By William Underhill and Jason Overdorf
Sept. 10, 2007 issue - The infamous "race to the bottom" may not be over. But increasingly, service industries are moving operations not to nations at the bottom—which is to say, nations like India, where labor is cheapest—but to where the work will be done best. The new race is to find the most-competitive service. And it speaks volumes about the rapid modernization of India that its companies are still out front.
This is even more remarkable if you consider how many new players and new kinds of services are crowding into the outsourcing market. According to consultants A.T. Kearney, there are now 55 countries, from Vietnam to Poland and Brazil, actively selling themselves as "remote service locations" to multinationals. And the kinds of services on offer continue to expand from call centers and back-office functions into new areas of information technology and R&D for industries as diverse as consulting, law and medicine. Western giants like IBM are getting in the game by setting up their own outsourcing arms (usually in developing nations). IDC research predicts that the world market for offshore IT services will grow to $37.8 billion by 2011, more than double last year's figure. Yet no new rival has derailed India's rise.
In the past decade, India's outsourcing revenue has increased tenfold. By some reckonings, Indian companies still capture more than 80 percent of the IT offshoring business. With growth in the Indian industry still running at a healthy double-digit rate, the top companies—Wipro, Tata Consultancy Services and Infosys—are evolving as fast or faster than the outsourcing market itself. Each now has a total stock-market value of more than $20 billion, when none were even listed 10 years ago. They are, in short, flourishing in a market that is now far more complex than the old caricature of Western firms' "exporting" well-paid jobs to poor nations, where salaries are far lower. "The smart companies are seeing outsourcing and offshoring not as a cost play but as a strategic way to transform their business," says Nandan Nilekani, CEO of Indian IT giant Infosys. "The customer is no longer just paying for 100 people to work for him, [but for a specific business outcome]. Therefore, the Indian companies have to improve the capacity of their people, so we have more people with a consulting mind-set. And we have to be willing to take risks."
The reason Indian companies can stay out front seems pretty clear: India, on the whole, remains poor and backward, but its leading companies are already world-class. Once humble and happy to take the IT drudge work of big U.S. or British multinationals, Indian firms are now multinational in their own right. The skills of their employees are improving fast, so they are able to offer higher-level services to Western blue-chip clients. And the sheer scale of past savings that Indian firms have delivered to Western clients puts them in a good position to win future contracts when those and other clients look to move more-sophisticated operations abroad. Kiran Karnik, president of India's National Association of Software and Services Companies, puts the matter simply: "While cost continues to be an important consideration, it's not the only one."
Geography is reasserting itself. Indian outsourcers are maintaining their edge in part by moving closer to clients, establishing their own bases in the West. Last month Wipro paid $600 million for an American infrastructure-management firm called Infocrossing, creating a beachhead that allows Wipro to deliver services and recruit U.S. talent more easily. (Last year Wipro hired more than 200 college and business-school graduates from the United States and Europe.) Proximity matters, says Suresh Vaswani, president of Wipro's global IT practice. "Data centers [for U.S. clients] have to be in the U.S., fundamentally because of customer comfort," says Vaswani. "That way all my servers ... are not so far away."
Trendspotters would do well to watch Sashi Reddi, whose relatively new Indian company is already moving to base employees overseas. A 42-year-old serial entrepreneur, Reddi founded AppLabs six years ago with a staff of less than 10, and it is now the world's leading independent software-testing firm, with 1,900 on its payroll and a client list that includes Sun Microsystems and Cisco. Already, some 400 of his employees are based in Britain and America, ready to bag ever more ambitious projects—with labor paid at Western rates. "You can only do so much with an offshore cost advantage," says Reddi, noting that customers want work done close at hand. Location can trump labor costs, says Reddi. "All the decent players are faced with the same decision."
Competition is helping to force the evolution of India's big players. A clutch of big-name operators has muscled into the business even on India's home territory. IBM Global Services, Accenture and Electronic Data Services now have a combined work force in India of about 100,000. And many nations are entering the outsourcing industry with built-in advantages. The Philippines, for example, has an edge in accounting services because it is well known for producing a generous supply of graduates. Bilingual Mauritius is rebuilding itself as a "cyberisland," and has an edge pitching to corporations that need services delivered in English and French. And new EU members, like Bulgaria and Romania, can help fellow members avoid violating EU regulations on matters like privacy, which insist that certain types of work must be handled inside the Union's borders.
For entrepreneurial Indians, the answer is simple: set up alongside emerging rivals. Look around any promising IT hot spot in Central or Eastern Europe and the Indians are there. Infosys already employs 250 people—almost all recruited locally—at a service center in the Czech city of Brno, handling business in 25 languages. And next month Infosys will open a facility across the border in Poland as part of a $250 million deal with Royal Philips Electronics. "Central Europe can't compete with countries like India on cost alone but it can better meet specific European customers' outsourcing needs due to the local talent and language skills and being in the same time zone," says B. G. Srinivas, the head of Infosys operations in Europe.
Nor are the Indians about to relinquish the low-cost advantage that provided their initial selling point. Inevitably, white-collar Indian salaries are climbing fast, but a staffer in Bangalore will still cost barely a tenth of his counterpart in Baltimore, and a youthful population should prevent serious labor shortages or wage spikes. And when it makes sense, India is now outsourcing the routine work to new outsourcing nations, some (like Vietnam) with even cheaper labor rates than its own. Satyam Computer Services, founded less than 10 years ago, now runs operations centers in Malaysia, Brazil and China and has plans to add more in the Czech Republic, Russia, Vietnam and Thailand. It was perhaps inevitable—Indian offshoring has finally gone offshore. That's the kind of flexibility it needs to stay ahead in this game.
With Katka Krosnar in the Czech Republic
© 2007 Newsweek, Inc.