India vs. China: Forrester right on facts, wrong on conclusions?

Forrester recently published a report entitled China's Diminishing Offshore Role which has been widely quoted by the likes of Computerworld, Times of India, the Hindu Business Line, and China Economic Review. The Computerworld article says:

Forrester Research came out with a report with a rather downbeat assessment of offshoring successes there to date. According to analyst John McCarthy, the market "has not taken off as expected. While there continues to be demand from Japan and multinationals with operations in China, the offshore business from the US and Europe has been slow to materialize. In fact, China’s percentage of GDM resources for the top services firms like Accenture has dropped, while India and the Philippines have seen far greater investment."
The findings in the report , China's Diminishing Offshore Role, were based on interviews with executives at 10 large IT services firms. Reasons cited for disappointing growth included high attrition rates, a lack of English speaking workers, and inadequate intellectual property laws. According to one executive interviewed for the report, offshoring to China "would have to be 20% cheaper than India to be viable." Currently, McCarthy says, the costs are about he same.

Forrester’s facts are 100% right, but their conclusions are almost certainly 100% wrong. The original Forrester report states: "What we found is that while Chinese services firms are supporting a vibrant local IT market, China has not achieved the offshore growth that people expected." I care much less about the absence of a significant offshore market, but the vibrant local market is certainly of interest to me. These Chinese vendors serving local customers do not enjoy a labor cost advantage relative to their customers and thus have to be much more labor efficient than the Indian vendors. Once these Chinese firms figure out how to credibly serve US customers, they will become a credible threat to the Indian vendors unless India can get a lot more labor-efficient. You can see more details on China’s threat to India at this recent article in a leading Indian newspaper [disclaimer: the article quotes me but that is not why I think its good] or at my post on theChinese BPOs’ secret weapon at the Rational Outsourcing Blog.

News article on India vs. China quoting yours truly

See this story entitled “India being Bangalored by China” which quotes me. It came out in Daily News and Analysis which is one of the leading newspapers in Mumbai (India’s financial capital). Here are a few choice quotes:

hard facts too make the point forcefully that India, today’s undisputed leader in outsourcing services, is gradually being, well, Bangalored by China. The Global Outsourcing Report, which ranks countries based on their opportunities, costs, and risks in relation to IT offshoring, predicts that by 2015, China, currently placed second, will have taken over the No 1 spot from India.

In Vespa’s estimation, Indian leaders — like Infosys and TCS — are so far ahead of their Chinese counterparts that even 10 years from now, their standing won’t be seriously threatened.
"If we look at the top 10 companies in the outsourcing market in 10-15 years, I have no doubt that six or seven of them will still be Indian… But China as a whole will have taken over from India as the leading outsourcing destination."

Sengupta too believes that the Indian BPO is at a defining moment. "Clayton Christensen, the author of Innovator’s Dilemma, describes how the integrated steel companies in North America were rapidly disrupted and eventually driven out of business by steel mini-mills.
Likewise, the British used to dominate the motorcycle industry, but the Japanese disrupted them very quickly. In both cases, the incumbents were initially overconfident about their strengths relative to the disruptors until it was too late. I fear that the same is happening today as regards Indian attitudes to Chinese BPOs.
If India wakes up to this threat, I believe it can compete effectively. If it does not, then eventually it will cede its leadership in the global service market and whether that happens in five years or ten, it will be catastrophic for the Indian economy."

Offshoring ≠ illegal immigration

I have been closely following the current immigration debate and I was disturbed to see illegal immigration and offshore outsourcing discussed in the same breath by many commentators. Let us not confuse the two: the first is illegal, the second is not only legal but in fact any limitations on outsourcing would probably run afoul of international free-trade agreements and could ruin the US economy.

It is amazing how shortsighted these opponents of outsourcing are. The United States counts for 12.06% of total world exports while China counts for 5.33% and India a miniscule 1.14%! [Data from “The Economist Pocket World in Figures” 2007 Edition] If the US initiates a trade war and disrupts the global trade environment it stands to lose more than 10 times as much as India. As I have written before, the last time the US turned protectionist, it slid into the Great Depression. Let us not repeat the same mistake again.

All this vilification of outsourced may even be completely counterfactual. Take a look at Robert Samuelson’s “What Offshoring Wave?” article in The Washington Post. He explains that only 4% of mass layoffs stemmed from offshoring. I must admit that there is a flaw in his argument: he is only looking at layoffs of 50 or more and it would have been much more interesting to look at all layoffs. However, there is no reason to believe smaller layoffs would have significantly different causes. Here are a few select quotes from Samuelson’s article:

For the United States, Kirkegaard examined a survey on "mass layoffs" from the Bureau of Labor Statistics to see how many stemmed from offshoring. The answer: 4 percent. That included both manufacturing and service jobs.

In 2004 and 2005, the BLS counted almost 1 million workers fired in layoffs of 50 or more. That isn't a huge number in a labor force of about 150 million. Moreover, most causes were domestic. The largest reason (accounting for about 25 percent) was "contract completion" -- a public works job done, a movie finished. Other big categories included "downsizing" (16 percent) and the combination of bankruptcy and "financial difficulty" (10 percent). Only about 12 percent of layoffs stemmed from "movement of work" -- a category that would include offshoring. But two-thirds of those moves were domestic.

It's true that offshoring doesn't measure the full impact of globalization on U.S. labor markets. That effect would also include trade and investment by multinational firms. Still, with the unemployment rate at 4.5 percent, it's clear that globalization hasn't crippled the U.S. job machine.

Losing a job is a wrenching experience for anyone, but the lesson here is that most job loss has local causes. The offshoring obsession reflects its novelty and the potential threat to white-collar jobs that seemed inherently safe from foreign competition. In our mind's eye, globalization is so powerful that it's sweeping everything before it. The reality is that, though globalization is increasingly important, it's still a weakling compared with the domestic economy. The antidote to job loss is job creation, and that depends decisively on national economic policies and conditions.

It's easy to blame all our economic anxieties and problems on globalization, because that makes foreigners and multinational companies responsible. Though satisfying, it will also be self-defeating if it diverts attention from fostering a healthy economy at home.

Cartoon on salary inflation in India (also applies to China)

Another interesting cartoon from www.doubtsourcing.com which is somewhat rooted in truth. Take a look at this Hindu Business Line story on how Indian salaries grew fastest in the world. “IT sector salary is set to grow by about 13.7 per cent, and ITES and BPO growth may be by 15.5-16 per cent.” The Economist has a more interesting analysis that looks at “real pay” rather than just salary. This claims that Chinese real pay actually grew faster than Indian ones.

India vs. China: The other side of the story

I was asked by a reader, “so why do you think you will win your bet with Benny?” Most of India’s strengths are self-evident and have been widely written up. Here are a couple of thoughts on why I still believe I will win the bet:

• Be careful what you wish for, or in other words, how China may fall victim to its own success: The Chinese government tends to think big and right now it is trying to start 1000 BPOs by 2010. 1000 is a large enough number that it attracts attention (which by the way is what I think the government was trying to do) but it is too large a number of companies in too short a time for them to learn how to compete smart. If they can’t compete smart, they will compete hard which means they will undercut each other on price and overbid each other on paying workers. Pretty soon they will face the exact same problems India is facing: high employee churn rates, wage inflation and lower margins. The Chinese government has to help Chinese BPOs grow smart rather than just grow fast and that can’t be done by spending money alone.
  
• When it comes to quality, perception is as important as reality: While the Chinese BPO industry has existed for years, they have very little experience serving US and European customers and dealing with their quality expectations. The newer Chinese BPOs also tend to have less extensive quality management experience and technologies. [There are exceptions to every rule: I have met some Chinese BPOs who are investing quite heavily on their quality, while others seem to have very few if any quality experts on staff.] Furthermore, often the definition of quality in BPO engagements is quite subjective. If US customers believe that China has a quality problem, they will perceive lower quality in the processes run by Chinese vendors. Indian vendors addressed this quality perception problem by aggressively adopting CMM and reaching CMMI certification levels that were often higher than their customers’. [Look out for an upcoming post on why CMMI is not sufficient for BPO as opposed to IT outsourcing. But the reality is that the market broadly perceives it as a quality certification.] Chinese BPO vendors can’t follow that exact same strategy. The leading Indian BPO vendors have already invested years in reaching the highest levels of CMM. Even after spending years, the Chinese BPOs can at best match the Indian vendors in CMMI certification, not beat them at it.

No Entrance to Greenland (without English)

I took this picture when I visited Shanghai in 2002. I assume the Chinese text means “please don’t walk on the grass” or some variant thereof. The hilariously incorrect English translation may turn out to be prophetic though: can China gain entrance to the land of “green” (slang for money in America) without addressing their English problem? Probably not. However, there are three forces ameliorating China’s English problem:

• The Chinese Government: A story in fDimagazine.com [part of the Financial Times group] entitled Battle of the behemoths explored the question of: “Will China upstage India and become the epicentre of offshoring?” While the article does say “In terms of talent, India will continue to score above China” it also highlights what China is doing to address the talent gap. “The Chinese government is driving long-term improvements, recently announcing plans to spend more than $5bn on language training to target the BPO market.” As I have mentioned in previous posts, the Chinese government has a track record of successfully spending its way to success. Building ahead of demand can be very risky but it can pay off. Is $5 Billion a large enough investment for China to catch up to India? Assuming a BPO industry headcount target of 1 million operators, this is $5000 per operator of English training. In China, I am sure $5000 buys you a lot of English training.
  
  
• The Olympics: If you haven’t visited China recently, it will be very difficult for you to appreciate how important the Olympics are to the Chinese people. The Chinese are a very proud people, and they want to show off their country in the best light during the Olympics. As part of the preparations for the Olympics, they are investing heavily on English training for hotel staff, taxi drivers, and even shopkeepers. Previous Olympic hosts have ended up with excess hotels and sports arenas after the Olympics ended. China will probably end up with excess English-speaking citizens.
  
  
• Chinese entrepreneurs: Some entrepreneurs are adopting very interesting process innovations to address the English problem. One leading Chinese BPO splits up every document into its smallest component parts. Thus, one of their operators only processes the ‘Social Security number’ field of every loan application while another processes only the ‘employer’ field. At this level of granularity, the skill required is not really English language skill, but rather symbol identification and transcription skill. The Chinese written language contains more than 3500 characters and thus the Chinese are exceptionally good at symbol identification and transcription. Of course, this solution only works for low-end data entry work because higher-order tasks such as Knowledge Process Outsourcing or even advanced BPO activities such as insurance claims adjudication can not be easily broken into minute components. However, low-end data entry work constitutes the majority of Business Process Outsourcing work today and most Chinese entrepreneurs would be happy to capture a significant proportion of this market away from India. [For details on Chinese characters, see the website of the Chinese Language Program at Harvard University: “The Xiandai Hanyu Changyongzi Biao (Modern Chinese Commonly-Used Word List), compiled by the national language committee and national education committee in 1987, includes the most frequently-used 2,500 characters, as well as the second most frequently-used 1,000 characters. Thus it comprises 3,500 characters altogether. Those who have received a junior or senior high school education should know and utilize these 3,500 most commonly-used characters.”]

Overall, I don’t think China has adequately addressed its English Achilles’ heel yet, but both the government and the people are aggressively trying to address this shortcoming. Anyone who ignores the Chinese threat to the Indian BPO industry on the basis of English language gap alone does so at their own peril.
Note: I wrote this post because of comments from reader Greg Cruey and a visitor from the “China Law Blog.” Keep the questions coming; I will try to answer them as soon as possible.

The secret weapon of the Chinese BPO industry

I have an ongoing bet with my COO Benny who happens to be Chinese. He believes that the Chinese Business Process Outsourcing (BPO) industry will eat India’s lunch in the next few years. I on the other hand have always been confident that Indian entrepreneurship and innovation will help Indian BPOs beat all competitors including the Chinese. Till recently, I never worried that I may actually lose the bet. A recent conversation with Mr. Roc Yang (CEO of China Data Group, a leading Chinese BPO) forced me to acknowledge for the first time that perhaps Benny could win the bet after all.

Mr. Yang raised several reasons why China might beat India on the BPO arena. Some of these reasons I had heard before: lower employee churn rates, lower effective salary, and better infrastructure. While China may have these advantages today, either India will be able to address them over time (as in the case of better infrastructure) or China will face the same problems as its own BPO industry develops further (as in the case of employee churn).

Some of the competitive factors Mr. Yang raised (such as an ability to provide end-to-end services or more sophisticated operational procedures) are quite possibly valid for his specific company but I can’t imagine that they are true for all Chinese BPOs. Moreover, I can imagine conversations with CEOs of Indian BPOs who would raise the exact same factors as competitive advantages that the Indians enjoy. An analysis of who is right is beyond the scope of this blog. Most probably, only time will tell who is right on this issue.

One point that Mr. Yang highlighted however may turn out to be the secret weapon of the Chinese BPO industry. Contrary to popular perception, the Chinese BPO industry has existed for many years and quite possibly is as old as the Indian BPO industry. The reason that the Chinese have stayed under the radar is that they primarily serve the Chinese market. As Mr. Yang pointed out, because their customers are also Chinese they could never count on labor cost differentials as a critical factor in their business. Thus, out of necessity, they have had to be incredibly cost conscious. He believes that because the Indians have enjoyed a large labor cost differential relative to their customers, they have been much less labor efficient than the Chinese BPOs.

I must admit that many Indian BPOs often have an attitude that labor is cheap so we can always throw a lot of bodies at any problem. This has in many cases led to inefficient use of labor. If Chinese BPOs have truly figured out a way to be profitable in the absence of a labor cost advantage and are now shifting their attention to the US market then Indian BPOs may have cause for concern. An industry that is used to running lean and mean in their own country would have a huge advantage once they gain the additional advantage of the labor cost differential between China and the US. Look out India!

In reality, if the Chinese BPOs can truly bring labor-efficient solutions to the market, that would only spur Indian vendors to respond similarly. Due to the high employee churn rates and salary increases, Indian BPOs have already started to become more labor efficient. The entry of labor-efficient competitors from China would only accelerate the trend. I would expect to see even faster efficiency and accuracy improvements primarily via the adoption of new technologies and consistent processes across customers. This competition from China may just help spur the Indian vendors to the next stage in their evolution.

Time for some BPO magic: 99.9% accuracy = 1.8% accuracy!

Fifteen Stanford students are working with me this quarter as part of a Stanford Marketing class. One of them recently asked me: “How can you say there is a quality problem with Business Process Outsourcing (BPO) if most vendors advertise 99.9% accuracy?” Before I could answer him, I had to explain what 99.9% accuracy really meant:

• Is it document-level, field-level or even character-level accuracy? Or how 99.9% accuracy can equal 2% accuracy! If 99.9% of documents have no errors, that is indeed an impressive level of quality. Let’s assume that the 99.9% accuracy is actually a field level number. Now, an insurance claim may easily have 200 fields. In that case, the document-level accuracy would just be 82% (if you like math, this is 0.999 multiplied by itself 200 times). However, usually once you ask the vendor, you will find that such a high accuracy level is actually a character-level accuracy. If 99.9% of characters have no errors, and most fields have 20 characters, then an average document field would only have 98% accuracy. Assuming 200 fields on average per document, if 98% of fields have no errors, then on average the document-level accuracy would be just 1.8%. In other words, if the character-level accuracy is 99.9%, only about 2% of documents would be error free. Make absolutely sure what is the context for the reported 99.9% accuracy, because it may translate to only 82% or even just 2% document level accuracy.
  
• Was the base of the field-level accuracy the hypothetical number of fields that might be filled out or the actual number of fields that were filled out? Or how 99% accuracy can equal 90% accuracy! I recently analyzed an insurance claim that had almost a thousand fields. For example, it had space to specify about 30 separate diagnoses along with associated details. However, most of the time the claims contained just one to three diagnoses and an average claim had only about 100 fields out of 1000 filled out. If there was an error in ten fields in such a document, is that 90% accuracy or 99% accuracy? Remember that in most cases, only a small subset of fields are filled out for each document. Thus, whether we divide the errors by the total number of fields that could have been filled our or the number of fields that were actually filled out can significantly affect the reported error rate.
  
• How was the accuracy evaluated? Or how 99.9% accuracy can equal 89.9% accuracy! Several vendors use double-entry for quality control and assume that any field that was consistently typed by both operators was not an error. Sounds reasonable, doesn’t it? After all, there is only one way in which a field can be processed correctly and multiple ways in which it can be processed incorrectly. Thus, if two operators typed the field consistently, they must have gotten it right! I recently evaluated a BPO vendor who leverages double-entry and discovered an interesting fact that completely blew this assumption out of the water. Over 50% of the errors in the insurance claims processed by the vendor came from fields being left blank. I was really intrigued by this pattern and researched it further. It turns out, in double-entry if the operator has any difficulty reading a field, they may leave the field blank assuming the 2nd operator will get it right. Leaving a field blank also reduces the probability that a discrepancy will be reported [a field may be entered incorrectly several different ways, but left blank only one way]. Even without collusion this can lead to systematic under-reporting of operator errors in a double-entry system. Essentially, the operators quickly figure out that if they try to interpret bad handwriting and put in their best guess, then the supervisor usually reports an error. However, if they are ‘lazy’ and simply leave the field blank, the supervisor rarely complains. Humans are really smart and quickly learn from such feedback, even when the lesson they learn is exactly contrary to what the BPO vendor would want them to do. In this specific case, if 50% of the errors come from fields left blank, 25% on average and up to 50% of the errors would not have been caught by the double-entry. Let us assume that the average first-time quality of the operators as reported by the double-entry system is 10%. The real first-time quality of the operators would thus be 13% to 20%. Now, almost all of the errors caught by the double entry system would have been corrected, and thus, the vendor might reasonably report a 99.9% accuracy. In reality, the 3% to 10% of the cases where both operators incorrectly left the field blank would never be caught, and the actual accuracy rate would be between 89.9% and 96.9%.

So what was my answer to the Stanford student? Be very careful what 99.9% accuracy really means. If a vendor has a real document-level error rate of 99.9%, they would really have exceptionally high quality. By the way, this vendor may still have a quality problem: they may simply be spending too much to achieve that level of quality!

Cartoons on outsourcing

I just came across a site with cartoons on outsourcing. The site is really new, but has potential. You can check them out at www.doubtsourcing.com.