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The next India

Outsourcing IT: challenges and opportunities

Paul Tjia | May 28, 2009

In developing countries, the current economic crisis has led to a decline in exports of goods such as textiles and to a reduction in foreign investments. However, exports of IT-related services could be on the increase.

The current economic crisis has had severely negative impacts on developing countries. It has led to a decline in exports of goods such as textiles and a reduction in foreign investments. However, exports of IT-related services from developing countries could increase. Because firms in industrialized countries are now struggling to find ways to reduce costs, outsourcing IT services to countries where labour is cheaper (‘offshore sourcing’) is an increasingly attractive option. Many developing countries are already engaged in IT services, including some of the poorest nations, such as Bangladesh, Kenya, Nepal and Uganda. Others, such as Afghanistan, Liberia, Myanmar and Rwanda, are preparing to enter this industry.

Software exports are a cause for excitement in developing nations that are hoping to become the next India. Once seen as a land of extreme poverty, India has now become an IT superpower. Large software companies, including Microsoft, Oracle and IBM, are using Indian software centres to develop their products. India’s independent firms now compete successfully with the largest companies based in industrialized nations. The low capital and high labour intensity of an IT-export industry is attractive for low-wage, labour-surplus economies. It demonstrates the advantages of globalization without most of its negatives, such as:

  • Job creation. Unemployment is a major problem in all developing countries. In Kenya, 75% of all university graduates in IT are not able to find appropriate jobs. This leads to labour migration, resulting in the ‘brain drain’. One promise of the IT-export industry is job creation. In India, the industry provided direct employment for more than 1 million people in 2008, and indirect jobs are at least double that. In Bangladesh, the industry employs 20,000 staff.
  • Revenue generation. Exporting IT services is a source of foreign currency revenue. In 1983, Indian software exports were estimated at a modest US$18.2 million, but by 2008 these had increased to US$43.3 billion. IT services currently account for 20% of India’s exports and are projected to become India’s single largest export within the next few years. However, net earnings from exports are low. This is due to expenses related to international travel, living allowances of software testers and programmers who work overseas, foreign marketing, multinational profit repatriation and imports of hardware and software. India’s net earnings are estimated to be around 55% of the gross figures.
  • National business culture improvements. Within India’s software industry, larger companies offer good working conditions in modern, air-conditioned offices. Employees receive benefits such as subsidized meals and transportation. In a country such as India, traditional distinctions based on religion, sex or caste are less important in the merit-based software industry than in other industries. The rapid growth in call centre jobs has given Indian women new confidence and social empowerment. For many young women, the relatively high salaries provide a much higher quality of life than they could have had expected in traditional occupations.
  • Other economic and social impacts. The success of the IT export industry has a positive effect on the domestic IT sector. Working on offshore projects is a form of knowledge transfer from the wealthy nations to the developing world. The technical and domain knowledge gained through working for foreign clients can be re-channelled and used for domestic projects. The IT export industry also boosts investment in infrastructure, such as telecommunications. In addition, it creates demand for various other services, such as training, transportation, construction, accounting, hotels and legal services.
Hollandse Hoogte / Polaris

However, IT outsourcing by definition mainly benefits urban areas and the middle classes, thus potentially increasing inequalities within countries. Even in India, most software development companies operate in only a handful of metropolitan areas and therefore do not benefit the country’s vast underclass. The impact of the IT-export industry is often limited to a small area of the economy. In poor societies, millions of citizens are marginalized by their lack of access to information and communications technologies (ICTs), and a successful IT-export industry will not automatically diminish this digital divide.

ICTs have become an important area for international development (ICT4D), while the focus of programmes in sectors such as education, agriculture, governance, microfinance and health is on the use of IT, such as access to information and communication networks. The key actors in ICT4D programmes – international development organizations and NGOs – focus on rural areas and target the people at the ‘bottom of the pyramid’ who live on less than two dollars a day. Assisting the creation of an IT-export industry has not yet been a target in most ICT4D initiatives, but the promise of job creation cannot be ignored. The new concept of ‘social outsourcing’ could create a connection between these two separate worlds. In this model, IT services would be outsourced to the poorest countries, or to subcontractor enterprises based in poor communities that specifically hire from marginalized groups. An example of this ‘fair trade’ in IT services can be found in India, where the Kerala state government has facilitated the creation of IT enterprises that are owned cooperatively by groups of previously unemployed women from below-poverty-line families. By 2006, 151 such enterprises were undertaking outsourced IT training work, mainly for public schools, and another 80 were carrying out outsourced data entry work, such as the digitization of government records.

IT activities

There are two main categories of IT-related activities in developing countries: IT-outsourcing services and IT-enabled services. IT-outsourcing services include software development such as programming or testing, and building websites. The specifications for the software are established by the Western clients such as airlines, banks, insurance companies and software producers.

IT-enabled services, also known as business process outsourcing (BPO), include

  • Manual data entry is required when data that is stored on paper needs to be converted into digital form and scanning is not an option. For example, a 40-volume dictionary was recently sent to India to be retyped.
  • Contact centre services, mostly voice-based, are provided by call centres and help desks. Many thousands of call centre jobs have been transferred to countries such as India, the Philippines and Kenya. Call centres in Mexico now serve Spanish-speaking customers throughout the Americas, and those in China employ Japanese-speaking staff to serve Japanese firms.
  • Various administrative tasks, including such work as handling airline or hotel reservations, or other services that require specific knowledge, such as claims processing for medical insurance companies. Document imaging also allows offshore locations to perform financial and accounting services. Dutch accountants are turning to India, South Africa and Suriname to perform these routine tasks.
  • Animated film production is very labour-intensive and is therefore ideal for offshoring. In North Korea, SEK Studio in Pyongyang is now one of the world’s largest animation studios, producing films for French, Italian and Spanish film and television companies.

Both forms of IT-related outsourcing create opportunities for developing countries. But at the same time many of the obstacles for productive development that exist in a general sense for those countries also apply to the IT industry. Apart from technical skills, functional and business knowledge is also required in order to understand the demands of the clients. In many developing countries, this knowledge is lacking and training is needed.

The complexity of offshore projects demands the skills to manage distributed tasks with time and language differences. Differences in national culture can have major impacts as well, although these are often
overestimated.

Erran Carmel of the American University in Washington, DC, has identified eight principal factors that explain national success in exporting IT services, together known as the ‘Oval model’ (see figure). These eight factors tend to interact with one another. Not all the Oval model factors need to be present to achieve some success; in fact in India, during its industry’s formative period of growth, several of these factors were absent or weak.

Government vision and policy

A government has influence over all the other factors in the Oval model. Governments of dozens of nations, including Costa Rica, Iran, Kenya, South Africa, Bangladesh, Vietnam and China, are taking concrete steps to promote their IT-export industries National visions for software have changed over the years. In the 1980s the fashion was to protect the industry as much as possible from international competition, rather than open it up. The form and content of state intervention changed into that of a facilitator of private sector initiatives.

Human capital

The number of engineers pouring out of universities and technical schools in India, China and other nations has surged. But in the IT industry, managerial experience is most acutely missing at the mid-level for project managers. This is even a challenge for India.

The ‘Oval model’: success factors for a national IT-export industry.

Wages

Low wages are a key factor in the success of offshore nations. Especially with the current economic crisis, cost reduction is the main reason to offshore. There has been a shift of work from India, where a heated market is pushing up wages, to lower wage nations such as Vietnam and China. In the long run, the only way for a nation to escape this cost-driven spiral is to differentiate its IT services. Clients will return because of factors other than costs, such as quality, knowledge, specialization and service excellence.

The industry

A nation’s software export industry cannot succeed without large companies; the number of firms will vary by nation. In Ghana, Kenya and Nepal, companies of 100 people are considered large. This implies that their software export industries will not grow very much. Small firms cannot win large contracts and have limited financial means. The largest IT firms in Indian now employ more than 100,000 employees.

Capital

An IT-export industry needs capital in order to grow. Most companies in developing nations grow using their own capital, but this restricts their ability to prosper. Outside capital for growth can come from either foreign or domestic sources. The large service providers have no problems raising capital. But smaller and younger offshore firms do not have such access to capital. For most software firms in developing countries, the difficulty of obtaining financing is a major obstacle. National governments can help in a number of ways: they can provide financial assistance through grants and loans, they can guarantee loans or they can seed risk funds (venture funds). Some international organizations provide funding, such as the World Bank through its International Finance Corporation (IFC).

Technological infrastructure

In much of the developing world, the power supply is unreliable, the telecommunication structure is outdated and the costs of communications remain high. An industry will never thrive under such conditions. Firms need reliable connectivity and it must be affordable compared to international levels. Access to fibre-optic links is important for countries that seek to attract call centre activities. In situations where the infrastructure is absent on a national basis, technology parks or high-tech office centres are alternatives.

Linkages

Linkages emerge between individuals, companies and nations due to geographical, cultural, linguistic or ethnic connections. The effective use of linkages is one of the most important success factors for developing an IT-export industry. Linguistic linkages are illustrated by the success of India, which is partly due to English fluency in this former British colony. African francophone countries such as Morocco and Tunisia are working for French customers. South Africa, where a very old version of Dutch is spoken, is targeting Dutch clients for its call centres. Diaspora linkages have been a powerful success factor. Indians came to the US for advanced education, stayed and rose to influential positions in high-tech companies. They were used by Indian IT providers to create initial business contacts.

Quality of life

The quality of life in a location helps attract foreign clients. Equally important, it also helps keep the best employees from moving away. Richard Florida of the University of Toronto calls these people the ‘creative class’ and argues that locations need to have a high quality of life in order to attract them. Locations with high measures of quality of life have several common characteristics: quality of place (natural, recreational and lifestyle amenities), an abundant labour market and high levels of environmental quality. But many developing countries have not developed the quality of location, have seen some of their top talent leave and have had difficulty attracting foreign activity. We know of Dutch managers who found Dhaka, the capital of Bangladesh, unpleasant for a long stay.

Less important factor: piracy

Most developing countries have very high software piracy rates and poor enforcement of violators. For most offshore clients, piracy is not a key factor. The incredible growth of software exports from high piracy nations such as India, China or Vietnam shows the irrelevance of this factor.

With the current financial and economic situation, it is expected that outsourcing to low-cost countries will grow. Developing countries should use these new business opportunities, but finding foreign clients is a challenge. While IT professionals in most industrialized nations are now well aware of the ‘India brand,’ providers in other developing nations are at a disadvantage. Intensive country branding needs to be done, which is a responsibility of governments and local IT associations. In addition, it is very difficult for service providers from developing countries to find clients if they are located on other continents. The many Indians working in the United States have been instrumental in creating business linkages with India, for example, and the Chinese software industry is now benefiting from the knowledge of returning migrants, or ‘brain circulation’. Without such personal linkages, the most effective way for companies to gain access to new markets is to open their own sales offices abroad. If this is not financially feasible, offshore providers need to consider other means of representation, such as working with local representatives or agents. Finding new clients abroad is impossible without a proper local presence.

Photo credit main picture: Hollandse Hoogte / Polaris

Footnotes

  • 1.

    One of the first collections of case studies can be found in Electronic Journal on Information Systems in Developing Countries, 13: www.ejisdc.org.


  • 2.

    NASSCOM is the national association of the software and services industry in India: www.nasscom.org.


  • 3.

    Statement from the IT association BASIS: www1.cei.gov.cn.


  • 4.

    Heeks, R. (1996) India’s Software Industry. State policy, liberalisation and industrial development. Sage Publications.


  • 5.

    Parthasarathi, A. and Joseph, K.J. (2004) ‘Innovation under Export Orientation’. In D’Costa, A.P. and Sridharan, E. (Eds.) India in the Global Software Industry. Palgrave Macmillan.


  • 6.

    Net earnings from exports are lower than the gross foreign exchange earnings. This is due to expenses related to international travel, living allowances of software workers who work overseas, foreign marketing, multinational profit repatriation and importation of hardware and software. Indian net earnings are estimated to be around 55% of the gross figures. Joseph, K.J. (2002) Growth of ICT and ICT for Development. Realities of the Myths of the Indian Experience. United Nations University, WIDER Discussion Paper No. 2002/78.


  • 7.

    Mitter, S. (2001) Asian Women in the Digital Economy: Policies for Participation. UNDP.


  • 8.

    Heeks, R. (2008) ICT4D 2.0: The Next Phase of Applying ICT for International Development. Computer, 41(6).


  • 9.

     

    See for example Richard Heeks: www.gk3onlineinteractions.net.


  • 10.

    A report of an IT-visit to North-Korea can be found at: www.gpic.nl


  • 11.

    Conducting offshore projects is covered in detail in Carmel, E. and Tija, P. (2007) Offshoring Information Technology: Sourcing and Outsourcing to a Global Workforce. Cambridge University Press.


  • 12.

    Hofstede, G. (1991). Cultures and organizations: software of the mind. McGraw Hill.


  • 13.

    Carmel, E. (2003) The New Software Exporting Nations: Success Factors. Electronic Journal on Information Systems in Developing Countries, 13(4):1-12.


  • 14.

    Florida, R. (2002) The Rise of the Creative Class. Basic Books.


  • 15.

    Tjia, P. (2003) The Software Industry in Bangladesh and its Links to the Netherlands. Electronic Journal on Information Systems in Developing Countries, 13(5):1-8. www.ejisdc.org


  • 16.

    The Business Software Alliance estimates the piracy rates in 2007 in Vietnam, China and Indonesia at above 80%:
    http://global.bsa.org


  • 17.

    Adapted from Saxenian, A. Government and Guanxi: China's Software Industry in Transition, University of California working paper, 2003.


  • 18.

    Article: 'Creating a virtuous circle'.