Productivity of india’s offshore outsourcing sector

Policy Brief February 2010

Productivity of India’s Offshore Outsourcing Sector: Business-based Evidence

Suman Modwel 1 Tawfik Jelassi

Abstract: Following on an earlier paper discussing the sustainability of India’s comparative advantage in IT offshore outsourcing, the authors pursue their enquiry whether rising labour costs are being compensated by rising productivity. A sample of sixfirms including the big three in Bangalore was selected for a field survey, and the total factor productivity (TFP) approach used to look at trends of output, capital employed and wage costs per unit labour, enriched by insightful discussions on site. While the trend towards decreasing age profile of the work force has succeeded in maintaining mean salary per capita constant, productivityperformance in TFP terms is not so uniformly brilliant across the sample. Caveats and cautionary notes on using TFP as a reliable tool to gauge efficiency of labour especially in times of sharp changes in capital and labour resources and other exogenous factors including exchange rate movements have been expressed. Keywords: Offshoring, outsourcing, total factor productivity, output, capital employed, wagecosts, age profile, attrition rates, Bangalore, tier 2 cities.

1

Suman Modwel and Tawfik Jelassi are respectively Professor and Director of Research, Chargé Mission Inde, and Professor and Dean of the School of International Management, Ecole Nationale des Ponts et Chaussées (ENPC) Paris, France. The authors would like to thank Groupe d’Economie Mondiale at Sciences Po (GEM) for its support.-1-

Introduction The rise of India as the leading destination for IT offshore outsourcing has made it a rich field for discussion. Of late, there has been some speculation about the sustainability of India’s competitive advantage because of rising costs of skilled labour and emergence of several other low cost competitors, with China the closest behind it. The authors too joined thisdiscussion and presented a paper on the sustainability of India’s comparative advantage in offshore outsourcing at the European Conference of Information Systems (ECIS) in Gothenburg (June 2006) 2 . That paper argued that the currently low wages of skilled IT staff in India may be eroding over time. The dramatic reversal of roles of some labour costs in the Indian economy, ranked amongst the lowestwage economies, to the most expensive one (in purchase price parity terms) for senior managers in « hot Indian spots » like Bangalore and Mumbai was demonstrated. Nevertheless it was argued that if Indian offshoring capabilities concentrate more on high value-added knowledge processing services leveraging on the well recognised skills of its senior managers in the IT and other service sectors, then itcan retain its competitiveness. Comparisons of health care costs between the US, India and some other countries were used as an illustration. This paper 3 continues with the question whether rising labour costs can be matched by rising productivity (total factor productivity at the firm level) in order to retain India’s leading position. It summarises the insights and evidence garnered during afield survey profiling across time the movement of some key indicators in a sample of six Indian firms, e.g. total revenue in value added terms, wage costs, output per worker, and capital per worker. The data furnished by the firms was enriched by discussions with their senior managers.

1. IT Offshore Outsourcing in India
As an industry-leading supplier of IT offshore-outsourcing, Indiacontinues to attract the investments of multinational corporations (MNCs). Offshore outsourcing refers to a broad spectrum of services ranging from (1) traditional IT outsourcing services (ITO), to (2) business process outsourcing (BPO), (3) the outsourced development of packaged software and (4) outsourcing of R and engineering. 4 By definition business functions in these areas are contracted to…