Cost Competitiveness of Global In-house Centers (GICs)

2012 AN EVEREST GROUP REPORT

Cost Competitiveness of Global In-house
Centers (GICs)
Nikhil Rajpal, Partner
The Reality of Wage Inflation and the Salil Dani, Practice Director
Anurag Srivastava, Senior Analyst
Sustainability of Cost Arbitrage Copyright © 2012, Everest Global, Inc. All rights reserved.

research.everestgrp.com

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COST COmPETiTiVENESS Of GlObAl iN-hOUSE CENTERS (GiCS)

Foreword

GICs have played a crucial role in the growth and development of the global
services (i.e., outsourcing and offshoring) industry in India. Key to the success of
the outsourcing model has been the fact that GICs have been consistently able
to deliver significant cost savings as compared to source locations, enabling
them to drive home the value proposition of the model, associated benefits and
added capabilities.

NASSCOM and Everest Group conducted joint research to understand the
extent of cost savings achieved, levers for driving cost savings, and future
sustainability of the same. Research showed that GICs continued to deliver
40-70 percent cost savings even from a Total Cost of Ownership (TCO)
perspective that includes costs associated with setting up and management of
GIC operations, in addition to the operating costs. Wage inflation in India is
often touted as one of the drawbacks, but research shows that actual salary
bands have historically increased at a much lower rate than what headline
numbers suggest. Further, GICs have been able to contain the impact of wage
inflation by modifying the employee pyramid and using alternate talent pools.
Additionally, lower growth of non-wage operating costs has ensured further
moderation in overall cost inflation. Arbitrage-driven cost savings in India are
likely to sustain for 12-15 years.

A number of people and organizations have assisted in the preparation of this
study. In particular, we would like to thank the senior executives of the GIC
member organizations of NASSCOM who spared their valuable time to share
insights on the cost arbitrage scenario. Special thanks to Deena Harapanahalli
(Invesco), Aveek Mukherjee (Wells Fargo), Nitin Seth (Fidelity Worldwide
Investment), and Sriram Dhanyamraju (Dell) for their guidance in the project.

A special acknowledgement to the NASSCOM research team for their efforts
and contribution towards this report.

We trust you find this report useful, and we welcome your feedback and
comments.

research.everestgrp.com 2

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Executive Summary

Over 3,000 GiCs have been
Captives or Global In-house Centers (GICs) are an important component of the
established across the world. global services market. Initially set up in low-cost locations (particularly India),
for supporting technology and contact center operations in the 80s and 90s, the
model is now firmly established and continues to grow and diversify across
multiple dimensions. While India continues to be the leading GIC location,
adoption of the model has spread to newer regions such as the Philippines, East
Asia, Eastern Europe, Latin America, and, most recently, Africa. Trends on recent
set-ups also indicate adoption of the GIC model across a wide range of industry
verticals (e.g., manufacturing, healthcare) and functions (e.g., engineering
services / R&D).

GICs have largely delivered on their mandate of providing meaningful cost
GiCs have been delivering
40-70 percent savings from a savings and adding capability to the parent organizations. Our analysis
TCO perspective. indicates that the GIC model continues to deliver typically 45-75 percent
savings over source costs, on an operating cost comparison. These savings
continue to be significant (40-70 percent) even from a total cost of ownership
(TCO) perspective that includes costs associated with the setting up and
management of the GIC operation.

Cost inflation in GiCs ranges
Contrary to popular perception, wage inflation is not likely to wipe out GIC cost
between 7-8 percent after savings in the near term. Our experience with GICs in India indicates that the
factoring in real wage inflation impact of inflation on their wage bills is typically much lower than often
and increases in other cost perceived. This is because a large part of the individual increases that are often
elements. reported (12-18 percent per annum) are merit-based while the actual salary
bands only move upwards by 4-5 percent per annum. Further, the high pace of
growth and high attrition levels of many of these GICs allow them to pro-actively
manage the pyramid and keep their costs down by recruiting large numbers of
lower-cost, entry-level talent to back-fill promotees and job-leavers. As a result,
net wage inflation experienced by GICs is closer to 6-8 percent per annum.

Our analysis further indicates that arbitrage-driven cost savings in key offshore
india’s and the Philippines’ cost
arbitrage is likely to remain locations (India, the Philippines) are likely to sustain for 12-15 years. The above
sustainable for at least 12-15 is based on a relatively safe set of assumptions of macro-economic projections
years. that most experts agree on. In reality, the arbitrage may sustain for 17-20 years.
On the other hand, even the worst case scenario projects arbitrage sustainability
of 8-10 years. The above results are reported from a U.S. perspective but the
range is largely similar for other source geographies (i.e., UK, Continental
Europe, and Japan).

It is important to note that while the timeframe discussed above holds true for a
majority of the work offshored today, there will be meaningful exceptions. On
one hand, there will be locations (e.g., Brazil, Czech Republic, and Ireland), or
functions (e.g., technology research and development) where a combination of
smaller starting cost differential, shortage in talent or macro-economic trends
could erode the arbitrage faster. On the other hand, GICs have several


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operational levers at their disposal to further improve their cost position and
prolong the cost advantage.

Additionally, while direct cost savings will always be important, many mature
GICs realize that they can harness the platform they have built to deliver
significant business value to the parent organizations. These organizations have
started to make investments in their engagement and delivery models to
reorient towards this goal that will define the impact GICs have in the long
term.


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Background and Context

“ i keep hearing and reading
about 15-20 percent wage
inflation in india. i am not sure
Captives or GICs are an important component of the global services market.
GICs were initially set up in low-cost locations to support technology and
contact center operations in the 80s and 90s.
about how much increase in
wage bills i should build in our While GICs have largely delivered on their mandate of providing meaningful
plans for the india center… cost savings and adding capability to the parent organizations, questions
– Global Sourcing Head of a
“ continue to be asked around the actual impact of cost savings and their
large BFSI company sustainability. These are driven by multiple issues and concerns (e.g., cost
inflation, exchange rate fluctuations, and labor market uncertainties) facing
GICs and their parent entities.

In this context, Everest Group conducted a study of leading GICs in terms of
their cost competitiveness. This study is based on inputs and perspectives from
leading GICs, supplemented with Everest Group’s proprietary knowledge and
information base. This study covered the dimensions outlined below:
 State of the GIC model with growth and adoption trends
 GICs’ current cost savings – taking an operating cost and total cost of
ownership (TCO) view
 Sustainability of GICs’ cost savings and impact of wage inflation and
exchange rate fluctuations
 Additional operational levers available to GICs to further optimize costs

This report describes these aspects in detail with supporting examples and
illustrations, as relevant.


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The GIC Model is Established, Growing, and Continues to
Diversify across Multiple Dimensions

“ for quite some time, we have
been hearing noise around the
GiC model being dead… but
Initially set up in low cost locations, primarily for supporting technology and
contact center operations, the GIC model is now firmly established, with nearly
3,000-4,000 GICs of leading companies globally.
anywhere you look, you see
GiCs expanding in scale and GICs continue to grow across multiple dimensions. While India continues to be
responsibilities, new GiCs the leading location, recent years have also witnessed new set-ups in locations
getting set up, and rare such as the Philippines, East Asia, Central and Eastern Europe, Latin America,
instances of closures/sell-offs… and Africa (Exhibit 1).
– Head of India GIC, leading
“
global healthcare company

EXHIBIT 1 Number of set-ups of offshore GICs of leading global companies
2009-11; Number

Recent years have witnessed
GiCs in multiple locations
Central and
beyond india Eastern Europe 20
12 11
East Asia
2009 2010 2011 36
Middle East 22 26
Source: Everest Group
& Africa
13 9
2 India 2009 2010 2011
2009 2010 2011 22 20 24
Latin
America
7 4 5 2009 2010 2011

2009 2010 2011

In addition, adoption of the GIC model is spreading to “new” industry verticals
such as manufacturing, retail, and telecom. In terms of functions, new set-ups
indicate diversification of the model to support higher-order and/or niche
functions such as analytics and engineering services / R&D support.


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GICs in Offshore Locations Continue to Offer Significant
Cost Savings to Their Parents

Typical TCO savings of 40-70 percent over source costs

Operating cost analysis is often used to assess GICs’ current cost
competitiveness. However, this may not reflect the ownership costs of GICs
(such as costs of transitioning, governance, and knowledge transfer).

Everest Group leveraged its proprietary total cost of ownership (TCO)
framework to compare the cost of owning and operating a GIC to the parent
cost. The TCO framework undertakes a comprehensive assessment of all costs
and includes the following cost items:
 Operating costs include people costs as well as expenses related to facilities
and other miscellaneous items (e.g., telecom and equipment)
 Set-up and transition costs incurred in establishing the center and transfer of
processes from parent to GIC
 Ongoing governance costs incurred by the parent for managing the GIC
operations

Exhibit 2 below, illustrates the TCO analysis of IT Applications Development
and Maintenance (ADM) function for a GIC based in a typical tier-1 city in
India. It is noteworthy that people costs contribute towards 60-70 percent of the
operating cost and typically 45-55 percent of the TCO.

EXHIBIT 2 Total cost of ownership (TCO) for IT-ADM | U.S.-India IT-ADM
2012; US$ 000s per FTE per annum
35-40
Percent of
People costs contribute towards operating 60-70% 10-15% 7-10% 10-15% 100%
cost 25-30
60-70 percent of the operating
cost and typically 45-55 percent
of TCO
Cost People Facilities Technology Miscellaneous Total Setup and Governance Total cost
component costs operating cost transition of ownership
(TCO)
Source: interactions with GiCs; Other operating costs
Everest Group
Operating costs Other elements
of TCO

Our analysis indicates that the GIC model continues to deliver typically 45-75
percent savings over source costs, on an operating cost comparison. These
savings continue to be significant (40-70 percent) even from a TCO
perspective. Exhibit 3 below, depicts the cost comparison for a U.S.-based
parent and a GIC supporting transaction processing BPO function from a
typical tier-1 city in India. While most of the cost savings are on account of
labor arbitrage, GICs also provide meaningful savings on facilities costs.


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EXHIBIT 3 TCO savings for BPO – Transaction Processing | U.S.-India BPO-TRANSACTION PROCESSING
U.S.-INDIA
70-80
GiC model continues to deliver
Other expenses 4-8
typically 40-70 percent savings Facilities 4-8
Operating cost savings TCO savings
over source costs from a TCO
perspective 60-75% 65-75%

People costs 60-70
Source: interactions with GiCs;
21-27
Everest Group analysis 18-21
2-3 1-2
2-3
2-3

13-18

U.S. parent India GIC Set-up and Governance TCO
operating cost operating cost transition

Note: Costs for U.S. corresponds to Tier-2 cities, whereas, costs for India correspond to Tier-1 cities

Differences in TCO savings are driven primarily by functions and
locations

TCO savings vary by functions as these determine the skills requirement,
thereby, impacting people costs. For instance, savings are typically higher for
transaction processing and IT applications work and usually lower for complex
and judgment-oriented business processes (Exhibit 4).

EXHIBIT 4 Typical TCO savings between India GICs and U.S. across functions U.S.-INDIA EXAMPLE
GIC-India Parent-U.S.
TCO savings depend on
function(s) supported by the GiC IT-ADM BPO-Transaction processing BPO-F&A (Judgment-intensive)

55-70% 100-110
55-70% 90-100
65-75% 70-80
Everest Group

32-40 35-45

21-27

Note: Costs for U.S. and UK correspond to Tier-2 cities, whereas, costs for India and the Philippines correspond to
Tier-1 cities

TCO savings are also dependent on GICs’ locations owing to differences in
people costs, facilities, and other expenses. For instance, current savings are
lower in locations such as Brazil, Czech Republic, and Ireland (typically 10-25
percent across functions). On the other hand, savings are higher in locations
such as India and the Philippines (typically 55-70 percent across functions).


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However, savings do not vary significantly across industry verticals for the same
location and function. The nature of the processes and work remains largely
similar for supporting the same function across verticals, and hence does not
notably impact TCO.

In summary, GICs in most offshore locations continue to deliver cost savings
even after incorporating a “comprehensive” TCO view that includes additional
expenses besides operating cost of delivery.


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Arbitrage-Driven Cost Savings in India and The
Philippines are Likely to Sustain for 12-15 Years

While GICs are delivering significant savings today, confusion remains around
the sustainability of these arbitrage-driven savings. The issue is fairly complex
given the multitude of macro-economic and operating variables affecting the
outcomes, such as:
 Wage inflation differential
 Inflation differential in other cost elements such as facilities, equipment, and
telecom
 Exchange rate

These factors significantly impact the cost differential between the parent and
GIC.

We assessed the sustainability of GIC savings by adopting the following
approach:
A) Understand drivers of change in costs, and historical trends in these drivers
B) Build potential scenarios based on a range of possible macro-economic
and operating possibilities
C) Project sustainability of cost savings across scenarios

Our analysis suggests a higher confidence in projections on cost inflation
(wages and other TCO elements). This is a result of higher predictability
associated with availability of talent and other factors such as facilities, telecom,
and equipment. On the other hand, currency exchange rates are difficult to
predict and sometimes fluctuate in a wider range.

Our scenarios on exchange rate movements and TCO inflation reflect this
trend. These scenarios impact cost sustainability of locations and are described
below in case of India (Exhibit 5).

EXHIBIT 5 U.S. India
TCO inflation TCO inflation Currency
forward-looking scenarios of (percentage (percentage exchange rate
Scenarios Description p.a.) p.a.) (2020; INR/USD)
TCO inflation and currency Worst case  Longer economic recovery in the 0% 10-12% 35-38
West
exchange rate movements in  Supply side constraints in offshore
india location (such as talent employability,
infrastructure)
Base case  Most common view of experts and 1-2% 7-8% 42-44
analysts
 TCO inflation similar to current levels
(i.e., moderate market growth)
Everest Group
 Exchange rate levels broadly
maintained
Best case  Faster economic recovery in the 2-3% 4-6% 48-50
West
 Easing of supply side constraints
(such as talent employability,
infrastructure) reduce pressure on
wage


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We analyzed cost competitiveness of GICs in India across the scenarios
described above, the results of which are indicated in Exhibit 6 below.

EXHIBIT 6 TCO savings sustainability for India GICs as per three scenarios
IT-ADM EXAMPLE
2012
TCO (in US$) U.S. inflation: 0-3%
Cost savings in india are likely Worst case scenario Base case2 scenario
U.S. Tier-1 @ INR 35-38 per USD (2020) INR 42-44 per USD (2020)
to sustain for 12-15 years 90-100K TCO inflation @ 10-12% TCO inflation3 @ 7-8%

Hurdle rate1 @
60-70%

Source: Everest Group Best case scenario
Exchange rate continuing
at INR 48-50 per USD
India Tier-1 @ TCO inflation @ 4-6%
35-40K
8-10 years

12-15 years

17-20 years
Time
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 60-70%
2. Base case currency appreciation is considered as the average growth rate during the last two years
3. Cost inflation includes multiple factors such as wage inflation, inflation in facilities and real estate costs, and
miscellaneous costs including equipment, telecom, and attrition

india’s and the Philippines’ cost
Our analysis further indicates that arbitrage-driven cost savings in key offshore
arbitrage is likely to remain locations (India and the Philippines) are likely to sustain for 12-15 years. The
sustainable for at least 12-15 above is based on a relatively safe set of assumptions of macro-economic
years projections that most experts agree on. In reality, the arbitrage may sustain for
17-20 years.

On the other hand, even the worst case scenario projects arbitrage
sustainability of 8-10 years. The above results are reported from a U.S.
perspective but the range is largely similar for other source geographies (i.e.,
UK, Continental Europe, and Japan).

Moreover, the above analysis does not account for any savings due to
operational excellence initiatives. In reality, GICs have several levers to improve
their cost competitiveness. Exhibit 7 below, provides instances of GICs
leveraging efficiency levers to optimize costs.

EXHIBIT 7 Efficiency levers Examples
Efficiency Significant impact of this efficiency lever on TCO. Many leading GICs have achieved
improvement significant savings with this initiative
GiCs have several levers to
Increase GIC of leading U.S. financial services firm introduced cross-training programs to counter
improve their cost resource skewed utilization across processes – achieved meaningful improvement in utilization ratios
utilization through flexible staffing
competitiveness
Leverage lower- GIC of leading U.S. bank with large operations in Metro Manila recently expanded to Cebu
cost locations (tier-2 city in the Philippines) for transaction processing and voice work; overall reduction in
operating costs by 10-15 percent. Some GICs have also expanded their operations in tier-2
cities in India (e.g. Jaipur, Vizag) to diversify access to talent pool and reduce facility costs
Reducing GIC of leading U.S. bank streamlined transport operations across its offices in India and
Everest Group general and reduced per FTE expenses on employee transportation by more than half. This included
administrative reengineering transport modes and facilities, and streamlining transport operations
expenses

These measures can help GICs further prolong their cost advantage by 4-6
years.


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The curious case of wage inflation

Media reports in most emerging economies, especially India, talk about high
wage inflation rates and the apparent impact on savings offered by GICs. On
the other hand, GICs claim lower increases in their wage base year-on-year,
as compared to the reported wage inflation numbers.

Everest Group analyzed this aspect of operating costs in detail; key findings
are detailed below:

Merit-based salary raises at the individual level (arising from promotion/
growth) decrease with increasing seniority as depicted below – although
numbers reported in the media are for the junior levels.

Manager
and above  Form ~20-25% of the overall delivery workforce
 Lower individual raises @ 4-8% p.a.

Team Leader

Senior Programmer

 ~75-80% of the overall delivery workforce
 Higher individual raises @ 10-15% p.a.

Junior Programmer

Consequently, wage inflation netted for the entire pyramid is much lower, at
around 11-12 percent per annum.

Further, salary bands at the same level in GICs do not change significantly.
For example, entry-level salaries (for junior and senior programmer roles) for
the IT-ADM function have changed only by 3-8 percent per annum over
recent years.

Further, the high pace of growth and high attrition levels of many of these
GICs allow them to pro-actively manage the pyramid and keep their costs
down by recruiting large numbers of lower-cost, entry-level talent to back-fill
promotees and job-leavers. As a result, net wage inflation experienced by
GICs is closer to 6-8 percent per annum.


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While the Sustainability Analysis is True for a Majority of
the Work Offshored Today, There Will Be Meaningful
Exceptions

It is also noteworthy that there are meaningful exceptions to the analysis
presented in the section above. There are locations (e.g., Brazil, Czech
Republic, and Ireland), and functions (e.g., technology research and
development) where a combination of multiple factors could erode the arbitrage
faster. Some of these factors are:
 Lower cost differential: Some locations may lose their cost advantage given
lower cost differential (e.g., Ireland costs are only 20-30 percent lower than
UK for most functions).
 Skills shortage: Impacts cost competitiveness compared to functions where
skills are more readily available. For instance, the arbitrage sustainability
time horizon is relatively lower for technology R&D compared to F&A
transaction processing work.
 Unfavorable macroeconomic movements: Abrupt unfavorable
macroeconomic movements related to currency movements and
hyperinflation also impact arbitrage sustainability as in the case of Brazil.

Exhibit 8 indicates the base-case arbitrage sustainability horizon for multiple
geographies in Asia-Pacific, Latin America, and Eastern Europe. While India and
the Philippines have a longer arbitrage sustainability window, locations such as
Brazil, Ireland, and Czech Republic have much smaller arbitrage sustainability
time frame, particularly for certain functions.

EXHIBIT 8 TCO savings sustainability across functions Current arbitrage sustainability (base case)
and locations >8 years 5-8 years <5 years
2012
Arbitrage could erode faster in Parent/source location – U.S.

certain locations and functions BPO – Transaction BPO – Judgment
GIC location IT – ADM processing intensive IT – R&D

India

The Philippines
Source: Everest Group
China

Poland

Chile

Malaysia

Czech Republic

Ireland

Brazil

Additionally, while direct cost savings will always be important, many mature
GICs realize that they can harness the platform they have built to deliver
significant business value to the parent organizations. These organizations have
started to make investments in their engagement and delivery models to reorient
towards this goal that will define the impact GICs have in the long term.


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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. 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.

for more information about Everest Group, please contact:
+1-214-451-3000
info@everestgrp.com

for more information about this topic please contact the author(s):
Nikhil Rajpal, Partner
nikhil.rajpal@everestgrp.com
Salil Dani, Practice Director
salil.dani@everestgrp.com
Anurag Srivastava, Senior Analyst
anurag.srivastava@everestgrp.com


EGR-2012-2-R-0664

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