Rising people costs are the single biggest challenge the Indian software and services sector faces. This is to be expected in a services business where people matter more than machines.
But people costs are more critical for India as it has been a winner in the global outsourcing game mainly on account of abundant low-cost skills. Some of that advantage is in danger of getting eroded in the face of emerging challenges from places as far apart as "New Europe" and Vietnam.
Margins are clearly under pressure and attrition rates high. The latter is more true for the BPO end of the business, but then the proportion of BPO to total software and services revenue has been going up. In short, Indian industry must crack this issue if it is to remain ahead of the others.
The latest Nasscom-Hewitt rewards study for 2005 acknowledges these trends and puts some numbers on them. The software and services sector (exports plus domestic) is slated to grow by 28 per cent in the current year, to reach $36 billion, and staff costs can account for as much as a third of a company's revenue.
There is pressure on profitability and difficulty in sourcing talent. The Indian software industry has devised a solution to the problem out of the cause itself--rapid growth. The total increase in cost to companies, at around 10 per cent, has kept behind average salary increases of around 16 per cent as large numbers of freshers and those with less experience have been recruited.
A key factor has been the industry's ability to make a person with three years' experience do the job of one with five. Another reactive strategy has been to shift to second- and third-tier cities, where both staff costs and attrition rates are lower.
But there is also the need to remain in Tier 1 cities, as they have the best supply of the right kind of skills. Bangalore and the national capital region are ahead of the average, all-India increase in compensation by 3-4 percentage points, followed by Hyderabad. Fascinatingly, Chennai is well behind the national average!
To stay on course, Indian industry has to keep moving up the value chain. But the post-2000 concern with getting more out of every dollar invested in IT remains, despite the global economy being buoyant. Hence, pricing has merely stopped getting worse.
The industry has been able to fight back by innovating with and improving on processes, and this has created greater value for itself. It has also been able to use the high growth rates to bring down the share of selling and administrative expenses. Process improvements will continue, but scrounging on selling expenses has its limits as deal sizes get bigger, requiring more consulting inputs and longer-term investment in customer relations.
The larger Indian firms have been buying up carefully chosen consulting practices; their staff don't come cheap. Besides, Indian leaders will have to increasingly set up global delivery centres so as to offer more near-shoring capabilities.
Soon will come the need to take over the hardware and staff of large firms, as IBM does and TCS has begun to do with its Pearl deal. You can't pay Indian-scale salaries to such staff.
For India to retain its position as the leading offshore destination, it is critical that the country keeps producing more and better engineers.
But for India to become a top global IT player, its leading companies themselves will have to become global players and keep getting better at the game.
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