Introduction:

The global devaluation of the U.S. dollar against other currencies is a major cause of concern for the outsourcing industry all over the world. The impact of the weakening of the dollar against currencies of major outsourcing destinations, particularly India, has actually overshadowed other serious concerns like wage inflation. Let us review the impact of these currency movements and wage inflation on the outsourcing business in leading offshore destinations.

India:

The Indian rupee has significant strengthened over the last year against the U.S. dollar, falling from 45 rupees to 39 rupees per dollar. This huge strengthening of 13 percent coupled with significant pay increases has shaved part of the Indian cost advantage. Further, most economists are expecting further strengthening of the Indian rupee in 2008.

The outsourcing businesses hit hardest by the dollar's slide are small and midsize Indian programming companies that do not have the option of shifting work around the world. Many of them work with a limited number of clients under contracts often fixed at rates for a year or more.

The rupee appreciation impacts BPO companies more than it does IT companies. A one percent rise in the value of the rupee against the dollar has a 75 to 80 basis points impact on the operating margins for BPO companies, unlike IT companies where the impact is about 40 basis points. This is due to the fact that a significant chunk of expenses for BPO companies remain in India while IT companies have some expenses in dollars due to onsite sales force and development centers in other countries.

Many North American and European companies that started their own offshore set-up in India to lower the cost of product development or back-office are now struggling due to spiraling costs, rising attrition, lack of integration and management support. In fact, the rupee's appreciation against the dollar has claimed its first victim in the business process outsourcing space. US-based Spectrum Global Fund Administration that provides back-office operations to hedge funds in the U.S. and the U.K. is closing its facilities in India. The company had started its operations there only two years ago.

In an effort to combat these threats, Indian outsourcing giants in the technology sector, such as Tata Consultancy Services, Wipro and Infosys Technologies, are hedging their bets by expanding in countries such as China where costs are lower. Further, these companies are expanding business with European and Latin American countries whose currencies have stayed relatively stable compared with the rupee. Indian IT giants have already set up base in Latin American and East European nations to capture the emerging near shoring trend.

The domestic IT-BPO firms have devised many strategies to combat the approximately 15 percent annual climb in wages. Some of the strategies include hiring freshers and students with non-engineering backgrounds, establishment of operations in tier-II and tier-III cities, increased billing and employee utilization rates, and improving the business mix to increase productivity to beat the heat of the rising salaries. Industry analysts believe that with these strategies, coupled with an indexed wage differential, the IT-BPO firms should be able to retain their competitive edge in outsourcing for at least another 10-15 years.

Latin America:

The strengthening of the rupee against the dollar has made the Latin American outsourcing industry even more attractive because Latin American currencies have gained little against the dollar as compared to the rupee. Interestingly, Argentina's currency, the peso, has depreciated against the U.S. dollar, making this country even more attractive in terms of outsourcing. Even Mexico's currency is relatively stable against the dollar, making it increasingly competitive with its time zone in line with the U.S.

"A significant gap exists between the benefits sought and those realized by ITO buyers, particularly in the areas of innovation and flexibility," says Ben Trowbridge, CEO and senior executive at Dallas, Texas-based global advisory firm, Alsbridge. "The gap is causing a majority (57%) of ITO buyers to consider renegotiating their existing contracts before they come to term."




Many companies are looking to Latin America as an option for IT services delivery to combat the issues related to staff attrition and rising salaries in Asia. Large service providers that focus on the U.S. market have already established their presence in countries like Mexico, Brazil and Argentina.

China:

The rising rupee is turning out to be a blessing for China, which has historically struggled to match India's experience and expertise in the area of IT outsourcing. China, with its control over its yuan and rather subdued wage inflation, is becoming increasingly attractive for Indian IT giants as well as US companies that are looking to set up their own offshore operations.

Several Indian outsourcing and IT giants like Wipro, Infosys and Satyam have already set up their operations in China, where an excess supply of well-trained software engineers has kept salary inflation under control.



China has a huge pool of skilled workers, especially in the IT sector and this abundant supply of skilled IT workers will help in keeping wage growth under control in China.

Eastern Europe:

Eastern European countries certainly have an edge over other outsourcing destinations in terms of currency fluctuation. The currencies of these nations are relatively stable. Further, wage inflation moves at a very slow pace in Eastern Europe. All these factors have attracted the attention of European companies towards these nations as an attractive near shore destination. Leading Indian outsourcing service providers have started establishing their operations in these nations to combat the issue of rising currency value and increasing wage inflation.

The modest wage growth, coupled with thousands of skilled graduates in sectors like IT boosts the potential of Eastern European countries in the outsourcing sector, especially when their Asian counterparts are struggling due to currency movements and wage inflation. Further, wage inflation is even lower outside of major cities like Prague and Budapest. Therefore, a real potential exists in tier two and three cities in Eastern Europe in terms of highly educated workforce and low wage growth.

The political and economic stability of this region also boosts the chance of a stable road ahead for currency exchange rates.

Summary:

The currency appreciation of major outsourcing destinations is indeed a cause of concern and is expected to erode the attractiveness of these destinations as a preferred outsourcing destination. The currency appreciation, coupled with wage inflation in many of these destinations, has already started taking its toll on both large and small players in IT and BPO industries. Leading companies in these nations have already started establishing new centers in nations where wage growth is still under control and currency movements are relatively stable.

Although countries like India still hold an advantage over others, the forecasted trend of the weakening dollar and spiraling salaries does not provide a good picture for these outsourcing destinations.