party providers who are winning ownership of business processes will move them from one developing country to another. Profits will be repatriated to developed-nation companies by the truckload. But the jobs won't go back. Not for a long time.

Services, especially those that companies considered to be part of their core operations, are typically slower to outsource.

Nascent Industry

From contacting a potential customer to making him sign the outsourcing agreement takes 18 months to two years.

``Outsourcing of core operations is something that the market is still learning,'' Roddam says.

The rarity value of the companies that provide such services is evident in their valuations.

Do people buy a shampoo or a hair gel if an advertisement tells them it will make combing easier? Or does it make more sense for the marketer to stress soft and silky hair? How does an insurance company look at its claims data and spot fraud?

Answering questions such as these for Fortune 100 companies recently fetched investors in Marketics Technologies, a Bangalore-based analytics company started by former Procter & Gamble Co. employees, about $65 million in payouts from acquirer WNS （Holdings） Ltd. That translates into $325,000 per employee, more than double the going rate, according to a report by J.P. Morgan Securities Inc. analyst Christine Pezino.

Wages Versus Profits

Princeton University Professor Alan Blinder says he is being ``treated as a heretic'' by fellow economists for merely suggesting that offshoring of service jobs will be painful for U.S. workers.

Blinder has a point. Gains from free trade in services will occur, though not to the same people -- or even the same class of people -- who lose from it.

The manufacturing economy may serve as an example. Apple Inc. had fewer than 18,000 employees as of Sept. 30, 2006. Revenue per worker was in excess of $1 million. That's 10 times the value an average worker produced last year at Taiwan's Hon Hai Precision Industry Co., a contract manufacturer -- among other things -- of Apple iPod music players.

However, Hon Hai, according to Bloomberg data, had 382,000 employees. That's 382,000 paychecks.

If outsourcing becomes as widespread in services as it already is in manufacturing, Western economies may still grow strongly, thanks to surging corporate profits. However, the falling share of wages in economies across the developed world will keep offshoring a hot political issue for decades to come.

（Andy Mukherjee is a Bloomberg News columnist. The opinions expressed are his own.）

China, India vie for outsourcing market

BEIJING - Asian heavyweights China and India continue to battle it out for major slices of the increasingly lucrative outsourcing pie. While China has long been considered a hub for manufacturing and research and development （R&D）, India has traditionally attracted the lion's share of the services and information-technology （IT） projects.

However, as China leverages its superior infrastructure and cheaper labor, and expands its pool of highly qualified, English-speaking personnel, the dynamics are set to change.

According to a recent report by the market-intelligence firm IDC, total revenue from China's offshore software outsourcing market will grow fivefold over the next five years, and the compound annual growth rate of the market will reach nearly 38%. China's offshore software outsourcing market continued to grow rapidly in 2006, with reported total revenue reaching nearly US$1.4 billion, up more than 48% year on year.

In addition to cheap labor, other drivers for the expansion of the Chinese IT outsourcing market include market deregulation, large-scale investment in technical education, better intellectual-property protection, IT core standards and infrastructure development, and the flourishing Chinese economy. Despite promising growth, however, China still needs to consolidate its workforce capabilities in terms of English-language proficiency, project-management skills, and experience to step up its challenge to India in the global market.

Kenneth Wong, a managing partner at SmithWong Associates, a China-focused US consulting firm, commented: "Language issues are no longer the major handicap to China-based outsourcing that they were before. In the past, the big advantage of the Indian market was that a lot of Indians spoke English. However, many IT personnel in China today are US-educated with undergraduate and graduate degrees.

"Soon there will be more people speaking English in China than in the US. The Chinese government knows it has a way to go in this area, but the signs are encouraging."

Tao Ye, president of Objectiva Software, a leading provider of software outsourcing services to China with offices in the US and Beijing, commented: "More and more customers are confident of doing business in China.

"Two years ago potential clients would say to us, 'Why China?' Now they say to us, 'Why you?' Since I founded this company in 1999, we have employed two full-time English teachers - language skills are very important in China's outsourcing sector. To say Chinese employees have no English is a myth."

While Chinese IT companies are increasingly bidding for international outsourcing projects, they are also leveraging their proximity to markets such as Japan and South Korea, where they have an advantage in both geography and language. Last year the Korean electronics firm Samsung outsourced about US$18.5 billion of business to China in an attempt to lower production costs.

To take advantage of China's low wages and Asian-language skills, a growing number of Indian outsourcing service providers are hedging their bets by directly investing in China. In a trend officially supported by the Chinese and Indian governments, many Indian firms - including Infosys, Satyam Computer Services and Wipro Technologies - have already established operations in China.

Learning from Indian companies, the best Chinese outsourcers are gradually incorporating more advanced applications, integration and infrastructure services into their offerings. Some are developing strong embedded software capabilities to work with makers of mobile phones and other hardware devices.

Edwin Ye is engagements manager at Beijing-headquartered MDCL-Frontline, the China-based subsidiary of pan-Asian IT company Frontline. He commented: "Compared to India, the Chinese IT outsourcing market is still very young. I believe the future is promising if we keep refining our products and services, investing in personnel and infrastructure, and exploring new markets and opportunities."

MDCL Frontline has recently registered strong license sales of its China-developed software products, and won strategic multimillion-dollar deals with Dalian Techport Systems and Dalian Port Group for software application development and management.

IDC analysis also showed that in contrast to India, the Chinese market features considerable domestic demand. In 2006, more than 40% of offshore software outsourcing revenue came from multinational companies that were actually located in China. It is predicted that this demand will continue to grow rapidly over the next three to five years, providing an excellent opportunity for service providers by allowing them to expand while avoiding direct competition with Indian companies in European and North American markets.

Shenyang-based Neusoft Group is China's largest IT outsourcer, employing more than 10,000 staff, and providing software and IT services, as well as medical technologies. Most of Neusoft's revenue is derived from domestic software and service sales.

"One of the top reasons for outsourcing to China these days is that companies in the US or Japan are trying to align their target overseas markets with their outsourcing destination," said Neusoft chief technology officer Walter Fang.

This means such companies as Microsoft, Motorola and Nokia, eager to tap China's enormous consumer market, need outsourced services to support their China-based expansion strategies. Only last month Microsoft announced outsourcing service orders worth $100 million to Chinese companies.

Though Beijing, Shanghai, Guangzhou and a handful of other seaboard hubs remain the destinations of choice for most foreign companies, they may not be the best locales for businesses on a budget. Wong said: "Many of China's 'second-tier' cities like Xian, Dalian and Chengdu are becoming prominent players in the IT outsourcing market due to lower costs of doing business and improved infrastructure."

Companies looking to cut costs should bear in mind that China has nearly 100 cities with a population of 1 million or more - nearly all of these are actively trying to attract foreign investment. Businesses that select second- or third-tier cities can expect favorable treatment that can translate into substantial savings. Xian, a city of more than 4 million in China's rapidly developing west, for example, has a "High-Tech Zone" that offers foreign companies heavily discounted office space and tax exemptions until they've attained profitability for two consecutive years.

Objectiva Software is in the process of setting up a second office in Xian. Tao Ye said, "We chose Xian because of cheaper setting-up and running costs, and the fact that it has excellent infrastructure and a good enough supply of well-qualified staff to meet our needs."

In addition to IT and business process outsourcing, China is also becoming an increasingly attractive market for international biotech companies, with low set-up costs for manufacturing and R&D units, a regular supply of inexpensive professional personnel, and a relaxed regulatory environment. At present, overseas companies generally operate in the Chinese market by establishing joint ventures with local firms, by setting up manufacturing bases, or by outsourcing R&D to domestic companies. At the end of 2005, China had about 750 R&D centers supported by foreign capital in the form of joint ventures.

Wong said: "Many of the people involved in the biotech fields in China are expatriates from the United States. Due to the high level of competency found in China now, many companies here in the US are looking to outsource their R&D to China. This work can now be done at a fraction of the costs without compromising the quality of work being done."

The biopharmaceutical industry, underpinned by strong government support, the machinations of some major multinationals, and a rising demand for prescription drugs, is a key driver of the biotech industry in China. Last year China's biopharmaceutical industry grew by 15%, with revenues rising sharply.

As large enterprises pressed ahead with their globalization strategies, the R&D outsourcing market, where small and medium-sized enterprises play a leading role, experienced remarkable growth. However, the scope for outsourcing business in the biotech sector to China is still huge, with global firms still only outsourcing about 5% of their total requirements to the country.

Bridge Pharmaceutical Inc, a US biotech company, opened a research center in Beijing last year employing 200 people. The company says that even though it operates along US regulatory guidelines, its drug-development costs are about 80% lower in China than in the US; salaries of research scientists in China are estimated to be one-fifth to one-tenth those in North America. Pharmaceutical giants such as Novartis and Pfizer have also established research facilities in China, and AstraZeneca is opening a new "Innovation Center" in Shanghai this year.

Although China's biotech infrastructure is a work in progress, with a mix of First World and Third World support, the growing number of industrial and science parks that are opening around the country guarantee power, water and Internet access to high-level specifications. While many cities offer support and incentives for biotech firms, the top destinations are still Beijing and Shanghai, where the intellectual workforce tends to congregate and where services are most reliable.

Animal testing is China's specialty, with virtually non-existent regulations and severe penalties for animal-rights activists. If the research process of companies looking to outsource involves a significant amount animal testing, especially with primates, then China is the No 1 choice.

China certainly has the potential to outpace India and become the world's top outsourcing destination over the course of the next decade. There is room for growth - the McKinsey Global Institute estimates $18.4 billion in global IT work and $11.4 billion in business-process services have been outsourced overseas so far - just one-tenth of the potential offshore market.

Looking to the future, Wong said, "With developments in infrastructure, technology and personnel, China is closing the gap with the Western world. The country has a huge hunger for success, and will continue to strive toward higher goals and to be competitive with other nations. I have no doubt that it will become the outsourcing country of choice in many sectors before too long."

Beijing is drafting a human-resources training plan for Chinese outsourcing service providers. The plan outlines the development of 100 qualified outsourcing service providers in 10 base cities in the next five years in an effort to attract about 100 well-known multinationals to outsource to China.

As desirable as building a highly qualified, English-speaking army of workers may be, the trend toward offshore outsourcing is a lot more complex than simply finding language skills and resources in the lowest-cost locations. Major drivers in the outsourcing market include quality, innovation and speed to market, not just cost of services. To maintain their competitive strengths as competition intensifies, Chinese outsourcing service providers need to increase their attractiveness to users by offering high standards, demonstrable creativity, and an array of value-added benefits.

Daniel Allen is a freelance writer and photographer from London who has lived in China for the past three years.

Daniel Allen

Five outsourcing trends to watch

Which way is the wind blowing in the outsourcing market? What's looming on the horizon in the next five years?

Silicon.com has identified five areas to watch.

Consolidation
Competition for outsourcing contracts is more cutthroat than ever, with a huge expansion in the number of suppliers, so some significant consolidation is on the horizon.

Recent rumors of a merger between information technology heavyweights Infosys Technologies and Capgemini Group suggest that the stars are aligning for some significant marriages. Duncan Aitchison, managing director of business advisory company TPI, told Silicon.com that even if the rumored Infosys-Capgemini merger never materializes, it reflects current "market sentiment." What's more, other industry experts are predicting more merger-and-acquisition activity in this sector over the next year or two.

Globalization
There has long been talk of India losing its edge in the offshore-outsourcing market --including warnings of a shortage of skilled workers--but a bigger threat to India's dominance could lie closer to home. According to a study by analyst IDC, cities in China will overtake their Indian counterparts as top destinations for offshore global delivery by 2011.

While it remains unlikely that China will outstrip India in the outsourcing business overall, the trend is for increasing globalization of the market as more regions seek to cash in on the offshoring boom.

Beyond the so-called BRIC bloc of countries (Brazil, Russia, India, China--or BRICM, if one includes Mexico), developing nations such as Egypt and Poland are emerging as sources of offshore labor. The trend is not only for a "greater pattern of diversity" in the outsourcing sector, said TPI's Aitchison, but also for greater specialization as smaller players seek to distinguish themselves in an increasingly crowded marketplace.

Person-to-person offshoring
Offshoring is more commonly associated with large-scale business redeployments--the relocation of a back-office function, say, or a whole department. But research suggests that there's growing momentum for redeployments of a much smaller scale. According to a report by research company Evaluserve, offshoring has reached small businesses and even homes--a trend it dubs "person-to-person," or P2P, offshoring.

Examples of services outsourced in this way include online tutoring , Web and software development, and writing and translation services. Customers for these services can be small businesses or even individual consumers.

Evaluserve says revenue for this sector stood at more than $250 million between April 2006 and March 2007, and it predicts that the value of the P2P offshoring market will rise to more than $2 billion by 2015.

Green sourcing
Rising energy prices have put ecology issues firmly on CIOs' radar. But could pressure to demonstrate green credentials influence businesses' outsourcing decisions as well?

Silicon.com's CIO Jury--a pool of chief information officers and other corporate IT professionals who are polled on various technology issues--recently revealed that environmental factors play a key role in the selection of technology suppliers and partners.

Virtual worlds
The rise of virtual worlds such as Second Life is making it easier for companies to justify hiring offshore workers for tasks that may include building virtual offices or even working as virtual-world "meeters and greeters."

The market for outsourced virtual-world services is still very new, but businesses increasingly are taking an interest in the likes of Second Life, so momentum is likely to build.

Last month, news emerged of a partnership between a Chinese online-entertainment company and Entropia Universe, a virtual world with a science fiction theme, to create a virtual economy that could provide as many as 10,000 jobs.

Over the longer term, customer contact jobs, including those for help desk and call center services--could migrate into virtual worlds, where customers can be both informed and entertained.

Natasha Lomas of Silicon.com reported from London.

Tech outsourcing: Mumbai, Bangalore face a Chinese threat

Bangalore: Chinese cities of Beijing, Shanghai and Dalian will overtake Indian outsourcing hubs Bangalore and Mumbai by 2011 as destinations of outsourced services, thanks to the massive investments. China is making in improving English language skills of its technical workers, and as customers are forced to look at alternatives to India because of its infrastructure problems and soaring wages, says tech researcher IDC.

This is the first time an international research house has clearly laid out the future for Asian cities—in India and China, in particular—to host delivery centres for offshoring of back office and tech services. IDC analyzed 35 locations in Asia Pacific, including Adelaide, Bangalore, Dalian, Hanoi and Kuala Lumpur on the parameters such as cost of labour, rentals, language skills and attrition.

"Chinese cities are on the rise and nipping at India's heels," IDC said in a report by Conrad Chang, research manager for IDC's Asia-Pacific research. "IDC forecasts that Chinese cities will overtake Indian cities by 2011 due to massive investments made (eg infrastructure, English language, Internet connections, technical skills etc.) which are favourable towards offshoring."

Other researchers supported IDC views but stopped short of a clear prediction as to when Chinese cities could count themselves on par with Indian peers as homes for outsourced services.

According to the Gurgaon offices of Everest Research Institute, China's revenues from exporting software services stood at $2 billion (Rs8,200 crore) in 2006, and will grow at a rate of 38% to reach $7 billion by 2010. India is currently far ahead; it closed fiscal 2007 at over $39 billion software revenues and is predicted to top $60 billion in such sales by 2010. In revenue terms, China is far behind India now, "but with cities such as Mumbai struggling to cope even with issues of rain, many customers are looking at China, which offers much better infrastructure," said Vikash Jain, engagement director with Everest Research. He added that China is looking to focus on the segments of financial services and telecom—two industries in which customers outsource the most—rather than trying to ape India and position as an end-to-end destination for application development and maintenance of all kinds.

The tech-savviness of the Chinese population will help the Asian powerhouse to catch up with Indian programmers (about 1.6 million at last count). "China's potential is real and gaining momentum. The country is very technology oriented, and this benefits it greatly in the IT outsourcing space," wrote Ben Trowbridge, chief executive of Dallas-based Alsbridge Research in a June report.

Outsourcing hotspots in China include Chengdu, Shenyang, Guangzhou, Hangzhou, Jinan, Nanjing, Shenzhen, Tianjin, Wuhan and Xian. With more than 1.3 billion people in China, "these cities offer a substantial population of skilled IT professionals," wrote Trowbridge.

The rush by companies such as General Electric Corp., HSBC Plc., Pfizer Inc. and Citigroup to have projects serviced in India to take advantage of lower costs has resulted in salary levels at leading Indian vendors rising by around 15% in 2006, impacting margins of many software exporters. Rising salaries in cities such as Bangalore have become a cause of concern for many Indian software companies. According to a Dun & Bradstreet survey, salaries of software workers will rise by 15-20% in 2007, making it one of the biggest challenges for many software exporters.

Cost, however, is not the only driver for companies looking at Chinese cities. Many Indian companies are planning to hire more workers in China, as their clients demand location redundancy.

Raja V., senior vice-president for talent engagement at Wipro Ltd said in a March interview with Mint that the company will increase its workforce in China from 110 currently to anywhere between 300 and 500 by year end.

India's largest software firm Tata Consultancy Services Ltd also said in March that it would have around 5,000 software programmers in China by 2010. Satyam Computer Services Ltd, which is working out of four locations in China, has 500 people there.

The company is now building a campus for over 2,500 associates in Nanjing, a tier-two Chinese city.

Indian companies do not see China as a threat "but more of an opportunity to establish a global presence," said Virender Aggarwal, director and senior vice-president at Satyam.

Salaries for engineers are as expensive in Shanghai and Beijing as in Indian cities such as Bangalore or Mumbai, particularly for those who have skills in business software such as packages that handle 'enterprise resource planning', but are much lower in tier two cities of China.

Chinese cities also score over the ease of setting operations compared to setting shop in India, but there are inherent weaknesses like lack of English speaking talent, difficulty in obtaining visas for Chinese engineers to work onsite at customer locations and a perception of weak protection for intellectual property rights there.

Also, not only does China produce less than half the 450,000 engineers India graduates from its colleges annually "the percentage of English speaking graduates is miniscule compared to India," says Sabyasachi Satyaprasad, senior director at neoIT, a consulting firm that helps customers to outsource their IT work to different locations.

He said though there is competition between Chinese cities, there is still a lack of collective will to promote 'Brand China' as an investment destination for IT companies. "It will be years away to provide full fledged competition," said Satyaprasad.

(pankaj.m@livemint.com)

China outsourcing sector no match for India

China is promoting its information technology (IT) outsourcing sector as a rival to that of market leader, India. A look at the figures, however, paints an altogether different story.

Consider this. In 2006, the Chinese IT services market reached a size of $7.7 billion, with a growth rate of 17.8 per cent over the previous year. On the other hand, software and services exports from India for the financial year 2006-07 grew by 33 per cent to register revenue of $31.4 billion, whereas the domestic segment grew by 23 per cent to register revenue of $8.2 billion, according to Nasscom's latest figures. Moreover, analysts note that the demand for IT outsourcing from India is around four times that from China.

"China has the potential but India has the edge" says Nasscom Vice-President, Ameet Nivsarkar. He adds: 揅lients of Indian outsourcing vendors simply expect more out of the services. This has led Indian vendors to set up base in places like China."

The myth associated with China as a key challenger to India for offshore supremacy is diminishing gradually with issues like language, attrition and intellectual property (IP) protection continuing to haunt multinationals, according to a recent Forrester report. The other global delivery model (GDM) locations like the Philippines � which grew at two and half times the rate of China, on the strength of its English-speaking skills and large investments led by Accenture � and Brazil are growing at a faster pace.

China does not have any significant cost advantage, note analysts. The average IT salaries in China are around $10,000 per annum and the average BPO salary is around $7,634 per annum, according to a KPMG-Nasscom study. The salaries are close to the Indian average salary of $9,867 and $7,779 per annum in IT and BPO sector, respectively. A relatively small supply of IT professionals with English language proficiency allows these employees to command higher salaries. Besides, as of Decemeber 2006, China's headcount with regard to outsourcing was less than one-tenth that of Indian firms, according to Vikash Jain, Engagement Director, Everest Group (a research firm).

The Chinese IT consulting market benefits from various IT consulting projects of the telecommunication industry. The Beijing 2008 Olympics project has further helped the system integration market to garner a high-speed growth. However, due to the historical interdependencies, cultural and linguistic similarities and physical proximity, China has been able to establish itself as a key near shore destination for Japan and Korea. They contribute around 60 per cent of IT services exports revenues and also a significant chunk of BPO revenues. The US and UK markets account for the rest.

However, according to IDC, North American and European markets accounted for 75 per cent of the world抯 $320 billion IT service and outsourcing market. And these two markets are expected to expand more than 60 per cent annually in the coming years -- almost twice the speed of the Japanese market. Everest Group Research Director, Sheetal Bahl, opines: "China is unlikely to substitute for India or other mature offshore destinations in the short or medium-term -- it will work best as a supplement that matures over the years".

Meanwhile, Indian IT service providers like Satyam, Wipro, TCS and Genpact are setting up base in China and tapping the market. "With the presence of Indian vendors in the Chinese market, the Chinese firms might face difficulty on the global front. The Chinese outsourcing firms are more focused on the domestic market as compared to the Indian companies which have made their mark on the export front," says Anish Zaveri, Associate Director, KPMG Advisory.

He adds, though, China provides India with a healthy competition. 揑t not only helps the Indian outsourcing majors to evaluate themselves better but will also encourage the Indian government to keep on their toes, looking at the initiatives taken by the Chinese government."（Leslie D'Monte & Ishita Russell / Mumbai / New Delhi July 4, 2007）