The Rational Outsourcing Blog

Wednesday, December 20, 2006

Why globalization does not mean your job will get outsourced to India

We live in a “flat world” where physical location does not matter and where jobs will migrate to the least expensive locations. An Indian worker may cost 60% less than an equivalent American worker. Does this mean your white collar job will necessarily move to India and that you might as well give up the fight and reconcile yourself to Ross Perot’s “giant sucking sound”? Not necessarily.

Labor costs are not a perfect indicator of overall costs. To make an apples-to-apples comparison between an American worker and an Indian worker we have to consider the total costs of their performing equivalent tasks. The three major additional components of total cost are: productivity, quality, and management overhead. Let’s tackle these in order:
  • Productivity: First, some basic math: If one person costs $10 / hr and takes two hours to do a task, while a second person costs $15 / hr and takes just one hour to do the same task, which would you rather employ? If you didn’t sleep through math, you realized that the first person costs $20 per task, which is more than the $15 per task that the second person costs. Thus, you would select the second person even though her hourly rate is higher. So, the question is: who is more productive, an American worker or an Indian worker? It is tough to say. What we can say for certain is that our productivity is under our control and can be improved by orders of magnitude through process innovation. My favorite example of this was described by Dr. Michael Hammer in his “Reengineering Work: Don't Automate, Obliterate,” article in the Harvard Business Review. He described how Mutual Benefit Life, an insurance company, transformed a customer application process from a typical turnaround of 5-25 days and a best effort time of 24 hours to a typical turnaround of 2-5 days and a best effort time of just 4 hours. Mutual achieved this by creating a new position called a case manager and empowering these workers to process entire applications instead of having applications “go through as many as 30 discrete steps, spanning 5 departments and involving 19 people.” “Case managers have total responsibility for an application from the time it is received to the time a policy is issued. Unlike clerks, who performed a fixed task repeatedly under the watchful gaze of a supervisor, case managers work autonomously. No more handoffs of files and responsibility, no more shuffling of customer inquiries.” The productivity gain achieved by this company would be more than sufficient to offset the 60% difference in labor costs between Indian and American workers. Moreover, the job of the case manager is far more complex and “high-touch” than the tasks performed by the original clerks and is far less likely to be outsourced in the future. Dr. Hammer concludes his article with “We must have the boldness to imagine taking 78 days out of an 80-day turnaround time, cutting 75% of overhead, and eliminating 80% of errors.” Such boldness and innovation are far greater assets than 60% labor cost differentials.
  • Quality: Well, you guessed it, time for some more math. Let’s say processing an insurance claim correctly costs $1. How much do you think correcting an error in an insurance claim costs? Well, once you add up the cost of quality control, the call center costs for fielding customer complaints, and the cost of reissuing a corrected claim, the costs climb quite high. Let’s say the cost is $100. If the error rate is 3%, then this company would be spending three times as much on the downstream cost of errors as on the original claim processing costs. Thus a 1% change in error rates would have the same total cost impact as a 3% difference in labor costs. The specific ratio of the cost of errors to original processing costs varies from case to case; however, the cost of errors is almost always greater than the processing costs. Thus, output quality is almost always more important than labor cost. In other words, if outsourcing increases your error rate even slightly, it can wipe out the benefits of lower labor costs. In one case, an US insurance company outsourced its claims processing to a BPO vendor that delivered 30% lower claims processing costs. Unfortunately, the vendor’s error rate was also slightly higher than the customer’s: just 1.1% instead of the original 1.0% error rate. Such a small 10% difference in error rates seems trivial, but it is sufficient to wipe out the benefits of the 30% cost difference from outsourcing. [For details, see the Case Study at]
  • Management and training overhead: It is not easy to manage a task from across the world. You need proper oversight mechanisms which often require expensive international travel, managers who are trained in cross-cultural interactions, information security safeguards, etc. Other factors such as the high employee churn rate in India and the resultant training costs contribute to management overhead as well. In general, due to relatively high management overhead the overall cost benefits of outsourcing to India are often reduced to just 10 to 20%.

Once we consider the total cost differences between an American worker and an Indian worker, we find that the 60% labor cost differential is much less important than all the other factors that are included in the total cost. Thus, if American workers focus on their productivity and quality while leveraging their inherent management overhead advantages, they can effectively compete against Indian workers notwithstanding the labor cost difference. The unfortunate reality is that instead of focusing on these goals Americans are focusing on protectionism. In the meantime, Indians are focusing on improving these exact same factors. Let’s revisit them again:

  • Productivity: If you visit a major Indian Business Process Outsourcing vendor you will be amazed by the way it manages its productivity. In many ways the major Indian firms have replicated the assembly line in a business process environment. While Indian firms aggressively adopt methodologies often invented in America, US firms are beginning to lag behind the Indians in process improvement in the service industry.
  • Quality: The quality of Indian providers varies widely. I have evaluated vendors who had critical errors in more than 17% of processed documents, and I have evaluated others that demonstrated less than 0.5% errors. What is uniformly true is that most major Indian firms are investing heavily on quality improvement methodologies and software.
  • Management and training overhead: While employee churn remains a significant problem, Indian firms have come a long way in tackling this problem through improved training systems. They are also beginning to invest in business service operations management software and some of the leading firms have even created home-grown management software. The most obvious change is in the corporate cultures of the larger firms. In 1999, I remember being surprised by the lack of sophistication of many Indian outsourcers. Today when I deal with the larger Indian vendors, it is easy to imagine that the meeting is taking place in New York or London and the vendor’s managers are invariably steeped in western corporate culture.

When the Japanese motorcycle manufacturers first entered the US market, the dominant British manufacturers laughed at them. The larger Japanese motorcycles leaked oil, “looked ridiculous,” and broke down regularly. The smaller Honda Cubs were considered “toys” by serious motorcycle enthusiasts. Their only advantage was that they were cheaper than British motorcycles. While the British laughed, the Japanese improved their motorcycles until they essentially drove the British out of the motorcycle business. It is true that Indian BPO vendors still have many problems with employee churn, security, infrastructure, quality; and today I truly believe Americans could give Indians a serious run for their money based on the overall cost of business processes. However, if Americans remain distracted by protectionism they will lose the chance to improve themselves and compete fairly for their slice of the global business process market.

I have a fierce belief in the inherent abilities of Indians and Americans. Americans today believe that the game is unfairly stacked against them due to the low Indian labor costs and they are essentially refusing to play the game. You can’t win a game that you don’t show up for! Of course Americans can’t beat the Indians on labor costs, but these costs are only a small portion of overall costs. Americans need to rejoin the game and figure out how their inherent strengths in innovation, management / training overhead and possibly quality can counter the core strengths of the Indians in productivity and costs. That would be a fair match worth competing in, and may the one with the lowest overall cost win.

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  • I totally agree with you Mr. Sengupta as Rupee is getting stronger over $ the cost arbitrage is on the decrease, so its high time that indian corporates start to focus in this direction.


    By Blogger ABI, at 10:50 PM  

  • I agree with Mr.Sengupta, thank you.

    By Anonymous David, at 2:29 AM  

  • Globalization and the Internet has made it possible for anyone to tap talented workers in emerging economies at a low cost. Why pay for a job in dollar figures what can be done remotely for rupees. Today, virtually all large companies Globalization and the Internet has made it possible for anyone to tap talented workers in emerging economies at a low cost. Why pay for a job in dollar figures what can be done remotely for rupees. Today, virtually all large companies outsource portions of their business development to other nations.outsource portions of their business development to other nations.

    By Blogger Alex, at 11:28 PM  

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