Getting Pricey?

The Indian IT sector has proved to be the country's fastest growing segment
during 2001-2003 and recorded a growth of 17% y-o-y. Companies are undertaking
large-scale investments in the technology and outsourcing sectors to gain
advantage of the new emerging business opportunities. India is experiencing a
surge in tech hiring due to growth of the IT industry and expansion of its
well-publicized offshore IT outsourcing option. The US continues to be the
largest buyer of Indian IT products and services and will continue to drive the
industry performance and growth.

Given the intense pressure on MNCs to drive profits in an era of low
inflation, labor cost control and outsourcing are high on the agenda of
executives that lead these companies. Further, in the light of recent social and
political debate on outsourcing, it is necessary for managers to explore and
analyze the actual difference in labor costs between India and US and gain
perspective on where this difference may be headed.

India, because of its large, highly educated, English-language speaking
workforce and its demographics that support continued rapid growth of this
workforce, and cost advantage, has become a popular center of attention for cost
management decisions to outsource, initially IT-related jobs, and increasingly,
a much broader range of "back-office" service jobs.

With this investment and rapid expansion of the size of foreign MNC
workforces in India, the years 2003 and 2004 have seen the growing demand of
labor leading to labor supply/demand imbalances that are leading to spiraling
salary costs, thereby raising questions about the long-term benefits of
outsourcing work to the country.

The fundamental questions, then, are: if labor cost competitiveness is a key
driver of offshoring investment in India, and, if labor costs continue to rise
at the rates we have seen over the past two years, then will India price itself
out of this market? And in how long?

Mercer Human Resource Consulting recently carried out a comparative analysis
of labor costs between the US and India in the IT sector. The Mercer study
focused on identifying the determinants and drivers of compensation and
utilizing the projected movement of these variables to compare historical
compensation trends and forecast future movement in compensation in the two
countries.

In the India market, Mercer data shows that y-o-y salary increases for the
hi-tech industry have been comparatively higher than other countries in the
region (in the high range of 10-25%) over the last decade (1995-2003). Employees
in the Indian hi-tech sector are coasting a global crest with their skills in
high demand. There is also a significant movement up the value chain across the
industry, and the y-o-y salary increases for the next few years look certain to
remain at significantly higher levels than the average of a few years prior.
From a compound growth perspective, for 2004, salary levels in the Indian
hi-tech sector were 33% more than what was paid for similar jobs four years ago.
Salary levels are expected to experience a continuous increase during this
period though a dip in the rate of increase in salary is expected in 2006 and
2007.

Contrary to this phase of high increases in India, most employees in the
American workforce received the lowest average salary increases of their career
in 2003. Mercer data reveals that employees experienced a 12% hike in salary
levels in 2004 when compared to 2001. The trend for 2005-2007 for the US shows
downward pressure on y-o-y salary increases, such that they would be hovering
around a 4% level.

Although the analysis at Mercer shows that traditionally annual salary
increments have been higher in India as compared to US, IT employees in the
United States continue to earn considerably more than their counterparts in
India. This is true across industries, levels and functions though to different
degrees. Of importance is not just the magnitude of increase in compensation
levels within each country but the proportionate cost differential between both
countries for a particular management career level; this cost differential is
expected to decline significantly by 2007. This is on account of salary
increments in India, which are predicted to be at much higher levels than that
for the US for 2005-2007.

The cost differential has been the source of margins for American companies
and of business and revenues flowing to India. But now, escalating trends in
Indian hi-tech compensation costs indicate that Indian salaries are catching up.
For example, a "manager" in the US enjoys annual total remuneration
3.9 times higher than his/her equivalent in India in 2004; whereas in 2007, he
will receive remuneration only three times higher. Thus, there is expected to be
a narrowing down of cost differential between India and US over the years.

The cost of labor in India will continue to rise and it is fair to expect
that this will happen at an accelerated rate as demand increases, as
demonstrated by the Mercer study. This is also directly affected by the quality
and productivity of the labor supply. These are key issues for the Indian labor
market, since both quality and productivity are at global standards only in
sections of the industry. Further, the time difference works to India's
advantage distinctly, and while this will not change, the number of options
available to the US, like emerging South East Asian economies, within this time
zone, will increase and thus, again, India's selling proposition may lose
appeal.

India can counter this competitive combination of cost and skill only by
moving up the value chain, where cost plays a smaller role in decision-making
and by increasing its focus on productivity and quality. Companies looking at
the Indian market as an attractive cost location need to look beyond bare cost
and consider the impact of economic factors which may have a medium to long term
impact on the promise of cost advantage.

This article is a copyright Mercer publication. For more details on the study
refer The IT Industry: Labor Cost Comparison between India and the US; Asia
Intellect Issue 1, September 2004