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Will India price itself out of offshore market?

Growing demand from the United States for offshore services in India is raising the cost of labor there, causing U.S. firms to begin eyeing China, Romania and other options. But India has some tricks up its sleeve.

The U.S. technology industry's demand for offshore services is apparently beginning to drive up pay rates in India, raising questions about the long-term benefits of outsourcing work to that country.


What's new:
Growing demand from the United States for offshore services in India is raising the cost of labor there, causing U.S. firms to begin eyeing China, Romania and other options.

Bottom line:
Even if companies turn to other countries for outsourcing, India would by no means be in dire straits. India's offshoring business is more advanced than those of other countries and has unique benefits. Many executives of Indian companies also believe political changes will help their industry start developing technologies of its own.

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Information technology workers in India reported double-digit salary growth in 2003, according to recent research, while pay for similar work within U.S. borders has been relatively stagnant if not declining. Although India's salaries generally remain significantly lower than U.S. averages, the narrowing wage gap and other unforeseen factors are leading at least some American companies to reassess the cost savings to be had by sending work offshore.

"Expectations about the benefits of outsourcing are becoming more realistic," according to a report by DiamondCluster International, a Chicago-based consulting firm, which recently released a survey of more than 180 companies involved in offshore outsourcing. "Most buyers in the previous study expected gains in efficiency in the range of 50 percent. Today, those expectations have declined to 10 to 20 percent."

India's wage inflation, which approached an estimated 14 percent last year, is a natural byproduct of a classic supply-and-demand scenario. Although projections for outsourcing remain highly speculative, Forrester Research has estimated that 3.3 million American jobs will be moved to other countries by 2015. But as far back as a year ago, India technology trade association Nasscom (National Association of Software and Services Companies) was already concerned that India would fall short of demand for workers by as many as 235,000 professionals.

India quickly became the outsourcing nation of choice for U.S. companies years ago because of its abundance of engineers, large English-speaking population and historical ties to Western countries, as well as its relatively low labor costs. So it is understandable that wages there would eventually rise as demand increased, especially as the expanding technology market has created new prosperity and begun to raise the cost of living in some parts of the country.

"If you had to come to Bangalore today, you would see very significant signs of development, a lot of new construction, a lot of young people, a lot of energy, a lot of shops and restaurants," said Nandan Nilekani, co-founder and CEO of Infosys Technologies, in a recent interview with CNET "I think you get a sense of economic vitality that can largely be traced to the IT explosion."

India reported gains of 12.8 percent and 13.7 percent last year for positions in categories labeled "IT solution provider" and "software development," according to an annual Asia-Pacific survey of more than 500 companies by Hewitt Associates, an international business consultancy. The numbers, which reverse a six-year decline in pay raises in India, are far more than any increases reported among other nations surveyed.

By region, India's highest increases were reported in Chennai, at an average of 13.5 percent, followed by Bangalore, with 12.5 percent, and Kolkata, with 11.5 percent. For 2004, the study predicts that average wages will rise again, as much as 13.4 percent.

Choosing China
Though it is too early to predict any sort of bubble on the horizon, the rise in India's salaries could prompt more U.S. companies to consider other parts of the world, where wages are far lower. Indeed, even some Indian companies have begun offshoring their own work to China.

"Tata Consultancy Services, one of India's four largest exporters of software, has begun to offshore its staff," the American Electronics Association says in a new report. "By 2005, TCS plans to have 3,000 software engineers in China, or 15 percent of their global work force."

China's universities, like those in India, award more bachelor's degrees in engineering than their counterparts in the United States. Yet China's wage growth rate for technology jobs was about half as much as India's, according to the Hewitt study. U.S. pay rose 3.3 percent to 3.5 percent, the lowest increases ever recorded for American technology positions in the annual survey.

Eastern Europe may also become more attractive as an offshoring center. Last September, a research report estimated that a recent graduate of a specialist university in Romania could be hired for $6,500 a year in software development. An additional possibility is Russia, another country that produces more bachelor's degrees in engineering than the United States.

"There is great competition for cost, and there is a view that India is getting more expensive," said Pete Foster, a research director at Pierre Audoin Consultants, which released the report. "Europe represents a good opportunity and a new area to find resources--but it is virtually ignored by the U.K."

Even if companies turn to other countries for outsourcing work, however, India's technology industry would by no means be in dire straits. Executives and analysts on both sides of the Pacific agree that India's offshoring business is far more advanced than those of other countries and has unique benefits ranging from common language to Western-like entrepreneurialism. Most Indian technology companies offer stock options and other forms of compensation linked to performance.

"India's education system and culture foster risk-taking," said George Gilbert, managing partner of the Tech Strategy Group consultancy and former market analyst with Credit Suisse First Boston. "They also have financial backing and geographic intensity in Bangalore and New Delhi."

And India's technological future is not limited to offshore services. Many executives of Indian companies believe that political changes in the last decade will help their industry become more independent and develop technologies of its own, rather than simply service those made in the United States and elsewhere. As a result, business leaders say India will become a "knowledge center" for the global technology economy.

"India has undergone a series of reforms, opening itself to globalization and investment, leading to innovation, opportunities and jobs for its indigenous population that heretofore never existed," the American Electronics Association said in its report. "Before these reforms, India did not welcome foreign investment, had strong protection and trade policies and questionable intellectual-property protections."

At the same time, however, politics could also have a negative effect on India's international business and work against further wage increases. Potential customers may avoid the region altogether because of recent news about terrorist calls for attacks on the sitting government of neighboring Pakistan and conflicts along the border between that country and India.

"Eighty percent of offshoring work is done in India. It's raising the question of, 'How do I protect myself in the event of some negative catastrophe?'" said Dean Davison, lead analyst on outsourcing for the Meta Group consultancy. "Even though the risk of going offshore might not really be that much higher, there's going to be a lot of companies that go to domestic vendors just so that they have the perception of not having higher risk."