Maintaining a 25% profit margin in this crazy world of globalization

June 21, 2007 | Phil Fersht

The recent discussion between BusinessWeek's Steve Hamm and Tata Consultancy Services' (TCS) CFO S. Mahalingham reveals some fascinating insight into how TCS has managed to maintain profit margins at the 25% level, despite intense pressures from wage inflation, employee attrition, aggressive competition and rupee appreciation against the dollar and other leading currencies.  Some key thoughts I took away from the dialog:

  • Creating an environment for staff to develop their soft skills, technical expertise, and global experience is the answer to improving employee retention.  S. Mahalingham explains "There are points when a person decides to make a choice, perhaps in the first two to three years. They are look at their career aspirations and they might leave the company. But if we can cross that hump, and go beyond that period to say seven or eight years, we do find that people want to stay with the organization. At that point, if they do leave, they will become an executive in another organization".  From my experiences working with suppliers, the key issue for them is employee retention in offshore locations.  Some suppliers prefer to hire experienced staff, who are likely to be more settled and less likely to jump ship in a year or two - which has the drawback of higher wage costs; other suppliers - especially the ambitious offshore providers headquartered in India - prefer to hire college graduates and work on intensive programs to retain them through the early years of their career to a stage where they will be more likely to stay with their employer as a settled manager-level employee when they mature.  It is plainly apparent that the more successful offshore providers are those which have developed successful training programs for their new hires, in order to keep their wage costs at a minimum through lower attrition.  Moreover, an experienced outsourcing provider employee who has three years plus experience working with their firm will have far higher productivity than a brand new employee - due to the simple fact they are familiar with their company's and clients' processes.  S. Mahalingham also points out that college graduates in India are not only looking for technical or process training, they also understand the need to develop their soft skills (business development, relationship-building etc) and get global experience.  This indicates to me that the established large Indian outsourcing providers are far more attractive places to work than the smaller Indian firms seeking to increase their market share, as they can offer the best graduates the environment they need to develop.  This also means that the established firms also have a better handle on keeping their employees' wages in check (but rupee appreciation is another issue out of their control...).  Hence, we probably have our established Indian offshore giants for the next couple of decades now... I cannot see many of the smaller vendors on the sub-continent finding room to grow and compete when you analyze the tough competitive climate nowadays.  The next wave of offshore mammoths are more likely to spring from the Philippines and China, as they become more experienced in providing global outsourcing services.
  • Multiple technical environments, servicing multiple languages underpinned by low cost offshore labor is the key to keeping margins high.  Steve Hamm points out:  “Over the past few years, Indian companies have become more like Western companies and Western companies are becoming more like the Indian companies.”  The lines between what constitutes and "Indian" versus "Western" company are blurred:  they are all "Global" firms now, with delivery infrastructures that often resemble each other.  The key advantage the Indian firms hold is that they are scaling outward from their Indian bases, with sound understanding of the next locations where they need to establish themselves (Latin America, China, Eastern Europe etc).  Hence, they are in a great position to keep a lid on their costs, whereas the Western suppliers have been forced to re-engineer their entire global delivery infrastructures in recent years to move away from high-cost locales and establish themselves in offshore territories, which comes with many new challenges and costs.   As these two sets of outsourcing supplier continue to become closer in infrastructure, the profit margins will eventually become more comparable, but for the medium-term, the Indian giants will continue to enjoy these high margins.  The wild card is clearly the rupee - if it appreciates out of control, this will clearly impact profits, but India's sheer scale is currently keeping that in check.

Posted in: IT Outsourcing / IT Services

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