I knew you had more than a passing interest in outsourcing. Maybe you can come up with a solution for the problem outsourcing companies in India are facing. You may know that majority of the income for outsourcing companies comes from engineering of end [...]]]> A former colleague of mine wrote me the other day:

I knew you had more than a passing interest in outsourcing. Maybe you can come up with a solution for the problem outsourcing companies in India are facing. You may know that majority of the income for outsourcing companies comes from engineering of end of life products (products that are deployed and are in sustenance mode). While overall income from these products has grown, margins have been rapidly going down even before the recession. Outsourcing companies are also scared that if and when we come out of recession SaaS [software as a service, or hosted solutions] and cloud computing will have a huge impact on the topline of outsourcing companies in the wrong direction. Your thoughts…

First, I think margins will continue to decrease for multiple reasons:

• Water seeks its own level, so to speak. As the US transfers money to India, for example, by paying for offshore work there, the basic laws of economics dictate that the value of work there will go up relative to here. Workers will get paid more, the Indian economy will do better (the rupee rising against the dollar), and so on. So it will be more expensive to do work in India next year than it was last year.
• As India gets more expensive, and as other countries do a “”hey, we can do what they’re doing,”" India will have more competition, at least in some areas. There are lots of English speakers in the Philippines, for example; I used to outsource work there a decade ago, and they still have a price advantage. India for now has a skills advantage, but given sufficient price differential, and that will vanish. There’s also a “”nexus”" advantage in that groups of workers congregate and are easy to reach, and they share skills. Both can be overcome with money.
• China is entering the market. There are enough people who read English well enough in China to do outstanding technical work from American documents. There’s still a price advantage in China.

There are other difficulties and issues:

• China also has a time-zone advantage. India is half a clock cycle away (actually, 12.5 hours) from the West Coast. It’s super-hard to get a team meeting to happen, because if it’s 9AM here, it’s near-bedtime there, and vice versa. You can get individuals to connect, but it’s hard to get two full teams on line at the same time. China is 8 hours away from here, which gives a lot more overlap. (It’s 11 hours from the East Coast, though.)
• It slows up work when there is an overnight cycle. You can do only one communications cycle a day with India, and it’s pretty much the same with China. We send something at the end of our day, they work on it while we’re with families and asleep, and we get it back as they go to bed. That’s slow.
• Brazil and Argentina are entering the game. Same time zone, give or take, which is an advantage for collaboration.
• The overhead is significant when dealing with India. There are flights, and time lost to travel. There’s the overnight/full-day-cycle issue. There are general communication difficulties; it’s hard enough for two Americans to communicate and transfer full meaning; it’s a lot harder when there are fewer cultural referents. (That said, India is culturally closer to the US than China or Brazil because of the long history of the British in India.)

I had mixed luck with sending work to India. One project went well, but it had an effective leader (the colleague who wrote me the note above). Two others went poorly, with lots of rework; they ended up costing more — and taking longer — than it would have had I sent them to Bozeman or Bangor rather than Bengaloora (Bangalore). The upshot is that if I looked at costs all up, including transactional friction and opportunity costs, I’m n0t sure I’d find India economical for technical work at this time. That can only get worse with SaaS and the cloud, where much of the work will need to be in the same sort of timezone as the customers. Should the US emerge from the recession before India does, there’ll still be some price arbitrage… but I’d bet the recession will end in Manhattan, NY before it does in Manhattan, Kansas, and so there’ll be price arbitrage opportunities to “”offshore”" to the US and Canada. Bozeman and Manhattan (Kansas) are also offshore. They’re not within 200 miles of an ocean.

Also, the perceived — and possibly quite real — need to do rapid turns (revisions) on cloud-based work argues against an India or China solution. There’ll still be work going there, but it may not continue to grow — and it may well be lower-margin work.

There is, however, another area where the price differential remain enormous — the legal world. Legal Process Outsourcing (LPO) will utilize India and other nations for some time to come… but again for low-margin work.

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There is one critical assumption implicit in all this. I’ve avoided it until now.

That assumption is that the US will continue to be the center of both technological advancement and the source of work such as LPO. Given our litigious society, the latter seems reasonable. But I’m not confident the US will remain the unchallenged “”big dog”" of technological innovation.

China is a scary (from a US-centric viewpoint) rival. India is too. Will the next Microsoft or Google emerge from an “”emerging”" nation? Maybe, if you’re talking about a business. However, will the innovations that drive this mythical company come from outside the US? That’s much more likely than it was ten years ago.

Ten years ago, that was unthinkable. Now, it’s very thinkable.

And therein lies the key to the question raised at the start. India will grow stronger to the extent that it become the technology innovator. Same goes for China.

Think I’m smoking something? Consider: There are a handful of very cool phones at the moment. The iPhone is a US idea, but both the Touch and the Google Nexus come from China. (HTC created both.)

Innovation is the high-margin business. Insight, courage, education, a bit of capital. Used to be, the West was a sole-source supplier of the last two. Today, not so much… and with education, seriously not so much. The opportunity is out there….