Offshoring to India -- No Longer a Smart Strategy?

For North American companies looking to stay competitive, outsourcing some or all of their back-office business operations to India has achieved the status of dogma. However, in the past couple of years poor outcomes, changing cost dynamics and continued cultural challenges have swung the value and performance advantage back to North American providers in many cases.

The times they are a-changin’

Firms migrated operations to India to save money, focus on their core competencies, and move away from a fixed cost structure. Today, faith in offshoring must be tempered by reason. In the last few years, India’s significant advantages have yielded to some harsh economic realities. New cost dynamics and the reality of doing business halfway around the world with a very different culture have reduced the attraction of offshoring many operations, particularly those in knowledge intensive industries.

India’s fading appeal

Four key developments, unlikely to dim in the medium term, are contributing to offshoring’s declining appeal:

Shrinking wage differentials

India’s primary advantage, low labor costs, has been steadily declining. According to the U.S. Bureau of Labor Statistics, India’s average per-hour cost advantage in 2010 had shrunk to only 6-7 times U.S. rates versus 11 times the rate in 2001. This shrinking differential traces to a combination of Indian wage inflation and North American wage moderation. If present trends continue, this gap could shrink to five times the U.S. rate by 2014.

Pervasive cultural challenges

India remains a culturally challenging place to do business; a situation unlikely to change in the medium term. The differences–language, cultural mores, business practices–generate high indirect costs by introducing complexity, miscommunication and risk. Furthermore, persistently high labor turnover in all Indian firms complicates attempts to close this ‘cultural gap’.

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Higher than expected administrative costs

When they began outsourcing, firms understood there would be transaction costs — travel, communication, compliance and relationship management. What virtually every company has experienced are administrative costs typically three times higher than their estimates and all tracing back to geographic and cultural challenges. In some cases, these costs can make up close to 20% of the total project cost.

Increased business risk

Today, effective risk management (e.g., protecting intellectual property and sensitive data, business continuity) is a strategic prerequisite for many companies. Lingering doubts remain that sensitive data and intellectual property sent over to India (or any other emerging economy) is as secure as it would be in North America. Not surprisingly, some government regulations continue to prevent certain types of IP and sensitive data from leaving North America. Furthermore, India remains in the center of one of the world’s most dangerous regions, withinstability on all of her bordersand inside to boot.

Case in point: IT services

IT services provide a good illustration of the challenges of offshoring. For the past 10 years, CIOs and professional services firms have enthusiastically offshored to India large swathes of their IT work in order to reap the advantages of lower wages and round-the-clock development.

In many cases, however, the promise has not kept up with reality. India no longer possesses the same IT cost advantage versus innovative Canadian firms. Alex Rodov, managing partner of North America’s largest dedicated software testing firm, QA Consultants, contends that "Canadian IT labor rates on average are no more than 20% higher than India’s. After you factor in the high administrative costs, lack of visibility and hassle of doing business around the world, then our delivered costs are roughly equivalent." Secondly, India’s workers continue to suffer from poor productivity. Despite working in modern facilities, most Indian IT workers (including recent grads) lack basic technical skills and rudimentary English language proficiency. In fact, the Wall Street Journal has reported that 75% of India’s technical graduates are unemployable by their IT sector.

Finally, the integrated structure favored by most Indian software enterprises — firms develop and test their own code — poses real quality and delivery risks. "This [model] often leads to poor outcomes. Testing should never be done by the same firm and people writing the code," says Rodov, "as they lack objectivity and independence. Furthermore, when a project runs late or is over-budget, the same Indian firm will prioritize development, often cutting corners with vital testing operations."

For many business operations, the pendulum is beginning to swing back to North America. Many companies have done the math and now realize that some local providers can deliver better value and lower risk versus an offshore Indian solution.

Mitchell Osak is managing director of Quanta Consulting Inc. Quanta has delivered a variety of winning strategy and organizational transformation consulting and educational solutions to global Fortune 1000 organizations. Mitchell can be reached at mosak@quantaconsulting.com