Yesterday I wrote about the changing economics of outsourcing/offshoring to India and that got me thinking about our experience with this. About five years ago the focus was very much on price and outsourcing/offshoring to low-cost countries like India, the Philippines etc was very compelling.

But over the last six-months or so we’ve won a series of assignments and outsourcing contracts, usually taking over from Indian-based outsourcing companies. These aren’t one-off assignments, but rather ongoing work that for five or more years has been offshored to India but is now being repatriated.

So why? Clients give us a few reasons; some I could have predicted:

Staff continuity – Indian-based providers often have churn rates of 25% or more and for a client it becomes exasperating having to suffer the second-hand consequences as vendor staff leave and replacements have to learn the ropes afresh. We sometimes have the same problem but not to the same degree; our teams are made up of people working from home and good work-from-home opportunities are hard to find, which likely explains why our churn rates are 2-5%.

Ease of communicating – for all the apparent logic of pushing work to the lowest cost provider on the other side of the world, we repeatedly hear that clients prefer to deal with someone local  - they’re easier to reach in the working day and likely more familiar with the issues at hand.

But some reasons are unexpected, and here are two:

Diversification – we were recently asked to bid to provide research services to a large investment bank (not so large any more!) with the condition that all the work had to be completed outside of India. The client’s rationale was that they already had sizable exposure to Indian operations and wanted to hedge their bets.

The Mumbai attacks are likely to spur companies to diversify operations. A December 4 article in Financial Week - Attacks in Mumbai could force execs in U.S. to rethink outsourcing plans – carried a series of quotes and comments about the need for large corporations to diversify across multiple locations.

Moreover, the added security will increase costs of offshore providers, and this brings us to the most surprising reason we hear – Cost.  We all know that professionals in the US are paid way more than those in India, so how can this be?

While hourly rates in India remain much lower, the differential has fallen substantially.  Wage inflation at Indian KPO companies has been in the region of 14-16 percent annually, with increases approaching 30 percent for some of the higher-skill knowledge service areas; applied over ten years or so, this starts to make a difference.

Similar trends apply to other costs, like infrastructure and real estate. In an October 2007 article Anantara Solutions CEO, Mr Prabhat, said

“The cost of rentals and office infrastructure (including secretarial services) is higher by around 15 per cent in Chennai than it is for far superior infrastructure in places such as New Jersey” (Anantara Solutions has offices in both locations).

Perhaps most important, clients are getting better at fully costing outsourcing services. They are now starting to think about the costs of churn (and the additional training costs they bring), additional management time entailed in managing relationships, additional costs required for internal quality control, travel costs, rework time, the value of dealing with vendors on the same time zone, the costs of errors, the rising costs of IT security and so on.

None of these alone will make US professionals cost competitive with Indian professionals on an hourly basis, but bring it together and the case for wholesale outsourcing of many knowledge functions gets less compelling. Factor in things in which US professionals excel - quality, experience, local knowledge, benefits of same-day working etc – and the pendulum starts to swing.

I did a quick scan to see what is happening beyond our niche and it does show that some service providers and their customers are “rediscovering” the US. Companies like Accenture, BearingPoint and CapGemini are now setting up in smaller, less expensive areas like Kansas City; Hattiesburg, Miss.; and Tulsa, Okla., all of which has to be encouraging.

As an organization, Busines360 is indifferent to where the work goes – we have teams and individuals in all the main provider countries (as well as some well off the beaten track) – but from a personal perspective I’m really pleased to see that companies are at last starting to think beyond just hourly rates to comparing the full like-for-like costs of services.

Over the last five years or so the dominant direction of business process outsourcing has been to India, with other countries like the Philippines and China lagging behind but still taking a fair chunk of work from US and European professionals.

And the biggest reason was the chance to lower costs, mainly on the back of lower wages in these countries. The wage differential remains substantial but the case for pushing ever more work to these countries looks to be weakening.

A December 2008 report from TowerGroup points out that managers at some US companies are discovering that offshoring in India is not the cost-saver they imagined, especially for captive offshore operations, in which the US parent sets up and runs the outsourcing operation, usually employing local workers to staff much of the operation.

Reading this reminded me of a February 11, 2008 article in the Wall Street Journal –
Rethinking the India Back Office; Some Western Firms Weigh Selling Their Units as Costs Rise, Dollar Weakens. The author, Jackie Range, cited a study by McKinsey & Co. and Nasscom, the Indian tech and outsourcing industry group, which found that, on average, company back offices - “captives” - were less efficient than companies run by outsourcing firms that specialize in the business. For some types of back-office work, captives’ costs are 30% higher. The survey also found that the higher costs didn’t lead to lower staff turnover or better-quality work.

More recently, the September issue of McKinsey Quarterly had an article – Time to rethink offshoring? – that showed how shifting cost curves mean the US is becoming a more competitive place to manufacture high-tech products.

“The production of high-tech goods has moved steadily from the United States to Asia over the last decade. The reasons are familiar: lower wages, a stable global economy, and rapidly growing local markets. These factors combined to make nations such as China and Malaysia favored manufacturing locations. In the last two years, however, the favorable economic winds that carried offshoring forward have turned turbulent. The new conditions are undermining some of the factors that made manufacturers of every stripe, including those in high tech, move production offshore” – Ajay Goel, Nazgol Moussavi, and Vats N. Srivatsan, McKinsey Quarterly, Sept 2008

McKinsey’s argument rests mainly on higher wage inflation in offshore locations and transportation costs and here is their summary analysis:

Manufacturing high-tech products is obviously different from knowledge services, but it all goes to show that this change is affecting business across a number of fronts.

Also, since McKinsey complete its analysis the dollar has strengthened, especially against the Indian Rupee, and oil prices have collapsed, so their findings wouldn’t be as compelling today. But these are likely short-term affects that won’t affect the longer-term view.

All up, clients will start to be more discerning when it comes to outsourcing and offshoring. One to watch.

For a business based entirely on the web we are late to the blogging game, but here we are! (We actually started a blog over a year ago but didn’t like the software package and got too busy to change it, so we now have even more time to make up…)

Business360 provides many business services - research, writing, analysis, consulting, placements and more. What makes us different is how we do it. The terms outsourcing and offshoring are commonplace, and that’s what we do, but we use teams of people around the world that work from home to deliver the services. This gives us a different perspective on business process outsourcing, and that is what we’ll write about.

We’ve been in business for about 10 years now and have seen various trends, some ebb and flow and others never leave. This blog will share some of thoughts and opinions and ideas and we hope it will be a useful springboard into the terrain.