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Tuesday, January 03, 2006

Offshoring : Sustainable Advantage & Favorable Drivers

Very recently when covering the Mckinsey -Nasscom study on looming Indian IT labour shortage, I wrote that The problem is not non - fixable & that with concerted efforts from Government, educational instituitions & corporates & suggested that on reading the specific recommendations( thought they look generic - the roots of the solutions anyway lay there) to overcome the shortfall and once can easily relate how this fully doable. While several people are talking about the rising wages and potential petering of interest in outsourcing from Asian contries a key finding from Everest group suggest otherwise. Very recently we covered the view from Everest Group about the impending restructuring of the outsourcing market, where Peter Bendel Samuel of Everest explained how the outsourcing is poised for a huge change and noted that offshoring is here to stay and what could be offshored would get offshored certainly. In what can be seen as a related finding – Everest Research Institute's Offshore Market Report looks at the competitive sustainability of labor arbitrage in various offshore locations.Sustaining of offshoring is even stronger than the viewpoint on sustainability of labor arbitrage. This is because labor arbitrage itself is not a concern, and also there is enough else going on for offshoring. Amongst the key finding of the report includes with all other things being equal and based on current known facts about the drivers, it is very clear that for the next thirty years, labor arbitrage will sustain in most offshore locations.

Some european nations like Ireland (where the advantage may not last beyond five years) and in Canada and Czech republic the estimation is that the t is expected to last for 8-20 years. Sheetal Bahl from Everest outlines that "Sustainability of labor arbitrage depends on a multiple set of factors:
- First of all, it depends on the existing wage differential between the source city and destination cities, which is different for different processes, skills and so on.
- Secondly, it depends on wage inflation in the source city and wage inflation in the destination city.
- Thirdly, it depends on the exchange rate differential, and finally on what is called the hurdle rate

Looking at Hurdle rates, wage inflation & depth of talent the report finds that the competitive price advantage is sustainable even with unplanned activities. Also to note is the fact that the currencies of developed nations will continue to strengthen against the currencies of developing nations helping labor arbitrage opportunities much more. But most importantly the report comes down heavily against the tendency to equate sustainability of labor arbitrage with sustainability of offshoring. Recently, this blog covered about the need to assess correlation between productivity & offshoring. Everest group notes that productivity improvements are making offshoring more value yielding (This is based on Everest group’s data – some times enagagements show close to 10% productivity improvements on an annualized basis). Clearly it is likely that productivity improvements offset wage inflation. In all offshoring and its growth, is anything but shortlived.

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