IT Offshoring in India

An Investor's Perspective

Term Paper (Advanced seminar) 2011 35 Pages

Business economics - Offline Marketing and Online Marketing


Table of Contents

A) India lures Offshoring Investment

B) IT Offshoring in India
I. Recent Developments
II. Determinants of Success
1. Strengths of the Indian IT Offshoring Market
2. Weaknesses of the Indian IT Offshoring Market
III. Alternatives on the Asian Market
1. South-East Asian Alternatives
2. China as IT offshoring destination

C) The Trend of India’s Competitive Edge

D) Appendix
I. Graphs and Tables
II. Reports and Studies

E) Sources

A) India lures Offshoring Investment

The last two decades have witnessed an unprecedented flow of services to- ward Asia. India, in particular, appears to have been the chief beneficiary for qualified services. According to the A.T. Kearney Global Services Location In- dex, 2011, India ranks highest as offshoring destination.1 Given the immense poverty of a large percentage of the population, it seems worthwhile to inves- tigate how India managed to become a solicited provider for high-tech servic- es.2 Business analysts present straightforward answers. India reportedly benefits from three key advantages.

B) IT Offshoring in India

I. Recent Developments

By 2011 the Indian IT service industry faces two main trends. One recent trend is the emergence of Cloud Computing as a business model. Another current phenomenon is the surge in average wages in traditional IT centers such as Bangalore. The latter development undermines India’s competitive edge as a repudiated provider of low-cost services.

Cloud Computing is a concept that proposes integrating software and hard- ware resources into a network, e.g. the Internet, in order to cut costs.4 In this concept, clouds represent an ample pool of accessible virtualized resources that can be adjusted to customers’ needs.5 Customers idiosyncratically follow the pay-per-use model, i.e. they pay precisely for the services they utilize. For a plethora of IT service providers this shift in technology stands for change in their business model. Today’s IT companies are challenged to enlarge their service in order to meet comprehensive customers’ requests while driving down costs. Nonetheless, it appears that Indian IT businesses are doing well in the race for cloud solutions. According to a survey conducted by VMware Inc., India leads the paramount Asian nations in terms of adoption plans (43% of all national IT firms) followed by China (39% of all national IT firms).6 Thus, it is safe to say that Indian companies are well poised to weather the coming competitive storm due to cloud-based services.

Another predominant factor to be considered is the second trend of avoiding traditional high-tech centers. As early as 2007, a few American companies de- cided to withdraw service centers from Bangalore, the much heralded Silicon Valley of India.7 As average savings due to IT offshoring have decreased glo- bally, this trend has continued. Inflationary pressures mitigated the average labor cost advantage from 38% a decade ago to 27% in spring 2011.8 Thus, in the case of Bangalore, the attraction as a low cost center for IT offshoring has largely diminished. Surrounding cities, such as Chennai or Hyderabad represent possible destinations where the wage level remains lower while the standard of technical expertise rivals that of Bangalore. Concerning local infra- structure, both vast metropolises and smaller cities suffer from significant teething problems in terms of viability. India’s government fails to keep up with the pace of population growth in the metropolises. Medium-sized cities are not necessarily either disposed to adequately support IT companies. This explains why every larger IT firm in Bangalore is in dire need of a current generator.9 Failure to address this practical need will ultimately stunt the competitiveness of the companies concerned. It is reasonable to state that a higher wage level partially repels foreign investors from India’s software centers. Additionally, provision of basic supplies is not granted in Indian metropolises. Subsequent- ly, this paper discusses the vital ingredients for a successful offshoring strate- gy.

II. Determinants of Success

Given the two main trends outlined previously, a potential investor may want to further investigate on the Indian option before comparing it to other Asian alternatives. To obtain an accurate picture, it is crucial to scrutinize strengths and weaknesses of the Indian IT offshoring market.

1. Strengths of the Indian IT Offshoring Market

A remarkable advantage of India as an offshoring destination is that its IT companies are performing well on the international stage. Notwithstanding in- creasing inflationary pressure and a weak dollar, India’s top three technology firms10 are sanguine about the coming fiscal year. An Infosys representative, for example, regards the offshoring trend as continuous, as demand remains brisk.11 Another aspect favoring Indian IT companies is their independence from the Indian state. Both tax breaks and special economic zones have allowed local and multinational businesses to evade bureaucratic and legal restrictions. This policy also brought forth several regional high-tech hubs where spin-over effects and synergies among companies run rampant. Bangalore, Mumbai, Delhi, Kolkata and their suburbs stick out as paramount IT centers.12 Although unflagging urbanization has downsides, it does also benefit offshoring companies seeking to recruit qualified staff.

Against this backdrop demography plays a vital role. Given a population growth rate of 17.6% during the decade from 2000 until 2010, India’s popula- tion is expanding much quicker than that of China (6.7%).13 The upside of this rapid growth of India’s population is that the youth of India can maintain and enlarge its share of the working population.14 This process is beneficial to the Indian labor market as education currently is better than in previous years. For instance, the adult literacy rate is 66% which is extremely low, while among the 15-24 year olds the literacy rate is slightly above 80%.15 Another indicator suggesting an improving educational level of the Indian workers involved in offshoring is India’s high score in the A.T. Kearny Index 2011.16 Here India is placed only second after the USA, in the dimension “People Skills and availa- bility scores”. In this setting, it is mainly the size and availability of the work- force that aided India to position herself ahead of smaller countries, such as the UK or Germany. This trend of an ever growing well-educated workforce should enable Indian IT offshoring companies to sustain their comparative ad- vantage in managerial capabilities.17

2. Weaknesses of the Indian IT Offshoring Market

Nevertheless, a growing population can turn out to be a mixed blessing as well. In the realm of exponential urbanization, an overall population growth contributes to infrastructure congestion. There are several dimensions to be taken into account. Power, telecommunication and housing facilities and the corresponding rates are prominent factors that have to be compared among the potential attractive city. Broadly speaking, India fails to come to grips with the mass influx into its vast cities and its metropolises. For instance, the official report on Indian urban infrastructure indicates the necessity to progressively augment the investment in infrastructure from 0.7% of the GDP in 2011 to 1.1% in 2031.18 Experts, however, contest whether this rise in investment will suffice to deal with the realities of the surge in urban immigration.19 Consequently, this weakness will most likely continue to put a strain on the functionality of urban areas in India.

Another striking shortfall of India is endemic corruption. In spring 2011, the Prime Minister Manmohan Singh was held accountable for his failure to fight corruption, as an important anti-corruption officer was found embroiled in a “black money” affair.20 This is but one example of scandals that regularly ap- pear in Indian media. Nevertheless, it is crucial to note that this obstacle is less pervasive in the software industry and therefore also in the IT offshoring sector. This is due to a low dependence on governmental decisions.21 Still, it remains a critical strike against India as destination as legal disputes might re- quire “speed money” in order to come to a satisfactory settlement of conflict.

Apart from these strengths and weaknesses, there is a further decisive deter- minant of success. It is about personal contacts and trust. While the preceding factors zeroed in on dimensions that can easily be computed, the quality of a personal contact between the local and the ordering entrepreneur is less tang- ible. In some cases the value of personal contacts can only be determined af- ter the failure of an offshoring activity. This loss might be in terms of intellec- tual property, money and or any other company resource or potential en- trusted to the offshoring partner. To preempt a bad experience, consultants recommend direct contact between both partners prior to a legal commitment. For small and medium-sized companies, one approach is to draw from con- tacts established during trade fair visits.22 Personal contacts might suggest other destinations other than India. Thus the following section is going to ex- amine alternatives on the Asian Market.

III. Alternatives on the Asian Market

1. South-East Asian Alternatives

Against the backdrop of the weaknesses that fetter India’s capabilities, it is ne- cessary to compare India to other IT offshoring destinations such as China and Malaysia.23 Both are challenging rivals for the Indian service industry.24 It is possible to state that ITO25 is much less developed in Malaysia than in both India and China.26 Therefore, it suffices to mention Malaysia as a viable option for simple IT services.

The Philippines have a similar structure as India, in terms of general offshoring activities.27 When it comes to ITO, however, Philippine companies are far from the quality Indian IT service providers offer. But, the Philippines remain a cheaper alternative to India for American IT offshoring partners.28

Both Vietnam and Indonesia dispose of an extraordinary financial attractive- ness which surpasses the cost advantage of the Philippines.29 Their financial attractiveness rests in essence on the extremely low compensation rate in these two South-East Asian countries. Notwithstanding this advantage, indus- try activity in Indonesia remains low in the realm of IT. Vietnam plays in the same league with the Philippines, when it comes to ITO. However, all of these South-East Asian countries apparently lack the market scale to challenge India on this dimension. Therefore, the subsequent analysis is going to zero in on China.

2. China as IT offshoring destination

First of all it is recommendable to take a look at the current development of IT offshoring in China. Globally, China is on the ascendance in the IT sector. While in India ITO companies are largely independent from the state, the Chi- nese government offers tremendous incentives for local companies. These stimuli include an exemption from business tax on all offshore contracts until 2014.30 This policy suggests the obvious aim to overtake India’s position as IT offshoring leader. Domestic conditions appear favorable as the wealthier Chi- nese market for IT services was with $8.1 billion in 2009 larger than that of In- dia.31 This national policy translates into a rise in rating attractiveness. In 2009, China was ranked among the top five global offshoring destinations and in 2011 it positions itself as the runner-up.32

Regarding the strengths of China as an offshoring destination, two dimensions stick out. IT companies that set up offshoring deals will perceive an outstand- ing Chinese infrastructure among the emerging economies. One dimension that plays a pivotal role is national broadband penetration as an indicator for 3 First, the English language straddles regional barriers and is therefore widely spread. Second, average standard of living compared to developed western nations is low. Last, the level of education and professional training has been markedly improving for the past twenty years. Against this backdrop investors wonder how this trend is likely to evolve. Furthermore, with India’s steadily growing economy, it is prudent to consider if it would be more profitable to outsource IT services to another Asian country. Ultimately, foreign investors want to know the ingredients which lead to success in the Asian market.

In summary, this paper focuses on IT offshoring in India from an investor’s perspective. The objective is to identify strengths and weaknesses, opportuni- ties and risks related to the outsourcing of services and departments to India.


1 See A.T. Kearney (2011), p. 2.

2 The export of IT Offshoring services accounts for 24% of India’s exports͘ See Table 1: Economic importance of IT offshoring in India and China.

3 Compare Müller (2007), p. 177.

4 See Vaquero et al (2009), p. 50.

5 See ibd. p. 51.

6 6,953 companies from Japan, Australia, China, India, Singapore, Malaysia and Thailand responded to the VMware Inc. survey. See VMware (2010), p. 1.

7 The Financial Times Ltd. (2011).

8 See CXO Media Inc. (2011), p. 1.

9 Compare Mahadevan (2007), p. 122.

10 These are Tata Consultancy Services Ltd, Infosys Technologies Ltd and Wipro Ltd as of 2011.

11 See Thomson Reuters (2011).

12 Compare Graph 1: India’s dominant IT hubs.

13 See Government of India (2011), p. 51.

14 Still the pace of the expansion of the workforce appears limited in the long run. The share of children (0-6 years) further decreased from 15.9% in 2001 to 13.1% in 2011. See Government of India (2011), p. 74f.

15 Compare The Economist (2010), p. 68f.

16 See A.T. Kearney (2011), p. 8.

17 Due to the independence from the state, Indian IT managers have been able to build up a sound reputation as professionals. See EzineMark.com (2011).

18 The Report of Indian Urban Infrastructure and Services, i.e. the Ahluwalia report is referred to in the source below.

19 Compare Indian Urban Infrastructure Review (2011).

20 See The Economist (2011), p. 57.

21 See The Economist (2010), p. 69.

22 See Schraudy (2007), p. 146f.

23 Further attractive Asian countries are Vietnam, the Philippines and Indonesia. See A.T. Kearney (2011), p. 13.

24 Compare A.T. Kearney (2011), p. 2.

25 Information Technology Outsourcing.

26 See A.T. Kearney (2011), p. 13.

27 Ibd.

28 See Daily News (2011).

29 See A.T. Kearney (2011), p.15.

30 See iStockAnalyst (2011), p. 1.

31 India had a domestic IT services market of $5.8bn. See iStockAnalyst (2011), p. 2.

32 Compare ZDNet Asia (2011).


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Investment IT Offshoring India Competitive Advantage China



Title: IT Offshoring in India