In 2011 and 2012, firms will restructure their offshore outsourcing contracts and enter rate card negotiations with their providers. Offshore rate cards are influenced by nine overarching industry factors. If India’s offshore service providers want to maintain their profitability, clients will have to expect a rate increase between six and nine per cent. While some providers boost full sales pipelines and will be unwilling to sacrifice profitability for discounts, other multi-national providers are currently struggling to meet their headquarters’ offshore penetration targets in some geographies and will go a long way to pocket more deals. However, providers will try to recover from such discounts via shortcuts potentially leading to mid-term delivery problems and long-term pressures to increase rates even further.
Increasingly, offshoring IT and BPO work to India is seen as an opportunity not to only reap savings in costs, but also to industrialize the delivery process. As the market slowly comes out of a recession, firms are thinking about restructuring their contracts with offshore providers.
We notice that:
- Clients negotiate offshore rates with their providers – but don’t know the fair market rate.
- Clients are going through a provider consolidation process and allocate more volume to selected providers. Still, providers cite margin pressures and are unwilling to give sizeable discounts.
- Clients overestimate the measures available to an offshore provider to recover from discounts.
The following are the top nine factors which will influence India’s offshore cost rates in ITO and BPO projects in the second half of 2011 and 2012.
Factor 1: Direct cost percentage / overhead ratio
Indian offshore providers achieved savings of 5 to 6 per cent of their operating costs during the recession of 2008-09 and are continuing with their efforts in light of an on-going weak economy. They have also implemented measures to reduce their bench, i.e. the number of people being idle and waiting for a project. As a rough guideline across the industry, about 45 per cent of the costs are directly attributable to an Indian consultant; the remaining 55 per cent are overhead costs.
Firms of Indian Origin (FIOs, also called ‘pure-players’) have long had a competitive cost advantage over multi-national companies (MNCs) due to their reduced onsite presence and lower salary levels in India. However, as well as MNCs are currently investing into better industrialized delivery models in order to keep up with the FIOs, the FIOs themselves are expanding into the Western world and strengthening their onsite presence. This requires an initial and on-going investment into more expensive employees, which at the end of the day, adds to the overhead of the cost rates.
Factor 2: Staffing pyramid
A major driver of offshore rate costs is the staffing pyramid. Clients may believe that they pay a rate per level, however, as there is a scarcity of experienced senior consultants and middle managers, their rates are often ‘subsidized’ through the rates charged for the most junior people. After all, annual salaries start at USD 5,000 for new joiners (so-called ‘freshers’) and can easily go up to and beyond USD 40,000 for project managers with no end at the pay scale for Directors and Vice Presidents.[i] On the other hand, end-client charge-out rates for project managers are at most a factor of 2.5 or 3.0 as compared to freshers thus not entirely recovering the salary costs.
Offshore providers are moving towards hiring more and more freshers rather than already experienced personnel in order to make full use of the salary leverage at the lower end of the pyramid. For instance, in 2011 Wipro aims to recruit 70 per cent of new joiners directly from campus – up from 45 per cent in 2010.[ii] They also take more and more science and commerce graduates on board rather than graduates form computing and engineering disciplines. This is partly driven by the lack of qualified engineering graduates, but is also a means of further lowering the average entry-level salaries. Also, science and commerce graduates are more likely to stay with the same company and work in the same project for a longer period of time as they will need to gather knowledge and experience for a longer time before they can prove their worth as an experienced resource to another employer.
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[i] See the table with salary bandwidth in the book ‘Working with India’ by Wolfgang Messner (Springer 2008, p81): http://www.globusresearch.com/workingwithindia.htm.
[ii] See the Financial Times article by M Palmer and J Fontanella-Khan on ‘Fresh Blood at heart of Wipro’s Revamp’ of 15 May 2011 http://www.ft.com/cms/s/2/6416a0f8-7f21-11e0-b239-00144feabdc0.html (accessed 13 Jun 2011). Azim Premji, chairman and majority owner of Wipro is quoted as: “I think we have enough people in middle management and supervisory levels. We don’t want to be top-heavy. What we are doing is recruiting 70 per cent of our people from campus now. Whereas last year, we recruited just 45 per cent from campus”.