Cost Competitiveness of Global In-house Centers (GICs)
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Cost Competitiveness of Global In-house Centers (GICs)

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Joint Everest Group and NASSCOM research on cost competitiveness of Global In-house Centers (GICs), or captives, examines the actual impact of cost savings to the parent organization as well as the ...

Joint Everest Group and NASSCOM research on cost competitiveness of Global In-house Centers (GICs), or captives, examines the actual impact of cost savings to the parent organization as well as the sustainability of GICs.

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    Cost Competitiveness of Global In-house Centers (GICs) Cost Competitiveness of Global In-house Centers (GICs) Document Transcript

    • 2012 AN EVEREST GROUP REPORT Cost Competitiveness of Global In-house Centers (GICs) Nikhil Rajpal, Partner The Reality of Wage Inflation and the Salil Dani, Practice Director Anurag Srivastava, Senior Analyst Sustainability of Cost Arbitrage Copyright © 2012, Everest Global, Inc. All rights reserved. research.everestgrp.comEGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) Foreword GICs have played a crucial role in the growth and development of the global services (i.e., outsourcing and offshoring) industry in India. Key to the success of the outsourcing model has been the fact that GICs have been consistently able to deliver significant cost savings as compared to source locations, enabling them to drive home the value proposition of the model, associated benefits and added capabilities. NASSCOM and Everest Group conducted joint research to understand the extent of cost savings achieved, levers for driving cost savings, and future sustainability of the same. Research showed that GICs continued to deliver 40-70 percent cost savings even from a Total Cost of Ownership (TCO) perspective that includes costs associated with setting up and management of GIC operations, in addition to the operating costs. Wage inflation in India is often touted as one of the drawbacks, but research shows that actual salary bands have historically increased at a much lower rate than what headline numbers suggest. Further, GICs have been able to contain the impact of wage inflation by modifying the employee pyramid and using alternate talent pools. Additionally, lower growth of non-wage operating costs has ensured further moderation in overall cost inflation. Arbitrage-driven cost savings in India are likely to sustain for 12-15 years. A number of people and organizations have assisted in the preparation of this study. In particular, we would like to thank the senior executives of the GIC member organizations of NASSCOM who spared their valuable time to share insights on the cost arbitrage scenario. Special thanks to Deena Harapanahalli (Invesco), Aveek Mukherjee (Wells Fargo), Nitin Seth (Fidelity Worldwide Investment), and Sriram Dhanyamraju (Dell) for their guidance in the project. A special acknowledgement to the NASSCOM research team for their efforts and contribution towards this report. We trust you find this report useful, and we welcome your feedback and comments. research.everestgrp.com 2EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) Executive Summary Over 3,000 GiCs have been Captives or Global In-house Centers (GICs) are an important component of the established across the world. global services market. Initially set up in low-cost locations (particularly India), for supporting technology and contact center operations in the 80s and 90s, the model is now firmly established and continues to grow and diversify across multiple dimensions. While India continues to be the leading GIC location, adoption of the model has spread to newer regions such as the Philippines, East Asia, Eastern Europe, Latin America, and, most recently, Africa. Trends on recent set-ups also indicate adoption of the GIC model across a wide range of industry verticals (e.g., manufacturing, healthcare) and functions (e.g., engineering services / R&D). GICs have largely delivered on their mandate of providing meaningful cost GiCs have been delivering 40-70 percent savings from a savings and adding capability to the parent organizations. Our analysis TCO perspective. indicates that the GIC model continues to deliver typically 45-75 percent savings over source costs, on an operating cost comparison. These savings continue to be significant (40-70 percent) even from a total cost of ownership (TCO) perspective that includes costs associated with the setting up and management of the GIC operation. Cost inflation in GiCs ranges Contrary to popular perception, wage inflation is not likely to wipe out GIC cost between 7-8 percent after savings in the near term. Our experience with GICs in India indicates that the factoring in real wage inflation impact of inflation on their wage bills is typically much lower than often and increases in other cost perceived. This is because a large part of the individual increases that are often elements. reported (12-18 percent per annum) are merit-based while the actual salary bands only move upwards by 4-5 percent per annum. Further, the high pace of growth and high attrition levels of many of these GICs allow them to pro-actively manage the pyramid and keep their costs down by recruiting large numbers of lower-cost, entry-level talent to back-fill promotees and job-leavers. As a result, net wage inflation experienced by GICs is closer to 6-8 percent per annum. Our analysis further indicates that arbitrage-driven cost savings in key offshore india’s and the Philippines’ cost arbitrage is likely to remain locations (India, the Philippines) are likely to sustain for 12-15 years. The above sustainable for at least 12-15 is based on a relatively safe set of assumptions of macro-economic projections years. that most experts agree on. In reality, the arbitrage may sustain for 17-20 years. On the other hand, even the worst case scenario projects arbitrage sustainability of 8-10 years. The above results are reported from a U.S. perspective but the range is largely similar for other source geographies (i.e., UK, Continental Europe, and Japan). It is important to note that while the timeframe discussed above holds true for a majority of the work offshored today, there will be meaningful exceptions. On one hand, there will be locations (e.g., Brazil, Czech Republic, and Ireland), or functions (e.g., technology research and development) where a combination of smaller starting cost differential, shortage in talent or macro-economic trends could erode the arbitrage faster. On the other hand, GICs have several research.everestgrp.com 3EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) operational levers at their disposal to further improve their cost position and prolong the cost advantage. Additionally, while direct cost savings will always be important, many mature GICs realize that they can harness the platform they have built to deliver significant business value to the parent organizations. These organizations have started to make investments in their engagement and delivery models to reorient towards this goal that will define the impact GICs have in the long term. research.everestgrp.com 4EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) Background and Context “ i keep hearing and reading about 15-20 percent wage inflation in india. i am not sure Captives or GICs are an important component of the global services market. GICs were initially set up in low-cost locations to support technology and contact center operations in the 80s and 90s. about how much increase in wage bills i should build in our While GICs have largely delivered on their mandate of providing meaningful plans for the india center… cost savings and adding capability to the parent organizations, questions – Global Sourcing Head of a “ continue to be asked around the actual impact of cost savings and their large BFSI company sustainability. These are driven by multiple issues and concerns (e.g., cost inflation, exchange rate fluctuations, and labor market uncertainties) facing GICs and their parent entities. In this context, Everest Group conducted a study of leading GICs in terms of their cost competitiveness. This study is based on inputs and perspectives from leading GICs, supplemented with Everest Group’s proprietary knowledge and information base. This study covered the dimensions outlined below:  State of the GIC model with growth and adoption trends  GICs’ current cost savings – taking an operating cost and total cost of ownership (TCO) view  Sustainability of GICs’ cost savings and impact of wage inflation and exchange rate fluctuations  Additional operational levers available to GICs to further optimize costs This report describes these aspects in detail with supporting examples and illustrations, as relevant. research.everestgrp.com 5EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) The GIC Model is Established, Growing, and Continues to Diversify across Multiple Dimensions “ for quite some time, we have been hearing noise around the GiC model being dead… but Initially set up in low cost locations, primarily for supporting technology and contact center operations, the GIC model is now firmly established, with nearly 3,000-4,000 GICs of leading companies globally. anywhere you look, you see GiCs expanding in scale and GICs continue to grow across multiple dimensions. While India continues to be responsibilities, new GiCs the leading location, recent years have also witnessed new set-ups in locations getting set up, and rare such as the Philippines, East Asia, Central and Eastern Europe, Latin America, instances of closures/sell-offs… and Africa (Exhibit 1). – Head of India GIC, leading “ global healthcare company EXHIBIT 1 Number of set-ups of offshore GICs of leading global companies 2009-11; Number Recent years have witnessed GiCs in multiple locations Central and beyond india Eastern Europe 20 12 11 East Asia 2009 2010 2011 36 Middle East 22 26 Source: Everest Group & Africa 13 9 2 India 2009 2010 2011 2009 2010 2011 22 20 24 Latin America 7 4 5 2009 2010 2011 2009 2010 2011 In addition, adoption of the GIC model is spreading to “new” industry verticals such as manufacturing, retail, and telecom. In terms of functions, new set-ups indicate diversification of the model to support higher-order and/or niche functions such as analytics and engineering services / R&D support. research.everestgrp.com 6EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) GICs in Offshore Locations Continue to Offer Significant Cost Savings to Their Parents Typical TCO savings of 40-70 percent over source costs Operating cost analysis is often used to assess GICs’ current cost competitiveness. However, this may not reflect the ownership costs of GICs (such as costs of transitioning, governance, and knowledge transfer). Everest Group leveraged its proprietary total cost of ownership (TCO) framework to compare the cost of owning and operating a GIC to the parent cost. The TCO framework undertakes a comprehensive assessment of all costs and includes the following cost items:  Operating costs include people costs as well as expenses related to facilities and other miscellaneous items (e.g., telecom and equipment)  Set-up and transition costs incurred in establishing the center and transfer of processes from parent to GIC  Ongoing governance costs incurred by the parent for managing the GIC operations Exhibit 2 below, illustrates the TCO analysis of IT Applications Development and Maintenance (ADM) function for a GIC based in a typical tier-1 city in India. It is noteworthy that people costs contribute towards 60-70 percent of the operating cost and typically 45-55 percent of the TCO. EXHIBIT 2 Total cost of ownership (TCO) for IT-ADM | U.S.-India IT-ADM 2012; US$ 000s per FTE per annum 35-40 Percent of People costs contribute towards operating 60-70% 10-15% 7-10% 10-15% 100% cost 25-30 60-70 percent of the operating cost and typically 45-55 percent of TCO Cost People Facilities Technology Miscellaneous Total Setup and Governance Total cost component costs operating cost transition of ownership (TCO) Source: interactions with GiCs; Other operating costs Everest Group Operating costs Other elements of TCO Our analysis indicates that the GIC model continues to deliver typically 45-75 percent savings over source costs, on an operating cost comparison. These savings continue to be significant (40-70 percent) even from a TCO perspective. Exhibit 3 below, depicts the cost comparison for a U.S.-based parent and a GIC supporting transaction processing BPO function from a typical tier-1 city in India. While most of the cost savings are on account of labor arbitrage, GICs also provide meaningful savings on facilities costs. research.everestgrp.com 7EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) EXHIBIT 3 TCO savings for BPO – Transaction Processing | U.S.-India BPO-TRANSACTION PROCESSING 2012; US$ 000s per FTE per annum U.S.-INDIA 70-80 GiC model continues to deliver Other expenses 4-8 typically 40-70 percent savings Facilities 4-8 Operating cost savings TCO savings over source costs from a TCO perspective 60-75% 65-75% People costs 60-70 Source: interactions with GiCs; 21-27 Everest Group analysis 18-21 2-3 1-2 2-3 2-3 13-18 U.S. parent India GIC Set-up and Governance TCO operating cost operating cost transition Note: Costs for U.S. corresponds to Tier-2 cities, whereas, costs for India correspond to Tier-1 cities Differences in TCO savings are driven primarily by functions and locations TCO savings vary by functions as these determine the skills requirement, thereby, impacting people costs. For instance, savings are typically higher for transaction processing and IT applications work and usually lower for complex and judgment-oriented business processes (Exhibit 4). EXHIBIT 4 Typical TCO savings between India GICs and U.S. across functions U.S.-INDIA EXAMPLE 2012; US$ 000s per FTE per annum GIC-India Parent-U.S. TCO savings depend on function(s) supported by the GiC IT-ADM BPO-Transaction processing BPO-F&A (Judgment-intensive) 55-70% 100-110 55-70% 90-100 Source: interactions with GiCs; 65-75% 70-80 Everest Group 32-40 35-45 21-27 Note: Costs for U.S. and UK correspond to Tier-2 cities, whereas, costs for India and the Philippines correspond to Tier-1 cities TCO savings are also dependent on GICs’ locations owing to differences in people costs, facilities, and other expenses. For instance, current savings are lower in locations such as Brazil, Czech Republic, and Ireland (typically 10-25 percent across functions). On the other hand, savings are higher in locations such as India and the Philippines (typically 55-70 percent across functions). research.everestgrp.com 8EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) However, savings do not vary significantly across industry verticals for the same location and function. The nature of the processes and work remains largely similar for supporting the same function across verticals, and hence does not notably impact TCO. In summary, GICs in most offshore locations continue to deliver cost savings even after incorporating a “comprehensive” TCO view that includes additional expenses besides operating cost of delivery. research.everestgrp.com 9EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) Arbitrage-Driven Cost Savings in India and The Philippines are Likely to Sustain for 12-15 Years While GICs are delivering significant savings today, confusion remains around the sustainability of these arbitrage-driven savings. The issue is fairly complex given the multitude of macro-economic and operating variables affecting the outcomes, such as:  Wage inflation differential  Inflation differential in other cost elements such as facilities, equipment, and telecom  Exchange rate These factors significantly impact the cost differential between the parent and GIC. We assessed the sustainability of GIC savings by adopting the following approach: A) Understand drivers of change in costs, and historical trends in these drivers B) Build potential scenarios based on a range of possible macro-economic and operating possibilities C) Project sustainability of cost savings across scenarios Our analysis suggests a higher confidence in projections on cost inflation (wages and other TCO elements). This is a result of higher predictability associated with availability of talent and other factors such as facilities, telecom, and equipment. On the other hand, currency exchange rates are difficult to predict and sometimes fluctuate in a wider range. Our scenarios on exchange rate movements and TCO inflation reflect this trend. These scenarios impact cost sustainability of locations and are described below in case of India (Exhibit 5). EXHIBIT 5 U.S. India TCO inflation TCO inflation Currency forward-looking scenarios of (percentage (percentage exchange rate Scenarios Description p.a.) p.a.) (2020; INR/USD) TCO inflation and currency Worst case  Longer economic recovery in the 0% 10-12% 35-38 West exchange rate movements in  Supply side constraints in offshore india location (such as talent employability, infrastructure) Base case  Most common view of experts and 1-2% 7-8% 42-44 analysts  TCO inflation similar to current levels Source: interactions with GiCs; (i.e., moderate market growth) Everest Group  Exchange rate levels broadly maintained Best case  Faster economic recovery in the 2-3% 4-6% 48-50 West  Easing of supply side constraints (such as talent employability, infrastructure) reduce pressure on wage research.everestgrp.com 10EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) We analyzed cost competitiveness of GICs in India across the scenarios described above, the results of which are indicated in Exhibit 6 below. EXHIBIT 6 TCO savings sustainability for India GICs as per three scenarios IT-ADM EXAMPLE 2012 TCO (in US$) U.S. inflation: 0-3% Cost savings in india are likely Worst case scenario Base case2 scenario U.S. Tier-1 @ INR 35-38 per USD (2020) INR 42-44 per USD (2020) to sustain for 12-15 years 90-100K TCO inflation @ 10-12% TCO inflation3 @ 7-8% Hurdle rate1 @ 60-70% Source: Everest Group Best case scenario Exchange rate continuing at INR 48-50 per USD India Tier-1 @ TCO inflation @ 4-6% 35-40K 8-10 years 12-15 years 17-20 years Time 1. Hurdle rate refers to the maximum wage ratio of the destination/source country, which still allows for meaningful offshoring. Hurdle rate is estimated as approximately 60-70% 2. Base case currency appreciation is considered as the average growth rate during the last two years 3. Cost inflation includes multiple factors such as wage inflation, inflation in facilities and real estate costs, and miscellaneous costs including equipment, telecom, and attrition india’s and the Philippines’ cost Our analysis further indicates that arbitrage-driven cost savings in key offshore arbitrage is likely to remain locations (India and the Philippines) are likely to sustain for 12-15 years. The sustainable for at least 12-15 above is based on a relatively safe set of assumptions of macro-economic years projections that most experts agree on. In reality, the arbitrage may sustain for 17-20 years. On the other hand, even the worst case scenario projects arbitrage sustainability of 8-10 years. The above results are reported from a U.S. perspective but the range is largely similar for other source geographies (i.e., UK, Continental Europe, and Japan). Moreover, the above analysis does not account for any savings due to operational excellence initiatives. In reality, GICs have several levers to improve their cost competitiveness. Exhibit 7 below, provides instances of GICs leveraging efficiency levers to optimize costs. EXHIBIT 7 Efficiency levers Examples Efficiency Significant impact of this efficiency lever on TCO. Many leading GICs have achieved improvement significant savings with this initiative GiCs have several levers to Increase GIC of leading U.S. financial services firm introduced cross-training programs to counter improve their cost resource skewed utilization across processes – achieved meaningful improvement in utilization ratios utilization through flexible staffing competitiveness Leverage lower- GIC of leading U.S. bank with large operations in Metro Manila recently expanded to Cebu cost locations (tier-2 city in the Philippines) for transaction processing and voice work; overall reduction in operating costs by 10-15 percent. Some GICs have also expanded their operations in tier-2 cities in India (e.g. Jaipur, Vizag) to diversify access to talent pool and reduce facility costs Source: interactions with GiCs; Reducing GIC of leading U.S. bank streamlined transport operations across its offices in India and Everest Group general and reduced per FTE expenses on employee transportation by more than half. This included administrative reengineering transport modes and facilities, and streamlining transport operations expenses These measures can help GICs further prolong their cost advantage by 4-6 years. research.everestgrp.com 11EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) The curious case of wage inflation Media reports in most emerging economies, especially India, talk about high wage inflation rates and the apparent impact on savings offered by GICs. On the other hand, GICs claim lower increases in their wage base year-on-year, as compared to the reported wage inflation numbers. Everest Group analyzed this aspect of operating costs in detail; key findings are detailed below: Merit-based salary raises at the individual level (arising from promotion/ growth) decrease with increasing seniority as depicted below – although numbers reported in the media are for the junior levels. Manager and above  Form ~20-25% of the overall delivery workforce  Lower individual raises @ 4-8% p.a. Team Leader Senior Programmer  ~75-80% of the overall delivery workforce  Higher individual raises @ 10-15% p.a. Junior Programmer Consequently, wage inflation netted for the entire pyramid is much lower, at around 11-12 percent per annum. Further, salary bands at the same level in GICs do not change significantly. For example, entry-level salaries (for junior and senior programmer roles) for the IT-ADM function have changed only by 3-8 percent per annum over recent years. Further, the high pace of growth and high attrition levels of many of these GICs allow them to pro-actively manage the pyramid and keep their costs down by recruiting large numbers of lower-cost, entry-level talent to back-fill promotees and job-leavers. As a result, net wage inflation experienced by GICs is closer to 6-8 percent per annum. research.everestgrp.com 12EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) While the Sustainability Analysis is True for a Majority of the Work Offshored Today, There Will Be Meaningful Exceptions It is also noteworthy that there are meaningful exceptions to the analysis presented in the section above. There are locations (e.g., Brazil, Czech Republic, and Ireland), and functions (e.g., technology research and development) where a combination of multiple factors could erode the arbitrage faster. Some of these factors are:  Lower cost differential: Some locations may lose their cost advantage given lower cost differential (e.g., Ireland costs are only 20-30 percent lower than UK for most functions).  Skills shortage: Impacts cost competitiveness compared to functions where skills are more readily available. For instance, the arbitrage sustainability time horizon is relatively lower for technology R&D compared to F&A transaction processing work.  Unfavorable macroeconomic movements: Abrupt unfavorable macroeconomic movements related to currency movements and hyperinflation also impact arbitrage sustainability as in the case of Brazil. Exhibit 8 indicates the base-case arbitrage sustainability horizon for multiple geographies in Asia-Pacific, Latin America, and Eastern Europe. While India and the Philippines have a longer arbitrage sustainability window, locations such as Brazil, Ireland, and Czech Republic have much smaller arbitrage sustainability time frame, particularly for certain functions. EXHIBIT 8 TCO savings sustainability across functions Current arbitrage sustainability (base case) and locations >8 years 5-8 years <5 years 2012 Arbitrage could erode faster in Parent/source location – U.S. certain locations and functions BPO – Transaction BPO – Judgment GIC location IT – ADM processing intensive IT – R&D India The Philippines Source: Everest Group China Poland Chile Malaysia Czech Republic Ireland Brazil Additionally, while direct cost savings will always be important, many mature GICs realize that they can harness the platform they have built to deliver significant business value to the parent organizations. These organizations have started to make investments in their engagement and delivery models to reorient towards this goal that will define the impact GICs have in the long term. research.everestgrp.com 13EGR-2012-2-R-0664
    • COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS) About Everest Group Everest Group is an advisor to business leaders on the next generation of global services with a worldwide reputation for helping Global 1000 firms dramatically improve their performance by optimizing their back- and middle- office business services. With a fact-based approach driving outcomes, Everest Group counsels organizations with complex challenges related to the use and delivery of global services in their pursuits to balance short-term needs with long-term goals. Through its practical consulting, original research and industry resource services, Everest Group helps clients maximize value from delivery strategies, talent and sourcing models, technologies and management approaches. Established in 1991, Everest Group serves users of global services, providers of services, country organizations and private equity firms, in six continents across all industry categories. For more information, please visit www.everestgrp.com and research.everestgrp.com. for more information about Everest Group, please contact: +1-214-451-3000 info@everestgrp.com for more information about this topic please contact the author(s): Nikhil Rajpal, Partner nikhil.rajpal@everestgrp.com Salil Dani, Practice Director salil.dani@everestgrp.com Anurag Srivastava, Senior Analyst anurag.srivastava@everestgrp.com research.everestgrp.com 14EGR-2012-2-R-0664