India - Reading the Runes

Introduction - According to US research house Everest the "offshoring market continued to witness high activity during the second quarter of 2011... transactions, plus captive set-ups, reached a 42-month high". However one veteran outsourcing commentator and advisor, Robert Morgan, from Burnt Oak Partners urges caution and even a rethink of this strategy.

Says Morgan, "The pre-eminence of India as the destination of choice and locale for all things offshore, is under attack like never before. Can India hold its crown for another decade or are its fortunes so rapidly shrinking so much that any CFO or CIO needs to re-assess the risk factors again before renewing existing contracts or contemplating new ones? - Think risk, think time to re-evaluate offshore assumptions".

In this article he contemplates the wider issues that determine the direction on services that are by and large out of control of executive management, things like regulation and politics.

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The next three years are crucial to the dominance of India in this global market. Sure India will still be around and a major player, however India is already losing ground to the more discerning corporate clients, where cost is not everything. Very viable and practical near-shore alternatives and new technological solutions are presenting themselves and providing clients with real alternatives to offshoring.

Just as the private sector has seen new solutions, the UK government has started to crack open its vaults as a result of the economic crisis gripping the world's economy.  Offshore volumes cannot keep rising without numerous governments conceding work volumes to overseas low cost centres. This certainly will not happen in France or Germany. Successive UK governments have paid lip service to the charms of India, but David Cameron has done more than any previous government to indicate a true softening of policy (perhaps only in the light of current economic imperatives) towards offshore economics - see the Politics section below. Perhaps he too needs to consult the "runes*". The runes that foretell of mixed offshore fortunes and even chances of significant career wrecking disasters ahead for the unwary.

*Reading of Runes - Runes are any of the characters of several alphabets used by ancient Germanic peoples from the 3rd to the 13th century and believed to have magic powers and are of mysterious significance in foretelling the future and warning of danger.

 The Six Runes of Indian Offshoring

1.      India - Emerging superpower or a flawed and precarious state in transition?

The frequency of terrorist attacks in India is much more commonplace than the western press reports. Sectarianism, ethnic and caste violence, major territorial conflicts with neighbouring Pakistan and china, and corruption at the highest levels of government are overlooked by successive European and American governments and of course corporations all seeking access to the cheap, plentiful and well educated pool of talent available in the world's most populous nation. Perhaps it is time for CEO's, CFO's and CIO's to show their elected representatives better risk management techniques. "In India the choice could never be between chaos and stability, but between manageable and unmanageable chaos", Ashis Nandy, Sociologist.  

"Corruption is not new in India, but the scale and ubiquity of these problems is unprecedented", renowned author and fellow of the Indian Institute of Management Calcutta Ramachandra Guha.  "The truth is that India is no position to become a superpower. It is not a raising power, nor even an emerging power. It is merely a fascinating, complex and perhaps unique experiment in nationhood and democracy, whose leaders need still to attend to the fault line within, rather than presume to take on the world without", Mr Guha added.

In July 2008 The Washington Post reported that nearly a quarter of the 540 Indian Parliament members faced criminal charges, "including human trafficking, immigration rackets, embezzlement, rape and even murder". So why is this important - it is important that any destination for your company's IP, data and commercial systems must have a high standard of law and an infrastructure that promotes the law. Recent thefts of personal data and being sold on the open market firstly appear to be random and not professionally organised but equally not treated with the severity we have come to expect. India's system and above all attitude does not reflect their preeminent world status.

If the CIO came to the board and said "we are off to Russia because of the cheap, well educated and multi-lingual skills of the labour pool" what would be the board's reaction? Why is India seen as a foregone conclusion and acceptable alternative to perceived "riskier" locations such as Arab 'Spring' countries like Egypt, or emerging countries like Brazil?

2.      The Executive Board of the service providers

All eight major India Offshore service providers are led by Engineers in the form of the Chair, CEO and majority of the board. Is this necessarily a bad thing? Well we all know that over-engineered solutions cost more money - ask any client who has offshored applications development or maintenance, how much extra it cost to bring their businesses up to CMM level 5. But mostly it was worth the investment. Over-engineering also leads to inflexibility and slows down quick and easy solutions. There are many client complaints in this department. However it is in the Indian boardroom that I wish to concentrate thinking. Engineers build things and they do not like things that they did not invent and nurture. How many times have you heard "the Indians are coming" and they will buy CapGemini, or Atos or Siemens or some other troubled European service provider. Well they never have and, in my opinion, never will despite the $Billions that they have slopping around in "readies". Acquisitions are always discrete application houses around $300m or less, that can function independently but with cheaper labour costs, and therefore more profitably. Some critics say that buying onshore competitors will dilute Indian profit records and adversely affect the stock price - the real reason is surely an "engineer's perspective and pride in what they have built".

3.      Expectations of continued growth despite the global financial crisis

India's once large agrarian economy  still employs just over half the workforce, but contributes a mere 16% of gross domestic product; industry 28.5% whilst the services sector accounts for 55.4%. Newly released Ernst & Young data on new IT services investment shows that the $76bn IT and BPO industry was much harder hit in 2009 by the global financial crisis, down some 36%, the largest decline in Foreign Direct Investment (FDI) in any sector. But in 2010 these figures were even grimmer - "... there was a further accentuation of the decline of FDI interest in the software and IT services sector in 2010. The number of projects in this sector in 2010 fell to 80, 43% lower than the medium term average for 2003-10, while the fall in the number of jobs created was even sharper, at 63% below the medium term average. Although this sector still attracts more projects than any other, the number being attracted annually is now less than half that attracted in each of the peak years for this sector 2004-2006" - Financial Times.

Major foreign investors are finding other geographies more attractive. Are they right? The trend to sell off previous investment in IT service entities is nothing new. General Electric was one of the first to set-up in India in 1997 and one of the first to sell the captive to Genpact in November 2004.  This formula has been followed by Aviva to WNS, Citigroup to Wipro and TCS, Philips to Infosys, and numerous others. This is a quick way to generate significant liquidity for the parent company but at the price of a back-to-back service contract for many years to come. Although, as stated at the beginning of this article, Q1 2011 is still proving successful for new captive setups the trend is definitely slowing and competition from other regions is picking up.

Should you look more closely at the longer-term trend if you are contemplating a significant contractual duration? Perhaps holding the right to move the workload to another geography (with the same supplier) when these come on-stream. All Indian providers are heavily investing in Brazil, Russia and China as well as South Africa and the Philippines.

4. Data Protection Act

The Indian parliament has rejected legislation closely resembling the European data Protection Act over eight times in as many years despite huge industry, overseas governmental and the Indian outsourcing industries association Nasscom, pressure. That is until on 11th April 2011 when parliament passed, with amazingly little publicity and zero fanfare, what appears to be an EEC equivalent set of data protection laws. But does this help UK and European outsourcing decisions? As Mark Lewis of Berwin Leighton Paisner stated "We do not yet know, because Indian law, having only just been enacted, has not been determined (by the European Commission under the Data Protection Act 95/46/EU) to offer 'adequate protection'". Lewis cited the case of Israel's equivalent legislation taking three and a half years to be accorded the EEC stamp of 'adequate protection' approval. So how have Indian deals been done in the past? "Further safeguards" have always been added in schedules to the main contract, but buyer beware, any prosecution for breach would most likely have to be "privately" led, as borne out by the spate of "data thefts and incidents" over the years and the corporately lead prosecutions. Meantime Lewis says "undertake proper due diligence on ... suppliers ... continue to monitor and audit the data processing operations ... and ensure they address, wider data sovereignty concerns, such as the under Indian law to which Government authorities or regulators ... are entitled to access and intervene in the processing of data, irrespective of what the contract says". Wise words indeed and for a few more years yet to come. Remember Twitter and Homeland Security's demand for details of Wikileaks supporters? Amazon succumbing to US government pressure to stop hosting Wikileaks website? Nothing like that influence could happen in India, could it? Can you risk a quirk in this new legislation bringing unwanted attention to an IT governance failure or data theft in your company?

5.      Currency issues

As at 27^th July 2011, the Indian rupee stood at a three year high against the US dollar because markets expect a rise in fund flows due to higher Indian interest rates compared with the US.  Being hammered on the exchange rate is something Indian shareholders have come to expect as offshore service providers bill clients in dollars, euros, sterling and other western denominations. The Indian rupee has constantly been subject to talk of its potential floatation on the world's markets, but these talks have come to nothing over the years. The rupee exchange rate is neither completely free-floating nor fixed, but is "managed" by the Reserve Bank of India through buying and selling other currencies. With more investment onshore where cash can be held pending favourable movements in exchange rates and currency hedging the net effect of currency changes is reducing the impact of such a large dependency and commitment to overseas trading. Large-scale customers of offshoring do need to think of the opportunities that a true floatation might have in the longer-term and allow for the option of payment in Rupees. HM Government please take note!

6.      Politics and Legislative changes - VAT, Visas and Vitriol

The CIO Council of the Cabinet Office published a 34 page report in mid-July 2011 entitled "Government ICT Offshoring (International Sourcing) Guidance Version 1.0" - so the message is very clear on the intent at least. It does contain wise words around "total costs of ownership" but central government has paved the way to massive offshore contracts.

This comes at a time when the US, Germany and France are doing everything possible to stop or slow such thinking. For instance, Indian outsourcers deploying staff overseas have hit protectionism barriers and opened furious debate after the US raised the cost of applying for business visas last year from $320 to $2,000 per person. The move came amid pressure on the Obama administration to protect jobs at home. Strangely enough, visa rejection rates in the US are currently running at almost 40%, up from 5% a mere 18 months ago. Citing visa changes as a having major impact to the business model economics of offshore companies CLSA recently downgraded the Indian IT outsourcing sector to "underweight". The likely cost to the providers is $250m a year.

This government's ill-thought out approach to "numbers" of people entering to support outsourced arrangement receives less publicity and seems fairer, however it is still having an impact due to the time to process the visa's causing delays to numerous IT projects.

Some US companies are moving workloads back onshore because of the political backlash over outsourcing. While in Europe we tend to find other "customers care" reasons for exiting India or other offshore venues. Santander become the latest UK business (or is it Spanish?) to move its call centre back to the UK in "an attempt to cut the levels of complaints from its customers". This is nothing new as German owned PowerGen, switched its offshore call centre work back to the UK from India five years ago, amid stated concerns over customers service and the number of customer complaints. NatWest featured in an ad campaign run in 2007, that it guaranteed that customers would speak to people in Barnsley or Cardiff rather than Mumbai or Calcutta. No political correctness then for a soon to be state asset.

Lest we forget under the guise of EU VAT/GST harmonisation, in January 2011, the VAT rules changes to imposing the tax at the point of consumption, thereby adding variously 17.5% or 20%, additional none reclaimable costs to charities and the financial service industry. A major sector blow to the economics of offshoring to non-VAT registered organisations, such as HM Government (again, are you listening Mr Cameron?).

Politics, protectionism, xenophobia, legislative adjustment ... call it what you will extra legislation WILL mean more barriers to offshore services and perhaps even extra direct taxes. I have heard that targeting offshore contracts for a 5-8% tax has been discussed and shelved in certain corridors of power. "But, if we did impose it, it would be temporary", I was told. Mmmm, did someone not say that about income tax after WWII?

There are other topics that should be considered before committing your employer and shareholder to a course of actions which need to stand the test of time. Of course all decisions have risk and so thorough investigation and due consideration need to apply. Here are a few to ponder:

• Moving Offshore Onshore - Offshore providers are putting a greater presence 'onshore'. How committed is that or is it a temporary strategy until the world economic situation picks up? How do the increased economics versus the extra surety stack up mid or longer-term?
• Cloud and new technologies - Will these innovations make the case for being offshore harder to justify? Truly investigate the TCO of such solutions versus the risk eg where data is logically held. Who has the big pockets to truly make cloud work? What new legislation will slant the table back towards the US and EU?
• Staffing - expectations, inflation and attrition- "Call centres have attrition rates of 25-35 %" Arup Roy Gartner. Salaries are due to increase 15-18% in 2011-2. Some high-fliers prime motive is purely for a visa or green-card opportunities in the end-client - recent audit report. Staffing and its continuity are everything to projects and the end-users
• Near-shore fight back - very real investment, progress in state of the art facilities and progresses, and even tax breaks apply to EU destinations. With same time zone, cultural and language synergies, high education standards, growing IT numbers of graduates and low wage inflation - expect a good solid and logical set of counter-measures for quality near-shoring to emerge

Take the time and thereby the credit, for getting it right.

Author Robert Morgan also is a regular contributor to Outsourcings Lex Column, a regular, pithy and hard hitting observation of today's outsourcing events, companies and personalities. To view this try: http://www.burntoak-partners.com/viewpoint/outsourcings-lex-column/