Is Wage Inflation Killing the Cost Advantage of Offshore Development ?

Posted by Kevin Brady on Wed 10th September 2008 at 02:05 PM, Filed in Industry News

As everyone knows I have a number of concerns about the current Outsourcing trend gathering pace at this present time.  My blogg post “Is Offshoring Worthwhile” summarises some of my views. I suggest anyone who is interested in initiating a major offshore IT project or programme should read this post and more importantly read the comments sections which show some focused debate on this subject by people clearly working for offshore suppliers. 

Some two years ago there was a lull in the demand for offshore software development as the limitations or side effects of running offshore projects /programmes became more apparent. However, the drive for cost reductions in the face of the “credit crunch” and the effect of short term corporate memories has meant the demand for offshore software development has really taken off again in the past year. On the supply side of the offshore equation suppliers have also tried to revive demand through risk reduction by offering better and cheaper communications technologies and the devising of offshore models /methodologies (what suppliers like to term their secret sauce) which promise effective low cost /high quality delivery. In fact during a recent conversation with a board director of one of the top 5 Indian outsourcers I was surprised to be told that the belief in these new changes is so strong that I was told that “Indian Software Development is no longer a cost saving decision but a preference for Quality IT development”.

Todd Olson, president of 6th Sense Analytics, which tracks offshoring performance, says that companies still are have trouble with language and communication problems with dealing with overseas workers. Managing large time differences can also waste time and resources as a foreign staff can be delayed for hours awaiting instruction from far away bosses. Moreover, turnover can be painfully high as competition for talent is intense and employees do not hesitate to leave for a better deal when they get some experience. This is manifesting itself in an annual Indian Offshore Resource inflation rate of +10%. 

Because of such difficulties, some companies have started to back out of existing outsourcing arrangements and have sought wage compromises at home that have allowed many office functions and new software development programmes /projects to be brought back to the States. However, such deals are very much special situations compared to the tidal wave of interest in software development outsourcing.

In my view it won’t be long before the cost differential between IT development resource in countries such as India starts to equal the cost of domestically sourced labour. Leading research from Hackett Group that if India’s inflation holds steady at 12 percent and U.S. inflation remains constant at 4 percent, it would take until 2021 for labour costs to be equal in the two countries. Long before this date IT project /programme offshoring would surely no longer be an appealing opportunity due to the “hidden” costs /risks of running offshore projects /programmes. May be offshore tidal wave of interest in offshore development is close to reaching it peak before a more general retrenchment takes place.

Indian offshore outsourcers are aware of these facts and are buying up UK and US companies at an accelerating rate so that when the gravy train slows they will have a new onshore business presence with a less cost differential based stake in the developing world’s economy.
If you’re a business thinking of making a major offshore software development decision you need to really think carefully and take a full 360 degree assessment of the risks /issues and short to medium term cost benefits before making signing up wink

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