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.

Bangalore nee Boston Globe: why the privacy red herring may come back to haunt the Boston Globe union

If you haven’t heard about the union objections to the Boston Globe outsourcing 50 positions to India, then you should see the Boston.com or Times of India or the Outsourcing Weblog sites. You can also see the actual ad here (as a pdf).

The union says: “Further, billing and account information will now be shipped overseas to Bangalore, India, putting customers’ most vital information at risk.” As I have written several times before, this is a red herring. Outsourcing these task to India may actually improve information security. Remember, just last year Boston Globe saw one of the most absurd privacy breaches I have ever heard of. If you have forgotten, here is a quick reminder from a Boston.com story.

Credit and bank card numbers of as many as 240,000 subscribers of The Boston Globe and Worcester Telegram & Gazette were inadvertently distributed with bundles of T&G newspapers on Sunday, officials of the newspapers said yesterday.

The confidential information was on the back of paper used in wrapping newspaper bundles for distribution to carriers and retailers. As many as 9,000 bundles of the T&G, wrapped in paper containing subscribers' names and their confidential information, were distributed Sunday to 2,000 retailers and 390 carriers in the Worcester area, said Alfred S. Larkin Jr., spokesman for the Globe.

In addition, routing information for personal checks of 1,100 T&G subscribers also may have been inadvertently released.

The Globe and T&G financial information was inadvertently released when print-outs with the confidential information were recycled for use as so-called "toppers" for newspaper bundles. A topper, placed on top of abundle of newspapers, is inscribed with the quantity of papers in each bundle and the carrier’s route number.

Oh, the irony! Before using privacy as a Fear Uncertainty and Doubt (FUD) attack against outsourcing, the union should have remembered that those who live in glass houses should not throw stones.

Related Posts:

• Reprise: Consumer privacy protection and outsourcing to India
  
• Consumer privacy protection and outsourcing to India
  
• Who would you trust with your credit card number: an Indian college grad, or an American felon?
  
• Nasscom’s new Data Security Watchdog: it has bark, will it have bite?
  
• Really informative article on the Information Security laws in India

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 www.totalcostoferrors.com/atcecasestudy]
  
• 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.

The outsourcing bogeyman is the real threat to the US economy

It seems I managed to confuse some of my readers with my "Why a US ban on offshore outsourcing is the best possible thing for India!" post. I was using sarcasm to make a point, and am not really suggesting that the US ban outsourcing. Any ban on outsourcing would harm both countries overall, but would be especially harmful to the US. Let me make the same point using economic data rather than humor:

Right now the focus is on Business Process Outsourcing (BPO), however, during 1998 to 2002 everyone was convinced that IT outsourcing (ITO) to India would gut the American IT services industry. Let us consider the IT services most directly affected by offshore outsourcing, namely: “computer and data processing services” and “data base and other information services.” According to the “Digital Economy 2003” report published by the U.S. Department of Commerce, US imports of these services rose from $0.3 billion in 1995 to $1.2 billion in 2002 (with a peak of $1.6 billion in 2000). This seems to be clear proof of Ross Perot’s “giant sucking sound” and any number of Lou Dobbs’ tirades. However, in the same time period, US exports of these services rose from $2.4 billion in 1995 to $5.4 billion in 2002 (with a peak of $5.7 billion in 2000). Thus, the U.S. trade surplus in these services expanded from $2.1 billion to $4.2 billion over the same years when the US faced the greatest threat from Indian outsourcing firms due to the Y2K contracts and the Internet boom.

If the US had magically managed to “ban IT offshoring” and other countries had done the same, the US economy would have lost $26.2 billion over these 8 years. How many US jobs do you think that $26.2 billion translates to? I realize data provides cold comfort to people who have lost their jobs due to outsourcing. However, the above analysis highlights how overall global trade creates far more jobs in America than it destroys. If you don’t believe the analysis above, you should at least learn from US history. The following excerpt from the US Department of State website highlights how US protectionism contributed to and exacerbated the Great Depression.

The Smoot-Hawley Tariff Act of June 1930 raised U.S. tariffs to historically high levels. The original intention behind the legislation was to increase the protection afforded domestic farmers against foreign agricultural imports. … But once the tariff schedule revision process got started, it proved impossible to stop. Calls for increased protection flooded in from industrial sector special interest groups and soon a bill meant to provide relief for farmers became a means to raise tariffs in all sectors of the economy. When the dust had settled, Congress had agreed to tariff levels that exceeded the already high rates established by the 1922 Fordney-McCumber Act and represented among the most protectionist tariffs in U.S. history.

The Smoot-Hawley Tariff was more a consequence of the onset of the Great Depression than an initial cause. But while the tariff might not have caused the Depression, it certainly did not make it any better. It provoked a storm of foreign retaliatory measures and came to stand as a symbol of the ‘beggar-thy-neighbor’ policies (policies designed to improve one’s own lot at the expense of that of others) of the 1930s. Such policies contributed to a drastic decline in international trade. For example, U.S. imports from Europe declined from a 1929 high of $1,334 million to just $390 million in 1932, while U.S. exports to Europe fell from $2,341 million in 1929 to $784 million in 1932. Overall, world trade declined by some 66% between 1929 and 1934.

Thus, between 1929 and 1934, US imports were reduced by just $944 million while exports were reduced by $1,557 million and so the US economy lost hundreds of millions of dollars and more importantly tens of thousands of jobs due to US protectionism. Moreover, today due to the high growth rate of countries like India and China, the rest of the world counts for a significantly greater proportion of global economic growth than they did in the 1930s. As such, US protectionism would probably harm the US even more in the current environment because American companies would be locked out of the rapidly growing Asian economies while Asian and European companies would probably benefit from the vacuum created by the absence of American companies.

Daniel W. Drezner in his thought-provoking article titled “The Outsourcing Bogeyman” (Foreign Affairs, May/June 2004) provides two excellent examples on how US protectionism has already caused US job losses.

Consider the example of candy-cane manufacturers: despite the fact that 90 percent of the world's candy canes are consumed in the United States, manufacturers have sent much of their production south of the border in the past five years. The attraction of moving abroad, however, has little to do with low wages and much to do with protectionism. U.S. quotas on sugar imports have, in recent years, caused the domestic price of sugar to become 350 percent higher than world market prices. As candy makers have relocated production to countries where sugar is cheaper, between 7,500 and 10,000 workers in the Midwest have lost their jobs -- victims not of outsourcing but of the kind of protectionism called for by outsourcing's critics.

A similar story can be told of the steel tariffs that the Bush administration foolishly imposed from March 2002 until December 2003 (when a ruling by the World Trade Organization prompted their cancellation). The tariffs were allegedly meant to protect steelworkers. But in the United States, steel users employ roughly 40 times more people than do steel producers. Thus, according to estimates by the Institute for International Economics, between 45,000 and 75,000 jobs were lost because higher steel prices made U.S. steel-using industries less competitive.

Proponents of American protectionism should keep such recent misadventures in mind while pushing for higher tariffs.

US protectionism impacts more than just the economy. The previously quoted US Department of State article goes on to say: “More generally, Smoot-Hawley did nothing to foster trust and cooperation among nations in either the political or economic realm during a perilous era in international relations.” Does this sound eerily applicable in the current international relations context? George Santayana wrote: 'Those who cannot remember the past are condemned to repeat it.' Unfortunately, the cost of repeating this past mistake could be greater than the anti-globalization brigade can even imagine.

Nasscom’s new Data Security Watchdog: it has bark, will it have bite?

It seems Nasscom is trying to address the information security perception problem in India by creating a new Data Security Watchdog (as reported in CIO India).

The National Association of Software and Services Companies (Nasscom) is setting up a watchdog organization that will focus on the introduction and monitoring of best data security and privacy practices in the country's IT services, call center and business process outsourcing industries. The move is one of several measures by Nasscom and the IT industry to strengthen data security and privacy in the Indian call center and BPO industries.

"We are planning a self-regulatory organization (SRO) that will be initially set up by Nasscom, but will operate independently with an independent chief executive officer and board," said Sunil Mehta, vice president of Nasscom in Delhi.

"Being a member of the SRO will in effect be a certification, as member companies will have to follow the best practices specified by the SRO," he said.

Besides setting benchmarks and training companies on the best data protection and data privacy practices, the new organization will also have the authority to punish and expel erring member companies

The SRO will be funded for one year by Nasscom, which has budgeted Rs 1.35 crore for the purpose. After the first year, the SRO is expected to finance itself from membership, training, and audit fees.

This sounds like a great idea, especially as this organization can become a forum for sharing information security best practices. I have been impressed by the information security and fraud detection methodologies used by some Indian vendors and if they start helping each other they can improve even more rapidly. I am a firm believer in incentives, and here I think the outsourcing vendors’ incentives are properly aligned: When one Indian outsourcer has an information security or fraud problem, every Indian outsourcing vendor suffers from the negative press. Japanese manufacturers helped each other build the “made in Japan = quality” perception, Indian outsourcing firms have to do likewise.

I am however not sanguine about the incentives for the enforcement component of this watchdog. After the first year, the watchdog will be funded by the dues paid by its membership and the only way for it to punish a member would be to “expel” the “erring member” and thus lose their “membership, training, and audit fees.” This sounds like classic incentive misalignment. I hope that the Nasscom leadership will address this problem before the organization goes live. Perhaps the organization could be funded by the outsourcing customers instead? Rs 1.35 crore (approximately $300,000) split among even thirty large outsourcing customers sounds like a very good investment. If that $10,000 a year helps them avoid a single information security breach, or more likely a PR headache, it would be money well-spent.

Who would you trust with your credit card number: an Indian college grad, or an American felon?

Recently there have been a series of articles on Indian companies’ problems with information security and fraud. However, the BPO vendors I personally evaluated in India tended to have as good if not better information security procedures than most US companies. I was recently semi-joking with the CEO of an Indian BPO that workers in California would never accept the kind of restrictions Indian companies regularly place on their employees to prevent information theft. Some of these restrictions (such as keystroke monitoring) may even be illegal in countries like Germany. However, right now when it comes to outsourcing, perception is reality and the pervasive perception is that India has a data security problem.

I must admit, I am a bit confused by this. If Americans are OK with felons in US prisons accessing their information, surely they would be OK with trusting a college graduate in India? Strange as this sounds, I am not making this up. In July 2004, USA Today reported:

About a dozen states — Oregon, Arizona, California and Iowa, among others — have call centers in state and federal prisons, underscoring a push to employ inmates in telemarketing jobs that might otherwise go to low-wage countries such as India and the Philippines. Arizona prisoners make business calls, as do inmates in Oklahoma. A call center for the DMV is run out of an all-female prison in Oregon.

At least 2,000 inmates nationwide work in call centers, and that number is rising as companies seek cheap labor without incurring the wrath of politicians and unions. At the same time, prison populations are ballooning, offering U.S. companies another way to slash costs.

As expected, there are some “information security problems” with using prison labor in call centers:

executives shudder at the prospects of inmates sharing the personal information of customers with fellow prisoners, as some did in Utah in 2000.

An article from NPR comments:

Labor unions and some states say they believe it's too much of a security risk to have prisoners talking to the outside world, even if they're being monitored. Private businesses say it's also a security risk to have prisoners taking down customers' credit card information.

Maybe it is just me, but it seems that if information security outcries restrict offshore outsourcing, companies are more likely to shift the work to similarly priced prison-based call centers than to hire American workers who even at the minimum legal wage are several times more expensive. To quote the UNICOR Federal Prison Industries website: “Imagine... All the benefits of domestic outsourcing at off shore prices. It's the best kept secret in outsourcing!” By the way, you also have to see the slick marketing video on their website. Maybe it is just me, but I would prefer to share my credit card information with an Indian college graduate than with a felon. [To be fair, I am sure UNICOR works hard to restrict their operators access to private information, as do Indian BPOs. The problem arises when the system does not work as planned.]

I am not trying to belittle the information security problem in India. It exists, just like similar problems exist in the US, and needs to be addressed proactively. But, let’s please take the politics out of business decisions and stick to Rational Outsourcing.

Impact of new IRS tax regulations on outsourcing

I just read a very interesting article in the Business Standard on the impact of certain US tax regulation changes on the overall cost of service operations in India. Here are a few interesting quotes from this article:

Prior to the new regulations, multinationals had an option to club several inter-related services and levy a single charge for the entire gamut of services. The new regulations, particularly SCM, would necessitate maintenance of onerous documentation for low margin services. The captive Indian business process outsourcing and the knowledge processing outsourcing units shall be impacted the most.

India’s numerous R&D centres in pharmaceutical, engineering design and technology sectors catering to US parent would have to review existing contracts for development of intangibles.

Whether or not the newly introduced regulations meet IRS’s objective of reducing compliance burden for corporations is something that time would tell. However, the regulations would certainly bolster revenue collections for IRS, while making US services costlier for Indian subsidiaries.

The article is a bit dense, and I am not qualified to judge the accuracy of the tax implications discussed, so you will have to judge for yourself. The article is written by Mukesh Butani who is a partner with BMR & Associates. Based on BMR’s website, he seems to have held senior positions in firms like Ernst & Young India and Andersen, so I will give him the benefit of the doubt.

If Mukesh is right, how do these new regulations (which will become effective from January 2007) impact Rational Outsourcing? Rational outsourcing aims to ensure that the benefits of outsourcing are greater than the total costs of outsourcing. If the new regulations “necessitate maintenance of onerous documentation for low margin services” then that would increase the total cost of outsourcing, while not significantly affecting the benefits of outsourcing (except as noted below). Thus, outsourcing projects that were marginally beneficial may now fail the rational outsourcing test.

These regulations may also impact the benefits of outsourcing in complex ways. Some of the major benefits of certain outsourcing relationships stem from the complex tax benefits of structuring the relationship in a certain manner. Any regulation that modifies the transfer pricing of services provided by the parent organization may significantly affect these tax benefits. At the very least, both the parent and the captive organizations will have to review their contracts and accounting in light of these changes. These unanticipated expenses may become a source of conflict between the parent and the captive if their contracts do not clearly spell out who will have to pay for these expenses. Finally, the Ernst & Young 2005-2006 Global Transfer Pricing Surveys document notes:

The definition of stewardship expense has been narrowed, presumably resulting in more headquarters or management services costs to be charged to affiliates;

This may affect the “profitability” of certain captives that were not being properly charged for the stewardship services provided by the parent.

I have a feeling that we will end up discussing these regulation changes again over the next few months. In the meantime, here are a few other documents that touch upon this topic. Once I find the time to personally review them, I will post my comments on this blog.

• A press release from the IRS
• An article from Deloitte
• An article by Baker & McKenzie

Why a US ban on offshore outsourcing is the best possible thing for India!

Perhaps I am imagining this, but the anti-outsourcing anti-free-trade crowd seems to be contorting the results of the recent election into an endorsement of their anti-free-trade beliefs. Perhaps they are right and perhaps the new Congress will be far more opposed to free-trade. In fact, today someone asked me, “So what will India do if we ban offshoring?” I would have just laughed if it wasn’t for the fact that I have been asked this question before. So, even though the question is somewhat unrealistic, let’s imagine a situation where the US magically manages to ban offshore outsourcing. What would this imply for India?

Companies like Microsoft, Oracle and others employ thousands of engineers in India. These highly trained engineers develop the code that gets shipped in software like Microsoft Vista. Microsoft’s profit margins on software such as Vista may be as high as 80%. Thus, the Indian engineer and the Indian economy capture a miniscule proportion of the value partially created by the engineer. The majority of the value flows into the US economy in the form of profits earned by Microsoft on the software partially created in India. McKinsey Global Institute (MGI) actually reported on this extensively in their “Offshoring: Is It a Win-Win Game?” report accessible at: www.mckinsey.com/mgi/publications/win_win_game.asp

Of the $1.45 - $1.47 of value MGI estimates is created globally from every dollar spend a domestic company chooses to divert abroad, the U.S. captures $1.12 - $1.14 while the receiving country captures on average 33 cents. In other words, the U.S. captures 78 percent of the total value [created when an activity is offshored].

So what happens when the US magically bans offshoring? Does the Indian software engineer go and start plowing the rice fields? Not very likely. It is far more likely that some senior manager in Microsoft India would reorganize the former employees of this now defunct organization into a new company called Microsoft Lite. These guys would then churn out similar software, but would be forced to move up the stack and sell high-margin packaged software rather than low-margin IT outsourcing. The cost advantage would however not disappear. Imagine new Indian companies churning out software pretty similar to those produced by US companies, but at a 30% lower price. There might be some quality differences, but these would be minor relative to the price advantage. All of a sudden, the revenues of the affected US companies would shrink and they would be forced to fire the exact same people they recently hired to replace the now illegal outsourced engineers.

The new Indian companies on the other hand would receive a much needed kick in the butt. Indians would no longer have the luxury of being satisfied with safe IT outsourcing jobs. They would be forced to learn how to compete in the global market for finished software. This is a much more high-risk market than IT outsourcing and for a few years these new Indian companies would go through many trials and tribulations. Eventually though, because necessity is the mother of invention, they would be forced to figure out how to compete in the packaged software market. Indian immigrants in America have started hundreds of successful software companies; there is no reason to believe they can’t eventually do the same in their home country. All of a sudden, the US offshoring ban would have kicked the Indian IT industry several rungs up the evolutionary ladder. India would start capturing tens of billions of dollars of packaged software profits instead of the billions of IT outsourcing revenues it is currently earning. To the Americans who sacrificed tens of billions of dollars of GDP to give India the much-needed boost by banning offshoring, all the Indians would say is, “Thank you America!”

China planning its way into Business Process Outsourcing?

Sometimes it seems like everyone I know in India is either starting a BPO firm or working for one! Entrepreneurs all over the country have started BPO firms focusing on every conceivable business process. While the Indian government policies have helped somewhat, most Indian BPO entrepreneurs seem to see the Indian government more as a necessary evil than as a core promoter of BPO market growth.

Interestingly enough China seems to be taking a more planned approach. Ecommerce Times reports:

The China Development Bank (CDB) will issue 5 billion yuan (US$632.7 million) worth of credit to foster service outsourcing in five cities.

Chinese Minister of Commerce Bo Xilai said at the inauguration ceremony for the five cities, which are Chengdu, Xi'an, Shanghai, Shenzhen and Dalian, that the ministry will take measures to promote the fast growth of service outsourcing in the next five years.

Under the country's 6th Five-Year (2006-2010) plan, China aims to build service outsourcing bases in 10 cities, encourage 100 multinationals to outsource services from China, and foster 1,000 large and medium-sized service outsourcing enterprises.

It will be interesting to see whether China's planned approach will be more effective than India's unruly but entrepreneurial milieu. I admit I am biased, but my bet is on India.

So why did I start this blog and www.totalcostoferrors.com

I was born in India, and will always remain a proud Indian. I have also lived in the US for most of my adult life and I have gained a deep appreciation of the American people. I believe both Americans and Indians share a common vision of the individual’s right to compete based on his or her inherent abilities. Both nations are natural allies, yet the current negative sentiments regarding outsourcing are building a wall between us. Indians are pained by web commentary regarding “Indian slaves” stealing American jobs. Americans are equally frustrated by their apparent helplessness in the face of globalization.

America was founded on the vision that if you work hard you have a fair shot at success. Americans today believe that they are competing against Indians and Chinese on labor costs. This is rightly viewed by them as a game in which the odds are unfairly stacked against them. The anti-outsourcing brigade however claims that Americans are somehow owed a job. The American dream promises a fair shot, not a guaranteed shot at success. Both visions patently jar with the American dream.

I believe that a focus on quality and the Total Cost of Ownership of Business Processes can provide a way out of this conflict. My belief is based on my conversations with over 250 US executives, 20 outsourcing vendors, and hundreds of Americans and Indians.

Quality is of paramount importance to the Total Cost of Ownership of outsourced business processes. (Please visit www.totalcostoferrors.com for evidence supporting this claim.) Hence, relocating a process to a low-cost country is much less important per se than achieving the highest level of quality possible. Under this paradigm, workers across the world would be able to compete equally for their slice of the Business Process market based on their ability to provide the highest quality, not just the lowest labor costs. If US employees meet their employers’ financial goals through quality improvements, there may be no incentive for outsourcing to low cost locations.

This is not an anti-outsourcing message. The reality is that the best outsourcing firms deploy the latest technologies, invest heavily in best practices, and thus often provide significantly better quality. However, many upstart BPO firms are focusing merely on cost reductions and are ill-serving their customers.

We need to explicitly and aggressively shift the outsourcing debate to focus on quality. This focus on quality would present American workers a fairer competition, and one that they have a chance of winning. At the same time, the focus on quality would actually give the best outsourcing firms a competitive edge and increase the benefits their customers gain from outsourcing. I invite you to this open forum to discuss these issues.

Possible bias disclosure: Arijit (Apu) Sengupta founded a company that is focused on monitoring and improving the quality of outsourcing vendors and on helping companies meet their financial goals through quality improvement as a possible alternative to outsourcing. While this may bias his view of the world, Arijit believes this merely proves he puts his money where his mouth is.