Operating Models in Indian Outsourcing Industry
Indian growth story for the past decade was driven by the polynomial growth in IT/ITES sector. Service sector contributes to 57% of the 2 trillion dollar economy and IT and IT enabled services have been a major contributor to this growth. Of the ten leading cities for off-shoring, according to “The Handbook of Global Outsourcing and Off-shoring”, six are Indian. In 2008 India claimed 65% of all off-shored IT work and 43% of off-shored business-process work.
The deluge of outsourcing started with the code maintenance for fixing Y2K bug in 1999. A software developer in India used to be paid 10–20% of what a developer used to be paid in the US. This cost arbitrage drove outsourcing of IT support and back-office work to India. Major playgrounds in the outsourcing arena are as follows
• IT support
• Engineering services (design & testing)
• Finance & Accounting (AP, AR and GL)
• Legal services
• Market research
• Equity research
• Insurance (Claims )
• Mortgage (Closing and Underwriting)
• Call Center
• Virtual assistant
In this article, we will explore a framework to analyze outsourcing industry in India.
Three major drivers behind service outsourcing are
1. Cost Arbitrage
2. Availability of specialists
3. Productivity gains
The operating models that evolved in the industry took advantage of each of these drivers.
Due to differences in purchasing power of dollar and rupee, the pay scales of knowledge workers in service sector vary widely between India and the US. Services of an accountant will cost around $40,000 per annum in the US but the same work, outsourced to India will cost around $15,000 an year. This cost difference is too huge for companies with large back-end operations to ignore.
AVAILABILITY OF SPECIALISTS
Services like IT support are amenable to economies of scale. So a mid-sized firm will have access to highly paid specialists whom they wouldn’t be able to afford in case of independent support. This brings industry best practices and advanced knowledge within the grasp of a midsized company.
As outsourcing firms gain expertise and experience, they will have the advantage of learning curve effect. In case of ITES sector added advantage of economies of scope through software automation in back office services also provide step gains in productivity. These productivity gains reduce the operating costs for the providers as well.
These drivers have given rise to 3 major operating models in the industry:
• Service provider as a facilitator
Let’s look at each of these models in brief.
In some specialized services it makes sense to establish pure play service outsourcing model in which a particular service is provided to the client ‘on demand’. Eg. Equity research, Market research, Medical transcription and Legal services.
This model is similar to hiring a cab as and when required. You don’t pay for the car but only for the ride. The maintenance of the car and salary of the cabbie is the sole responsibility of the taxi operator. Taxi operator takes the risk of road accidents and slack periods.
In BPaaS model client and service provider will have a contract and SLA driven understanding. Apart from the 3 main drivers this model also incorporates the added advantage of
• Converting capex to op-ex
• Meeting the volume fluctuations
• Ease of scaling up
• Ease of scaling down
The margins for the service provider is higher in this model to take care of uncertainty in demand. The service provider will take advantage of economies of scale by catering to various client in the same industry.
A major disadvantage of this model is that not all services can be outsourced in this ‘On Demand’ model.
Another popular model for outsourcing is the captive model. In this model the parent company opens a Indian arm and outsources a non-critical aspect of its production. The parent company will have to shell out capital expenditure required for setting up the facilities for office space and recruitment of talent.
Think of it as opening a new branch in Kochi rather than Connecticut. If we go back to the cab analogy, we can look at it as buying a low cost Japanese car in place of your Buick or Cadillac. Both the cars will take you from point A to point B albeit at different speeds.
Cost arbitrage advantage still exists in this model. The cost to the company for hiring and employing a knowledge worker is comparatively lower than that in the US. The Indian arm may have to depend on onshore team for specialized knowledge as these arms may not be able to bear the cost of specialists due to lack of scale.
Captive outsourcing arms usually do not have stringent SLAs or productivity targets as these arms are yet another department in the parent organization.
Apart from the advantages on 3 main drivers captive outsourcing arms face ease in
• hiring specialized talent
• Attrition control
• safety of intellectual property
A major disadvantage is the capital expenditure required in setting up the facility and lack of flexibility in meeting fluctuating demands. Lack of familiarity with legal and social system in India might land up some of these companies in quagmire.
SERVICE PROVIDER AS A FACILITATOR
In this model an experienced service provider (or a consultant) is hired to set up a captive facility. The service provider runs the facility for a stipulated amount of time and establishes processes and practices required for the transitioned activities. The parent company takes over the operations including the staff after the stipulated period
This model combines the advantages of both the previous models but the margins available for the service provider is low hence this model has very few takers. More popular version of this model is one in which the parent company has an option of taking the control the outsourced facility which can be exercised at discretion.
Think of this as learning to ride a bicycle with training wheels.
Major advantages of this model are
• Support of a specialist to handle the nuances of a new geography
• Option to convert into BPaaS or captive as per the requirement
Let’s explore a framework to analyze any outsourcing relationship based on the insights from the main models explored in the previous sections.
The factors that we will consider are
• Capex vs. Op-ex
• Safety of IP
• Performance controls
• Availability of specialists
• Recruitment of talent
• Ease of scaling up
• Handling fluctuating demand
• Degree of cost advantage
In this paper we have explored 3 major operating model prevalent in service outsourcing sector in India. We have identified the major and minor drivers and developed a generic framework to analyze the outsourcing models.