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Offshoring Secrets: Is India Center Becoming Costly?

Posted on Sunday, Sep 23rd 2007

By Utkarsh Rai, Guest Author, Author of “Offshoring Secrets”.

Recently this question has flooded the web and the print media. Some companies are thinking about pulling back from India.

So what is the real answer?

Globally, weakening of the dollar has impacted almost every country whether it is Israel, China, Malaysia or Poland, and therefore all offshore operations are becoming costlier. India, however, still retains a competitive and cost advantage over others. Let us explore why.

In the 90s the cost ratio between India and US used to be 1:6, which now has come down to 1:3.5 or so. The economic slowdown at the beginning of this decade together with reduced H1B visas has led to reduced availability of skilled people in the US. The companies, therefore, are bound to offshore many jobs. This is simply a matter of demand and supply. Inevitably, it is leading to escalation of salaries in India.

However, cost of the offshore operation should not be seen in isolation, but in the right perspective. It should be evaluated based on the following parameters:

Experience level: It is true that for the last 3 years, annual salary hike has been around 15-20%. If you compare the cost against the average experience level, however, then you would find that the annual payroll increase is around 5% for most of the companies in India. Following is an example from my book:

Year X end: There are 50 people in the company with an average experience level of 5 years. Let’s assume the salary is $25K per engineer per year.

Year X+1 beginning: You decide to give a 20% pay raise.

During Year X+1: The 50 people are now averaging 5 years (which will become six by the end of this year) of experience and will cost $30K per engineer per year.

In the same year, you add 50 more people with an average experience of 3 years (which will become 4 by the end of this year) and with a salary of $20K per engineer per year (as per new salary chart).

End of Year X+1: You would have 100 people with average 5 years of experience at $25K per engineer per year.

This is an ideal case. If the growth rate slows down, then you would experience a payroll increase every year.

A WSJ article states that the cost of an engineer in India comes to around 75% of US cost. While this may be true for a few senior employees, when compared against the average experience level in the company, the ratio will come to around 1:3.5 or thereabouts.

Ownership of the product life cycle: Compared to the last decade the ownership in the product life cycle held by the offshore centers has increased significantly. Today offshore centers are contributing more to the core innovations in the product life cycle, having increased interaction with the end customers, developing strategy for emerging markets and customizing products for new market segments. This is adding ROI to offshoring well beyond pure cost advantages.

Time to Market: The right talent pool in India can help in round the clock development. This shortens the release cycle and can help realizing revenue quicker. Thus the cost of offshore center becomes secondary.

In summary, India witnessed rampant salary escalation from 1995 till 2000. From 2003 onwards, the escalation has restarted but is bound to slow down. The teams in India need to increase ownership in product development life cycles to justify the increased costs. Those who are setting up their centers should be patient in realizing the ROI.

[Editor’s note: Again, the ratio would look more like 1:4 or 1:5 in second tier cities. To get those numbers, you need to look outside Bangalore, Delhi, Mumbai for sure, perhaps even beyond Chennai, Hyderabad and Pune.]

This segment is a part in the series : Offshoring Secrets

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Utkarsh,
I like the way you point out that the weakening of the dollar has impacted many countries – Israel, China, Malaysia or Poland… even Canada. So India is no exception.
While the pundits and management gurus focus on economic trends, it is for services firms to continue to deliver. 😉

Mohan Sunday, September 23, 2007 at 5:15 PM PT

Utkarsh,
I agree with your assessment.
In my experience, the cost escalation is a secondary issue to the recruiting challenges. Finding, recruiting and retaining the right technical talent is the key challenge in India.

Umberto Milletti Tuesday, September 25, 2007 at 7:23 PM PT