A Global Labour Market
A study on service offshoring: India as the number one IT offshoring
destination, a country comparison between India and China.
Master Thesis by Roos Bulder
A Global Labour Market
A study on service offshoring: India as the number one IT offshoring
destination, a country comparison between India and China.
“The division of labour among nations is that some specialize in winning and
others in losing.”
Eduardo Galeano
Thesis by Roosmarijn Fleur Bulder Student at the University of Groningen Faculty of Management & Organization
MSc programme: International Business & Management First Supervisor: Prof. Dr. Ir. R. Goodijk
Second Supervisor: Dr. C.L.M. Hermes
PREFACE
A news paper item like this is just one of many. An ever expanding amount of companies is making the decision to outsource parts of its Information Technology (IT) to India. It is a trend which started a decade ago and which is still growing. The growth expectations for the future are very impressive and promising for the Indian economy.
When I arrived in India I did see the influence of this economic growth, large billboards on the street sides of international brands like Coca Cola, Mc Donalds and Philips. However under these bill boards, people were sleeping on the street, since they have no money to sleep elsewhere. India can be seen as a land of contrasts, economic growth on the one hand but also large poverty on the other. This journey through India gave me enough new impressions to start with my thesis.
I would like to give a word of acknowledgement to several persons that have contributed to the end result of this thesis. First of all I would like to thank Professor Goodijk and Dr. Hermes for all their useful feedback throughout the research process. I would also like to thank the persons that have showed interest in my research and that have spent time in answering my questions. These conversations have been very useful and gave me new insights into the topic. Thank you for that. Last but not least I would like to thank my family and friends for their support.
Roos Bulder
Antwerpen, October 2006
March 22, 2006: Dell plans to double India-Based Employee count to 20,000
Abstract
A decade ago offshoring was only used in industries that needed low skilled cheap workers. This has changed, nowadays an ever increasing amount of service related jobs are offshored. This trend towards offshoring of services by Western countries to the lower wage developing countries has attracted the increasing attention of researchers, practicing managers and policy makers. Currently India and China are respectively the number one and two service offshoring locations. The reason for this could be explained by a combination of outsourcing drivers and country characteristics. It appears to be that India’s country characteristics have a better ‘fit’ with the outsourcing drivers since it is the number one outsourcing location. This research confirms this belief.
TABLE OF CONTENTS
I. Introduction ... 6
II. Problem Statement ... 9
Research Objective... 9
Research Question... 10
Definitions ... 10
Methodology ... 11
Overview of the Thesis ... 11
III. Outsourcing Drivers & Country Characteristics ... 12
3.1 Outsourcing Drivers ... 12
3.2 Country Characteristics ... 14
IV. Country comparison India vs. China ... 20
4.1 Cost... 20
Labour Costs ... 20
Corporate Taxes ... 21
4.2 Availability of Skills ... 23
Labour Pool ... 23
4.3 Size of the offshore sector ... 25
4.4 Environment ... 28
Government support ... 29
Business environment ... 33
4.5 Risk Profile... 35
Intellectual Property Risk... 35
Disruptive events... 36
4.6 Infrastructure ... 38
ICT and Power supply... 38
4.7 Conclusion... 40
V. Conclusions and Recommendations ... 42
VI. Limitations ... 44
References ... 45
I.
Introduction
Outsourcing has been a hot topic for researchers and also for business managers throughout the past decade. The tone within these articles has changed during the past years. In the beginning nobody could stop about the rise of the new giants: China and India. The opportunities for the Western companies lie in the East. Large labour pools and markets have been attractive for a lot of Western companies. Today, however, researchers are questioning the benefits of offshoring for the ‘western’ worker, especially in America. There are concerns about the loss of skilled, well-paid jobs in for example computer programming and accounting.
Offshoring is no longer seen as a growing trend, but as a part of our economy. Jobs that were once performed locally are now performed globally where it is the cheapest (Ho et al., 2004). The term offshoring and outsourcing are a lot of times used as if they are the same, which is partly true. To avoid misunderstandings a definition of both concepts is in place.
There are many academic definitions of outsourcing. Lei (2005), for example, defines outsourcing as “the decision to utilize other firms to perform value-creating activities once conducted in-house.” The term offshoring refers to the relocation of jobs and production to a foreign country. The relocated jobs and production could be at a foreign office of the same multinational company or at a separate company located abroad (see table 1). In contrast the term outsourcing does not necessarily imply that jobs and production are relocated to another country (Gartner, 2004).
Table 1: Offshoring and Outsourcing – Some definitions
Location of Internalized Externalized
Production (‘outsourcing’)
Home Country Production kept in-house at home Production outsourced to third-party service Foreign Country Production by foreign affiliate, Production outsourced to third-party provider
(‘offshoring’) e.g. abroad,
British Telecom’s call centres in To local company, e.g.
Bangalore and Hyderabad - Bank of America’s outsourcing of software ‘Captive offshoring’ to Infosys in India.
There are many reasons why firms engage in outsourcing. Cost advantages often provide the initial motivation for outsourcing, especially offshore outsourcing. Apart from obtaining components at a lower price, outsourcing also helps the firm to lower its break-even point by reducing its fixed costs. A second advantage of outsourcing that is increasingly being mentioned in literature is that it can lead to a heightened focus on core competences (Quinn, 1992).
A decade ago offshoring was only used in industries that needed low skilled cheap workers. This has changed, nowadays an ever increasing amount of service related jobs are outsourced. Increasingly, components of back-office services such as payroll and order fulfilment, and some front-office services, such as customer care, are being relocated from the United States and other developed countries to English-speaking, developing nations – especially India, but also other nations, such as the Philippines (Dossani & Kenney, 2003).
When talking about offshoring of services, almost all researchers mention India (Chandrasekhar & Ghosh, 2006; Bardhan & Kroll, 2003; Farrell, 2006) as the number one offshoring location in Information Technology (IT) (AT Kearney, 2005)1. Research by NASSCOM and Mc Kinsey (2005) even suggest that “the IT and BPO industry becomes just as strategic for India as engineering and electronics are for Taiwan and oil is for Saudi Arabia.”
Manufacturing exports have been a key driver of growth for the Chinese economy; China is well known for its offshoring expertise when it comes to manufacturing. Throughout the past decade a lot of manufacturing is transferred from ‘the West’ to low wage country China, which has a large labour pool of low skilled, low paid workers. Furthermore China offers a large potential market with around a billion inhabitants. On the other hand China does not want to stay behind in this trend of service offshoring, since services are more value adding than manufacturing. They would like to attract more offshoring of services as well.
II.
Problem Statement
As illustrated throughout the introduction there is a recent trend in offshoring of services. Outsourcing is especially popular in the Information Technology (IT) sector, for example in the area of software development, maintenance and large-scale programming. Sometimes even call centres are transferred to low wage countries. At the moment India is the most popular country to which companies transfer their IT-divisions.
Research Objective
There are certain outsourcing drivers that are vital in a company’s decision making whether or not parts of the business should be outsourced. A combination of these outsourcing drivers and the economic conditions of a country, determine whether a company chooses to outsource and to which country. Since India is offshoring destination number one in the service industry, it seems that India’s country characteristics have a fit with business outsourcing drivers (see figure 1).
Figure 1: Offshoring of services
The following research objective is formulated:
To gain insight in drivers of companies for service offshoring in order to compare the current position of India as service offshoring leader in comparison to China, the number two offshoring location.
This research will consist of a general analysis of the determinants of service offshoring, based on available literature and empirical studies. This will be the basis for the explanation of the current position of India as the number one service offshoring destination.
Research Question
What are the drivers for service offshoring and why is especially India an attractive offshoring location compared to China for western companies when it comes to outsourcing of IT?
To explain the current leadership of India in the service offshoring industry and to assess whether there is a ‘perfect fit’ between the outsourcing drivers and the country characteristics, a comparison of a wide set of countries would be necessary. Since the timeframe and resources for this paper are limited it is unfortunately not possible to provide an analysis of a large set of developed countries. Instead a country comparison is conducted between India and China. These countries are at the moment the two favourite offshore locations according to a recent study by AT Kearney (2005). This will provide an insight in the current position of India, however, only in comparison to China. India and China are best comparable in economic development, size, and are eager to attract Western investors. China used to focus on manufacturing but after India’s growth and success in services, China does not want to stay behind and also sees potential in this higher value adding industry.
Definitions
There is not just one general definition of offshoring in the literature. It is often used interchangeably with outsourcing. The main difference between the concepts, as already illustrated throughout the introduction, is that when talking about offshoring of services, domestic supplied services are replaced by imported services. Foreign workers are substituted for Western workers while remaining in their country. Outsourcing in general can also exist within one country. The definition of offshoring in this paper is ‘international outsourcing’: The transfer of once performed in-house activities to an outside supplier that is located in another country.
A benchmark is needed to see why India is a preferred offshoring location. In 2005 A.T. Kearney publicised a Global Service Location Index (fig. 2 Appendix). 40 offshoring destinations were tested on financial structure, availability of people and skills and business environment. India is the overall number one, followed by China. With this table as a basis China is chosen as benchmark.
Methodology
In line with Baarda and de Goede (2001) this research can be seen as an evaluation or test research. The aim of this kind of research is to see whether the propositions, which are derived from theory, are true or false. With this kind of research it is often too early to develop a completely new theory, but a researcher does not start from scratch either. Since this thesis aims to research the fit of offshoring drivers and country characteristics for India according to a literature study, an evaluation study is the right research method. This kind of research can be seen as explorative. Evidence for explorative research may come from several sources. This paper is based on legal documents, official reports, academic papers, books, and press releases. It also builds on articles published in the Indian and International press.
Overview of the Thesis
This thesis examines to what extent offshoring drivers and country characteristics are the fundamental basis in the decision making process of offshoring. This will be examined by a country comparison between the number one and two service offshoring locations; India and China.
III.
Outsourcing Drivers & Country Characteristics
An interesting question regarding outsourcing of services is where in the global market it will take place. The demand for and the supply of outsourcing services has increased substantially since the early 1990s with continued demand from users in the USA, UK, Australia and various Western European countries.
Especially when companies have no experience in offshoring, they are not comfortable with locating an offshore operation somewhere that’s not tried-and-true (Farrell, 2006). In this paper a comparison is made between two offshoring locations based on facts, assuming that companies will make a rational choice when making an offshoring decision.
The transfer of a business part to another part in the world is not a new phenomenon. Economists like Hekscher and Ohlin (1933) already recognized that countries have a comparative advantage in the product which uses their relatively abundant factor. In the case of developing countries like China and India these are labour-intensive goods, since they are labour abundant compared to developed countries. On the contrary they will import capital intensive products, since the western countries are relatively capital abundant (Dunn & Mutti, 2004). Even classical economists got into the concept of globalization and tried to explain why certain business especially takes place in a certain country.
Business tends to search for the lowest costs and best quality to have profit maximization; an old phenomenon that still stands. This is also the main reason for offshoring, but certainly not the only one. Throughout the following paragraph the visions of different researchers are discussed to find out what the main drivers are for companies to outsource. A framework is developed according to these business’ outsourcing drivers, in combination with country characteristics. This framework will be the basis of the country comparison.
3.1 Outsourcing Drivers
within the transaction cost theory is the ‘make-or-buy’ decision; whether a firm should carry out an economic activity in house or outsource it to an outside supplier. If savings in production costs exceed the transaction costs then it is worth outsourcing and vice versa (Qu & Brocklehurst, 2003). Although cost savings are still a very important consideration in the outsourcing decision making process, companies outsource in order to obtain other benefits as well. The most common reasons, as suggested by various researchers, are listed below.
Cost reduction. The single greatest motivation for considering India, China, or any other
developing country for outsourcing is, quite simply, that the labour costs are significantly lower than those in developed nations are (Dossani & Kenney, 2004).
Cost reduction is one of the prime motivations for service offshoring. Various studies confirm that a large majority of companies cite lower costs as the prime reason for setting up an offshore shared service centre (UNCTAD, 2004; Rasheed et al., 2005; Bajpai et al., 2004; Kobayashi-Hillary, 2005). Although the costs of land and other resources may be cheaper abroad, the main difference between developed and developing countries is labour costs (Rasheed et al., 2005). In, for example, call centres labour costs account for 50-70% of total costs in developed countries. Moving to India, where wages are 80-90% lower than in the United Kingdom result in large cost savings (UNCTAD 2004, p. 165).
Improved quality. As some observers put it, some offshoring companies “went for cost,
stayed for quality” (Dossani & Kenney, 2004). This illustrates that the initial motivation of most companies is costs, but the reason why they finally stay in the country is because of the quality. Moreover, lower cost locations may offer better educated staff for the services than a developed country. For example in India, the majority of call centre agents are university graduates while they tend to be school-leavers in industrialized countries (UNCTAD, 2004). According to Yang et al. (2006), good quality of service is one of the most important success factors of outsourcing.
Flexibility. Firms expect service providers to adapt to the evolutions of their clients’
project requires major capital investments, the start-up process can be more difficult2. When a company would like to start with a project quickly, outsourcing could be a solution. Through this flexibility involved with outsourcing, companies are enabled to quickly respond to customer needs.
Focus on core business. Another advantage that is increasingly mentioned in the
literature is that outsourcing can lead to a heightened focus on core competencies (Quinn, 1992). This usually refers to an intellectually based activity of system that the company performs better than any other enterprise in the market (Yang et al., 2006). Hamel and Prahalad (1994) insist that companies that measure competitiveness in terms of price are only contributing to the erosion of their core competence. Their main idea is that only goods or services which are regarded as core competencies should be produced internally. Nike, which is outsourcing virtually all of its manufacturing, is a good example of a company that is really focussing on their core competences: design, research & development, and marketing. Why do it yourself when someone else can do the same or even better at lower cost? “An outside provider’s cost structure and economy of scale can give a firm an important competitive advantage” (Rasheed et al., 2005).
Reduce risk. Every business investment carries a certain amount of risk. Markets,
competition, government regulations, financial conditions and technologies all change very quickly. Through outsourcing a firm is able to take advantage of emerging technologies without investing large amounts of capital in uncertain technologies. This will also increase the flexibility of an organization by avoiding the need to commit to a specific type of technology, because it can switch from supplier when new, more cost-effective technologies become available (www.outsourcing.com).
3.2 Country Characteristics
Every outsourcing manager has a set of goals, which were stated in the previous chapter, it may be a selection of many goals including cost reduction, access to new skill sets, or improving the product quality. The company should compare its different options by comparing the different macro-economic conditions of the various countries.
2
A company will use its drivers as a basis when considering an offshoring location. The translation of these drivers to country characteristics is done by various researchers. A selection of these researchers is given.
According to Ge, Konana & Tanriverdi (2004), managers can assess potential benefits, costs and risks of outsourcing by considering characteristics of their business process and comparing macroeconomic conditions of the home country and offshore countries. Firms will decide to outsource their business to a particular country based on trade offs between attractiveness of comparative wage advantage, potential market, labour pool, country incentives and the risks associated with the foreign country. The uncertainty of a new environment such as infrastructure, country risks, and the distance in linguistic, cultural, legal and political system adds to the transaction costs (Ge et al., 2004).
Countries like India and China offer cheap labour rates, and have different areas of expertise. These are all factors that make outsourcing possible. However, there are other business promoting factors that must be considered as well, such as the number and quality of skilled workers, maturity of the outsource market, government support, the legal system, political stability, location and accessibility, education, infrastructure, technology and English language skills (Siems & Ratner, 2003).
Research bureau Gartner published research comparing the attractiveness of several nations for offshore outsourcing (2003). The research concludes with a country rating table, in which ten different nations are compared on nine criteria. The ratings of this well respected research bureau are based on the following criteria: government support, labour pool, infrastructure, education system, cost, political stability, cultural compatibility, data/IP security, overall climate. Based on the outcomes of the ratings on these factors in a country comparison the preferred offshoring location can be found according to research bureau Gartner.
An endless list could be made of various researchers about factors that should be considered in the decision making process of an offshoring location. Most research, however, encompasses the same macro-economic features. Some encompass more or less factors then the other, but the basics remain the same. The following figure (fig. 2) encompasses the main factors in choosing an offshoring location based on the research of Farrell (2006). An adaptation has been made however. The factor Market potential has been replaced by ‘Size of the IT offshoring sector’. This because of the assumption that when performing this consideration in an offshoring location for IT-enabled services specifically, market potential will not be very important. Offshoring of services specifically deals with back office activities, like data entries and call centre work. In this specific area, market potential will not be a consideration when choosing an offshoring location. The call centres of Dell in India, are a clear example, market potential was, in this case, not an issue.
As stated by Dossani and Kenney (2004), quality is an important driver in choosing an IT offshoring location, the size of the IT offshoring sector together with the factor ‘availability of skills’ will give indication of quality of the location. “Went for cost stayed for quality”, confirms the believe that the ‘size of offshoring sector’ should be analyzed in a country comparison for an offshoring location.
Fig. 2: Factors for considering an offshoring location
This research consists of an analysis on an industry level, so all factors are researched on a higher aggregation level than when performing this kind of research for a specific firm. That is the reason why an adapted operationalisation of the model by Farrell (2006) is made. Like in the model of Farrell (2006) the basic factors remain the same, except for market potential,
the level of aggregation is however higher3. In order to describe the different factors in a country comparison the following operationalisation is used for the different factors, based on the previous given research (Farrell, 2006; Gartner, 2003; Ge et al., 2004; Siems & Ratner, 2003).
Cost
As is seen in the paragraph of outsourcing drivers, cost is mostly the main driver of a company in its outsourcing decision making process. Especially within service offshoring labour cost is an important aspect (Bajpai et al., 2004; Kobayashi-Hillary, 2005; Rasheed et al., 2005; UNCTAD, 2004) since this kind of work is very labour intensive. Besides labour costs corporate taxes are also taken into account. To attract more offshoring, countries tend to have a special tax regime for the IT industry to attract foreign companies. This can be an incentive for a company to favour a certain country. The following factors will therefore be considered in the country comparison:
• Labour costs: current average wages for skilled workers
• Corporate Taxes: the total tax burden or, conversely, the tax breaks and other incentives for foreign companies.
Availability of skills
One of the main drivers of firms for offshoring is quality, Yang et al. (2006) indicate that environment factors such as market maturity and labour pool influence the level of outsourcing and therefore its quality. Almost every researcher recognizes the importance of a good labour pool in being successful in outsourcing. Farrell (2006) states that one of the main factors in choosing an offshoring location is the availability of skills, without the right people and equipment, a good service cannot be delivered. The availability of skills will be described according to a countries labour pool and the size of the offshoring sector. This to see whether there is the required labour pool and the size of the offshore sector will be an indication of quality (Yang, 2006).
• Labour Pool: Size of the labour force with the required skills, including language skills.
• Volume and share of employment in the sector
Size of the Service Sector
Companies tend to favour a location that’s already tried-and-true (Farrell, 2006). Furthermore the size of the sector can be an indication of its quality; environment factors such as market maturity influence the level of outsourcing (Yang, 2006). As stated before, quality is one of the main drivers in the outsourcing decision making process (Dossani & Kenney, 2004; Yang, 2006). An illustration of the size of the service sector will be made according to:
• Share of services as percentage of total exports
• Foreign Direct Investment
Environment
In the case of offshoring the company has to deal with another country, this can have certain complications. Offshoring mostly takes place between developed and developing countries. The government policies and cultures of these countries can vary a lot from the ‘western way of doing business’. Therefore it is important, when making an offshoring decision, to see what the environment of the other country is like in the sense of government policies and cultural compatibility (Farrell, 2006; Gartner, 2003; Ge et al., 2003). The factors that will be used in the country comparison are therefore:
• Government support: Policy on foreign investment and level of corruption
• Business environment: Cultural compatibility
Risk Profile
Operating in another country can come with some risks. Especially when operating in IT, it is essential that the firm’s data is in good hands and that not just anyone has access to it. Furthermore it is important that the IT business can, for example, be protected by patents, otherwise it could be possible that in the end the outsourcing partner becomes a competitor, because of its gained knowledge of the outsourcing company. Besides business risks it can also be that there is political unrest which can generate a negative influence on the business as well. The risk profile for India and China in the next chapter consists of the following elements:
• Disruptive events: Political unrest, natural disasters
Quality of Infrastructure
Operating within an IT environment means that power supply together with a well operating internet connection is necessary. Infrastructure that is of importance in the IT sector includes the availability of poser and the quality of the telecommunications infrastructure (Li & Gao, 2003). In the ‘Western World’ this is a common good, unfortunately is most developing countries this is far from common. Quality of infrastructure within the country comparison consists of the following factors, since these are the main elements when it comes to outsourcing of IT (Farrell, 2006; Li & Gao, 2003).
Telecom and IT: network downtime, connectivity Power: reliability of power supply
IV.
Country comparison India vs. China
As the two largest developing countries in the world, China and India have similar economic foundations. Both are very large in terms of territory and with a population of over a billion, they are also very large in terms of population size. Both have been evolving from an agricultural economy towards industrialization over the past decades. Both countries have gained more and more attention from other parts of the world as their participation in the worlds IT industry increases (Li and Gao, 2003).
Throughout this chapter India and China will be rated as offshoring destinations on the different outsourcing factors as given in the previous part: cost, availability of skills, environment, market potential, risk profile, and quality of infrastructure.
4.1
Cost
As stated in the previous chapter, the factor cost consists of the components: labour costs, and corporate taxes and incentives.
Labour Costs
One of the main reasons for offshoring is the lower labour costs in developing countries. Labour costs of for example a call centre agent in a developed country are a fraction of the cost of an employee with the same job description in a developed country. What are the differences however in wages between the different offshoring locations, in this case India and China?
The following table gives an indication of the average wages of a common profession within the IT industry, that of a computer programmer.
“China and India. Rarely has the economic ascent of two still relatively poor nations been watched with such a mixture of awe, opportunism, and trepidation. The post-war era witnessed economic miracles in Japan and South Korea. But neither was populous enough to power worldwide growth or change the game in a complete spectrum of industries. China and India, by contrast, possess the weight and dynamism to transform the 21st-century global economy.”
Table 2: Average salaries of computer programmers in US Dollars
Country Salary range
India $5,880 – 11,000
Philippines $6,564
Malaysia $7,200
China $8,952
United States $60,000 – 80,000
Source: Economic review, third quarter 2004 p. 13
Throughout this table it is seen that both China and India have a large wage advantage compared to the US. When comparing China and India, it can be assumed that India will in general be cheaper than China. However when hiring the most expensive workforce, one can be off worse, in terms of salaries, in India. One can assume that India will, in general, be cheaper. This is confirmed by a study of Nasscom (2002) which finds that the average wage costs in China are 15% to 20% higher than India. The differences with the US are for both countries enormous, which indicates that offshoring, in terms of wages, is interesting at all of the above countries.
Corporate Taxes
Taxes are an important cost burden for companies. Developing countries are responding to this with specific tax policies, in for example the IT industry, to attract foreign companies. For a company it is therefore interesting, to compare the tax policies, and the incentives for foreign companies per country to see where the costs are the lowest.
As the Indian government realizes that offshore outsourcing is a major economic driver, the government is offering packages of tax incentives and is backing telecom deregulation to support the growth of this sector.
Both countries have special economic zones (SEZs) where there are special regulations for foreign IT companies, this also involves tax breaks. These zones entail however more than just tax breaks and will therefore be discussed in the paragraph ‘government support’ (see p. 27).
The Worldbank developed a so called Knowledge Economy index which is the average of performance scores of a country or region in all four knowledge economy pillars: economic incentive regime, education, innovation, and information structure. From this index it becomes clear that India scores a little bit better than China on Economic Incentive Regime. Both scores are however poor, since scores are normalized on a scale of zero to ten relative to 130 countries, encompassing both developed and developing countries (Worldbank 2004). This score is based on the analysis of its tariff and non-trade barriers to trade, such as import restrictions and quotas as well as for example licensing requirements4. In general, both India and China are not providing foreign business with exceptional economic incentives. This is however different when considering the technology parks which are specific for the researched industry. Data specifically about the tax breaks and economic incentives within these parks are however not available and tend to differ across the different technology parks and industries.
Table 3: Rating of the Economic incentive regime of India, China, and comparable countries.
Economic Incentive Regime
2004 1995 Korea 5.39 6.74 Poland 5.84 5.15 Russia 3.34 2.33 Brazil 3.94 4.18 China 2.55 2.29 India 2.91 2.85 Source: Worldbank 2004
PricewaterhouseCoopers is also in favour of India when it comes to costs, they put the cost of operations in India 37% lower than in China and 17% lower than in Malaysia (The Economist, 2003). In general India is already more experienced with the phenomenon of special economic zones for IT-enabled services. The wage differentials are so far still in favour of India, with the growing IT industry in India the demand for good personnel is also
4 For all variables used in this rating see:
increasing, which is leading to higher wages. The Chinese government is however getting more aware of the importance of services compared to manufacturingand is willing to make an effort to grow within the IT sector. With its current policy the Chinese government is trying to compete with India.
4.2
Availability of Skills
When offshoring IT-enabled services, it is especially important to attract the right people. These people can no longer be low skilled like within general manufacturing work. The number of graduates in the low-wage developing countries is increasing. When comparing the increase of graduates in developed countries with developing countries it is seen that there is an average growth of university graduates in the developed countries of 1% compared to 5.5% per year in the developing countries. Self-evidently, developed countries have a larger base of graduates, but faster growth in the developing world’s graduate pool is closing the gap (Farrell, 2006). Throughout this chapter the labour pool of China and India will be compared concerning suitable graduates for working in IT.
Labour Pool
Every year, approximately 19 million students are enrolled in high schools and 10 million students in pre-graduate degree courses across India. Moreover 2.1 million graduates and 0.3 million post-graduates pass out of India’s non-engineering colleges. While 3 percent of them find jobs in other fields or pursue further studies abroad, the rest is looking for employment in the IT industry. If the flow from high schools to graduate courses increases even marginally, there will be a large increase in the number of skilled workers in the industry. Even at current rates, there will approximately be 17 million people available to the IT industry by 2008 (Country Profile, 2004). The Indian education system places strong emphasis on mathematics and science, resulting in a large number of science and engineering graduates. High knowledge in quantitative concepts together with good English has resulted in a skill set that has enabled the country to take advantage of the current international demand for IT.
There were 1,731 universities and institutions of higher education in China in 2004, up from 1,041 in 2000, with a total student enrolment figure of 13.3m, up from the 2000 level of 5.6m. Engineering and management are the two most popular courses (Country Profile, 2004).
low-companies. Research by Mc Kinsey under 83 human-resources managers at multinationals that look for talent in the emerging world, showed that they would, on average, consider employing only 10 to 25 percent of the country’s graduates. They, however praise the cultural fit and work ethic of their Indian employees. This is a higher proportion of suitable graduates than China produces but only half that of central Europe.
Looking at the pool of post-secondary graduates the gap between for example the US, and China and India is still very big. The difference between China and India in number of graduates is rather small. China is ahead of India with 17.5 million graduates compared to 16.1 in India (table 4).
Table 4: Number of Post-Secondary Graduates in mns
Source: Barro and Lee, 2000; quoted by Purushothaman in India: revealing BRICs potential (2004) p.8
When focusing on university degrees and more specifically on computer science, the statistics are in favour of India (see table 5).
Table 5: Education Education CHINA INDIA Population (Million) 1273 1029 Students in University (1000s) 7562 8000 Graduated in 2001 (1000s) 1020 2000
Graduated in Computer Science 62,000 110,000
An illustration of the labour pool according to is the volume and share of employment in the sector, should have been part of this analysis. Unfortunately this data is not available for India and China (see employment by activity worldbank5).
To date, offshoring has been dominated by American and British companies offshoring their internal operations and outsourcing to third parties, located in Ireland, Canada and India. The reason that these countries are especially chosen is because of the similarities in language. This is so far an important reason why China is less favourable since the English language skills of the Chinese are very poor. The Indians speak English, maybe not with the same accent and at the same level as Americans, but they do speak and understand the language. Chinese, on the other hand is a complete different language that uses hundreds of symbols instead of an alphabet, which presents a far greater challenge in basic communication. Westerners learning Chinese and the Chinese mastering English can be a serious stumbling block to outsourcing growth. India, as a former British colony, has an important advantage when it comes to language skills.
Concluding it can be said that India is the favourable country when it comes to the factor labour pool. The size of an educated workforce is comparable at both countries, the language is however a real obstacle for China and a large advantage for India.
4.3 Size of the offshore sector
Outsourcing of goods and services is said to have been worth USD 3 783 billion worldwide in 2001 and to be growing by around 16% a year. IT and business process services are among the largest and fastest-growing market segments, with ICT-enabled services outsourcing worth an estimated USD 490 billion in 2003 and growing 20% a year. Even higher rates of growth are expected in finance and accounting, market research, human resources, administrative and corporate services (OECD, 2004).
The Chinese and Indian Economy
The Indian economy is in development and is still far behind China. In GDP China is over twice the size of India. This is also seen in the share of Agriculture; the share of agriculture of the total GDP is very high in developing countries. The share of agriculture is decreasing but it is also seen that India is still relatively more dependent on agriculture than China.
Table 6: Comparison of the of Indian and Chinese Economy
Economy INDIA CHINA
2000 2003 2004 2000 2003 2004
GDP (in current US$ billion) 457.4 600.6 691.2 12,000 16,000 19,000
GDP growth (annual%) 3.9 8.6 6.9 8.4 10.0 10.1
Services, etc., value added (% GDP) 48.8 50.7 51.7 39.3 41.5 40.7 Exports of goods and services (% GDP) 13.9 14.9 19.1 23.3 29.6 34.0 Imports of goods and services (% GDP) 14.6 16.4 22.5 20.9 27.4 31.4 Commercial service export6 (current US$) - - 23.092 - - 62.056 Share of services of total exports (%) - - 30 - - 10
Source: The Worldbank
Table 6 shows that the share of services in India with 30 percent of the total exports is a lot higher than China. An indication of the size of the offshore sector is the share of IT-enabled services as percentage of total service exports (table 7).
Table 7: Structure of service exports
Structure of Service Exports
Commercial service Computer, information,
Exports Communication and
Other commercial services (in US$ millions) (as % of commercial services)
1990 2003 1990 2003
China 5,748 46,375 18.7 44.4
India 4,610 25,043 42.7 75.1
Source: Worldbank
The share of services of total exports is a lot higher in India compared to China. Also when looking more specifically to computer, information and communication as part of commercial services, this is, with 75%, a large part of the Indian service sector. In dollars it is seen that the growth of services in both countries has been enormous. China has grown even faster and in amount of dollars it has even surpassed India. To specifically look at the offshoring sector, it is necessary to look at the foreign direct investments in both countries within the IT enabled service sector.
Foreign Direct Investment (FDI)
FDI is considered to be an important driver in economic growth (OECD, 2003). The amount of FDI attracted to a country is an indication of the openness of a country, in the sense that
6
they are stimulating foreign business. FDI is playing an important role in offshoring, although this is difficult to quantify because of the lack of reliable data (UNCTAD, 2004).
“FDI is an activity in which an investor resident in one country obtains a lasting interest in, and a significant influence on the management of, an entity resident in another country. This may involve either creating an entirely new enterprise (so called ‘greenfield investment’), or, more typically changing the ownership of existing enterprises (via mergers and acquisitions) (OECD, 2003).”
Between 1991 and 1996, FDI inflows into India ran at an annual average of USD 1,085 million. Since 1997, inflows have increased rapidly to USD 3 449 million in 2002, at which time inward FDI stocks in India amounted to almost USD 26 billion. Nowadays FDI inflows to India have averaged only around US$ 5 billion annually over the past few years, as compared to US$ 40 billion annually to China. McKinsey and Company (2003) estimated that USD 400 million of the FDI inflow into India in 2002 was invested in offshoring activities, up from USD 300 million in 2001 and from an annual average of around USD 100 million between 1996 and 2000.
India is attempting to liberalize FDI in the service sector since 1990/91. In India, the venture capital rules were reformed in 2000 to allow foreign venture capital to invest in India on the same terms as domestic funds (Dossani & Kenney, 2003). FDI is however still subject to limits in India, particularly on full ownership by foreign players. For example, FDI is currently not permitted in pure retailing; global retailers can participate in India’s retail sector only through wholesale trade or by operating retail outlets through local franchises (Worldbank, 2004).
In principle FDI affects offshoring in two ways: through captive offshoring (Production at a foreign affiliate7), and when specialized service providers set up foreign affiliates to serve foreign clients (outsourcing). Such investments can create many jobs, they however do not generate large capital flows. This has the consequence that they do not account for large shares in the FDI statistics (UNCTAD 2004). Therefore UNCTAD (2004), examined the number of export-oriented FDI projects related to offshored services, instead of their value. Of the more than 300 export-oriented IT projects in developing countries, 37% went to India, and 19% to China.
When specifically looking at the number of projects in Call Centres and IT services (table 8) it is seen that India attracts twice the number of FDI projects in comparison to China.
Table 8: Export-oriented FDI projects in call centres, and IT services 2002-2003.
Call Centres IT services
No of Share No. of Share
Region/Economy Projects of total projects of total
China 30 6 60 9 India 60 12 118 19 Malaysia 16 3 8 1 Philippines 12 2 9 1 Thailand 2 - 7 1 Taiwan 4 1 9 1 Bangladesh 1 - - -
Source:UNCTAD; World Investment Report 2004: the shift towards services 2004 p. 163.
Throughout this paragraph it is seen that India, in terms of size of the service offshoring sector, is still considerable larger than China. India has therefore an advantageous position versus China in attracting offshore services, because of the assumption that foreign companies prefer a location that is experienced and therefore qualified (Dossani & Kenney, 2004; Yang, 2006).
4.4
Environment
The developing countries that are offering offshore services differ greatly from some that can be easily integrated into a western style of management culture, such as Ireland or South Africa, to those that are quite remote from the US or European way of doing things, such as
7
India or China. That is the reason why it is important to take a look at different environmental features when choosing an offshoring location.
Government support
The General Agreement on Trade in Services (GATS) is the first multilateral agreement under the auspices of Uruguay Round to provide legally enforceable rights to trade in a wide range of services along with their progressive liberalization (Chade, 2000). Each separate country has its own government regulations concerning trade. Trade barriers, for example, can have a negative influence in the openness of the country concerning offshoring. Especially in developing countries a lot of companies, for example in telecom, are still owned by the state and are therefore not markets that are open for (foreign) private parties. This paragraph will give an overview of the government regulations related to foreign business for India and China.
India is the world’s most populous democracy and has held free elections since 1947. It is a parliamentary federal democracy with an indirectly elected president, Abdul Kalam. The Prime Minister, Manmohan Singh, leads the United Progressive Alliance (UPA). Over the past decade India has made great advances in the reduction of the role of the state by opening service industries to domestic and foreign competition in telecommunications, banking, insurance, business and health services (Worldbank, 2004). This is done because the Indian government is aware of the need to improve the provision of services. India has liberalized its FDI regime during the 1990s.Foreign equity up to 51 per cent is now automatically allowed in restaurants and hotels; support services for land and water transport; parts of renting and leasing; business services including software; and health and medical services. Railway transport continues to remain among four industries reserved for the public sector. The insurance sector has only recently been opened to private sector.
almost all companies are private. Since joining the World Trade Organisation in 20018, China has rapidly become a global economic force. The strength of China still lies in manufacturing with its large low skilled and cheap labour force. Especially the eastern part of China can be seen as free market. The Chinese Government wants to try to move away from labour-intensive and low value-added manufacturing to more highly value-added services which the offshore IT market provides. This will become essential as Chinese living standards rise and it ceases to be competitive as a source of cheap manufacturing labour (Qu and Brocklehurst, 2003).
Exports are the major focus of India's trade policy. Most products can be freely exported from India. A few items are subject to export control in order to avoid shortages in the domestic market, to protect national resources and the environment. Export profits are exempt from income tax. Inputs required to be imported for export production are exempted from the basic customs duty. Export Oriented Units (EOUs) and Export Processing Zones (EPZs) enjoy special incentives such as duty free import of capital goods and raw materials for the purpose of export production. A Brand Equity Fund has been set up to popularize high quality India brands in the world market9.
Special Economic Zones
In order to attract foreign companies, so-called Special Economic Zones (SEZ) are set up. These zones are run by the Ministry of Commerce & Industry of the central government. The SEZ can contain any line of business, and gives benefits in every imaginable area such as tax benefits, special environmental regulations and reduced bureaucratic procedures. Another attraction of SEZs is that they provide in their own infrastructure, therefore they do not have to rely on the outside for water and power. This is the reason for a better infrastructure within a SEZ compared to outside the zone. There are many software companies residing in the SEZs in India but most of them have chosen to go for the more liberal Software Technology Park concept (Oskarsson 2005). Software Technology parks or India (STPI) is a society set op by the department of Communication & Information Technology of the government of India in 1991, with the objective of encouraging, promoting and boosting the software exports from India (www.stpi.in). The Software Technology Parks (STPs) have excellent infrastructure facilities at their disposal and provide other services like technology assessment and
8 China joint the WTO in January 2001, India is already a member since January 1995. 9
professional training. Today over 7,756 software-exporting companies exist under the STPI legislation, in 41 technology parks all over India. These firms are both domestic and foreign owned. Anything to do with software, IT or telecommunication is allowed in a Software Technology park. The benefits are extended to BPO businesses such as call centres.
In China government policy is detailed in its document Policies on Encouraging the Development of Software and Integrated Circuit Industries, which was issued by the State Council in June 2000 (www.mii.gov.cn). Preferential taxation and special zoning arrangements, including high-tech parks to attract domestic and foreign investors, have sprung up. Many regional and local government organizations are following these national initiatives by providing further subsidies such as corporation and individual income tax deductions, low interest loans, 3 years rent-free offices in software science parks and investment in the education of IT labour.
Table 9 provides estimates of trade restrictiveness, originally for a set of 91 countries including both tariffs and Non Trade Barriers (NTB) (Worldbank 2005). A rating of 0 indicates that there are no trade barriers, contrary to 1 which indicates a closed economy.
Table 9: Trade restrictiveness
Trade Restrictiveness Indices
Country TRI US 0,215 China 0,314 European union 0,331 Japan 0,474 Malaysia 0,476 India 0,508
Source: The worldbank 2005, Development Research Group.
parks. All facilities within these Indian Parks are adjusted to needs or the IT-enabled services industry.
Governance Indicators
In the Western World, all companies have to conduct to rules set by the national government and international organisations, like the European committee in Europe. In most developing countries this is the same, but there are however ways to get out of this. Corruption can be a necessary element of doing business in some countries. The governance indicators provide insight in most important regulatory affairs in the business environment.
India’s bureaucracy is famous for its inefficiency and corruption, something that still plagues the daily lives of millions of citizens who need some paperwork done by a public office. Unfortunately China is not more efficient on this matter. The Worldbank views good governance and anti-corruption as central to its poverty alleviation mission10. That is why they conduct research on different governance indicators which consist of six dimensions: voice and accountability, political stability and absence of violence, government effectiveness, regulatory quality, rule of law, and control of corruption11. When looking at the governance indicators of the Worldbank (table 10), the table shows for India and China the percentage of countries worldwide that rate worse than them on the four different factors. It becomes clear India is ahead of China on all governance indicators. China is particularly scoring poorly on voice and accountability. This has, for a great part, to do with the political system. As is seen throughout the previous paragraph, China is reforming but is still a communistic country with a one-party system. A remark has to be made, that these figures are from 2000, China was not a member of the WTO then, it can be assumed that when the same research would be performed now that China would score better.
The governments of both countries are aware of the potential for their economies when allow foreign business into their country. This is also the reason why special economic zones have arrived. Especially within these zones IT related business, both local and foreign, are
10
http://web.worldbank.org/WBSITE/EXTERNAL/WBI/EXTWBIGOVANTCOR/0,,menuPK:1740542~pagePK :64168427~piPK:64168435~theSitePK:1740530,00.html
11 See for mee information about the dimensions:
stimulated by special regulations, infrastructures, and mostly also with technical universities to supply the right people.
Table 10: India and China: Governance Indicators
* The above chart depicts the percentile rank on each governance indicator. Percentile rank indicates the
percentage of countries worldwide that rate below the selected country (subject to margin of error).
Source: World Bank Governance indicators 2000; quoted by Purushothaman in India:Realizing BRICs potential(2004) p.6.
Business environment
The nations involved in offering offshore services can differ greatly in regarding business environment. They vary greatly from those who can be easily integrated into a western style of management culture -such as Ireland or South Africa- to those that are quite remote from the US or European way of doing things, like India and China. They have, however, the advantage of being a lower cost location than countries like Ireland. Lower costs is mostly the driver for a lot of companies, but the company needs to adapt far more in order to work with the culture and management structure at these locations.
Culture
Culture is defined as: ‘The collective programming of the mind that distinguishes the members of one category of people from those of another”(Hofstede & Bonde, 1988).
“If we go into another country and make decisions based on how we operate in our own home country the chances are we’ll make some very bad decisions” (Hofstede, 1980).
Hofstede (1980) developed a model that identifies four primary dimensions to assist in differentiating cultures (www.geert-hofsted.com). After conducting an additional international study a fifth dimension was added. The dimensions are the following:
Power distance (PDI): the extent to which the less powerful members of organizations and
institutions accept and expect that power is distributed unequally.
Individualism (IDV), societies in which ties between individuals are loose, everyone is
expected to look after their selves and their immediate family. This versus the opposite; collectivism, societies in which people from birth onwards are integrated into strong, cohesive in-groups, often extended families which continue protecting them in exchange for unquestioning loyalty.
Masculinity (MAS), versus the opposite, feminity, refers to the distribution of roles between
the genders.
Uncertainty avoidance (UAI), deals with a society’s tolerance for uncertainty and ambiguity.
It indicates to what extent a culture programs its members to feel either uncomfortable or comfortable in unstructured situations.
Long-term Orientation (LTO) versus short-term orientation. Values associated with LTO
are thrift and perseverance. Values associated with short term orientation are respect for tradition, fulfilling social obligations, and protecting one’s ‘face’.
Based on these dimensions different countries can be compared in their possible cultural fit of misfit.
Table 11: Rating cultural dimensions
PDI IDV MAS UAI LTO
China 80 20 66 30 118
India 77 48 56 40 61
US 40 91 62 46 29
UK 35 89 66 35 25
Source: www.geert-hofstede.com
China on individualism is lower than any other Asian country, at 20 compared to an average of 24. This may be attributed, in part, to the high level of emphasis on a collectivist society by the communist rule(www.geert-hofstede.com). Both India and China can be seen as collective cultures, with the family as the main collective unit, which provides both psychological and practical security and identity. Furthermore they can be seen as a ‘high power distance’ culture, with great respect for strong vertical order. The basis for authority within the Chinese culture is paternalism, concern for employees and their welfare legitimates the holding of power, and the exercise of discipline. Chinese people are ‘programmed’ to fit into a hierarchy, whether it is at state, firm, or family level (Redding, 2002). China is particularly scoring high on long term orientation (LTD), which is true for all Asian cultures, but extreme for China especially compared to India and the rest of the world which has an average of 48. The Indian culture fits in that respect better with the UK and US which are more short term oriented, especially in comparison to China.
The language barrier and culture fit are two very serious obstacles for China in being a possible leader of offshoring IT. On the other hand, language is a very important advantage for India. English is the official language in business and education in India and that is perfect for the US and UK markets. The cultural differences both have negative and positive sides. Both Indian and Chinese employees are said to be very loyal and driven, and they can be a dream of every boss because they will not argue with their boss. However when it comes to own initiative, which is very common and appreciated in western society, both the Indian and Chinese culture fail.
4.5
Risk Profile
Offshoring involves doing business in another country, this can lead to certain risks and uncertainties. These possible risks are described throughout the following paragraph, divided into intellectual property risk and disruptive events.
Intellectual Property Risk
Governmental regulations on technology transfers, intellectual property and copyrights, privacy laws, and trans-border data flows can all impact the success of the outsourcing relationship.
operation of the Agreement and promote the transparency of Members' policies on intellectual property protection.
Intellectual property (IP) rights are often a gray area in many developing nations. Because outsourcers must often hand over their source codes (for testing and debugging) or share sensitive systems designs (in the case of applications development), they run the risk of industrial espionage by competitors.
The World Trade Organization’s TRIPS (Trade-Related Aspects of Intellectual Property Rights) agreement attempts to standardize the way in which intellectual property is protected across member countries.
China did not take a lot of action against software piracy in the past but is now in the process of passing laws that protect private ownership and intellectual property (Furniss, 2003). This has for a great part to do with their WTO membership, which makes China subject to WTO oversight, the same accounts for India.
It can be assumed that there is a higher risk concerning intellectual property when comparing the property rights in for example the US and China, and India. There is however not enough real data to make a concrete comparison between Indian and China on the topic of intellectual property rights.
Disruptive events
“After the wake of hurricane Katrina, the Mumbai floods and the Asian Tsunami, there has also been increased interest in the level of disaster preparedness across locations” (AT Kearney 2005). Certain events can be disruptive in operating a business, this can be political unrest or natural disasters (Farrell 2006).
anywhere else. Who would have expected for instance that a large city like New Orleans could be damaged like hurricane Katrina did.
The chance of political unrest is on average higher in developing countries, since the political system is mostly less developed.
India can be seen as a political stable country. It is one of the world’s oldest democracies. However there are some political difficulties in the region of Kashmir. Communal and religious violence has increased risk in India. The kashmiri impasse between India and its neighbour Pakistan has increased tension on the sub continent and internationally. Both countries have nuclear capabilities, and terrorist incursion in India Kashmir 2002 by Kashmiri militants on the Pakistani side of the border brought the two nations to the brink of war. The international community headed by the USA and the UK have intervened and have managed to head off what had at one time appeared to be certain war.
The Middle East Crisis, the attack upon Iraq by the USA, the war with Afghanistan and 9-11 and its aftermath have significantly dampened down the conflict between India and Pakistan, which has received significant aid from the USA and forgiveness of some $10 billion in debt for its support for the US intervention in Afghanistan (Times publications 2006). However, the Dutch government often gives a negative travelling advice for this region. Since it occasionally suffers from bomb attacks, often occurring on buses or trains, or at bus stations (Country report India, 2004).
China’s low-key response to North Korea’s missile launches emphasises its dilemma as it tries to both support and pressure Pyongyang. The two countries have enjoyed strong ties but international uproar over the tests have made it difficult for China to remain loyal to North Korea and maintain good relations with the US. Besides that, there has been some unrest in the Tibet region. It is however quiet at the moment. The Business Monitor International (2006) has made a political risk rating. The political risk in a country is zero when the rating is 100. Table 12 indicates that China scores better on political risk than India, India even
“The reason why it didn’t lead to a war between Pakistan and India in 2002 is business. Both countries knew that when they would start with this war, foreign companies would withdraw and would not return within maybe ten years.”
Table 12: BMI Political risk ratings
Short-Term Political Rating Rank* Trend
Singapore 88.0 1 = Vietnam 80.0 13 = Laos 75.0 21 = China 74.0 24 = Hong Kong 74.0 24 = South Korea 74.0 24 = Malaysia 73.0 32 = Myanmar 66.0 56 = India 62.0 70 = Cambodia 60.0 74 = Indonesia 59.0 77 = Thailand 59.0 77 = Philippines 57.0 82 = North Korea 55.0 87 = Sri Lanka 50.0 95 = Pakistan 49.0 98 = Bangladesh 43.0 101 =
Regional Average: 64.6 Emerging Market Average: 65.4 Global Market Average: 67.6
Source: China Business forecast report, Political Outlook p.6, Q4 2006.
Disruptive events are hard to forecast. A natural disaster can happen everywhere now a day, with the changing climate. Political stability is also becoming hard to forecast, who would have expect that that someone would hit the Twin Towers in the US. Looking at the data on political risk it is possible to make some assumptions. It appears that China has a lower risk rating than India. Especially in the region Kashmir, in the north of India, there have been some terrorist attacks. Offshoring of IT-related services, however, mostly takes place in the special economic zones with their own security just outside the large cities. This can positively influence the amount of risks.
4.6
Infrastructure
The companies coming to India or China have to sell a service from a country that is still economically developing, so the basic infrastructure may not be at the same level you would expect in the US or Europe.
ICT and Power supply
VSNL, the state-owned international call carrier, lost its monopoly and was privatised on April 1st 2002. Long-distance services have been open to private competition since January 2000. Rates for long-distance and international calls have fallen, but remain high by international standards. The result has been the arising of a telecommunications network with quality and cost levels approaching that of developed countries, though mainly in the larger cities (Dossani & Kenney, 2004). Internet connectivity remains low at 6 users per 1,000 people, compared with 26 in China.
China’s telecommunications market has seen an amazing growth. A decade ago, China’s phone system had one fixed line for every 100 people and no mobile phones. Today, China has five times as many fixed lines as India and 25 times as many mobile subscribers. In 2000, 70 million Chinese subscribed to mobile phone services, and by 2005 the number of subscribers could reach 240 million, making China the largest mobile phone market in the world (Haley, 2003).
Electric power and telephone lines are especially important, when it comes to outsourcing in IT. In general China is already more developed, which was also already showed by its difference in GDP compared to India. Electric power consumption and telephone lines are therefore also double the figure of India (table 13).
Table 13: Infrastructure, comparison between the BRIC countries, indexed to India.
Source: Worldbank, quoted in Realizing BRICs Potential 2004
