The next wave in India outsourcing

Nice summary from the economist. The point that legal services, like accounting, can be outsourced rings particularly true to me. Most legal services (from IP to contracts to employment law) that we consume as a startup are delivered over the phone or Internet, at exorbitant prices ($300 per hour is what you are charged for an associate; a partner bills even more). The effectiveness of the attorney is largely driven by raw brainpower, once some basic knowledge is acquired. I can easily see a model with a US-based partner and half or more of his or her staff (including associates) based in India. $30 per hour would be very good compensation for a highly intelligent Indian attorney.

Should we be concerned for the future of our young friends in law school? See here for related discussion.

ASKED for a sound-check at a function in Delhi this month, Bill Gates eschewed the “1,2,3...” favoured by ordinary mortals. “One billion, 2 billion...,” he counted. They think big, these IT moguls, and especially, these days, in India.

Microsoft later announced plans to invest $1.7 billion in India over the next four years, about half of it in adding to its existing research and development (R&D) and technical-support operations. “The only thing that limits us in India,” Mr Gates told the local press, “is the speed at which we can recruit.” A few days earlier, Intel, a giant chipmaker, had unveiled plans to invest more than $1 billion over five years, much of it in expanding its R&D centre in Bangalore. In October Cisco Systems, the world's largest maker of the routers and switches that direct internet traffic, announced its own plans to invest $1.1 billion in India.

The euphoria is confined neither to American multinationals, nor to information technology. It also encompasses India's own IT industries, and the expanding range of other back-office services that can now be performed remotely. The three biggest Indian IT-services firms—Tata Consultancy Services (TCS), Infosys and Wipro—are each recruiting more than 1,000 people a month. And to take just one example of the other services now moving to India, J.P. Morgan Chase, a big investment bank, this month revealed it is to double, to about 9,000, its staff there. Anyone who assumes J.P. Morgan will simply be doing low-level “back office” tasks in the country—a bit of data entry and paper-shuffling—would be flat wrong. One task for the new recruits is to settle complex structured-finance and derivative deals, what one insider calls “some of the most sophisticated transactions in the world”.

All these investments illustrate that a third stage of the great Indian services-export boom is well underway. In the first, firms such as TCS developed world-class expertise in software “application development and maintenance”, and their low-cost developers became the preferred partners of many Western IT firms. In the second, Indian firms and the local “captive” operations of multinationals started offering low-end back-office services that could take place a continent away—telephone call-centres, transcribing medical records, processing insurance claims and so on. In the third, in both IT and the broader spectrum of other “business processes”, ever-more sophisticated functions are happening in India.

So strong are the forces driving this shift that what seemed improbably rosy projections by NASSCOM, the Indian software- and service-industry lobby, and McKinsey, a consultancy, back in 1999, are coming true. This week NASSCOM and McKinsey produced the second full-scale update of their study. It argues that exports from India's IT industry and from “Business Process Offshoring” (BPO)—both from services “outsourced” to Indian firms and those performed by captives—are on track to reach $60 billion a year by 2010.

That would be a huge surge from the $17.2 billion in the year ending in March 2005. But it implies a compounded annual growth rate of 28%—below that achieved in recent years. Moreover, according to McKinsey's estimates, it requires India merely to maintain its present shares of the markets for offshore IT services (65%) and BPO (46%). This is because the study predicts a massive rise in the size of the overall market, estimated at present to make up just one-tenth of those services that could be sent offshore. The proportion is expected to rise as demography—a western labour shortage—becomes more pressing than protectionism.

In IT the growth in Indian exports is expected to come both from the software market, and from “traditional IT outsourcing”—such as the remote management of whole systems, a market now dominated by the big global IT consultancies. This is expected to rise from 8% of Indian sales now to about 30% in 2010, while software-development's share will fall from 55% to 39%. In business-process-offshoring, the big industries will remain banking and insurance. But rapid expansion is also expected in other areas, like legal services.

The law, in fact, illustrates how vast is the untapped potential market. About $250 billion is spent on legal services world-wide, about two-thirds of it in America, and as yet only a tiny proportion goes offshore. Forrester, a research outfit, has estimated that, by last year, 12,000 legal jobs had moved offshore, and forecast that this will increase to 35,000 by 2010. India, with its English-language skills and common-law tradition is well-placed to secure a big share of the business. It is not just a question of “paralegal” hack work such as document-preparation. Sanjay Kamlani, of Pangea3, a small Indian firm, calls it “real lawyering”—drafting contracts and patent applications, research and negotiation. His clients are both big law firms and in-house legal teams.

India's fundamental attraction has not changed since it first drew software developers: fantastic cost savings. With American lawyers costing $300 an hour or more, Indian firms can cut bills by 75%. Across the board, despite climbing rates of pay in IT and BPO, where rapid expansion has brought frantic job-hopping, India remains, say NASSCOM and McKinsey, the lowest-cost of all the main outsourcing destinations. It also has, among these countries, by far, the largest pool of employable people—those with the necessary language and technical skills. On this measure, India, which produces 2.5m graduates a year, 250,000 of whom are engineers, has 28% of the global available workforce, compared with 11% in China.

Yet the supply of talent may be the biggest constraint on the Indian industry's growth. On these latest projections, the number of people working in IT and business-process exports in India will increase from about 700,000 now to 2.3m by 2010. But on today's estimates only 1.05m suitably qualified people will graduate from college between now and then, so there will be a shortfall of nearly 500,000, with business-processing the worst affected. McKinsey's Jayant Sinha believes the education system can be fixed in time to plug the gap. A bigger worry, he says, is India's creaking urban infrastructure. IT firms in Bangalore, for example, are in revolt against the local government for its neglect of basic amenities. Yet India's IT and business-process industries will need about 14m square metres (150m square feet) of office space by 2010: “a new Manhattan”.

Hectic building is under way, and not just in the big IT and business-processing centres (Bangalore, Mumbai and around Delhi) or the “second tier” of cities such as Pune, Hyderabad and Chennai (Madras). The industry's worry over infrastructure, as over education, is that it cannot do everything by itself. Having thrived by keeping government at arm's length, business now needs help.