Software economics | Outsourcing is too wild to fit economic theory

Software economics | Outsourcing is too wild to fit economic theory

Moline, Illinois, probably isn’t a place that springs to mind when one thinks of pioneering efforts in services outsourcing.

Yet, it was in this city that in 1991, Satyam Computer Services Ltd, a fledgling Indian software company, launched “Little India", a simulation exercise in writing code for customers who may be thousands of miles away.

Satyam rented an office across the road from Deere & Co., the tractor maker based there with whom it had a contract for an onsite software project.

Ten engineers were assigned to the project at the new location. They could work only at night, accessing the Deere network via a 64 kilobits-per-second satellite link. None of them could contact the client directly.

The experiment, as Satyam chairman Ramalinga Raju recounts in his article in Ed Cohen’s book Leadership Without Borders, was a success beyond expectations.

The next step was simple enough: Raju asked Deere, its first Fortune 500 client, if he could stretch the telephone lines a little. Deere agreed. Raju extended the communication link by 8,302 miles (13,361km) and took the work from Moline to Hyderabad in India.

It wasn’t the first time “offshoring" was being tried: Texas Instruments Inc. had been doing in-house design-related software work out of Bangalore since 1986. It was, however, the first instance of a local Indian service provider supplying commercial software from India using a satellite link to a customer in the US.

As telecommunications costs plummeted after the bursting of the dotcom bubble—thanks to overinvestment in undersea fibre optic cables—the model gained widespread acceptance and became a political hot potato in the developed world. Economists, however, were unfazed by the arrival of the “flat world". Outsourcing was, after all, something that fit nicely into their models of how comparative advantages drive international trade from which ultimately everyone benefits.

The narrative is no longer that simple.

Of late, the business of outsourcing has started moving in a rather unexpected direction.

As the New York Times reported this week: “India is now outsourcing outsourcing." Top Indian companies are hiring people of all nationalities—including Americans—and setting up development centres from China and Romania to Chile, Uruguay and even the US.

A US bank looking to develop software targeted at its Hispanic customers gave the order to Bangalore-based Infosys Technologies Ltd, which then got it executed in Monterrey, Mexico, said the Times report.

The need for Indian companies to break into non-English-language markets is one reason why outsourcing is going crazy. But it isn’t the only motivation. Explosive growth is playing a part, too.

The global market for information technology services last year was worth $672 billion (Rs26.7 trillion).

According to Gartner Inc., only about 2% of this business was shared by the top six Indian software exporters. By comparison, International Business Machines Corp. (IBM) alone fulfilled 7% of the demand, and Electronic Data Systems Corp. took 3% of the pie.

That snapshot view probably doesn’t give a very sharp picture of just how fast the ground is shifting.

For instance, IBM, being the dominant player in the industry, added only about $840 million to its services revenue of $48 billion last year.

Contrast that with Tata Consultancy Services Ltd. The No.1 Indian software company increased sales by more than $1 billion in its financial year ended March 2007 even when IBM’s global services business is 12 times larger, notes Allie Young, a Gartner vice-president.

Growth of this order can’t be sustained in a globalizing world by running an “India-only" or “Indians-only" business. It’s almost impossible for a company to say today that while it wants to compete globally with the biggest and the best in its field for customers and capital, it will only recruit locally because domestic talent is abundant and cheap.

This is something that a chief executive of an Indian software company intuitively knows.

The jury is still out on what the current trend of a rising rupee will mean for the long-term future of India’s software industry, which earns most of its revenue in US dollars.

Will the business model that began by stretching telephone lines halfway around the globe survive the cost pressures arising from adverse exchange rate movements?

If India’s home-grown challengers can sustain their present rate of growth, Gartner predicts that a couple of them might even join IBM on the list of the world’s 10 biggest software services companies. So 20 years from now, these Indian firms might either become international behemoths or not exist at all. The beauty of globalization, as Nayan Chanda, editor of Yale Global Online, argues in his book Bound Together, is that no one is in charge of it.

That makes global commerce very unpredictable. Outsourcing is just one such wild business. BLOOMBERG

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