A recent eWeek article (July 24th, 2006) reports on how escalating wages are squeezing profit margins for Indian outsourcers. The current compounded annual growth rate for salaries is 12 percent in India versus 4 percent in the United States. There’s also a high turnover rate as local outsourcers compete for talent, both with each other and with companies like IBM who have set up shop there. Further, training costs are high, with many Indian outsourcers saying that Indian universities must do a better job of educating the workforce so that they can avoid exorbitant sums spent on training. One customer mentioned in the article brought their product development operations back to the United States from India, citing little to no cost savings when all was said and done.

However, at least one analyst doesn’t believe this to be a big problem:

Eugene Zakharov, an analyst at Technology Business Research, in Hampton, N.H., disputed the idea that Indian wage inflation has reached the critical point. “They are feeling the pain, but I don’t think the rising costs will turn away the benefits of India. Even if the wage inflation rate continues to grow at the present rate, then only in 2031 will there be an overlap with the rates of U.S. software engineers,” he said.

In my own experience, I’ve felt the rising costs and high turnover directly, especially amongst the more organized outsourcing firms, but there is still plenty of talent to be found for a fraction of what it would cost in the United States. The key is making sure the right systems and processes are in place to facilitate proper communication and productivity. And, of course, outsourcing is not just about wage arbitrage, but is crucial to any sustainable business strategy for a number of reasons.

With India’s cost advantage fading, will US firms run to the next source of cheap labor, possibly China?

From an older eWeek (June 2005):

“Our goal is to build the Infosys or Wipro of China,” said Ramsey Walker, co-CEO of San Francisco-based Freeborders. Walker asserted that a company that has developed sufficient scale and maturity of process will emerge to fill that role within 12 to 24 months. “We believe that only China can rival India because of raw numbers of talent. So we are making our bet on China,” Walker said.

[…]

The software development market in India is rapidly reaching saturation, Walker said. He agreed with the conventional wisdom of India critics that the country’s tech sector is undergoing rapid wage inflation and that corporate loyalty extends only as far as the biggest signing bonus. “When you have teams that are turning over, and you have wage inflation of 15 to 25 percent, then India is running into issues,” he said.

In this case, cultural differences are a benefit, with the deep personal relationships that play an important role in Asian cultures offering the potential to cultivate more stability in China and to avoid the high attrition rates seen in India.

Yet, I do think that India offers many benefits over China (plenty of English speakers for starters) and, while the outsourcing landscape will continue to shift and spread to other locales, India will remain the top destination for information technology outsourcing for some time to come.