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Global Services Insights
Executive Opinion
Rethinking Globalization:
Future-proofing global services

The Changing Cost Dynamic
Introduction
Have we reached an inflection point in the In 2003, an organization that engaged with an
offshore manufacture of high-tech goods? In offshore third party service provider for its
other words, has the cost of production of servers, application development and maintenance (ADM)
switches and other high-tech products become initiatives could reasonably expect to notch up
higher in emerging markets such as China and savings of 45-50%. Today this number is in the
Malaysia than in the U.S. and Mexico? A recent 25%-30% range. What has changed?
article in the McKinsey Quarterly suggests that we
have. With the rise in fuel costs, raw materials, In 2003, an organization that set up a captive
wage inflation combined with a weaker dollar, it is center in India for its back office functions could
now more cost effective to manufacture these reasonably expect to save 30-35% on its
products in Mexico, and even certain low-cost operating costs. In 2008 the savings are often
locations in the U.S. less than half that percentage. And in some
cases, the savings are negligible forcing
That is the scenario with manufacturing. But companies to put up their captives for sale. What
what about services? The services business deals has changed?
with a range of entirely different factors. Or does
it? It’s unimaginable that ITO and BPO sectors are Wages, to start with. At an average 13-15% year
headed for the same fate. over year growth rate, wage inflation in India has
forced third party service providers to steadily
Unfortunately, we now live in a world where what increase prices to maintain the attractive profit
is unimaginable in the morning becomes stark margins which have made them the darlings of
reality by the afternoon. Take these recent Wall Street. And just when the wage growth rate
examples. The collapse of Lehman Brothers, a dropped a bit in anticipation of waning demand
158-year old institution in investment banking. for IT and BPO services in the U.S., the inflation
Bear Sterns’ fire sale. High volatility in oil prices, rate in India – reflecting higher global prices for
Russia’s Soviet-style invasion of a sovereign everything from food to gas – hit 11%, effectively
democratic neighbor. The U.S. government’s setting the floor for salary hikes in the coming
takeover of Freddie Mac and Fannie Mae which year.
control over 50% of U.S. mortgages. Indy Mac.
Merrill Lynch. AIG. The list goes on. Currency appreciation has also been a
contributing factor to the diminishing cost
So should we, those in the outsourcing and advantage of offshoring. Although in recent
offshoring industry, still think that we are months, the Rupee has eased against the U.S.
insulated from adverse changes in the future? If dollar, it is still roughly 4% ahead of the 2003
your answer is ‘Yes’, your organization is woefully levels, and there’s uncertainty about what is to
unprepared for the changes ahead. If your come.
answer is ‘No’, you are on the right track. The
need of the hour is to re-think your globalization, What’s the Total Cost of Offshoring?
offshoring and outsourcing strategy and ensure If we look only at wage growth, it would take
that it is adequately ‘future-proofed’. India another 20 years to achieve wage parity
with the U.S.. But can that be the sole factor for
determining the cost advantage? No.

Enter Total Cost of Offshoring (TCO). Let’s look have made in training, benefits and other
at the changes that have impacted the other cost retention tools. Although retention costs do not
line items during the past five years. impact the customer directly, the increase in the
service providers’ cost base will ultimately affect
Consider travel costs. In 2003, the cost of a hotel the end user organization. Captive centers, on
room at the Sheraton Windsor Towers the other hand, also face similar attrition and
(Bangalore) was $200 per night. That same room retention issues as third party providers do, but
today goes for $480 per night. Business class don’t have the same luxury. Escalating wages
airfare for a person traveling roundtrip between and rising retention costs have forced many
New York and Bangalore, in 2003 was just over organizations to reevaluate their captive strategy.
$4,000. Today the same airfare today is over Some are opting to sell out. Some others are
$7,000. Factoring in the increase in per diem giving their low-end processes out to other
costs and local transportation, the average providers, while moving the high-end processes
organization that sends an executive to Bangalore from high cost locations to their offshore captive
for a 5-day visit will spend approximately 90% centers.
more than it did five years ago!
While India’s labor pool issues have been
Consider real estate and infrastructure costs. In accelerating in the past five years, many other
2003, the cost of leasing Class A office space in markets have entered the offshoring realm to
Bangalore was approximately $1.1 per sq. ft. In provide alternatives to buyers. Countries such as
2008, Class A office space rents for $2.1 per sq. the Philippines, Romania and Mexico now provide
ft. That’s an increase of 91%. In 2003 the highly qualified resources at reasonable price
monthly cost of renting a T1 line was $3700. In points without the extremely high attrition rates
2008 the monthly cost has surged to $5000. An of India. This results in greater labor stability,
increase of 35%. continuity and higher productivity. With annual
staff attrition in the high single digits, third party
This is true, not just of India, but of many service providers and captives alike have taken
countries that are both existing and new entrants advantage of a highly qualified labor pool, high
to the services globalization marketplace. As cost rates of productivity and moderate wage
increases for everything from wages to travel to appreciation in these countries.
infrastructure and technology, we are looking at a
dramatic shift in where organizations will find At home, the U.S. economic slowdown has
offshoring cost savings in the next five years. contributed to the global labor pool shake up.
With U.S. unemployment hovering at over 6% – a
The Changing Labor Pool five year high – employers now can consider
hiring IT and back office talent, from their own
Dynamic backyards.
Although India still graduates the largest absolute
Consider the case of Buffalo, NY. With a
number of English-speaking engineering students
metropolitan population of over 1 million, the city
per annum, it has become that much more
is New York state’s second largest and boasts of
difficult to retain this talent and keep it productive.
15 universities that produce over 60,000
In 2003 attrition rates, as reported by Indian IT
graduates per annum. A casualty of the
service providers, hovered in the range of 8-10%.
economic downturn that impacted much of the
Today, IT services providers must manage
Rust Belt in the 70’s and 80’s, revitalization
attrition rates in excess of 15-18% while BPO
began in Buffalo, in the late 90’s. But these
providers reel under attrition rates exceeding
efforts will undoubtedly stall as the overall U.S.
25%. Arguably, these rates would be even higher
economy continues to struggle. With a median
if not for the significant investments Indian firms
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income of just over $30,000 per year and an such as taxation, immigration, layoffs and
unemployment rate of 6%, most of the city’s severance, data privacy and increased regulation.
graduates migrate to other parts of the country to
find employment. Can Buffalo be the backyard Although the U.S. election dominates the
for an organization based in New York City? What headlines about political risk and offshoring, there
role should Buffalo (and many other Buffalos is another wind – one that emanates from
across the U.S.) play in an organization’s services Moscow – that may also impact how the
value chain? offshoring industry evolves in the coming years.
Russia’s recent invasion of Georgia has produced
a slough of media articles on a return to Cold War
The Changing Political Dynamic tensions, territorial sovereignty, strategic energy
dependence and most notably the West’s
unenviable position of not being able to impose
Although political risk has been long factored into
any meaningful sanctions on Russia in response
organizations’ decision-making around offshoring,
to the aggression. So, how might these gyrations
outsourcing and globalization, it is only recently
in global geopolitics impact the offshoring
that developments around the world have brought
industry? Visas will be affected, for one. And
this risk to the forefront. Political risk has been
there is perceived future risk. Let’s explore.
notoriously difficult to assess and can have broad
ranging affects on the offshoring industry. It is
The Russian IT services industry has grown by
also not just limited to emerging markets where
leaps and bounds over the past five years – from
government stability, and in worst cases armed
IT services exports of barely $300 million in 2003
conflict, come into play. Political risk also exists
to projected exports of $5.6 billion and $10 billion
in developed countries that buy services and
in 2009 and 2010 respectively. And with good
ranges from major policy shifts to elections to
reason. With 200,000 engineering graduates per
changing popular sentiment.
annum and more scientists per capita than any
other country, it has become a favored
Today, as in no other time during the past five
offshore/nearshore location for leading companies
years, we are faced with political winds that have
such as Google, SAP, Microsoft, Hyperion, Reuters,
the potential to sweep in drastic effects on the
Philips, Deutsche Bank, Motorola and Boeing.
offshoring industry.
Now, let’s consider this scenario. The head of
In November, we will be electing a new President
Microsoft’s offshoring efforts is unable to obtain
in the U.S. For those of us who had the good
an entry visa to visit her contracted service
fortune of being in the offshoring industry during
provider in Moscow. Furthermore, she finds it
the last U.S. election and managing through the
increasingly difficult to obtain U.S. travel visas for
‘Lou Dobbs Witch Trials’, we know that U.S. job
her Russian staff to visit Redmond for critical
loss will inevitably become a hot button issue
strategy sessions.
again. Although the last go around produced little
sustainable impact on the industry, there was a
Historically, as tensions mount between
period of disruption that was felt by many. This
governments that are unable or unwilling to
time, the situation will be different. With the U.S.
impose meaningful sanctions on each other, one
economic downturn spreading to Europe and
of the first diplomatic shots across the bow is a
beyond, historically high unemployment and
tightening of the visa regime. If this scenario
uncertainty about inflation, opponents of
seems implausible, consider the case of Robert
offshoring and globalization will undoubtedly pull
Dudley, CEO of TNK-BP (a joint venture between
out the heavy artillery. If a Democratic president
Russian consortium AAR and British Petroleum),
is elected, organizations – both buyers and
one of the largest oil companies operating in
suppliers – will surely feel the impact across areas
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Russia. After a protracted sparring match with its be played out in parts of Asia Pacific and Latin
Russian partners who have close ties to the America.
Kremlin, Mr. Dudley was denied a Russian work
visa and forced to leave the country to perform
Future-Proofing the Offshoring
his duties as CEO from an undisclosed location in
Model
Europe. Visa tensions, however, started even
earlier than the TNK-BP incident. In response to
the murder of a former Russian spy, Alexander
As organizations digest the myriad trends, forces
Litvinenko who was a UK citizen, UK officials were
and developments that impact the future of
quoted as saying that Britain was putting a halt
globalization or offshoring efforts, it will be
on a reform under negotiation with Russia, which
incumbent on them to put in place strategies that
would speed up Russian visa applications for
can effectively deal with impending risks,
diplomats and fast-track visas for tourists and
uncertainty and generate the value which is still
businessmen. Increased scrutiny of visa
very much inherent to the practice. Both buying
applications could also take place, especially for
organizations and service providers need to be
applications from government officials, they said.
keenly aware of developments that may change
the face of service globalization and respond
In such a scenario, how effective would the
accordingly.
Microsoft executive be if she were limited to
managing remotely? How effective would the
What should buying organizations be
offshoring initiative be if her Russian staff were
asking?
unable to attend meetings in Redmond?
• Is our global services portfolio sufficiently
insulated from changes in global cost
Now, take perceived future risk. Interest rates
structures?
for Russian companies have risen to a point
• Have we fully thought through the impact
where borrowing is virtually no longer viable.
of geopolitical events on our globalization
Western investors have already priced in future
efforts?
risk and established their appetite. The Russian
• Is our organization prepared for a
stock market has dropped by 30 percent to its
Democratic administration and the
lowest level since 2006 and the Ruble has slid by
resulting impact on our offshoring
4 percent against the dollar since Russia’s
initiatives?
invasion of Georgia. The nature of this future risk
• Have we recently assessed our Total Cost
is yet to be determined – be it further Russian
of Offshoring (TCO) to ensure we continue
aggression against its neighbors, explicit or
to meet our business objectives?
implicit, further strengthening of ties with Cuba
• What is our U.S. low cost strategy?
and Venezuela or an unsavory exertion of political
• What is our Nearshore strategy?
and economic pressure on Europe via its gas
• How do we proactively assess, manage
pipeline.
and mitigate risks?
Regardless of its nature, at risk is the ability of
What should service provider organizations
leading organizations to effectively manage and
be asking?
expand their offshoring/nearshoring operations –
• Have we considered geographic
both captive and third party – in Russia.
diversification to insulate ourselves from
cost escalation, geopolitical risks as well as
As unfortunate as the Russian political scenario
changing client demands?
and its effect on offshoring/nearshoring may be,
• Have we evaluated possibilities of cost
there exists the potential for similar scenarios to
take out in order to maintain our margins?
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• Should we disaggregate the services into situation and the uncertainty over taxation
individual components and perform the and other such policies related to
different pieces based on the optimal mix outsourcing, it certainly makes sense to
of location/capability? If yes, are we consider these low cost locations within
geared up to re-aggregate the pieces in a the U.S.
seamless fashion?
So, is this the death of offshoring? Is this the
• Do we have a strategy for communicating
death of India as the darling destination for
with clients on how changes in our
outsourcing? Does this mean mass return of IT
business will have an impact on pricing?
jobs to the U.S.? Does it mark the emergence of
a country like Mexico as an IT services
These are certainly times for soul searching, but a
powerhouse? No, no and no.
number of themes seem to be crystallizing:
So what does it all mean? It means that we are
1. Develop a portfolio of service delivery
on the threshold of major change in the services
locations that is globally diversified in
globalization arena. It is the time now to
order to be able to leverage market
consider our efforts to date, take a lesson from
expansion and service efficiency
the high-tech manufacturing sector, and ask
opportunities while effectively managing
ourselves some difficult questions to ensure we
geopolitical, security and macroeconomic
derive the best, in terms of talent and innovation,
risks
as well as cost savings from our globalization
initiatives.
2. Develop location strategy to suit business
objectives while taking into account the
Welcome to the new era of services globalization.
current and future attractiveness of
various geographies. This should factor in
service maturity, financial attractiveness,
business environment, talent landscape,
infrastructure availability and risk profile of
the location.
3. While geographies such as India and the
Philippines pioneered the offshore delivery
model, several countries in Eastern Europe
and Latin America are fast emerging as
attractive offshore/nearshore destinations.
Explore the role nearshoring plays in your
future state global services portfolio.
4. With the current economic situation in the
U.S. and the record-high unemployment
rate, U.S. cities are becoming viable
locations for both buyers and suppliers for
ITO and BPO. With the current political
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About neoIT
neoIT is a management consulting firm that helps leading corporations improve and grow their business by
capitalizing on services globalizationSM. Through a blend of strategic advisory services and hands-on execution
support, neoIT provides advice and management expertise on the globalization of Information Technology (IT)
and Business Process Outsourcing (BPO) services. For more information, visit www.neoIT.com.
neoIT Global Offices About the Author
Eugene M. Kublanov
neoIT Global Headquarters CEO
2603 Camino Ramon
Eugene is an industry veteran, a
Ste. 200
recognized thought-leader and a regular
San Ramon, CA 94583
speaker on the subject of services
Telephone: 925.355.0557
globalization at conferences in the US,
Facsimile: 925.355.0558
Canada, India, The Philippines, Russia,
Brazil and Mexico. His expert opinions
are frequently quoted by CNET,
Asia Headquarters Computerworld, India Times, Economic
Times, CIO Magazine, The Washington
Phoenix Towers, 5th Floor
Post and The Wall Street Journal.
No 16 & 16/1, Museum Road
Bangalore 560 025, India His client work has included global
Telephone: +91 80 4018 2000 portfolio strategy, operating model
Facsimile: +91 80 4018 2010 evaluation and implementation, M&A
strategy and global risk assessment and
management. Eugene’s clients include
neoIT Philippines leading organizations in the technology,
telecom, banking, finance, insurance,
8/F Pacific Star Building pharmaceuticals and professional services
Senator Gil Puyat Ave. cor Makati Ave. industries.
Makati City, Metro Manila, 1200, Philippines
Telephone: +63 (2) 811-5519
Facsimile: +63 (2) 811-5545
Your feedback is greatly appreciated. info@neoIT.com
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