is the arbitrage of your offshore locations sustainable?

Is the Arbitrage of Your Offshore Locations Sustainable?October 18, 2011

Today’s Webinar is brought to you by Everest Group

Today’s Webinar

Is the Arbitrage of Your Offshore Locations Sustainable?

Synopsis:Increasing cost pressures in leading offshore markets are driving companies to question the sustainability of the offshore proposition. Additionally, fluctuating currencies pose challenges to the predictability of arbitrage in many locations. In this webinar, Everest Group experts will answer the following questions:

About Everest Group

How sustainable are offshore locations? Are there real risks of arbitrage eroding? What implications are companies facing in setting their global services strategies?

About Everest Group

Everest Group is an advisor to business leaders on the next generation of global services with a worldwide reputation for helping Global 1000 firms dramatically improve their performance by optimizing their back- and middle-office business services. With a fact-based approach driving outcomes, Everest Group counsels organizations with complex challenges related to the use and delivery of global services in their pursuits to balance short-term needs p g y g pwith long-term goals. Through its practical consulting, original research and industry resource services, Everest Group helps clients maximize value from delivery strategies, talent and sourcing models, technologies and management approaches. Established in 1991, Everest Group serves users of global services, providers of services, country organizations and private equity firms, in six continents across all industry categories. For more information, please visit www.everestgrp.com and research.everestgrp.com.

Proprietary & Confidential. © 2011, Everest Global, Inc. 2

please visit www.everestgrp.com and research.everestgrp.com.For more information, contact Mark Williamson at [email protected]

Q&A

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Introductions

Eric SimonsonManaging Partner, ResearchEverest [email protected]

H. KarthikVice PresidentEverest Grouph k thik@ [email protected]


Agenda for today’s webinar

Sustainability of offshore locations– Introduction– Arbitrage sustainability– Talent sustainability

Implications for global services strategies Implications for global services strategies


Global companies have built significant offshore workforce and leverage multiple locations

Total offshore scale2011; Thousand FTEs

Number of offshore locations leveraged (#)Regions1 Countries Cities2

33-34

30-31

UK Bank

U S Bank

Substantial (10-25%) proportion of global workforce already

3

3

9

4

21

830-31

15-16

U.S. Bank

Global energy company

offshore

Most companies plan to further increase scale and scope of

3

3

4

3 4

9-10

6-7

U.S. financial services firm

Global technology

scale and scope of offshoring

Increasing complexity of

2

3

4

4

4

46-7

4-5

firm

Global investment bank

managing global sourcing; need to take a “portfolio” view

3

2

4

3

4

3


1 Four offshore regions considered: Asia, Latin America, Central & Eastern Europe, Africa & Middle East 2 Only includes cities with captive operations

Companies are concerned about the sustainability of their offshore locations

Key concerns Impact areas

InflationInflation

Currency movementsCurrency movements

Arbitrage sustainabilityArbitrage sustainability

Focus of d ’Currency movementsCurrency movements

Market saturationMarket saturation Talent sustainabilityTalent sustainability

today’s discussion

Market saturationMarket saturation

Geopolitical stability Geopolitical stability

yy

p yand natural hazards

p yand natural hazards Location diversification and

business continuity planningLocation diversification and business continuity planning

Concentration risksConcentration risks


How to answer the polling question…

1. Recall your starting salary The first year you started work

( f

1. Recall your starting salary The first year you started work

( f

3. Calculate the ratio of the 5th year to the 1st year of salary

/ (

3. Calculate the ratio of the 5th year to the 1st year of salary

/ (

2. Recall the amount of your salary th

2. Recall the amount of your salary th

The annualized amount (if you were to work a full 12 months)

The annualized amount (if you were to work a full 12 months)

Ratio = Year 5/Year 1 (divide year 5 amount by year 1 amount)

Example– Year 1 (1990) = 20,000

Y 5 (1994) 30 000

Ratio = Year 5/Year 1 (divide year 5 amount by year 1 amount)

Example– Year 1 (1990) = 20,000

Y 5 (1994) 30 000in your 5th year of work Simply add 4 to the year in which

you started work (1990+4 = 1994) This is your fifth salary

in your 5th year of work Simply add 4 to the year in which

you started work (1990+4 = 1994) This is your fifth salary

– Year 5 (1994) = 30,000– Ratio = 30,000/20,000 = 1.5

Select the closest amount to answer the polling question

– Year 5 (1994) = 30,000– Ratio = 30,000/20,000 = 1.5

Select the closest amount to answer the polling question

1990 (year 1) 1991 (year 2) 1992 (year 3) 1993 (year 4) 1994 (year 5)

Example

1990 (year 1) 1991 (year 2) 1992 (year 3) 1993 (year 4) 1994 (year 5)20,000 22,500 25,000 27,500 30,000


If your salary changed currencies, please don’t answer the poll!

Poll Question: What is the approximate ratio of your year five salary to your starting salary (beginning of career)?

4%

7%

1.00

1 25 7%

16%

14%

1.25

1.50

1.75 14%

9%

14%

1.75

2.00

2.25

37%2.50


Source: Live polling conducted during the “Is the Arbitrage of Your Offshore Locations Sustainable?” webinar on October 18, 2011

What does the ratio imply for your average annual increase in compensation?

RatioAnnual % increase in salary over 5 yearsy y

1.00 0%

1.25 5.7%

1.50 10.7%

1.75 15.0%

Typical band for lower levels of offshore pyramid

Typical band for lower levels of offshore pyramid

2.00 18.9%

2.25 22.5%

2.50 25.7%

What portion of increase is role progression and what is inflation?


What portion of increase is role progression and what is inflation?

Agenda




Commonly perceived myths on arbitrage sustainability

Myth

W i fl ti i th d i t d iW i fl ti i th d i t d i C i t i ll th d i t d iC i t i ll th d i t d i

Reality

11Wage inflation is the predominant driver of arbitrage erosionWage inflation is the predominant driver of arbitrage erosion

Currency is typically the predominant driver of arbitrage movements and is often the “wild card”

Currency is typically the predominant driver of arbitrage movements and is often the “wild card”

Wage increases directly correspond to an increase in overall people costsWage increases directly correspond to an increase in overall people costs

Overall people costs typically increase at a lower rate due to multiple efficiency leversOverall people costs typically increase at a lower rate due to multiple efficiency levers

22

India’s arbitrage could erode soon (over the next 5 years)India’s arbitrage could erode soon (over the next 5 years)

India’s arbitrage is likely to last at least 12-13 years, even under highly pessimistic scenarios

India’s arbitrage is likely to last at least 12-13 years, even under highly pessimistic scenarios

33

scenariosscenarios

Locations beyond India have stable costs and are therefore becoming more costLocations beyond India have stable costs and are therefore becoming more cost

Costs increasing in multiple locations; India retaining comparative cost positionCosts increasing in multiple locations; India retaining comparative cost position

44


and are therefore becoming more cost competitiveand are therefore becoming more cost competitive

retaining comparative cost positionretaining comparative cost position

1Myth: Inflation is the single biggest driver of arbitrage erosion

Change in annual operating cost per FTE over 2007-11Indexed: Base = 2007 operating cost

Currency depreciation offset the impact of high

ITO: ARGENTINA EXAMPLE

100 28 30 98

offset the impact of high wage inflation

2007 costs Inflation (wages and others) Currency depreciation 2011 costs

Percentage of total operating

Average annual inflation (CAGRElements of

Trends in ARS/USD

WagesWages60-65%

total operating cost

inflation (CAGR over 2007-11)

10-12%1

Overall

Elements of operating cost

0.2

0.3

0.4Ratio

Real estateReal estate

Telecom and othersTelecom and others

10-15%

20-25%

2-3%

Largely stable

operating cost inflation: 6-7%

0.0

0.1

2007 2011

Steadily depreciating as a result of government policy


1 Average wage inflation over five years; recent wage inflation is higher (15-18%)

2Myth: Wage increases directly correspond to an increase in overall people costs (page 1 of 2)

ITO: INDIA EXAMPLE

Wage increasesEmployee pyramid

Annual compensation increases for

i di id l (2011) Wage increases significantly correspond to an individual’s career progression (e.g., gain experience within their role)

7-9%

individuals (2011)

Manager and

above

Weighted

role)

For the same role and experience level, salaries have remained largely stable in India (e.g.,

Team leader 8-10%

increase in wages: 9-10%

entry-level salaries for college hires)

Also, wage increases are typically lower at senior levels Therefore the

Senior programmer 12-14%

levels. Therefore, the overall impact on costs is lower than what is typically perceived/highlighted

Junior programmer 14-16%


Myth: Wage increases directly correspond to an increase in overall people costs (page 2 of 2)

2

Increase resource utilization

Efficiency levers used by companies

Increase entry level

mix in overall

pyramid

Reduce general and

admin expenses pyramid

Leverage l tlower cost locations

(e.g., Tier-2 cities)


Reality: Impact of inflation can be controlled through multiple efficiency levers

Myth: India’s arbitrage could erode soon (page 1 of 2)

3

Historical trends Scenarios used to assess future trendsFactors affecting arbitrage

Wage inflationWage inflation

Optimistic

9-10%

Base case Pessimistic

8-9% 9-10% 11-12%

Fluctuating, with depreciation of 2-3% p.a. over the past five yearsCurrency

movementsCurrency movements

Remains stable

Appreciates at 1% p.a.

Appreciates at 2% p.a.

Trends in INR/USD Scenario based approach used to assess

0.03

Trends in INR/USDRatio

Scenario-based approach used to assess arbitrage sustainability

Although the Indian rupee has depreciated (by 2-3% p.a.) over the past five years, forward-looking scenarios assume appreciating

0 01

0.02

g pp gcurrency, consistent with long-term views on India’s economy and currency


0.012007 2008 2009 2010 2011

Myth: India’s arbitrage could erode soon (page 2 of 2)

3

US$

Number of years for arbitrage sustainability ITO SERVICES

Hurdle rate1

US Tier 1 city

US$

Pessimistic scenario

Base case scenario

Optimistic scenario

Hurdle rate1

@ 70%

India Tier 1 city

15-17 years

12-13 years

Time23-24 years

2011

Reality: India’s arbitrage likely to last 12-13 years even under pessimistic scenarios


1 Hurdle rate refers to the maximum wage ratio of the destination/source country, which still allows for meaningful offshoring. Hurdle rate is estimated as approximately 70%

Poll Question: Which scenario do you think is most likely?

45%Pessimistic

39%Base case

12%Optimistic

2%Don't know


Source: Live polling conducted during the “Is the Arbitrage of Your Offshore Locations Sustainable?” webinar on October 18, 2011

4Myth: Locations other than India have stable costs and have become more competitive (page 1 of 2)

Wage inflation (CAGR over 2007-11)Percentage

8-10% 8-10%

ITO SERVICES

8 10% 8 10%

5-7%4-6%

3-4% Most locations (except

Philippines) have

India Philippines Malaysia Brazil Poland

Currency trends over 2007-11Local currency/USD indexed to 2007

Philippines) have witnessed lower inflation than India

However, currency movements in multiple xx% Net change in currency over 2007-11 pcountries have been less favorable compared to India

Consequently, India’s

+19%+13%

+7%

Appreciating currency: Increases costs in USD

PhilippinesMalaysiaBrazil

relative overall cost position has not changed significantlyIndia

Depreciating currency: Decreases costs in USD

7%

-4%-10%

Poland

Philippines


2007 2008 2009 2010 2011

4Myth: Locations other than India have stable costs and have become more competitive (page 2 of 2)

Annual operating costs per FTE per annum2011; Index: India = 100

300 320

ITO SERVICESxx% Arbitrage relative to U.S.

Tier-1 city (Chicago)

300-320

100115-120

170-175 175-180

India (Bangalore) Philippines (Metro Malaysia (Kuala Poland (Krakow) Brazil (Sao Paulo)India (Bangalore) Philippines (Metro Manila)

Malaysia (Kuala Lumpur)

Poland (Krakow) Brazil (Sao Paulo)

80-85% 42-47%67-71%75-80% 69-72%


Reality: India has retained its cost position relative to other locations

Agenda




Talent sustainability is influenced by multiple external and internal factors

Growth plans Growth in h

External factors

Quality of talent pool

Growth plans of competitors other

industries

Talent development

initiatives

Talent pool sustainability

Scale of talent pool Migrationyp

Talent and operating

model

Skills and quality

required


Internal factors

Alternative talent models can help companies cope with market saturation challenges

Annual demand and supply at entry levelNumber

KRAKOW – VOICE BPO

10,000-12,000

~20 times

3,000-4,0002,500-3,000

4,000-5,0006-7 times

500-600

Industry demand at l l

Supply of employable i d

Supply of employable d d

Employable pool from dj i i

Total employable poolentry-level tertiary graduates undergraduates adjoining areas

Exploring alternative talent pools (e.g., undergraduates, part-time students) can create more room for growth This requires a different operating model (e.g., hiring, training) to implement and scale


q p g ( g , g, g) p

Companies need to view talent sustainability in context of their specific functional/skill needs

Total annual graduate pool and annual relevant pools for F&A and IT

KUALA LUMPUR

for F&A and IT2011; thousands

31-32

Ratio of annual supply1 to demand2 – IT

3

9-10 8-9 1

2

Total tertiary graduates

Graduates relevant for F&A

Graduates relevant for IT 0

2011 2012 2013 2014 2015

Sizeable overall graduate pool, but smaller for specialized functions

Potential challenges with sustainability of IT services in Kuala Lumpur, given small pool and players’ growth plans

1 Supply is defined as the number of relevant employable tertiary graduates every year willing to work in the sector


1 Supply is defined as the number of relevant, employable tertiary graduates every year, willing to work in the sector2 Demand is defined as the total demand for professionals at the entry-level (<3 years of experience) from offshore industry (expansion of existing players

and setup of new centers)

Agenda

Sustainability of offshore locations

Implications for global services strategy


Global services strategies should reflect supply and demand factors that influence sustainability

Supply factorsSupply factors

Leverage locations that are able to attract in-bound talent to offset saturation effects (i.e., talent can and will move to the location from surrounding areas)surrounding areas)

Proactively plan for and manage impact of career progression/tenure in the delivery model – be realistic about what happens in 3-5 years (and when is attrition a good thing)Use sourcing models to intentionally provide options for re balancing work Use sourcing models to intentionally provide options for re-balancing work to new markets

Demand factorsDemand factors

Restructure nature of work to broaden the skill sets which can complete much of the work– Redefine the process– Isolate scarce skill activities from commodity skill activitiesy

Proactively shape demand for locations and sourcing models– Use an integrated view of locations to place work– Use historical trend information and potential future scenarios to

educate business on implications


p

Best practices for helping your organization deal with sustainability questions

Fully own the fact that headlines will impact management perceptions– Be prepared and proactive about education

Help organization understand what changes create the greatest impact on total cost (e g– Help organization understand what changes create the greatest impact on total cost (e.g., currency, labor rate, career progression, real estate, attrition)

Track sustainabilityIndividual cost elements– Individual cost elements

– Impact on aggregate cost– Relative to onshore costs– Latent talent supply and demand in key locations

Put changes into context – provide historical view of how exchange rates and wage rates move

When exchange rates move ensure both the positive and negative impacts are appreciated; When exchange rates move, ensure both the positive and negative impacts are appreciated; avoid temptation to take credit for “savings” from exchange rate movements


Summary of key messages

Sustainability questions regarding offshore locations are typically around arbitrage and talent pool sustainability

Sustainability questions regarding offshore locations are typically around arbitrage and talent pool sustainabilityp y

Currency movements typically have a more significant impact on arbitrage than wage inflation

p y

Currency movements typically have a more significant impact on arbitrage than wage inflation

Contrary to perceptions regarding arbitrage potential from India– Arbitrage from India is likely to last for a significant period (15+ years)– India is currently retaining its comparative cost position

Contrary to perceptions regarding arbitrage potential from India– Arbitrage from India is likely to last for a significant period (15+ years)– India is currently retaining its comparative cost position

Talent sustainability is influenced by multiple external (i.e., location related) and internal factors (e.g., company-specific talent and operating models)

Talent sustainability is influenced by multiple external (i.e., location related) and internal factors (e.g., company-specific talent and operating models)

Companies need to take an integrated, “portfolio” view towards assessing sustainability. Global services strategies should reflect supply and demand factors that influence sustainability

Companies need to take an integrated, “portfolio” view towards assessing sustainability. Global services strategies should reflect supply and demand factors that influence sustainability


Q&A

Attendees will receive an email enabling them to download today’s webinar presentation as well as access a recorded audio version

Attendees will receive an email enabling them to download today’s webinar presentation as well as access a recorded audio version

For advice or research on offshore sustainability, please contact:– Eric Simonson, [email protected]– H. Karthik, [email protected]

For advice or research on offshore sustainability, please contact:– Eric Simonson, [email protected]– H. Karthik, [email protected]

For background information on Everest Group, please visit:– www.everestgrp.com– research.everestgrp.com

Thank you for attending today

For background information on Everest Group, please visit:– www.everestgrp.com– research.everestgrp.com

Thank you for attending today

To ask a question during the Q&A session

Click the question mark (Q&A) button located on the floating tool bar in the bottom right of your screen

To ask a question during the Q&A session

Click the question mark (Q&A) button located on the floating tool bar in the bottom right of your screen

Thank you for attending today Thank you for attending today








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About Everest Group

Everest Group is an advisor to business leaders on the next generation of global services with a worldwide reputation for helping Global 1000 firms dramatically improve their performance by optimizing their back- and middle-office business services. With a fact-based approach driving outcomes, Everest Group counsels organizations with complex challenges related to the use and delivery of global services in their pursuits to balance short-term needs with long-term goals Throughservices in their pursuits to balance short term needs with long term goals. Through its practical consulting, original research and industry resource services, Everest Group helps clients maximize value from delivery strategies, talent and sourcing models, technologies and management approaches. Established in 1991, Everest G f l b l i id f i t i tiGroup serves users of global services, providers of services, country organizations and private equity firms, in six continents across all industry categories. For more information, please visit www.everestgrp.com and research.everestgrp.com.


Everest Group leads clients from insight to action

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