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Tuesday, Dec 02, 2003

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Outsourcing for development

C. P. Chandrasekhar
Jayati Ghosh

UNCTAD's E-Commerce and Development Report 2003 uses India's experience to argue that the growing market for IT services and business process outsourcing offers poor countries a new development opportunity. C. P. Chandrasekhar and Jayati Ghosh examine the rather disparate evidence on the size, pace of growth and nature of this market to assess this argument.

THE use of information technology for development is the flavour of the season. With the World Summit on the Information Society (WSIS) slated for the second week of December, United Nations agencies, government, NGOs and, not the least, the industry with an eye on a big market, have all concentrated their attention on the potential benefits for developing countries from the use of information technology.

Conventionally, ICT4D, as it is often acronymised, involves the use of information technology for better governance (e-governance), for greater transparency and easier information access on government policies, programmes and performance, and for ensuring better delivery of a wider range of social services.

While there are a number of innovative and successful experiments with the use of ICT in these areas, most of them are not financially self-sustaining and are completely state or donor-funding dependent.

However, the UNCTAD's recently released report on E-Commerce and Development 2003 (ECD 2003), the third in an annual series, has, inter alia, chosen to look at the development benefits that could come from:

i) the productivity increases that the diffusion of the technology into the commodity producing sectors like manufacturing and agriculture could deliver; and ii) the growth of the market for business process outsourcing and IT-enabled services (BPO-ITeS), facilitated by information technology.

Both these are areas in which the benefits, if any, are commercial and can be targeted by private entrepreneurs. Of these, the first is still just an area with promise. In fact, even in the developed countries there is considerable controversy on whether IT is transforming the so-called "old economy" and enhancing its productivity.

Despite the upbeat survey of the literature and evidence on this count in the UNCTAD report, the fact remains that such benefits, if they are reaped at all, would take such a long time coming, that they are of little relevance to the pressing development problems in the poorer regions of the world.

However, the opportunities in software services and the BPO-ITeS areas are a different matter, since there is the evidence that a country like India is riding the wave of outsourcing and garnering large increases in revenues, employment and foreign exchange earnings.

As ECD 2003 puts it, "Outsourcing to offshore vendors or "offsourcing" is expected to continue growing in the near future," because "competitive advantages and economic pressures encourage companies located in the United States and Europe to look for partners in developing countries to deliver quality business services."

The pressure to outsource non-core operations and concentrate on core business functions has always been characteristic of large companies. Initially, this resulted in the hiving off of certain operations to be undertaken by specialised, local firms in the developed countries themselves.

The change now is that, with the increasing availability of cheap and better or larger network technology, communications infrastructure and bandwidth, many of these services can be managed and provided from remote locations.

So long as a cheap workforce with the requisite language abilities and skills can be found or created, this is an opportunity waiting to be exploited by developing countries, according to many. The evidence too seems to support this argument. As the ECD 2003 report argues, "many companies in certain developing countries (mainly India) have flourished by providing, in particular, software applications development and management services to clients worldwide."

It is true that India has certain specific, historically determined advantages, such as English language abilities that serve it well in the principal outsourcing market, the US; a large pool of educated and, in many cases, professionally trained manpower; and, above all, an autonomously evolved software services industry base.

However, even in countries without these advantages, other capabilities can, if combined with national government and international support, be used to win them a slot in the BPO-ITeS space. This is not necessarily true in the case of IT services which requires more advanced skills, but would definitely be true in the BPO-ITeS segments. The role for policy is then obvious.

The real questions relate to the premises on which this argument is based. To start with, it assumes that the hiving off of large chunks of crucial business process to be outsourced is a real, as opposed to a hypothetical, possibility in so many industries that we can expect the market to grow to a size that is large enough to benefit a reasonable number of developing countries. The difficulty here is that outsourcing as a business practice is itself relatively recent and outsourcing to developing countries so novel that assessments of the size of the market are all in the nature of predictions or projections.

These predictions and projections themselves are made by international consulting firms such as Forrester, Gartner and IDC, for sale at exorbitant prices to companies looking for ways to cut costs and restructure their operations or to those looking for new markets to venture into. In either case unless the reports are identifying new opportunities, they are unlikely to find buyers. Not surprisingly, selected bits of information, providing hints of a huge opportunity, are offered to the press to serve as teasers that would persuade them to acquire the full study or attend an expensive, executive education workshop to discuss its results.

Not surprisingly, there are many commonly quoted estimates of the IT services outsourcing and the ITeS-BPO market and projections of their growth. These often do not make clear which segment of the market is being spoken of. Partly as a result of this, they also differ substantially. Even estimates from the same source vary widely over time.

Thus, ECD 2003 quotes a Gartner estimate from 2002, which predicts that the ITeS/BPO market will grow to $300 billion by 2004. However, in June 2003, Gartner reported that the worldwide BPO market is expected to grow 10.5 per cent, to $122 billion, up from $110 billion in 2002. While this may possibly be because some ITeS segments were left out, it also is because of a change in sentiment.

Gartner analysts were now arguing that after several years of double-digit growth, delays in contract signings and lower negotiated rates for large BPO deals have led to moderate growth in 2002 and 2003. Gartner's principal analyst Rebecca Scholl is quoted as saying: "Although several large BPO deals of over $1 billion will be signed in 2003, there will be a decrease in growth linked to a period of disillusionment starting in 2004. 2004 corresponds to the five-year mark after the signature of several early BPO `mega-deals'. These deals will be renegotiated, in some instances re-competed, while other late adopters take on a `wait-and-see attitude'."

These signs of despondency are seen in other recent estimates as well. According to an August 2003 report titled BPO's Fragmented Future from leading technology-impact forecasting firm, Forrester Research, talk of a BPO market bonanza is a myth. The core BPO market, Forrester predicts, will grow to only $145 billion even by 2008. This is because firms looking to outsource core business processes such as human resources, and finance and administration because of significant cost savings, are not only reporting inability to find a single vendor who can manage such complex offerings, but also as being stalled by inflexible contracts, difficulty managing vendors, and a lack of performance metrics.

As a result, the market is likely to fragment into four segments: simple bulk transactions, such as credit card or stock trade processing (estimated $58 billion in 2008); broad shared services, such as finance and administration, indirect procurement, and HR ($57 billion); high-volume vertical processes, including policy administration, claims, and loan process applications ($6 billion); and, niche vertical applications, such as environmental data reporting and chemical process control monitoring ($24 billion).

Of these, the first is the easiest to master and is likely to be, along with the second, the area into which developing countries such as India would enter. But these would be the areas in which competition would result in a substantial squeeze in revenues per employee, leading to a reduction in wages and/or a squeeze of profit margins.

The limited size and possible slowing of the process of outsourcing raises questions about the other premises underlying the `BPO as development opportunity' argument. One is that the Indian experience hitherto can be replicated on the same scale in other developing countries, if supported with governmental and international assistance. The other is that the Indian experience marks a significant development advance and is sustainable.

It should be clear that if the experiment with business process outsourcing is already resulting in some degree of `rethink' in developed country corporate circles, leading to the fragmentation of the market, the restriction of remote outsourcing to those involving bulk transactions or broad shared resources, then the overoptimistic estimates of the likely size of the global outsourcing market (example, $585 billion by 2005 according to Goldman Sachs) is unlikely to materialise.

Even India's current presence in global outsourcing reflects its domination of the market, at 80 per cent of the total according to an (unconfirmed) estimate by newspaper Le Monde quoted by ECD 2003. If that market is unlikely to grow rapidly, then the space available for new players is indeed limited, unless the market is redistributed. That would mean, as we argue below, that BPO is no great opportunity even for a country like India. It would also mean that, as in the case of primary products, competition between developing country providers of lower end services would drive prices down and transfer the benefits of low wages to international corporations leaving little behind in the developing world.

The point is that even in the model country, namely India, BPO-ITeS is only an opportunity in the making. This comes through from figures quoted by NASSCOM, the industry body that is gung-ho about the potential in this area and has (unfortunately) emerged as the leading purveyor of information in this regard.

In 2002-03, NASSCOM estimates that IT software and services yielded revenues of Rs 60,000 crore or about 2.4 per cent of India's GDP (Chart 1). Exports accounted for a large part of these revenues, accounting for Rs 47, 500 crore, or close to 80 per cent (Chart 2). Further, in recent times growth of these revenues has been sustained by the rapid expansion of IT-enabled services. While revenues from IT services, which still constitutes 65 per cent of the total, grew by 18 per cent in 2002-03, that from IT-enabled services grew by 67 per cent (albeit from a smaller base) (Chart 3). Finally, while as recently as 1999-2000 just 35 per cent of these revenues were earned through offshore delivery, by 2002-03 that ratio had risen to 58 per cent (Table 1).

Rising offshore delivery reflects the ability of Indian firms to exploit in full the advantages of the new technology. Prior to the digital revolution's transformation of service activity, the provision of most services required the presence of a service provider at the point of delivery of the service. As a result, services export took the form of migration of personnel to the location where the service was provided, as epitomised by the migration of skilled technicians, doctors and nurses to the US and of semi-skilled and unskilled workers, including carpenters, masons, chauffeurs and housemaids to the Gulf countries from India.

Benefits to the home country came in the form of remittances of hard currency earnings by these migrants to their families, which augmented the scarce pool of foreign exchange available to these countries. But the magnitude of such income was limited by the restrictions on the movement of skilled and semi-skilled and unskilled personnel set by the immigration laws and practices of countries where the relevant service demand originated. In the IT services area, this form of delivery was reflected in the use of H1B visas to provide IT services onsite in the US, India's principal market.

The "BPO backlash" resulting from complaints of loss of jobs for American citizens or legal "aliens" has resulted in a decision of the US, to reduce the number of such visas from 195,000 to 65,000 starting 2004.

The digital revolution has helped overcome this obstacle. Now there is a range of services being provided by workers located in a country different from the one in which the service is actually delivered. These services are `outlocated' or outsourced and delivered via telecommunication or data networks from remote locations like India's metropolises.

The rapid increase in revenues from this form of delivery is what gives rise to optimism about the role that IT services can play in growth. The strategy driven by that optimism implicitly sees growth in services as more likely to deliver employment, income and export revenue increases than that in the commodity producing sectors. As a recent report in a business daily put it: "The leading Indian IT companies, the likes of TCS, Infosys and Wipro are rapidly overtaking the giants of Indian manufacturing such as Telco, Hindalco and L&T, when it comes to the number of people employed. ... The manufacturing sector in India seems to be witnessing its own version of jobless growth as companies shed workers to gain cost efficiencies and automation of menial jobs drives down the need for more workers. On the other hand, IT and ITeS companies are hiring, leveraging technology to grab the worldwide outsourcing market." The latter, to some extent, allows the government to ignore the fact that growth of employment in the commodity producing sectors has not merely decelerated sharply but is increasingly less responsive to increases in output — the jobless growth syndrome.

Needless to say, growth in IT services employment is relevant only to those capable of finding employment in the organised sector and even in that sector, the share of IT services is still a small proportion. The optimism that IT services generate is only because this is the only segment where employment is increasing significantly. The outsourcing dream is really confined to the bedrooms of India's numerically large but still minority middle class.

The dream is sustained because of the limited amount of reliable information and the hype that surrounds this area. NASSCOM routinely quotes IDC figures which point to the small share that India has in the world IT services and BPO market.

IT services spending in 2002-03 is estimated at $349 billion in 2002-03, in which year, the share of India's IT services exports is placed at just 2.8 per cent of the market worldwide and 3.9 per cent in the North American region (Table 2).

Further, worldwide ITeS-BPO spend in 2001 is estimated to have been $712 billion, with $451 billion of that being accounted for by the US (Table 3). This implies that even now India's share of the 2001 pie amounts to just 0.3 per cent of the world market and 0.5 per cent of the US market. If a rising share of this market is outsourced, India's opportunity is indeed immense. But as argued earlier, these estimates are excessively optimistic, when judged in the light of more recent predictions.

The problem is not just that the hype surrounding the Indian experience is based more on growth rates from a small base rather than the aggregate figures and their relation to economy-wide estimates. To make India a model at this stage is, therefore, to jump the gun. Particularly so, since the sustainability of the current trend is under question because of the BPO backlash.

Recently, computer major Dell, it appears, had decided to stop routing calls from some corporate and institutional customers to its India-based call-centre, and take them in the US instead. The decision ostensibly was a response to customer complaints about the services provided by the call centre's employees and their difficult-to-understand `thick' English accents. The rerouting decision, reports said, did not involve any cut in the size of the India operations. Dell itself denied that there was any plan to downsize. Yet, the media has been agog with the implications of the decision for India's outsourcing future.

While it would be partly correct to dismiss the attention devoted to this relatively minor incident as mere media sensationalism, it reflects real fears generated by recent developments. Before the Dell call-rerouting drama, the Indian industry and NASSCOM were concerned with efforts in the US to halt through protectionist legislation the outsourcing surge of the last few years. The stray New Jersey Bill has set off a torrent, and eight states have introduced legislation intended to ban or limit outsourcing of government contracts.

In a more dramatic development, the state of Indiana has cancelled a $15 million contract that has been awarded to Tata Consultancy Services. And virtually every major deal involving a shift of workplaces is catching the attention of the US media. If this is the response when India has acquired just a fraction of the market, however estimated, the backlash will only intensify as contracts currently being negotiated come to fruition.

It is in this context that the media attention to the Dell episode needs to be understood. If in addition to a backlash, if India's reputation as not just a cost-effective, but a quality provider of IT-enabled services is under challenge, American corporates may just choose to save themselves the criticism of exporting American job and outsource at home than offshore. This is a greater danger than the threat of competition from the likes of countries as diverse as Israel, the Philippines, China and Romania. The response to the backlash may be alarmist as NASSCOM spokesmen suggest. But it does point to the narrow and vulnerable area in which employment for India's educated unemployed is principally being delivered.

Moreover, outsourcing dreams as well as the nightmares indicate how much the international marketplace rather than the growth of the domestic market has come to be accepted as the principal source of new employment by the Indian middle class.

Migration, whether actual or digital, seems to be the limited and tenuous option that the current development strategy offers those who defend it most. This hardly can be the basis for a strategy to be recommended to the rest of the developing world.

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