Offshoring has been driven by the ubiquitous 'cost advantage' offered in a lower cost location. In a scenario of financial instability in global markets, questions about India post-Satyam and 26/11, the BPO industry is facing increasing margin pressures.

Service providers are looking at ways to manage their costs in order to provide the same level of cost savings to the clients while maintaining their profit margins. The 'people cost' forms a major chunk (>50%) of the total cost for Indian BPOs. Over the last couple of years, overall salaries in the US are growing at an average rate of 3% p.a., whereas in India average salary growth has been around 15% p.a. or higher. This led many to question the sustainability of offshoring. In addition, lower productivity in India means that actual cost savings are between 20-50%. Some analyst reports and recommendations suggest scenarios where, in the next 10-15 years (or sooner!) cost savings from offshoring will disappear. However, we do not prescribe to this theory for several reasons:

• The wage growth differentials are often over-hyped. While individual salaries have been growing at this pace, overall wage costs growth is around 7-8%. This is because there is influx of fresh (junior) employees at lower wage levels.
• The past increases in salaries are already generating supply responses, and increased supply will dampen wage inflation.
• The current pressure on margins is prompting industry-wide slowing of wage hikes.
  
  

Reining Costs and Enhancing Productivity

Indian BPOs have enormous 'slack' in the system - largely due to low productivity levels. A balance between removing the 'fluff', moderate wage growth and productivity improvement will provide significant margin benefits for vendors going forward. A consistent 15% wage growth (which has been the story so far) with negligible productivity gain with turn out to be an unviable proposition. The following exhibit measures the impact on margins for different scenarios for the year 2012.

Impact of productivity improvement on margins

                                              Source: ValueNotes Research

Assuming that billing rates remain at the current levels and the dollar - rupee equation does not change significantly, productivity improvement of 15% and an average 10% wage growth (or lower) can provide 20% improvement in vendor margins by 2012. Addition of more high value services, expansion of services to other segments can contribute additionally to increased margins. Productivity enhancement is the key towards survival from competitive threats!

"Adversity is the test of one's character"; this couldn't be truer for the BPO industry more than it is now. While in the next couple of years, we will see several BPOs/KPOs struggle, crumble or go under; those of the stronger breed will survive to emerge winners when offshoring regains momentum.