Lured by the bench strength of India's technology shops, financial firms such as Goldman Sachs, ING and Fidelity are eyeing new areas of interest in offshoring.
With the industry's value expected to hit $64 billion by 2012, how long will it be before India addresses its crumbling infrastructure? Of course, with firms like Infosys successfully creating small oases of functionality in an environment of dysfunctionality, why should anything have to change?
Infosys Technologies' 77-acre headquarters of provocative architecture, pristine roadways and manicured lawns is an oasis of efficiency and order in this nation of inefficiency and disorder, a potent symbol of how the offshoring explosion has gripped Bangalore, a city of six million known as India's Silicon Valley. Some 15,000 employees-the average age is 26-commute the campus on communal bicycles or golf carts, spending off-work hours at the company's swimming pool, gyms, food courts, bookstore, miniature-golf course and bowling alley. The firm's global reputation draws 1.4 million applications a year, and employees joke that it's easier to get into Harvard Business School than Infosys.
Founded in 1981 by seven friends with $1,000 in startup capital, Infosys is now worth $23 billion, the globe's second-largest outsourcer after Tata Consultancy Services. Revenue skyrocketed 41 percent between fiscal 2002 and 2006, to $2.15 billion-solely from organic growth. Operating margins are stunning, ranging between 27.9 percent and 32.8 percent in each of those four years. And U.S. financial services firms keep lining up for Infosys' services: To date, it claims Aetna, Fidelity Investments, ABN Amro, ING, American Express Bank, Bank of America, Citigroup, Goldman Sachs, Visa and India's ICIC Bank as clients, offering software development, maintenance and reengineering services, as well as research and development. With more than 66,000 employees, the firm supports 20 development facilities in India, nine in North America, five in the Asia-Pacific region, and four in Europe.
But beyond the serenity of Infosys' Bangalore campus, chaos reigns. Water buffalo jockey for position on the narrow, pothole-pocked roads with exhaust-coughing vans, teenager-pedaling rickshaws, horse-drawn carts and herds of baying goats. Garbage chokes the grass between ramshackle shops and tin-roofed mud shacks where families cook over open fires fueled by buffalo dung. Sure, the road leads to other technology parks, office complexes and shopping malls, but commuters have to negotiate it with women balancing stacks of firewood on their heads and barefoot children begging for rupees. "India lives in four centuries at the same time," quips Infosys CFO T.V. Mohandas Pai during a recent session with visiting journalists.
But the disconnect of these conflicting realities isn't lost on the average Indian in this nation of 1.1 billion, whose per-capita annual income hovers around $3,300. The miracle of outsourcing, which has created more than 1.3 million jobs in Bangalore, Delhi, Gurgaon, Chennai, Hyderabad and Mumbai in the last decade, hasn't touched the 650,000 villages where two-thirds of the population lives on less than $1 per day. Disease is also a factor: At least 5.1 million people are living with AIDS, the second-highest infection rate after South Africa.
Despite a strong regulatory and legal infrastructure, bribery remains endemic, labor skirmishes are becoming increasingly common, and a widely defended caste system continues to hamper social and educational mobility. Outdated labor laws make it difficult to lay off workers or allow even voluntary overtime beyond 54 hours in a three-month period. Moreover, the corporate world, long dominated by a small clique of family-owned conglomerates, operates under its own rules, and firms thrive on government protection and tax favoritism.
And don't even mention the crumbling electrical, water and transportation infrastructures to Infosys' Pai. The company pestered the government for five years to build a new airport in Bangalore before the strategy paid off: A new facility is due to open in 2007. "The pace of change is too slow for us," he moans. Add to that the uneven quality of roads, poor communication links and erratic electricity supplies, and India hardly seems prepared to accommodate the next wave of outsourcing. "Public infrastructure is still a huge challenge," agrees Madhavi Mantha, a senior analyst at Celent. "There is so much to do that whatever the government does is not enough. And the companies are very vocal about the need for better infrastructure. Will it be a limiting factor for the growth of outsourcing in India? Yes."
Though India rejected socialism in 1991 in favor of democracy, many leftover programs still sting of bureaucratic overlapping. "It's an uphill battle to get the government to improve infrastructure," agrees Sunil Mehta, vp of the National Association of Software and Service Companies, or NASSCOM. "It's not about the funding, but there is a multiplicity of regulatory agencies involved in various projects. But India knows that it's in its interest to address this issue as quickly as possible. ...We're getting there." Indeed, service at the New Delhi and Mumbai airports, which were recently privatized, have dramatically improved, he says, and, in addition to Bangalore, a new airport is due to be built in Hyderabad by 2008.
"The infrastructure is a challenge in terms of getting from place to place," agrees Mehta. But the problem is not so severe that it will affect outsourcing and captive operations. "If you look behind the infrastructure issue, which I admit is a visible and emotionally charged one, to the kind of gains banks are able to get in India-including the higher quality and productivity-the infrastructure is just an irritant."
David Wyss, chief economist of Standard & Poor's, is equally sanguine. "It's just something that you have to deal with," he says. "Things are improving. The infrastructure issues are slowing down [the outsourcing movement], but it's not stopping it."
It's not easy to ignore the Indian tiger. Growing at a rate of eight percent annually-with output surging to 12.4 percent in July alone-the nation remains the No. 1 outsourcing destination for banks on the planet, according to the Economist Intelligence Unit. Pai is even more optimistic: He estimates the country's GDP will jump another 25 percent by 2009, thanks exclusively to outsourcing.
That figure may prove to be too low. The value of the outsourcing industry swelled 40 percent this year over 2005, to $5.8 billion, and is expected to hit $64 billion and employ three million people by 2012, according to a recent NASSCOM/KPMG study. In 2005, financial services represented 39 percent of the outsourcing pie in India, the largest slice. TowerGroup reports that top 15 global financial institutions will increase IT spending on vendor-direct offshore outsourcing by 34 percent annually, to $3.89 billion in 2008.
The main draw? Unquestionably, it's talent. India's huge competitive advantage is its inexpensive, highly educated, English-speaking workforce, carved out of a burgeoning middle class, 300 million strong and growing. The nation pumps out more than 400,000 engineers annually. And with half of India's population under age 25, a seemingly unending supply of potentially skilled labor is waiting in the wings.
But the bottom line for U.S. banks is, well, the bottom line. Nearly half of all U.S. bank offshoring operations generate savings of nearly 40 percent, according to Deloitte Touche Tohmatsu. And the consultant estimates firms could triple that figure if institutions streamlined their operations. For example, the average bank commits 3.5 percent of total employees to overseas outsourcing-for an average cost savings of 38 percent; if that figure is raised to 6.7 percent of headcount-the industry's best practice-the average savings would rise to 60 percent, by DTT estimates. And the Indians are nothing if not resourceful in accommodating U.S. banks' needs. Outsourcers are offering ever-more specialized services, giving banks added reasons to say "yes" to outsourcing. Once a handler of only back-office and call-center activities, the average Indian outsourcer today is equally adept at superannuation-fund account management, trust-administration accounting, share-transfer registry and legal-brief preparation.
Stymied by government inaction on infrastructure development, private industry has jumped in to grease the wheels of commerce. Long proponents of an informal program offering tax advantages to IT firms willing to build infrastructure at private industrial parks, trade groups were instrumental in creating a formal plan to create special economic zones, or SEZs, to attract more IT firms. In October, Mahindra World City opened the first SEZ on 1,300 acres outside Chennai. These privately run sites offer tax breaks to firms-no taxes for the first five years and limited ones for the next five-willing to build the infrastructure and offer jobs to surrounding communities. Mahindra boasts wide roads, water and sewage networks, a fiber-optic cable system, and an electric power grid that powers street lighting. More than 200 national and international firms have already signed up to rent in the industrial park. "Because the infrastructure is way behind, companies are creating these safety zones," says Wyss. C. Steven Crosby, senior managing director of PricewaterhouseCoopers, goes even farther, calling these IT parks "mini centers of excellence" across the nation.
NASSCOM, the industry trade group, has heard more complaints from outsourcers than any other group-and has responded. For example, background checks of personnel remains a nagging concern. No central criminal databases exist and credit agencies remain relatively new, so any background checks must be done in person, which is often invasive. "Sometimes they'll just ride around the [potential employee's] neighborhood and talk to the constable," says Crosby. "None of this stuff is documented." Moreover, because the turnover rates at outsourcers are high by U.S. standards-up to 70 percent at a company, with many employees staying only six months in pursuit of even more lucrative jobs-security is profoundly important. Last year, NASSCOM created a national skills-registry database, now 35,000 names strong-with another 300,000 names expected to be added by 2008-of vetted personnel working in the IT sector. "Since 85 percent of all security breaches are committed by insiders, this database will be a useful tool for enforcement authorities to identify people and establish an audit trail," says NASSCOM's Mehta.
NASSCOM is also spinning off a self-regulatory organization, independent of the trade group, to police firms in the IT and BPO industries. Membership of the New Delhi group, which is now seeking a CEO, includes the trade group's 1,100 members. "They would agree to abide by a code of ethical practices of information security, agree to be audited annually and to abide by sanctions," says Mehta. "We are very optimistic this will have the teeth to ensure that it's effective."
But U.S. banks' biggest fear, says Mehta, remains security of customer data. Does Indian law provide prosecutors and law enforcement sufficient tools to prosecute cyber criminals? Well, that depends who's answering the question. True, the Indian Information Technology Act of 2002 makes cyber crimes a federal offense, enforceable by India's Central Bureau of Investigation. The CBI established the Cyber Crime Investigation Cell in March 2002 to patrol such crimes, including a crime lab to train investigators. Parliament is now debating an amendment to the act, already approved by the Cabinet, that would make fines and jail time more stringent for those convicted of IT privacy crimes.
Already, U.S. financial firms compel Indian outsourcers to comply with U.S. laws in the handling of consumer data, and specifically name the U.S. as the jurisdiction and venue for dispute adjudication. However, one key problem is the lack of a U.S.-India treaty that requires judgments rendered in U.S. courts to be valid in India, and such judgments often need to be submitted to Indian courts. Many banks have been protected by arbitration clauses, which require disagreements to be resolved before even entering the courts.
But security at outsourcing centers remains uneven, says PWC's Crosby, who says firms haven't all adopted the best practices of intense scrutiny of all who enter and exit a center. Therefore, he suggests banks ask their outsourcers: Do you know where our data is right now? "People just need to understand the risk they might be exposing their information to," he says. "It's unclear if India is fully grappling with this issue."
In a recent visit to India, TowerGroup analyst Craig Focardi found security standards for data centers to be "at least as good as those of U.S. domestic data centers and often better." He says most banks store data and documents in the U.S., available only by remote viewing from India. Many outsourcers require employee biometrics for entry; employees rarely work from paper documents and those that do must shred them before their shift ends; personal items like cell phones and cameras must be kept in lockers to prevent confidentiality breaches; and laptops are secured with software that triggers an alarm if the computer is removed from the premises. Most firms also have closed-circuit monitoring, and their computers have dual firewall systems and intrusion-detection systems, which monitor network transmissions. Revolving passwords are retired monthly or weekly. Moreover, most outsourcers are compliant and certified for BS779 and ISO17799 controls, the two U.S. best-practice controls for information security, which have now become internationally recognized.
Customer data breaches have been front-page news, however. Earlier this year, a worker at HSBC's Bangalore call center was arrested on suspicion of selling confidential bank-account details of U.K. customers to fraudsters; that case is still pending. In 2005, three former employees of Indian BPO firm MphasiS were arrested for allegedly siphoning off $300,000 from Citibank customers; the trio was recently convicted and two received jail sentences. "The legal system is India's Achilles' heel," Crosby says. "I would suggest that people are rudely finding that things are not as secure as they think they are."
The Federal Deposit Insurance Corp. warns institutions of the inherent risks of dealing with an outsourcer's subcontractor. The FDIC urges banks to discourage such practices by amending outsourcing contracts to prohibit work from being subcontracted without the bank's permission.
But Celent's Mantha disagrees with the cry-wolf mentality. "The security issue is overplayed," she says. "There's a lot of fear, but there's also the perception that it is overblown. The reality is it's not that dire. The largest providers are using security policies that are up to par or higher than what is in the States."
Ron Somers, president of the U.S.-India Business Council of Washington, D.C., expects public pressure to grow in India for more aggressive prosecution of wrongdoing and better governance of the industry. "As the middle classes grow and as education permeates greater segments of the population, the demand for better governance has increased exponentially," he says. "The government of India takes data privacy very seriously."
Whatever the risks of outsourcing in India, it's hard to argue with success. IndyMac Bancorp's story is particularly compelling. The Pasadena, CA, mortgage issuer has been an aggressive outsourcer to India since it launched a pilot project in 2002 for mortgage processing and software development; it expects to have 1,500 jobs there by 2008, according to Ashwin Adarkar, consumer banking CEO. Currently, about nine percent of the 21-year-old firm's headcount is outsourced in India, and Adarkar is aiming for 20 percent.
"Now we're contemplating [building] our own captive," he says, adding the firm has saved between 40 percent and 50 percent of its IT expenses through offshoring. He attributes the firm's success to a number of factors: the implementation of a central outsourcing strategy; the building of a central team in India and the U.S. jointly responsible for the initiative; the investment in high-level performance monitoring metrics to track productivity overseas; the creation of a corporate culture that kept the Indians feeling they are part of the U.S. team; and a major investment in security. "You have to think about security the way you would think about it in the U.S.," he says. "We're very, very conscious about it."
The maturation of the outsourcing industry in India has yet to reach its peak, but it's clear that both third-party outsourcers and captives are evolving into different entities. However, they still require care and feeding.
The consultant DTT reports more than half of all financial institutions, particularly those with three-plus years of experience overseas, are using a hybrid strategy of third-party outsourcers and captives. "Current best practices in financial services suggest that the largest cost savings-up to 60 percent-are achieved by keeping the majority of offshore activities in-house," the DTT report notes. "Captive operations also appear more capable of sustaining and improving cost savings and service quality over time." However, scale is a key factor in savings. Financial institutions with more than 5,000 offshore workers reported average savings of 45 percent to 50 percent, much higher than the average of 38 percent, according to DTT. Moreover, management of the outsourcing relationship becomes even more crucial as it ages. Many banks encounter "an alarming dropoff in cost savings and quality" after the third year of outsourcing, says DTT, which the firm attributes to "offshoring fatigue" and manager turnover. DTT identifies four key ways for U.S. banks to achieve top performance: managing and minimizing complexity of their outsourcing contracts; ensuring compliance with regulators, particularly in security and privacy; developing a culture to nurture employee performance; and balancing near-term cost savings with the need for long-term strategic investment.
Sources agree, however, that the most acute issue in the coming years in India will be the talent crunch. Despite the high number of computer-science majors graduating every year, the quality of education varies; Infosys solves the problem by spending $125 million a year on training new recruits. "The biggest problem banks face is finding qualified people," says Mantha, who notes outsourcers are now broadening their reach, moving into second- and third-tier cities in search of talent that won't be so quick to relocate. "Talent will continue to be a big issue in the future." Rick Rossow, director of the U.S.-India Business Council, agrees, noting that "companies are now willing to go into tier three and four cities, where they hope attrition can be curbed. Indians are very family-oriented. Not everyone is willing to move to another city [in search of a better-paying job]."
And not only is the pool of talent shrinking-it's become more pricey. "It's going to become more expensive to operate in India," warns S&P's Wyss, who says the cost of salaries and benefits for engineers has doubled in the last four years in India, proof of the theory of supply and demand. And they're only destined to edge up higher, he predicts.
But inflation is a sign of a chugging economy, which no one can doubt defines India. Thomas Friedman, The New York Times columnist who authored the seminal tome on outsourcing, The World is Flat, likens India to a potholed superhighway, lined with broken streetlamps and sidewalks, where none of the lanes are marked for safe transit. "Off in the distance, the Indian superhighway looks like it smoothes out into a perfect road," he recently told interviewer Charlie Rose. "The question with India: Is that a mirage or is that an oasis? Is that the real thing out there, or is it just what I'm imagining? [It's] this big question mark going forward."
