Dr. Alok Aggarwal
Since its inception in early 2001, the knowledge process outsourcing (KPO) industry has grown at a steady pace. India has been the preferred outsourcing destination for KPO services where the industry grew from USD 0.26 billion in 2000–01 to USD 3.05 billion in 2006–07. Further, the Indian KPO industry is expected to reach approximately USD 11.2 billion by 2010-11, growing at a CAGR of 38.4 percent.
The initial drivers for the outsourcing of knowledge-based services to India or other regions have been cost arbitrage and the availability of large talent pool. These advantages allow the buyers of KPO services to maintain cost competitiveness and improve time-to-market. However, the recent appreciation of Indian rupee vis-à-vis the US dollar (10.8 percent in 2007 alone) and the wage inflation in India (14–15 percent over the past couple of years) have created skepticism on India’s cost arbitrage going forward, and thereby, its competitive advantage as a preferred KPO location in the coming years. Evalueserve analysis suggests that India’s wage arbitrage is quite attractive and is likely to remain so (equal to or greater than 50 percent) over the next 10–15 years, despite the looming concerns of wage inflation and rupee appreciation. Further, the analysis suggests that the absolute salary differential (difference between the average US salary and average KPO salary in India) will actually increase from USD 48,875 in 2007 to USD 51,421 in 2020.
Additionally, although cost advantages will continue to be an important driver for KPO offshoring, the dynamics of the KPO industry are already moving beyond cost arbitrage to more strategic elements, such as value creation and time -to-market ability as enterprises face challenges to acquire talent and manage knowledge. Success for KPO service providers will, therefore, depend on their ability to provide their clients with expertise required in various elements of research and a global knowledge services platform that enables the latter to achieve scalability.
Knowledge Process Outsourcing (KPO) refers to the outsourcing of high-end complex tasks to specialized service providers. This was a natural outcome of the need of outsourcing service providers to provide differentiated, higher- end services which would enable them to sustain profit margins and engage the clients at a more strategic level. The availability of a large, technically well-qualified and cheap labor pool helped the business case for outsourcing of
such activities and functions to offshore locations.
To remain competitive in the market, global enterprises realized the need to cut costs and reduce the time-to-market.
Outsourcing of high-end knowledge services, such as R&D, corporate strategy, and product development, allowed enterprises to meet these challenges effectively. Moreover, due to an incumbent shortage of highly skilled knowledge professionals in the developed nations, enterprises were seeking alternative mechanisms to tap into the global talent pool. The availability of skilled labor in countries such as India (that has been increasing at a steady pace),
positioned these countries to cater to the KPO requirements of enterprises in the developed economies.
Through the late 1990s, several large corporates, such as GE and AMEX, set up operations in India to provide such higher-end services. However, the KPO industry in India gained visibility and momentum in early 2000 with the emergence of third-party KPO providers, such as Evalueserve and Amba Research. Since then, India has been the preferred destination for KPO services, primarily due to lower costs and the ready availability of a large talent pool.
Over the years, new destinations, such as China, the Philippines, Sri Lanka, and Eastern Europe, are also emerging as potential destinations for knowledge process outsourcing. Most of these potential destinations offer a similar or higher cost structure as compared to India; the real value for a buyer of KPO services from these destinations hinges on the talent pool available, their multi-lingual capabilities, and the proximity to the target markets being explored.
Till now, cost arbitrage and access to the global talent pool have been the two prominent drivers for the KPO industry.
However, in the future, the potential of scalability and access to a larger talent pool will play a more important role for any buyer of KPO services. According to estimates, India produced 583,000 engineers in 2006–07 (12 percent more than that in 2005–06)1, with an average starting salary of USD 11,000, while the US produced 75,113 engineers (decline of 1.6 percent over 2005–06)2, with an average starting salary of USD 45,000 (excluding direct benefits).
Similarly, the number of management graduates in India increased from 65,000 in 2002–03 to 90,000 in 2005–06 (growth of 38 percent), while that in the US increased from 127,685 to 146,406 (growth of 15 percent)3
The KPO industry has witnessed steady growth over the years as it grew from USD 0.26 billion in 2000–01 to USD 3.05 billion in 2006–07 (CAGR of 50.7 percent)4 . However, now it faces new challenges in the form of high wage inflation (as compared to that in the developed economies) and the appreciation of the Indian rupee (against the US dollar).
Over the last couple of years, the wage inflation in the Indian KPO sector has been in double digits (14–15 percent), and this trend is likely to continue over the next few years. The Indian rupee has also strengthened against the US dollar (10.8 percent in 2007), further reducing the wage arbitrage. In fact, most analysts are predicting further strengthening of the rupee, which will worsen the situation. The figure 1 below depicts the historical USD-INR exchange rate.
However, Evalueserve analysis suggests that despite the wage inflation and rupee appreciation, the wage arbitrage between India and the US is likely to remain attractive (equal to or greater than 50 percent) for enterprises in the US to consider knowledge-based outsourcing to India. In this analysis, it has been assumed that the salaries and costs associated with IT services outsourcing as a close proxy of the costs in the KPO industry. The personnel requirements and skill sets in the two industries are identical to a large extent, and therefore, are expected to follow a similar trend in pricing and cost structure. The analysis predicts that due to the cumulative impact of rupee appreciation against the US dollar and wage inflation in India, the percentage savings (salary differential/US salary) for enterprises in the US will decrease from 81.5 percent in 2007 to 55.5 percent in 2020. However, the analysis further suggests that the absolute wage differential between India and the US will actually increase from USD 48,875 (2007) to USD 51,421 (2020)—maintaining a healthy wage arbitrage situation. Figure 2 below represents the results of the analysis.
Looking beyond India: To gain economies of scale, acquire talent, and diversify risk, KPO service providers are already expanding their global footprint both in terms of client base and service delivery. As a result, they have already started looking beyond India to other offshoring destinations such as China, South America, Eastern Europe, etc.
Although India is likely to remain the hub of global KPO services, KPO firms will expand beyond India and set up centers in other offshoring locations, such as China, the Philippines, and Eastern Europe, to acquire talent and research capabilities. The expansion of service centers in new geographies will provide KPO firms with the economies of scale required to maintain growth in the industry. For example, leading KPO providers, such as Evalueserve and Amba, have already set up delivery centers in some of these potential destinations. Evalueserve has delivery centers in China and Chile, and is opening another delivery center in Romania. On similar lines, Amba
Research has set up delivery centers in Sri Lanka and Costa Rica. These locations provide not only a larger talent pool for the clients, but also enable the service provider to offer other capabilities including multi-lingual support, proximity to target markets, and hence on-ground local knowledge.
An important characteristic of the other offshoring destinations is that they offer similar, or at times higher, cost and pricing structures. From the experience of the leaders in the industry, the overall cost of delivery from destinations such as South America and Eastern Europe are significantly higher than that in India. However, despite the higher cost structure, the value offered by this expansion in terms of the capabilities and local knowledge has emerged as a
critical success factor for the buyers as well as providers of KPO services.
Looking beyond wage or labor arbitrage: Unlike the BPO market that is (and will be) largely governed by the cost arbitrage, the KPO industry has been driven by domain knowledge and value creation. Productivity improvements (through increased efficiency, increased utilization, reduction in average handling time) and quality improvements (through process and methodology refinement, increased accuracy of deliverables, improved understanding of client
perspective) have played a key role in the growth of the industry. A research conducted by The Everest Group, a leading outsourcing consultant, reveals that “value creation” through productivity and quality have emerged as more important success factors in the offshoring industry, with more than 50 percent of the buyers surveyed already realizing the value. The figure 3 below represents the results of the Everest research.
Ability to offer effective scalability and time-to-market solutions: KPO services are gaining strategic value as they are offering effective scalability and time-to-market solutions. The talent arbitrage provided by the KPO vendors provides both cost and scale arbitrage for the clients. The scale advantage, in fact, becomes critical to the overall success of the client’s business in many cases. Considering a situation where a large US bank plans to launch a new financial services product and plans to hire 40–50 chartered accountants (CAs) or financial risk management
professionals for product development, the lead time associated with the hiring process alone will run into several months. In contrast, a KPO provider can assemble a team of 40 CAs within a couple of months, thereby shortening the overall time-to-market from over a year to a few months. Similar examples from other functions, such as R&D, corporate strategy, and sales and marketing emphasize the “value creation” through leveraging an appropriate talent pool offered by KPO service providers.
As the buyers as well as the providers of KPO services mature, the key criteria for judging the “value” is increasingly shifting toward “enablement” and leveraging various ways in which knowledge and specialized services can help the clients do business more effectively and efficiently. KPO services provide tremendous value in business as well as technical situations—in areas, such as marketing and product development, corporate finance, and corporate strategy, across industry verticals. This leads the way for the KPO services to become an integral part of the
business dynamics of the client, providing a host of other benefits in addition to cost savings, and an extended production cycle in many cases.
Blog Written by
CEO, Chief Data Scientist at Scry AI
Author of the book The Fourth Industrial Revolution
and 100 Years of AI (1950-2050)
