Anti-Sourcing Position in the US A

ANTI-OFFSHORE TREND IN THE US, A CREDIBLE THREAT FOR THE DEVELOPMENT OF INDIAN BPO?

Sergio Góngora April 23, 2004 15.227 India Trip Seminar Anti-Offshore Trend in the US, a Credible Threat for Indian BPO?

Introduction

The objective of this paper is to elucidate whether there is a real threat for the Indian IT industry behind US politicians’ speeches in this period of elections in the North-American country.

In order to answer this question, I will take advantage of the meetings that we held during our ten-day trip to India with top positioned members of the government such as Dr. Arun Shourie, Honorable Minister for Information Technology, Telecommunications, and Disinvestments as well as with top senior management of Indian companies such as Wipro Spectramind, Infosys, ICICI Bank and GE among others.

With the objective of addressing all the issues and answer the question posed in the most complete way, I have divided the paper into five main sections. Section 1 is a general overview of the current macroeconomic situation of India; section 2 describes the importance of the BPO practice in the Indian economy and the rate of dependence of the US; section 3 provides an outlook of the most recent debates and measures taken in the US about offshore; section 4 establishes some arguments to answer whether or not this political debate is a real problem for India and section 5 provides some recommendations to deal with this pressure.

1. Macro Economic Overview of India in 2004

Economic Growth

India's economy integrates traditional village farming, modern agriculture and a wide scope of recent industries. According to the Economist Intelligence Unit1 and the CIA World Factbook2, India’s real GDP growth in 2004 is expected to rise to 7.9%, from a 4.4% rate in 2003. The growth will be mainly driven by the development of two sectors: i) services and ii) agriculture. In addition, the rate of poverty in the country has been reduced by about 10% since 1991.

1 EUI Country Report March 2004. 2 CIA World Factbook (http://www.cia.gov/cia/publications/factbook/) 2 Anti-Offshore Trend in the US, a Credible Threat for Indian BPO?

Fiscal and Monetary Policies/Reforms

The Indian economic reforms since 1991 have been really impressive (ie. openness to private investment, privatization of state-owned companies, de- regulation of industries and liberalization of the exchange rate regime).

Nevertheless, some issues are still pending; the fiscal deficit has increasingly become one of the most relevant problems of the government (5.9% of GDP in 2003) after some unsuccessful attempts to control it during the last five years. On the contrary, fiscal policy has been right enough to reduce inflation 6 points since 1997, reaching a 3.8% in 2003. In addition, the rupee has continued to face upward pressure against the US dollar, endangering the exports of the country.

Politics

Parliamentary elections are scheduled to start from April the 20th. According to the Economist1 and Financial Times3 forecasts, The Bharatiya Janata Party (BJP), which leads the ruling National Democratic Alliance, is in a strong position to win and form the next government.

Population

Recent census estimated the number of Indian inhabitants at 1.06B with a labor participation rate of 39% (52% for males). India continues to have a low level of urbanization in comparison to other developing countries in the same region (60% live in villages with a population of less than 5,000). Nevertheless, the rate of migration from rural to urban areas is increasing steadily.

Education

India has made very important investments along the last ten years in education. A 2001 census recorded literacy rates of 65.4% up 8 points since 1991. The country has developed a very important knowledge-infrastructure with more than 225 universities, 6,800 affiliated colleges and 1,128 polytechniques. In this sense, we can confirm that India has developed a sustained competitive advantage by creating in the Economist’s words “a major international centre for the recruitment of high quality IT staff4”.

3 Financial Times, Comment & Analysis (April, 19th 2004). 4 EUI Commerce Report March 2004. 3 Anti-Offshore Trend in the US, a Credible Threat for Indian BPO?

Please find below a briefing of the most relevant indicators of the country.

India - Annual Indicators 2002 2003 GDP US$ bn 510.2 571.4 Real GDP growth (%)c 4.6 8.1 Consumer price inflation (av; %) 4.3 3.8 Population (m) 1,045.8b 1,061.60 Current-account balance (US$ m) 4,656.00 3,079.10 Total external debt (US$ bn) 98.0b 101.3 Exchange rate (av) Rs:US$ 48.61 46.58 2002: Actual ; 2003: EUI estimates Source: The Economist (Country Report - March 2004)

2. Overview of IT/BPO Services in India

IT Sector Overview

According to the Indian National Association of Software and Service Companies (NASSCOM5), the Indian IT industry is “on track to achieve its long term aspirations of USD 50B in export revenues by 2008, growing at a CAGR rate of 46% since 1999”. Today, this sector is critical for the Indian economy because it represents approximately 30% of the total exports of the country and employs more than 522,000 citizens. In this sense, the Economist6 values the amount of exports of India’s IT in 2003 on USD 9.9B. reaching a 3.9% market share in the US.

The performance of the Indian IT sector was determined by its growth in the following areas:

 IT software and services exports.  IT-enabled services.  The domestic IT market.  Telecom infrastructure.  Venture capital.

5 National Association of Software and Service (NASSCOM) (http://www.nasscom.org) 6 EUI Country Profile March 2004 4 Anti-Offshore Trend in the US, a Credible Threat for Indian BPO?

Indian IT Market (1997-2002) Indian IT Market (1997-2002)

18 0 0 0 3.5 16 4 9 4

16 0 0 0 3 13 7 8 3 14 0 0 0 2.5 12 4 10 12 0 0 0 2 10 0 0 0 8 3 5 7 1.5 8 0 0 0 6 0 14 1 6 0 0 0 5 0 2 1

0.5 4 0 0 0

0 2 0 0 0

1997 1998 1999 2000 2001 2002 0 19 9 7 19 9 8 19 9 9 2 0 0 0 2 0 0 1 2 0 0 2

Source: NASSCOM

The BPO Business

The fastest growing IT business during the last five years has been the IT- enabled services, mainly call centers and business process outsourcing (BPO), which accounted for 19.5% of IT exports in 2003.

A number of leading local software services companies have penetrated into the BPO domain. NASSCOM estimates indicate that in 2003, the IT-enabled services segment grew by a 65% reaching approximately USD2.7B.

Most Indian IT company icons include Wipro Spectramind, Infosys, Tata Consultancy Group and Patni among others. In the same way, global IT service companies and software providers have also created very important R&D facilities in the country such as GE, Dell, EDS, Accenture, IBM, SAP and Samsung.

Dependence of the US Market

The US market is the prime receptor of IT services proceeding from India. In this sense, according to IDC and NASSCOM, the US represents a 67.7% of India’s exports, leading to a relative dependence ratio of 1.4. This trend is reinforced by the fact that the US will continue to lead in terms of BPO spending accounting for more than 58% of total worldwide expenditures in 2004. IT Services Spending (2002-2003) IT services India's India's Relative Share in spending exports market dependence India's (USD B) (USD M) share (%) ratio exports North America 171.1 6,685 3.92 1.4 67.7 Western Europe 109.6 2,103 1.92 0.7 21.3 Japan 34.9 193 0.55 0.2 2 Latin America 17.5 583 3.33 1.2 5.9 Asia Pacific 16 311 1.94 0.7 3.2 TOTAL 349.1 9,875 2.82 100 Source: NASSCOM, IDC

5 Anti-Offshore Trend in the US, a Credible Threat for Indian BPO?

3. The Outsourcing Political Debate in the US

With the proximity of US elections, an intense political debate has started in the US. Some organizations such as the EUI7, ICICI8, Gartner9 and Smith Barney Citigroup10 explain some of the threats and measures that have already been taken.

 “The intensity of the anti-outsourcing reaction has increased in the past 7 months. If the topic was earlier discussed mainly on tech bulletin boards (2001-02), it is now in the mainstream daily newspapers.” (ICICI Research Report).

 “ In January 2004 the Republican senator for the state of Ohio, George Voinovich, added a section into a US$3.3bn government spending bill, which bans private contractors from sending government contracts offshore. Similar measures are being taken in over a dozen US states. New Jersey and Indiana have denied contracts to Indian firms, even though they submitted lower bids” (EUI Country Report).

 “ Gregory Mankiw, the Chairman of the Council of Economic Advisers, which reports to the US president, George W Bush, was criticised in February by Senator John Kerry, the Democratic Party front-runner in the presidential race. Mr Mankiw had said that the export of outsourcing jobs to India could benefit both countries. Mr Kerry said that his policy would be to reward companies for creating and keeping jobs in America” (EUI Country Report).

 “ The noise levels are set to further increase in the run-up to the presidential elections in the US later this year. Current Democrat party front-runner, John Kerry has already included an anti-outsourcing position in his agenda. As the presidential election race heats up, this could become a significant electoral issue” (ICICI Research Report).

 “ Lawmakers in the United States are pressured to review and change legislation related to H-1B visas, used predominantly by the offshore IT service providers to bring resources to the United States, as well as L1 visas, used by all multinational corporations to bring their global resources to the United States. The focus is on tightening the laws around the use of these visas to make it harder for offshore IT service providers to use these visa categories to address their need for on-site resources for projects” (Gartner).

7 EUI, Country Report March 2004 8 ICICI, Equity Research (February 11th, 2004). 9 Gartner, "How to Handle a Backlash Against Offshore Services". 10 Smith Barney Citigroup, IT Consulting India Offshore Outsourcing Trip Feedback (March 8th, 2004). 6 Anti-Offshore Trend in the US, a Credible Threat for Indian BPO?

4. A Real Problem for Indian BPO Companies?

The impact of the political backlash against imports of services into the US remains uncertain, but the common consensus about the topic is that globalization forces around IT services cannot be stopped or limited. Until this moment, the only visible repercussion that we learnt from the Indian BPO companies was the delay in some outsourcing initiatives until the elections took place during the month of November in the US.

From an economic perspective, Steve Golub, professor of Economics at Swarthmore College mentions in his paper “Does Trade with Low-Wage Countries Hurt American Workers?” that trade between these countries benefits most people in both places, irrespective of wage differences. In this sense, differences in wages largely reflect differences in labor productivity and are not a form of unfair competition. According to David Ricardo’s 1817 theory about comparative and absolute advantages between countries, both countries benefit from specializing in what each produces relatively efficiently.

The International Monetary Fund (IMF) has stated that a global setback in protectionism would harm prospects for economic growth in all countries. Mentioning its preoccupation over anti-outsourcing protests in the US, Anne Krueger mentioned that, "it would be a setback nobody wants to contemplate".

In the same way, Gartner’s Paper "How to Handle a Backlash Against Offshore Services", the research company mentioned that there were no long-term threats to Indian service providers. In this sense, the paper mentions that the Indian BPO business is going through the same “backlash cycle” as a lot of industries did in previous years such as electronics and automobiles in Japan in the late 1940s to early 1980s; semiconductors in Taiwan and Korea in the late 1970s to early 1980s; manufacturing in China in the late 1980s to early 1990s.

From a business perspective, the political threats should not become a reality for the reasons stated in the following paragraphs.

Smith Barney Citigroup, mentions that the number of prospect visits to India has increased. A high number of Indian BPO companies confirmed that new prospects include companies that have never been outside the US before, but are on a diagnostic mission to analyze what BPO is about. In this sense, the competitive disadvantage is a common fear that all the companies are facing in such competitive environment.

A study conducted by Ernst & Young stated that “while protests against outsourcing have reached a fever pitch amongst workers unions and politicians with the US presidential elections just round the corner, the flow of work to India has remained constant”. Gopal Jain, a private equity investor in 7 Anti-Offshore Trend in the US, a Credible Threat for Indian BPO?

India confirmed that, "the sentiment is very strong. None of our participants felt business on the ground had been affected".

The continuing need for US businesses to cut their IT operational costs has meant that outsourcing has become a strategic imperative for all Fortune 500 companies. Currently, over 330 Fortune 500 companies now offshore to India and the rest are considering their BPO strategies.

In this sense, NASSCOM states in its Strategic Review of 2003, that the differential in wages between the parent location in the US or UK and India is more than 70% to 80% for offshoreable processes. However, as India is a remote location, the interaction cost works out to around 20%, which still results in net savings of approximately 50% percent for offshore processes.

A recent report in Fortune magazine clearly illustrated the benefits of BPO to India. The report stated that a company that earlier found it unviable to follow up on defaulters with outstanding payments of less than USD1k, today profitably chases bills less than USD100, through its outsourcing firm, Wipro. This basically means that the benefits are not only based on costs, but also on quality and reliability of service.

Azim Premji pointed out that the US financial services sector alone had saved USD8B in the past four years by outsourcing to India. In the same way, he mentioned that the Indian technology industry employs 800k people, while the American technology industry employs 10.2M. And 300k people work in Indian call centers, compared with 6M in the United States. In addition, less than 2% of the government work is done offshore. In this sense, a direct reaction from the US government on its own routines would have a small impact on the Indian industry.

Finally, there is an important probability that the current political pressure in the US can represent a strategy by the government in order to press India to open its market for US high-technology goods.

Another expansionary policy that current BPO companies are implementing in order to mitigate the political backlash in the US is to open new markets. The US has always been the biggest client for Indian BPO, however, it is also the slowest growing market. BPO players are actively cultivating markets in Europe and Asia-Pacific. These are still nascent markets and language barriers are proving to be a major hurdle. Nevertheless, in the long run they are going to represent a major counterbalance to the North-American market.

5. How Can Indian BPO Companies Deal with this Issue?

Indian BPO companies should undertake different initiatives in order to deal with this negative propaganda. In this sense, to ignore the problem would amplify the negative externalities. Since this campaign does not come from the buyers themselves but from a lobby, the response strategy should be treated through two different and complementary channels: i) political and ii) public relations. The main objective would be to improve the public perception and to eliminate any negative reaction against the companies that are currently using or may potentially use these outsourcing services.

From a political point of view, India is still seen as one of the most protectionist countries in the world. In this sense, some economists and the Economist argue that if India took the lead in reviving the Doha Round of WTO negotiations it would send a positive signal of flexibility to policy makers in the US.

ICICI Research mentioned that Mr. Narayana Murthy, Chief Mentor of Infosys, suggested that the issue should be tackled “behind the scenes with key US policy makers instead of grandstanding in the media. Working with ITAA and US business, behind the scenes, is likely to be more fruitful in protecting the source of 98% of the industry’s revenues”.

From a business point of view, Gartner provides some specific recommendations that group all the initiatives that have been launched by the companies of different sectors involved during decades in this kind of collision. In this sense, Indian BPO companies can mitigate and counteract this campaign by implementing the following activities:

 Hire US experts in their practices.  Hire employees with real cross-cultural experience.  Engage local PR firms.  Publicize public value added.  Publicize business value added.  Publicize US exports to India.  Eliminate "Sweatshop" misconceptions.

6. Conclusion

Backlash against Indian BPO practices can create some negative effects for the growth and development of the industry in the form of delayed projects as well as harm the image of both, the companies that provide the services and the companies that use them. Nevertheless, all the experts agree that from an economic and business-wise perspective this lobbyist form of pressure will never affect the expansionist and globalizing trend of outsourcing. Companies’ independence and constant search for innovation and competitive advantages still remains the main reason to believe in a sustainable growth of BPO in India.

SOURCES OF INFORMATION

 “India Country Profile 2003”. The Economist Intelligence Unit, 2003.

 “India Commerce Report 2004”. The Economist Intelligence Unit, March 2004.

 “India Country Report 2004”. The Economist Intelligence Unit, March 2004.

 CIA World Factbook (http://www.cia.gov/cia/publications/factbook/)

 National Association of Software and Service (NASSCOM) (www.nasscom.org).

 ICICI, Equity Research (February 11th, 2004).

 Gartner, "How to Handle a Backlash Against Offshore Services".

 Smith Barney Citigroup, IT Consulting India Offshore Outsourcing Trip Feedback (March 8th, 2004).

 Financial Times, Comment & Analysis (April, 19th 2004).

 “Does Trade with Low-Wage Countries Hurt American Workers?” by Stephen Golub.

 “Integration if Trade and Disintegration of Production in the Global Economy” by Robert C. Feenstra.

Additional References:

 "Counter-Revolutionary Strategies for the Offshore Revolution" by Rolf Jester (Gartner).

 "Deciphering the Backlash Against Indian Service Providers" by Partha Iyengar (Gartner).

 "U.S. Offshore Outsourcing: Structural Changes, Big Impact" by Diane Morello (Gartner).

 “Indian Contact Center Outsourcing – Surviving the Shakeout” (DataMonitor).

 “Outsourcing to India” by Mark Kobayashi-Hillary.