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Behind the Indian outsourcing craze

perspectives In a conversation with McKinsey, the co-founder and chairman of one of India?s premier technology companies explains why global outsourcing is forcing IT change.

Behind the Indian outsourcing craze
From the McKinsey Quarterly
Special to CNET
November 30, 2003, 6:00 AM PT

India is fast becoming a global hub for back-office services as U.S. and European companies increasingly shift their IT services, call-center operations and other business processes to the subcontinent. What?s fueling the stampede, of course, is the desire to gain access to the country's lower-cost, high-quality labor--in some technology areas, higher-quality labor--as well as global technological changes that make it possible to offshore white-collar activities that once had to stay close to home.

Infosys Technologies, one of India?s premier technology services companies, is based in Bangalore, a region that has become ground zero for offshoring. Founded in 1981, Infosys helps Fortune 500 companies design, build and maintain very large business software applications, such as an integrated merchandising solution and a Web-based broker trading platform. The company also provides IT-consulting services.

Infosys grew modestly during its first decade, finishing 1991 with revenue of $3.89 million. The liberalization of the Indian economy in 1991 spurred the growth of the company, which took the opportunity to globalize its operations. Its revenue exploded to about $121 million by fiscal year 1998-99. Application-development costs in India were one-fifth of U.S. levels, so Western customers continued to jump on the offshoring bandwagon. By fiscal year 2002-03, the company?s revenues stood at $754 million.

Yet the Indian IT-outsourcing market is already changing, and analysts point to some dark clouds on the sector?s horizon. Giant IT services firms, such as Accenture and Electronic Data Systems, and many global IT-consulting firms, such as Computer Sciences Corporation are opening their own software-development centers in India. So are large Western software-product companies such as Microsoft and Oracle.

All these will compete with Indian companies for local talent. Global IT services firms also compete for work against Infosys and its Indian peers. Eventually, the software-product companies may even encroach on some service areas. At the same time, customers are squeezing IT vendors--including Indian technology firms--for price cuts across the board.

Narayana Murthy, the co-founder and chairman of Infosys, believes that his company is still well-positioned to compete with both Indian and Western challengers. Offshoring isn?t solely a matter of arbitraging low-cost labor, he argues. Providing low-cost, high-quality software-development services remotely requires well-developed processes for managing large-scale projects in distributed locations.

These are capabilities that Indian technology services companies have honed during the past two decades. In a conversation with McKinsey, Murthy discussed these capabilities, the economic differences between Indian and Western IT services firms and the challenges facing Infosys.

Q: Western companies have long had the opportunity to move IT services offshore, but until recently only a few pioneers did. Now the climate has changed dramatically. From your perspective, what has put the bloom in the offshoring rose?

Most chief information officers didn't believe that an Indian company could build the large applications they needed.
A: While the pressure on Western corporations to leverage the power of technology has been mounting for years, it became acute in the late '90s, and there was a tremendous shortage of trained manpower to do the application-development work involved. Infosys and other Indian companies have the trained manpower and can do the work while giving greater value for money. That, I would say, is what?s driving this.

But we also have had to work hard to create awareness among Western companies that we could do the work. In the early ?90s, when we went to the United States to sell our services, most chief information officers didn't believe that an Indian company could build the large applications they needed. The CIOs were very nice to us, of course. They offered us coffee or tea, listened to what we had to say and then said, "Look, don?t call us--we'll call you." We realized that there was a huge gap between, on the one hand, how prospective Western clients perceived Indian companies and, on the other, our own perception of our strengths.

How global is the offshoring wave? Are your clients primarily based in the United States or throughout the world?
We have offices in 16 countries--in the United States, Europe and Asia. The United States is a very important market for us: It is the country most open to outsourcing and to partnering with vendors to derive business benefits. Over 95 percent of our revenue comes from the G-7 countries (Group of Seven countries--Canada, France, Germany, Great Britain, Italy, Japan and the United States). In fact, out of our total revenue, about 73 percent comes from the United States, about 17 percent from Europe, about 5 percent from Japan, and the rest from elsewhere in the world.

But the boom in offshoring has also inspired U.S.-based services companies such as Accenture to open up operations in India--essentially to compete with you on your own terms in your own backyard. What will this mean for Infosys?
I think we're well-positioned against the big multinational IT services companies, such as Accenture, IBM Global Services, and EDS. Their customers now have a greater awareness that Indian companies can offer very high-quality application-development and IT-consulting services at much lower cost. The U.S. IT services firms are under tremendous pressure from their customers to demonstrate better value for money. That is why they are now here--to lower their costs.

But their coming here doesn?t change the basic economic difference between their businesses and ours. Typically, in the application-development work we would do for an average client, about 70 percent of the effort is done in India or another cost-competitive country. Our general and administrative expenses are centered primarily in India and are about 7.5 percent of revenues today. By contrast, the U.S. companies that are our competitors, despite a strong presence in a country like India, by and large have the majority of their work force in the United States or in the local market. It is not easy to let go of that work force. So the economics differ.

Also, it's not easy for the multinationals to create a work force equal to ours in a country like India. The multinationals have to compete here for the talent and then train the people. There are many processes that have to be built up over a period of time to do that effectively. And of course, just having talented employees trained to deliver services is not enough. We have developed tools, methodologies, processes, and the management expertise for providing services to clients across geographic distances.

We develop software in a geographically distributed way, in collaboration with customers. Our approach takes advantage of the 24-hour workday. It's not just a question of renting a building and hiring a few people and then saying to customers, "The shop is open." So for now, our primary competitors will continue to be India-based companies, such as Tata Consultancy Services and Wipro.

What you're saying is that offshoring is more than just a game of arbitraging labor costs. It's also about having distinctive capabilities.
Yes. It's about distinctive capabilities that leverage the economic advantage of having cost-effective talent. Let me tell you a little more about those capabilities. Infosys was the first company to articulate the concept of a global delivery model. In this model, we partition a large-scale software-development project into two categories of tasks. The first includes those that must be done close to the customer. The second consists of tasks that can be done remotely in talent-rich, scalable, process-driven, technology-enabled development centers located in cost-competitive countries like India.

It's not just a question of renting a building and hiring a few people and then saying to customers, "The shop is open."
The first category of activities--the ones that must be done close to the customer--involves defining the project with the client and helping the client to install and use the software once it is developed. These activities include business consulting, IT consulting, defining requirements, installing the software, training the customer to use it, and rapid-reaction maintenance services. The second category of activities--the ones done in our development centers in India--consists of technology tasks done most cost-effectively in remote locations. They include detailed function-design tasks, detailed technical design, database design, programming, testing, creating documentation and long-term maintenance services.

Tell us a little more about how you hire and train talent in India.
In August, a survey of engineering-college students in India rated Infosys as the No. 1 company to work for. This is one way in which we are very competitive with respect to other Indian IT services companies. We are also 10 to 15 percent more productive, per capita, than most of our competitors in India. Last quarter, we received over 250,000 employment applications from students, and we recruited about 2,600 people, which is about 1 percent.

You know, most of these students have excelled academically at engineering school. We put them through a rigorous test for "learnability" before hiring them. New hires go through a 14-week training program where we teach them generic analytical-thinking and problem-solving skills. We also teach them general principles of operating systems, database-management systems, networking, and so on. In later training sessions, we teach them customer-facing and negotiation skills.

To what extent do you measure the performance of your processes?
With our tremendous focus on systems and processes, we lay great emphasis on measurement. In fact, the capability maturity model--we are accredited at level 5, which is the highest level--requires the measurement of quality and productivity at every phase of the software-development life cycle. We measure people?s performance closely as well. Anywhere from 25 to 50 percent of an employee?s salary is variable, based upon the performance of the company, the team and the individual.

We collect data and we use data. Let me give you an example. To manage risk, we make sure we do not depend too much on any one customer, any one technology area, any one application area, and so on. For example, we measure and monitor around 120 parameters on a weekly basis, including macro and micro measures, looking at various markets, various technologies, various customers and employees. Our risk-mitigation group reviews this data and makes recommendations on actions we should take to manage risks. An internal group of company executives meets every two weeks to discuss the analyses and recommendations of the risk-mitigation group.

How sustainable is your model? In your sector, pricing is under increased pressure. Some large prospective customers are opening their own development centers in India. China is looming as a new market for low-cost technology talent. And in any sector, competitors eventually replicate or duplicate a successful company's capabilities.
I think our focus on speed, imagination, and excellence in execution is a sustainable competitive difference between us and others. So is our ability to attract and train the best talent in India.

At the same time, we are moving into higher-margin businesses. For example, last quarter, our enterprise services group accounted for 14 percent of our total revenue, and the group?s margins are much higher than those of our other practices. We are developing the skills to do more IT consulting, and now, business consulting. We have somewhere around 300 business consultants. These are people who do work that then leads to downstream software work. We have also started a systems integration practice as well as a business-process-outsourcing arm. We want to provide a large portfolio of services to our customers.

In China we just opened an office, which we will convert into a subsidiary. We believe that China is an important market, both for potential customers and for talent.

As you move into these new services--competing with large IT services companies that have established capabilities in these lines--what do you see as your challenges?

The multinationals have to compete here for the talent and then train the people.
There are many. Our biggest challenge is to become proactive problem definers rather than be reactive problem solvers. Right now, we solve problems our customers define. We need to be able to go to customers and say, "These are the problems we believe you will face, and here are some solutions." Our focus is on providing solutions leveraging IT. We need to help shape the design of the technology solutions and then implement those solutions. This is the biggest challenge we face--there?s no doubt about that.

The second challenge is to become more and more and more multicultural. Employees of 38 nationalities work for Infosys. We have efforts under way to integrate people across various cultures?And finally, the third challenge is to continue to retain the soul of a small organization in the body of a large organization. We now have more than 19,000 employees worldwide.

It will be tricky to balance the tension between scaling the organization as quickly as we have been doing against the need to maintain disciplined processes as well as an integrated multicultural organization.

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Copyright © 1992-2003 McKinsey & Company, Inc.

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