As I began to re-read the article querying if "the Party Over for Indian Outsourcers?"

Musting from others in the Industry using the article as a launch pad:

  • William Trent: I recently addressed concerns that Cognizant’s (CTSH) growth - as well as that of other Indian outsourcing firms - may be peaking. Now it seems that those in thee industry may be wondering the same thing. . . It is healthy that industry insiders are beginning to worry about the issue. Nothing is more dangerous than cocky management teams. For investors, though, there still needs to be an adjustment to the risks that growth will not be what it used to be.
  • Chuck Blogs: I mentioned this a few weeks ago. Here’s more on the topic from Business Week. Basically, the aren’t as many people available to fill the outsourcing demand, the rupee is rising against the dollar, wages are rising, and there’s more competition for existing talent. Visas to the US are running short too
  • Agave Mountain blogs: I usually ignore the hyperbole when it comes to Indian outsourcing. Articles about outsourcing generally fall into one of two categories: 1) business articles that exaggerate the benefits of outsourcing to with little factual data, or 2) visceral anti-outsourcing propaganda. However, Business Week has produced an interesting snapshot of the challenges faced by Indian Outsourcers: a falling US dollar, increased competition, lack of innovation, limits on the H1B Visas, and a severe shortage of technical labor. Perhaps most shocking is the admission that Tata is taking general science/math grads and putting them through a "7 month" program and then making them coders. Paradoxically, someone with seven months of training is billed at the same cost as a senior developer.
  • Members on a discussion forum wonder: Its a very Long Article but well worth reading....what are the affects of this IT scene in Pak and what good is it going to do for People/Companies in US. is Outsourcing is really going down among US companies and now instead of some company run by indians, its the IBM's and others are gettign that Outsourced work done

I began to jot down a few major flaws in the argument that Kripalani seems to be making in the article. My comments embedded. - Mohan [Opinions here are mine personally, and not that of my employer]

Is the Party Over for Indian Outsourcers?

Infosys, TCS, and Wipro still rake in profits, but they face challenges ranging from a stronger rupee to the likes of IBM and Accenture romping on their home turf

In late July, rumors swirled that Infosys Technologies (INFY) might be readying a takeover offer for Cap Gemini (CGEMY) or another major tech-services player in the U.S. or Europe. So on July 25, when the company alerted the press and the markets that it had a major announcement, there was a great deal of anticipation.

Instead, Infosys unveiled a $250 million outsourcing contract with Royal Philips Electronics (PHG) of the Netherlands. It was an acquisition of sorts, the company said, at least of the outsourcing centers that belonged to Philips. "We're taking the model to a newer level," said Chief Executive Kris Gopalakrishnan.

Landing a new contract certainly isn't bad news, but the development was somewhat deflating for those who believe that Infosys needs to redefine and reposition itself in the multibillion-dollar arena for global outsourcing services. In fact, Infosys and other Indian outsourcers are facing a raft of competitive challenges that will require some dramatic new strategies.

Adversities Add Up

True, India's biggest outsourcing firms continue to rake in the profits, at least judging by the latest earnings season. The top five players—Tata Consultancy Services (TACSF), Infosys, Wipro (WIT), Cognizant (CTSH), and Satyam (SAY)—reported robust profits in the quarter ended June, 2007. And executives generally forecast strong growth ahead.

"We're very happy with having beaten the forecast," said CEO and Managing Director S. Ramadorai of the $3.1 billion Tata Consultancy Services in Bombay. "TCS, as the leader, is doing well." Ramadorai predicts $60 billion in tech-services exports for the industry by 2010, nearly twice the current $35 billion, plus $20 billion in revenue from domestic business.

Yet behind this show of supreme confidence lurks deep unease. A confluence of adversities is at play. They include an appreciating rupee that is cutting into earnings, a severe shortage of qualified talent at home, and a cap on H-1B worker visas to the U.S., along with pre-2008 election protectionism threats.

Mohan>> IBM, Accenture and EDS too are crippled by the same archaic visa regulations and bottlenecks. Case-in-point is Microsoft's decision to move R&D to Vancouver in Canada, across the border to Redmond for the same reason.

If All IT players in the offshoring business are hit by this bottleneck, why do the writers claim that the problem is unique to Indians alone?

Diminishing Returns

On top of that, there is the end of preferential industry tax benefits at home and the growing success of multinational competitors such as Accenture (ACN) and IBM (IBM) on Indian turf. Perhaps most challenging for the Indian players is the pressing need to move up the ladder into business consulting, a domain that companies such as IBM have dominated for decades. Indian outsourcing firms need to invest heavily to secure a position in this arena, and that will erode their fat profits, at least in the short term.

For the first time, industry insiders are asking: Is the outsourcing game over for Bangalore? "The Indian IT companies have had an unusually long run in profits and growth," says Siddharth Pai, partner and managing director of global tech advisory TPI Advisory Services India. But that's "an anomaly," he adds. "As they mature, they can't expect the same kinds of returns."

Mohan>> Diminishing returns typically translates to either innovation or consolidation. The railroad boom in England a few centuries ago lead to an industry wide consolidation. The automotive boom in the early twentieth century in America lead to the demarcation of the turf by 'big three' automakers.

The Indian IT scene has long been dominated by Big-three - Infosys, TCS and Wipro. The tier-2 and tier-3 are almost non-existent. It is not sure if the author is suggesting a consolidation among the tier-1 players?

And mature they must. For the past decade, Indian software-services firms, which pioneered the business of delivering tech services to the developed world from India efficiently and at 40% of the cost of companies such as IBM, have grown exponentially. Revenues exploded from a mere $1 billion in 1997 to $35 billion in 2007.

Outsiders' Edge

At first, their multinational competitors such as IBM Global Services, Accenture, and Electronic Data Systems (EDS) were taken by surprise. But then they joined in the new game, setting up shop in India and leapfrogging by making local acquisitions, hiring aggressively, and offering similar services to their clients. As of June, the three multinationals alone have 100,000 professionals on their rolls in India. That's about a third of the top three Indian players, and the multinationals only began hiring three years ago.

Mohan>>'Outsiders' certainly have an edge: an edge in poaching trained employees from tier-1 Indian sourcing giants. Not many realize that a majority of the 100,000 that the multinationals claim to employ are employees poached from Indian companies; employees who probably joined as 'freshers,' got trained and productive at a considerable expense. Now, who is subsidizing whom?

Now that the competition is evening out at the bottom of the business, the battleground will start to move up to the higher end—business consulting and the integration of the offshore and on-site services. Here, the multinationals clearly have an edge. Not only have they been providing consulting services for decades, but they have been doing it across geographic borders, using experienced talent and cultivating long-term and deep relationships with customers. More important, companies have been investing in research and product development for decades—in 2006, IBM spent $6.2 billion on research and development, and its largest R&D center outside the U.S. is in Bangalore.

Mohan>>Not much argument here. R&D, investment in products and solutions that can be replicated is the forte of the IBMs. This said, tier-1 Indian giants are certainly catching on here too.

This said, the author conveniently omits Indian software product innovations including Infosys’ Finacle, iflex’ flexcube that have lead the domestic banking modernization

Indian companies, in contrast, have almost no research and development and spend very little on it. They began building their high-end consulting services only two years ago, and all of them have done so organically. Infosys began Infosys Consulting in Fremont, Calif. Wipro has been making small but strategic acquisitions in the U.S. and Europe. And TCS, which has the widest reach with 150 offices and 79 development centers worldwide, says that 3% of its revenue now comes from consulting. That's peanuts compared with foreign rivals.

Lagging the Competition

Nor have the Indians attempted to leapfrog into the big league through a major acquisition. "They have to, they should, to get a global footprint," says Avinash Vashistha of New York outsourcing consultancy Neo-IT. Do they lack confidence? Certainly, "the levers and supportive environment they have in India are not available to them overseas," says Kris Wadia, executive partner, global sourcing, at Accenture.

Mohan>>What supportive environment is Wadia alluding to, one wonders? He is probably aware of the bureaucracy and redtape that permeates Indian business. Fact remains corporate India, Indian software services firms included, have to jump through the hoops; the same hoops that the Accentures have to jump through.

Indeed, the tech industry in India is so pampered by New Delhi, and so admired by ordinary Indians, that they have been lagging behind the competition. Industry trade group Nasscom recently released a report on the necessity of Indian companies to begin to innovate to survive, and suggested the establishment of an ecosystem for innovation, helped by policy initiatives.

But while India lacks a formal innovation culture, one would never know from the assumed superiority over foreign rivals. Indian firms are simply unable, culturally, to absorb a Western company. Industry analysts say Indian companies such as Infosys are hierarchical, and have an elitist view of their business and suffer from "conceptual Brahmanism," referring to the group at the upper echelon of the Indian caste system.

Mohan>>While this may be true in large part, and the growth in the Indian software services sector has primarily been organic, one should not generalize. It is a matter of time before IT executives take a page out of Tata-Chorus or Mittal's M&A handbook. And speaking of conceptual Brahmanism, is the author referring to the Boston Brahmins or the (in)famous hold of the Skull andBones on Corporate America?

IBM's India Buildup

There's a ring of truth in that. While the companies all employ Indians and some foreigners from across economic and social lines, the top rungs of both Infosys and Tata Consultancy are dominated by upper-caste South Indians. Satyam has a big contingent of employees from the company's native state of Andhra Pradesh. Integrating a Western firm into that closed culture could be problematic. Infosys Chief Operating Officer S.D. Shibulal dismisses the inability to acquire, saying only: "We are perfectly capable of building things organically."

Companies such as IBM have taken a more democratic approach to building their business. The company began competing with the Indians in the outsourced tech-services business just three years ago, when it acquired Daksh, a call center. Since then, IBM has made plenty of acquisitions in India, absorbed them, and also organically expanded its business. Today, IBM has 3,000 workers dedicated to research and development at its offices in Bangalore. It is the largest R&D operation outside of the U.S. center in Armonk, N.Y., but one that is integrated with all of IBM's nine research centers around the world. Last year, IBM saw a 385% increase in patent filings from its India office.

IBM is already the dominant player at the top end of the tech-services market, with its large and established consulting business, and now it has also mastered the bottom end of the market, which offers low-cost servicing. More important, IBM is the leader in the Indian market for technology services, a market that the Indians have always overlooked. According to tech research firm Interactive Data (IDC), IBM has the largest market share in India, at 10% of the total $3.7 billion market, and customers across the board from the state tax department to the private players.

Missing Homegrown Opportunities

In fact, IBM is the top choice of India globally. Ambitious Indian corporations such as Bharti Airtel, since 2004, have outsourced roughly $1 billion worth of tech services to firms such as IBM with global expertise. In March, IBM bagged an $800 million, 10-year contract with Idea Cellular (IDEAF), formerly co-owned by Tata, Aditya Birla, and AT&T but now by the Birla group. In the first six months of this year alone, $1.4 billion in domestic telecom deals were grabbed by the multinationals.

According to researcher Gartner (IT), over the next two years, Indian companies in the private and state sector, from banks to the railways, are expected to spend an estimated $5 billion on new technology, all of which will need to be serviced. Save for Tata Consultancy, 9% of whose business is domestic, the Indian players have largely focused on exports and missed the big opportunity in their own backyard. Nasscom estimates that just a quarter of the revenues of Indian outsourcers are domestic, though it's growing at 22% a year. This year, for the first time though, Infosys said that it would bid for domestic business, admitting that the "home market has reached a level of maturity."

Of course, companies such as IBM in India share some of the same constraints as their local competitors. India is in the throes of a severe talent shortage in sectors from tech to retail to research. Part of the problem is the emergence of new businesses such as retail and telecom in which India has no prior expertise. But a significant part is the country's creaking education infrastructure, which isn't producing enough qualified engineering candidates who can be productive employees immediately.

Visa Restraints Hurt

Tata Consultancy, for example, is now mining deep for potential candidates, hiring not engineers, but math and science grads from colleges and putting them through a seven-month training course. "About 20% of our new employees are non-engineers, and that number will increase," admits TCS' Ramadorai. IBM solves the problem by paying higher salaries, but only recruiting engineers.

But what's strictly an Indian headache is the visa situation in the U.S. Just 65,000 H-1B legal worker visas are issued by the U.S., a strain on Indian firms that need to send their engineers to work in their U.S. clients' offices. The demand is so huge that for the last two years, on Apr. 1, the day that U.S. immigration officials release the quota for H-1B visas, nearly all are snapped up by Indian tech companies (see BusinessWeek.com, 2/8/07, "Work Visas May Work Against the U.S.").

With a Presidential election coming up in 2008, visas promise to be a hot-button issue. Already, companies such as Infosys and Patni Computers (PATIF) have been penalized by states such as California for not paying their H-1B employees market wages. The Indians are hiring locally, but it will surely affect their low-cost advantage. The Indians are doing "awesomely well," says IBM's software research chief in India, Harish Grama, "but what are they doing to stay in the game?"

Mohan>> Visa restrictions hurt offshoring. Period. Even multinational/global software giants like Microsoft are lobbying for reform in the sector. So it is not just an Indian challenge; right?

Overcoming a Fixation on Margins

The Indians defend their position stoutly. "Now, we are in the same position as IBM or Accenture, where people treat you like a partner and consultant, not a vendor," says Ramadorai of TCS. Indian companies, he adds, are spending increasingly on innovation. TCS says it has developed a full range of services, global network delivery, intellectual property, deep knowledge of different industries, and is starting to invest heavily in innovation, working together with clients. Ditto with Infosys, which has increased its R&D spending to $12 million this year, for instance. Wipro has made R&D a business to be outsourced from people, but that too is not sophisticated, cutting-edge work.

The future, say industry analysts, lies in doing things the multinational way: embracing innovation, consulting, and geographical expansion. To get there, Indian companies must get over their "25% margin fixation," says Ashish Thadani of Gilford Securities, who covers Indian tech companies listed in New York. "Those continuing high margins mean you are probably underinvesting for the future."

Mohan>> A nice theory to preach to graduate students in management schools. But is it a lesson to preach to Indian software giants who helped create the market?

Kripalani is BusinessWeek's Mumbai bureau chief.
With Nandini Lakshman in Mumba


- Mohan [Opinions here are mine personally, and not that of my employer]