Offshoring to India: Then and now - Views on News from Equitymaster

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Offshoring to India: Then and now

Jun 7, 2007

The US accounts for a disproportionate share of Indian software service exports. This share, which has remained stable at about 60%, is much greater than the US share in software development globally, especially when one looks at the development of custom built software. Since the Indian software industry is competitive because prices closely reflect costs rather than customer value, the US companies have benefited disproportionately from the services of the Indian software industry. Indian software companies offer low costs and customised (as per client’s requirements) low-end software services such as maintenance and application development & enhancement. Large teams can be assembled at much shorter notice and projects can be terminated with much greater flexibility. Thus, despite rising wage costs, offshore development will continue to offer cost savings of 30% to 40% for companies that outsource jobs to India. As Indian companies mature, and as US companies develop greater confidence in their vendors, the offshore component should increase, thereby lowering costs and offsetting some of the wage increases. The option of outsourcing has been of great value to US companies. Outsourcing to Indian companies allowed them (US companies) to use in-house staff for more valuable and creative activities, such as the development of new business applications with greater potential for influencing the firms’ growth.

We believe that, against all hype and hoopla, Indian software companies do not pose serious competitive challenge to US tech majors. Indeed, for the most part, they complement the US software industry, with the possible exception of those US companies that provide staff expansion and software services. Indian software professionals are substitutes, albeit imperfect substitutes, for their US based counterparts. Economic theory, and common sense, tells us that an increase in the supply of a substitute will reduce prices or prevent them from rising as much as they might otherwise have risen. It follows that outsourcing to India will have a negative impact on US based programmers, at least in the short run. However, it is not possible to get more specific than this because many of the services performed by Indian software companies are said to be those that US programmers are reluctant to perform, such as maintenance of old applications, and in general, working with older platforms and languages. Thus, were outsourcing to India not as extensive, US outsourcers might have delayed or postponed a variety of activities, thereby moderating any increase in demand for US based programmers.

The initial US experience with software outsourcing to India
The most frequently cited initial reasons for outsourcing to India was to do with the shortage of skilled professionals in the US. Companies claimed that they simply could not find enough software professionals fast enough for their projects. In addition, these companies outsourced because they did not wanted to invest in in-house capability in areas outside their core-competence such as developing applications for old computing platforms and did wanted to free their in-house IT staff from routine maintenance tasks for more creative projects. The companies in the US cited the ability of Indian vendors to assemble ‘functional’ teams of engineers at a very short notice as an important reason for outsourcing to India.

The companies engaged in developing software products emphasised the need for accelerating such development in the face of ever-shorter product lifecycles. Another advantage was that outsourcing to India allowed these companies the option of round the clock operations. Other reasons given in favour of outsourcing were availability of excellent programming and coding skills available in India. It was said that the Indian vendors were good and willing learners, and receptive to new ideas, and flexible in terms of the software and hardware platforms for which they provide services.

The most common reason was that outsourcing helped companies to reduce costs. They, in the initial phase downplayed this issue, insisting that cost was a relatively minor consideration and that there were other costs involved in outsourcing that partially offset lower wage costs in India. This appears to be a response to the prevailing concern in the US about the possible harm to US engineers from software outsourcing and inflow of foreign software programmers.

The current US experience with software outsourcing to India
The US companies now think that cost considerations are important and the apparent downplaying of cost considerations is inconsistent with the extensive price competition that prevails in the Indian software industry. Actually the fact is that companies that outsource extensively to India tend to have more than one vendor, and in some cases, as many as three to four vendors. In more than one case, long-standing vendors have been replaced after they failed to agree to lower rates. There have also been a number of areas of dissatisfaction. Many companies feel that Indian companies had no domain knowledge and poor management skills. Secondly, most of the managers believed that Indian companies could not work on high-level specifications or project definition stages of a project. However, we feel that this belief is unproven.

Third, the US companies consider that the employee attrition is a big problem and expect their Indian suppliers to tackle it quickly. Additional dissatisfaction is about the low productivity. In addition, there are also a number of cultural and political issues that the US companies perceive as irritants or barriers. One such issue is the apparent ‘unwillingness of Indian software professionals to point out potential problems up-front, and in general, an unwillingness to say no for fear of offending the clients’. Another related weakness is the lack of familiarity of many Indian companies and professionals with the work culture and work norms in the US.

Whatever may be the outcome of the current political embarrassment regarding the outsourcing issue, the fact is that the high-tech industry in the US has opposed the immigration bill being debated in the Senate stating that the measure would harm the US technology industry. We believe that the anti immigration bill will not do enough to compensate for a shortage of skilled workers and will make it more difficult for the US companies to hire qualified people from overseas.

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