Indian BPO Firms Step Out of the Back Office, toward Knowledge Process Outsourcing and BeyondPublished: February 15, 2007 in Knowledge@Wharton
In December 2006, Mumbai-based Tech Mahindra won India's biggest outsourcing deal to date -- a five-year, $1 billion contract from British Telecom to provide technical support. Tech Mahindra, in which BT has a 35% stake, bettered a September 2005 deal in which three Indian IT services firms were among five international providers picked by Amsterdam-based financial services company ABN Amro for one of the biggest outsourcing contracts ever handed out. Infosys Technologies, Tata Consultancy Services and Patni Computer Systems share that $2.2 billion, five-year contract with IBM and Accenture. In another corner of India's outsourcing industry, a much smaller firm created a niche "spot market" for knowledge services. Yet another Indian outsourcing service provider built a platform of expertise to provide patent-related legal resolution support services -- several notches above the patent writing functions that were considered high-end assignments until recently.
Those are just a few samples of the dramatic progression achieved by Indian outsourcing service providers in their offerings. Although 65% of India's 180,000 outsourcing services work force is involved in transaction-intensive services like call-center support or check processing, the industry as a whole helps its clients save $1.5 billion annually, according to a recent research paper, "Offshoring: Beyond Labor Cost Reduction," by the Boston Consulting Group (BCG). (India's outsourcing services industries employed about 415,000 people as of March 2006, according to India's National Association of Software and Services Companies.) GE alone saves more than $350 million annually after offshoring about 900 different processes to India, according to the paper, which was written by analysts in BCG's New Delhi offices.
At every juncture in the nascent industry's growth curve, its players seem to be discovering a kaleidoscopically changing array of new frontiers, beyond merely scaling up in their familiar territories. Interviews with experts at BCG, Wharton and outsourcing companies reveal the contours of tomorrow's service offerings. The industry now seems to have achieved critical mass in its quest for providing knowledge process outsourcing (KPO) services, where skills, judgment and discretion are the tools.
Ravi Aron, senior fellow at Wharton's Mack Center for Technological Innovation finds enough evidence to support that climb up value chains. In fact, Aron, who has consistently followed trends in this industry, had four years ago predicted the emergence of what is now commonly referred to as KPO. "Instead of routine data work, you move towards more of information extraction, which involves a certain amount of judgment, interpretation, discretion and inference," he says. "You are seeing more of that happen. Instead of medical transcription, data entry and minimal inbound call support, people are now offering high-end research services." He adds that these do not make for whole new trends: "What we are seeing is a substantial and significant difference in degree, but not of kind."
Thomas Bradtke, manager in the Boston office of BCG and one of the firm's topic leaders on globalization, agrees with Aron. "The Indian companies started as labor arbitrage shops and are now moving into knowledge-intensive services," he says. "These guys know how to reengineer processes; they don't just throw a hundred people at a problem, but they make the process flow better and make it more effective." He sees that as another form of innovation, much like what an industrial products manufacturer might produce out of its R&D labs.
BCG's in-house research found several U.S. and European firms achieving significant cost benefits from offshoring, in addition to mere wage arbitrage savings. One U.S.-based high tech company achieved productivity improvements of over 50% over six months, "driven by higher quality recruits, greater digitization, domain and re-engineering capabilities and continuous measurement of performance," according to the BCG-authored paper. The client had offshored a complex order management process; those 50% gains showed up in about 2,000 orders received every day from 50 offices in three languages. Other clients took home enhanced process quality from standardization, discipline, higher skilled resources and greater focus on process performance at their BPO services provider.
In this emerging market space, Aron sees some of the most compelling work at companies like Office Tiger, a New York City-based service provider with the heart of its delivery capabilities in Chennai, India. (Business solutions provider R. R. Donnelly & Sons acquired the firm in March 2006.) Office Tiger offers high-end decision support services for clients, including some of the world's largest investment banks and financial institutions, legal firms and retail chains. Another firm he cites is Pangea3, a legal and related services firm with offices in Mumbai, New York City and San Jose, Calif. that was founded by legal professionals with their primary grooming in U.S. practices. The firm has more than 65 attorneys and 25 patent engineers doing specialized background legal research for patent-related and other cases.
Leaping to the Next Level
Indian providers of IT services led the outsourcing boom in the late 1990s, mainly with data entry, standard processes and conversion assignments in the Y2K era. But to secure a local presence in foreign markets and become true multinational players like a Toyota America or a Sony USA, companies must invest in hiring locals, says Wharton professor of management Saikat Chaudhuri. Companies like Infosys, he notes, have begun doing that on a larger scale, hiring senior people away from industry majors like EDS of Plano, Texas. "These are people who have access to the higher-end executives at potential client companies, not those who do back-office work," says Chaudhuri.
Indian outsourcing service providers now have to make a leap to the next level, which is "access to the CEO or the CTO," and capture high-end consulting work at big companies, not just product development assignments, says Chaudhuri. "Such consulting work could be devising strategies for technology solutions -- like what IBM Global Services, Accenture or EDS do -- and not just implementing them. Indian companies are now starting to get into the implementation stage with larger, big-ticket deals, but they are still not bagging the high-end consulting services deals."
In the ABN Amro mega-deal with Infosys, Tata Consultancy Services and Patni Computer Systems (along with IBM and Accenture), the bank sought to achieve "in-house consolidation, partial outsourcing, multi-vendor strategies and offshoring." Over an 18-month period, ABN Amro projected a reduction in its own IT staff headcount by 1,500 full-time equivalents. With the resultant lower wage costs and related efficiencies, ABN Amro expects to achieve annual savings of $300 million by 2007, rising to more than $700 million thereafter.
The "Spot Market" for Research
Aron's third illustration of high-end KPO work is Pipal Research of Chicago, which was founded five years ago. The company employs about 100 analysts, with most of them based in New Delhi. Until recently, the bulk of its assignments came from equity research, fixed-income asset research and asset pricing-related work. A year ago, it carved out a division called PipalAnswers that functions like a "quasi spot- market for knowledge." These are essentially one-off assignments tailored to service occasional requirements of clients, unlike Office Tiger, which has dedicated long-term client relationships.
PipalAnswers is the brainchild of Sanjeev Arora, Pipal Research's vice president of products and operations based in Chicago. His new product offers speedy research on tightly focused client requirements such as snapshot insights of rival companies' ad spends and public relations. Arora cites one client who "needed information in three days. We picked up the information over the Internet, analyzed it and gave a quote within a few hours, which they approved online."
Arora says that while PipalAnswers' research work is carried out primarily in India, it certainly helps to maintain a U.S. base. "Within the first few days of launching our service, we fielded a project on pet foods," he says. Branded pet foods makes for a tiny industry group in India. "Someone in India may not even fathom how crucial that is for American customers. Having a strong presence here allowed us to understand the market."
To be able to muster the information resources across a range of industry domains, Pipal spends between $75,000 and $100,000 on a variety of databases. "You can't just Google everything," says Manoj Jain, Pipal Research's founder and CEO. Pipal's fees range from $20 to $100 an hour for its specialist research support products. The company also markets a Web-based proprietary "knowledge management tool" which client companies can use to absorb information across different divisions, functions and locations of their organizations, and retain it in a searchable repository. Jain says this allows clients to raise their "people power" from mere experience to one of apprenticeship.
Those ambitious ideas must have encouraged Firstsource Solutions (formerly ICICI OneSource), a large outsourcing services provider in Mumbai that in 2004 bought 51% of Pipal Research (the remainder is with Pipal's management). "They operate on the extreme high end of even the research space," says Ananda Mukerji, CEO of Firstsource Solutions. "We saw their business as an attractive area of outsourcing with a lot of potential." Firstsource Solutions is India's fifth largest outsourcing services company with more than 9,000 employees, and posted $124 million in revenue in its latest financial year ending March 2006. Mukerji declined to divulge Pipal's revenue.
Aron says that such high-end analysis requires domain expertise, not domain experience. When it comes to doing such work in India, clients are concerned with two things -- expertise and cost. To address the first concern, he says, "You want somebody with a master's degree in finance, who has a deep understanding of cash- flow analysis techniques, who's able to project and do numerical manipulations, which will be able to take data from an engineer and weave it into a report." And he sees the second issue as a "no-brainer." "There is no question that the cost of expertise is lower. In fact, the greater the expertise, the greater is the arbitrage ratio." He explains that the wage cost arbitrage for call-center operators between the U.S. and India "is a lot, lot less" than that for high-end information analysts. He puts that arbitrage ratio at 6:1 or 7:1.
According to Wharton's Chaudhuri, "cost advantage at equal quality" continues to be a powerful value proposition for Indian outsourcing services companies -- in the least, it works as a foot in the door. "As they get larger and larger contracts, such as the ABN Amro deal, inevitably they are going to be dealing with higher levels of the organization, because these are much bigger [than other contracts] for the organization that is giving them out," he says. "If you have done all the processes at a company -- not little bits and pieces here and there -- you understand a tremendous amount about how that company and its industry functions." That, says Chaudhuri, would mean a quantum jump for BPO service providers who get that far.
Room to Grow
BCG's Bradtke discounts industry watchers who talk of narrowing profit margins of the Indian outsourcing service providers as client companies drive harder bargains. "If you look at the growth rates of the big three or four Indian BPO companies, they are not reducing their levels of profitability," he says. Tata Consultancy Services (TCS) is the biggest: Its revenues grew 41% last quarter to cross the $1 billion mark in the last quarter ending December 2006, taking its tally for the last three quarters to more than $3 billion. TCS's profits grew 44% to nearly $470 million in the same period. Rival Infosys also showed robust revenue growth of 47%, to $2.16 billion in the last three quarters, while Wipro posted 42% growth in the same period to earn $2.4 billion in revenues. Profits also grew handsomely at both Infosys (50% to $600 million) and Wipro (44% to $470 million).
Unlike in many industries, the Indian outsourcing services industry has established itself in the global markets without a significant home market to act as a springboard. "It's a classic example which in some ways goes against conventional theory," says Arindam Bhattacharya, vice president and director at BCG in New Delhi.
Bhattacharya recalls that Japanese and Korean companies "leveraged their practically closed home markets" to build global businesses. By contrast, Infosys last year earned more than 98% of its $2.1 billion revenue from overseas operations. "It's a fundamental strength in the business model, where they break up the value chain and are able to leverage the low-cost position in their home country," he says. That is distinct from the advantage Chinese companies like appliance maker Haier or telecommunications equipment maker Huawei have with a large domestic market that dominates.
Peering into the future, Bradtke sees a glass that's more than two-thirds empty. "The big U.S. companies may have taken 30% of their services and given them to India, but there's still 70% of those services left in those companies, many of which they haven't even looked at," he says. Industrial companies may have started with outsourcing accounting, legal, commercial and other administrative processes, but Bradtke sees others in line -- environmental health and safety-related functions, for instance. He says a big multinational with 100,000 employees may have between 500 and 800 people doing just environmental health and safety work, from statistics that need to be sent to regulators to analysis and other back-office functions.
Bradtke says similar openings for outsourcing exist in areas like quality control and quality assurance, production planning and cost analyses. "Those higher-value services might be more difficult to outsource, but as the Indian companies learn how to deal with those clients, understand their needs and modus operandi, they will also upgrade their capabilities," says Bradtke.
The Risk Factor
BCG executives, however, advise client companies to weigh several factors before parceling away their services overseas, including the elementary lesson of not always picking the lowest bid. Understanding and defining acceptable risk levels is one of the first hurdles. "In our experience, most business leaders are most sensitive to the risks that business process outsourcing to low cost countries entails," write the authors of a recent BCG paper titled, "BPO: Keys to Successful Execution." According to the researchers, a common concern with clients is: "Will their customers go away if their calls are answered by an agent in India?" They also have to weigh operational risks like natural disasters and technology failures, and performance risks such as pricing traps and non-delivery on service-level agreements.
"All of these risks can be managed by the right delivery model, vendor selection, service level agreements and price negotiations," the authors say. Client companies would do well to check out geo-political stability and infrastructure capabilities -- among other factors -- in the outsourcing service provider's country, they add. Corporations are also advised to consider a risk-mitigation approach by hedging their operational risks across multiple locations.
While those may be reasonable protective measures, Firstsource's Mukerji doesn't relish the fact that isolated data security and privacy violations have become high-visibility issues disproportionate to the ground realities. "Any incident tends to get magnified," he says. "We as an industry follow better security practices than in the U.S., where you have violations every week but they don't hit the headlines." Adds Hal Sirkin, senior vice president at BCG based in Chicago: "I don't often hear about India in stories where people are discussing intellectual property violations."
As clients and service providers grapple with restructuring the delivery of their existing services, they will also likely find new opportunities to improve efficiencies -- and will begin to offer "services that don't even exist today." That will be the next wave of offshoring, says Bradtke. For instance, over the years many companies have collected piles of data on their operations. "Indian outsourcing providers could say: 'Give us your data and we will help you interpret it,'" he says. If analyzed, that data could provide valuable insights into new ways to cut costs or improve efficiency. While waiting for that to unfold, no one watching this industry is taking bets on what other unheard-of services lie out there.