Day 2: McKinsey says offshore outsourcing to boom

MUMBAI: The ITES-BPO segment is expected to grow in FY 2003 by 60 per cent,

blistering by today’s standards, to reach $2.4 B. However, the challenges the

industry is facing are different from the ones last year. This year, the

uppermost concern is the geo-political risk, the threat of war, and the

political backlash of US federal governments.

The drivers for this model from the demand side are the increasing impact of

labor costs, shifting demographics resulting in a decline in active workforce,

and the slowdown in the global economy forcing companies to cut costs through

downsizing, process reengineering, and new models like offshore outsourcing.

Labor costs in the developed economies have been rising because of which the

split between infrastructure cost and manpower cost is not in the favor of the

onshore model. For example, wages as a percentage of US GDP is expected to go up

to over 50 per cent by 2010 from the current levels of 44 per cent.

Even in pure terms, the knowledge worker category has overtaken the physical

worker category, especially post the nineties and correspondingly the costs

associated with it.






According to statistics, the physical to knowledge worker ratio has changed
dramatically from 83:17 in the 1900 to 38:62 by the 1990s. Adding to that, there

is a decrease in active workforce available in the developed economies due to

shifting demographics. In fact UK, Germany, and US will see a decline of 8 M in

its active workforce by 2010, the McKinsey study reveals.

From the supply side the key enablers are in place. For one, labor cost

differential and capital market thrust has created a critical mass of mature BPO

providers. Interaction costs have been rapidly declining due to technological

innovation. Besides, there have been enough success stories like GE, Citibank,

and JP Morgan who have been able to save costs through offshore outsourcing in

the past two-three years.

Leading global vendors are building offshore presence. Over 70 per cent of

the top 30 global IT services vendors have an Indian presence and are now

looking at BPO. Leading global ITES firms have also been building their presence

in India.






According to McKinsey, the labor factor cost savings itself would be about 30 -
40 per cent. Capital productivity could be a huge differentiator among

providers. Says Noshir Kaka, Principal, McKinsey, "Even at a commoditized

rate, vendors can make 30 per cent margin with capital efficiencies".

Would the ITES-BPO industry consolidate leading to the survival of only 4

or 5 players?






According to McKinsey, it won’t due to its very nature of being a service
industry and the kind of specializations possible. Four types of ITES-BPO

companies could emerge : task experts in areas like credit-card processing,

payroll processing; process boutiques like HR processing; horizontal factories

like call-centers; and bundled service providers. Consolidation if at all would

be seen only in the bundled service provider category.

The final reading is that the ITES-BPO industry is very important for India.

If predictions on the industry go right, by 2008 it will account for a third of

India’s agriculture and will contribute 7 per cent to India’s GDP growth.

Finally, users of BPO have learnt a few lessons:

1. BPO is not a cost reduction tool alone- it is assuming strategic
   
   dimensions.
2. Real differentiator would not come in the initial 5-6 pilot projects; an
   
   intelligent architecture has to be in place.
3. Vendor selections have to be based on future sustainability and not
   
   current capability.
4. The middle management has to be incentivized to buy the offshore
   
   outsourcing idea.

For the ITES-BPO companies it is critical to decide where to play and then

scale up in the chosen area and create efficiencies. There are several business

models that are yet to emerge in the long-term- what you do currently may not

dictate your success in future. Managing talent is going to be very key to value

creation. There is an urgent need to build skills and manage talent to avoid

commoditization. For some customer segments, bundling IT and BPO could be

attractive. Says Kaka, "Or else, you will soon find yourselves at the

receiving end of a labor arbitrage negotiation".