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(originally published by Booz & Company)


India and China May Not Be the Answer

An offshoring expert argues that companies could compete and profit best by outsourcing to small, more developed countries.

The global financial crisis and the resulting slowdown of international growth have given business leaders a breather to reconsider the future direction of offshoring. That’s a good thing, because companies have often failed to conduct disciplined analyses and, as a result, viewed offshoring as a foolproof panacea: a low-cost, high-return strategy that lets them shift overseas everything from information technology to manufacturing and call centers — with no offsetting costs or disadvantages.

But as time goes on, they are sacrificing more and more as they follow the offshoring fashion. For one thing, cost savings are transitory. Wages keep rising in China and India, by as much as 20 percent a year for some jobs. And personnel turnover is at abnormally high levels — at call centers in China and India, as much as 80 percent of the workers have to be replaced each year; as a result, training is anything but a negligible expense.

But more important, costs aren’t the only criteria to consider. Increasingly, offshoring is used to transfer overseas such brainy jobs as financial research, analytics, chip design, legal services, clinical trials management, and even magazine or book editing. Given that activity is trending from low-level to high-order functions, countries such as India and China known best for cheap labor and large populations become less and less attractive. Their overall subpar literacy and productivity levels, the endemic weaknesses in their educational systems, and their minimal environmental regulations make these nations ill-suited for high-end tasks, which companies must increasingly rely on as a potential competitive distinction and a way to differentiate themselves in the knowledge-based economy.

In this new landscape, offshoring to smaller, more developed countries such as Taiwan, Singapore, and Estonia — places with higher labor costs but better workforce quality, productivity, and political security — may be a more suitable option. If nothing else, these nations offer an alternative that companies should consider by conducting more sophisticated risk–reward assessments of offshoring opportunities.

In offshoring location studies, a large population has often been considered a positive factor, since it implies a reservoir of available, low-cost talent. Further analysis, however, reveals that the number of people in a country — or even the annual number of college graduates — says little about the quality of the workforce. For example, China’s population is 16 times larger than that of the Philippines, but its pool of suitable, young, English-speaking engineers is only three times as big. The situation is similar in India. There the number of recent graduates exceeds, in gross terms, that of China and the United States combined. With approximately 230 state-accredited universities and 458 engineering colleges, India mass-produces 2.5 million graduates for the labor market each year. Yet only about 2 to 5 percent of India’s existing workforce has basic vocational skills, compared with 96 percent in South Korea, 75 percent in Germany, and 68 percent in the U.S., according to Indian government reports.

From another perspective, whereas 50 percent of the engineers in Hungary or Poland have the language skills, practical knowledge, or appropriate cultural attitudes to work for multinational companies, only 10 and 25 percent of the engineers in China and India, respectively, do, says Diana Farrell, deputy director of the U.S. National Economic Council, in Offshoring: Understanding the Emerging Global Labor Market (Harvard Business Press, 2006).

Finally, India, with a population of 1.1 billion, has the highest absolute number of people receiving very little education. Its literacy rate of 61 percent compares unfavorably with that of Singapore (92.5 percent), Taiwan (96.1 percent), and Estonia (99.8 percent). All of this raises a question: Since only a small, elite segment of the Indian and Chinese populations can legitimately compete with U.S. and E.U. workers, does population size really matter in offshoring comparisons when assessing a smaller location like Taiwan? Probably not.

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