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Rethinking the India Back Office; Some Western Firms Weigh Selling Their Units as Costs Rise, Dollar Weakens

Jackie Range. Wall Street Journal. (Eastern edition). New York, N.Y.: Feb 11, 2008. pg. A.6

New Delhi -- Many of India's back-office businesses -- the industry that propelled this nation onto the front lines of global commerce -- may soon be changing hands.

Some of the largest outsourcing units are still those belonging to Western companies, including Wall Street's biggest banks, which set them up here in recent years to take advantage of India's low-cost, educated labor force. Now, many of the big companies could soon be looking to get out of part or all of the business by selling either to Indian companies that specialize in outsourcing services, to private- equity firms or through initial public offerings.

The reason: The costs for big companies of having their own Indian units are rising sharply -- India's skilled-labor wages are shooting up -- and many, particularly financial-service companies, are looking to cut their overhead as the U.S. economy slows and the credit crunch takes its toll. The dollar's weakness, which makes doing business in India comparatively more expensive, is another incentive for Western companies to leave the sector.

Moreover, a study by consultants McKinsey & Co. and Nasscom, the Indian tech and outsourcing industry group, found that, on average, company back offices -- or "captives," as they are referred to in the tech and outsourcing industry -- were less efficient than companies run by outsourcing firms that specialize in the business. For some types of back-office work, captives' costs are 30% higher. The survey found that the higher costs didn't lead to lower staff turnover or better-quality work.

The scale of many of these individual deals is expected to be small, mostly in the range of $50 million to $100 million. But together they could total sizable numbers at a time when deals elsewhere are expected to become scarce because of the economic slowdown in the U.S. and elsewhere.

"As U.S. companies come under pressure, in a recessionary environment, I think this will be a good way to cut their costs -- and also get some money," said Amitabh Chaudry, CEO of Infosys Technologies Ltd.'s fully owned business-process outsourcing arm, Infosys BPO Ltd.

India's tech and business-process outsourcing industry is growing fast and has been a big factor in boosting economic development here. Nasscom says sales for the industry totaled more than $47.8 billion in the year to March 31, 2007, up almost 10 times over the past decade. The Indian tech sector was 5.4% of the nation's gross domestic product in fiscal 2007, up from 1.2% in fiscal 1998.

Four or five years ago, setting up a unit in India made sense: Shift the accounts, tech department or customer-care center to India and cut costs by 45%. Many American and European companies rushed to do it. Swiss bank UBS AG has a back office employing about 2,000 in tech hub Hyderabad. Goldman Sachs Group Inc., J.P. Morgan Chase & Co. and HSBC Holdings PLC have their own, too.

For some companies, such offices have now become a headache. Once the initial benefit was felt, companies found it hard to keep on top of their costs. Salaries and the cost of office space jumped. Staff turnover has been high, and companies are having to spend on headhunting fees and training.

India, however, remains a low-cost destination that offers a large quantity of people with the often-special skills required to make such businesses work, says Pankaj Kapoor, an analyst at ABN Amro Asia Equities in Mumbai. Although costs have risen, they remain substantially lower than in the U.S. or Europe. While some companies have begun to move their back-office operations to lower-cost countries such as Vietnam, Mr. Kapoor says he thinks many -- particularly the more complex back-office functions -- will remain in India. But at the same time, Western companies are still likely to look for ways of getting those functions off their balance sheets, he adds.

Not all back-office operations are suitable for sale or for operation by another company. Functions that are very central to a business or are too sensitive to be outsourced are likely to stay owned by the parent company, says Viju George, an analyst at Edelweiss Securities, a financial-services firm in Mumbai. Companies that market themselves as having an India presence, often as a low-cost benefit to clients, are also unlikely to sell, Mr. George says.

But already, sales are happening. Genpact Ltd., a business-process outsourcing concern, was spun out of General Electric Co. and listed on the New York Stock Exchange in August. GE and private-equity concerns General Atlantic LLC and Oak Hill Capital Partners remain big shareholders.

Travelport Group, a U.K. travel-services company that is owned by private-equity concern Blackstone Group LP, in December sold Travelport ISO, its Indian back-office operation, to Mumbai-based Intelenet Global Services Pvt. Ltd., a company 80%-owned by Blackstone. At the same time, Intelenet unveiled a deal to buy Upstream, an international outsourcing company, from its major shareholders based in Fargo, N.D. Together, the deals were valued at $75 million.

Back offices also have changed hands as part of bigger outsourcing deals. As part of a $250 million outsourcing contract last July, Infosys bought three back offices in India, Thailand and Poland from its client Philips Electronics NV of Amsterdam for $28 million.

Citigroup Inc. has eyed a sale of its Indian back-office unit, Citigroup Global Services Ltd., people familiar with the matter say. Citigroup declined to comment. And United Kingdom insurance giant Aviva PLC said a strategic review of its Indian offshore business, Aviva Global Shared Services Pvt. Ltd., had come to the early conclusion that partnership, in a variety of forms, could be a better alternative to its current back-office set up. Aviva is now in talks with "a very small number of parties before reaching a final conclusion," the company said in a statement.

Comments

I found this article interesting in light of our discussion on outsourcing. Of particular interest is the fact that Indian business units (IT, call centers, etc) that were set up 5 years ago are now becoming a headache for U.S. corporation, who have seen their salaries and office costs soar. It looks like the new trend will be toward outsourcing the already-offshored business units that were set up when offshoring first became a craze for U.S. and European companies.

I think the article demonstrates the positive influence of outsourcing on the Indian economy and workers, who are now able to demand higher salaries and better conditions as a result of the demand for their services. It also goes to show that outsourcing, when it is not a core competency of a firm, can turn into more of a headache than the cost savings are worth.