Of Wage Inflation and Outsourced Jobs

Information Week attempts to explain why India's wage inflation won't bring outsourced tech jobs back to the U.S. in this article. Example, Cognizant Technologies. Like many Indian outsourcers, Cognizant is growing fast and hiring aggressively. Its revenues in the most recent quarter jumped 57%, and the firm increased its head count last year by 49% to house more than 28,000 employees. Narayanan, CEO of Cognizant, offers perspective:

Seventy-five percent of Cognizant's workers are based in India, but those workers account for only 20% of its labor costs. Conversely, Cognizant workers based in the West, mostly in the U.S., account for 80% of the company's wage expenses even though they're just one-quarter of its total staff.

Because wages paid to workers in India represent such a small percentage of total costs for companies that operate there, a 15% increase in salaries results in no more than a 2% rise in prices charged for IT services, says Narayanan.

And that's precisely the problem. Given that supply is limited, wage inflation represents a growing concern (no pun intended). Narayanan describes the scenario over the next year. So, an annual wage inflation of 15% translates into an average annual increase of 2% in prices. Ceteris paribus, of course. Given that the supply of skilled labor to sustain the torrid growth of the outsourcing firms remains limited, the estimate for wage inflation can only rise over time, engendering further price inflation.

For example, this article in yesterday's Financial Times (subscription required) discusses how Chinese exporters, in the face of rising input costs, including growth in manufacturing wages, and raw material and intermediate costs, are increasingly confronted with the choice to either accept lower margins or raise prices. Export data points to evidence of both. Goldman Sachs expects Chinese annual consumer price inflation, currently 1.4 per cent, to reach 3 per cent by the end of 2006. If this increase were replicated in import prices from China, Goldman estimates the impact on US inflation could be 25 basis points.

Indian service providers are not immune to similar inflationary risks. Clothes and consumer durables account for only 15 per cent of US consumer price inflation; 60 per cent is from services. However, globalization is not widespread in services and this should help the Indian service providers offset inflationary impacts of higher priced services. The (new) services that they replace will still be cheaper than the American counterparts. Increased volume of business will help preserve margins and prices. Of course, both these solutions assume a constant supply of quality labor, which is clearly not the case. Perhaps, the Indian firms could leverage their expertise in service provision to transition into a skilled systems integrator that coordinates service providers in other emerging low cost countries. Coordinating work across firm and national boundaries is a distinct competitive advantage that the Indian firms have come to acquire over the past decade.

Finally, the Indian service providers will have to invest in innovation and providing more value-add services. Innovation is the latest management mantra, especially in a growing number of large, established firms that have long focused on reducing costs and budgets. Executives are working on becoming more creative to capture customers in the global market. As mentioned in my previous post, firms will look to offshore providers who can transition from being a strategic service provider to being a business unit that develops and delivers products to the firm's customer in the region where it is located. This calls for increased flexibility, responsiveness and vision.

And if the providers fail to deliver, Narayanan may well need his U.S. workforce to cover. So, India's wage inflation may not bring outsourced tech jobs back to the U.S. but it might just engender a cross border war for managerial talent which brings forward U.S. workers to India and at the forefront of new international paystakes.