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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Productivity of India’s Offshore Outsourcing Sector: The TFP Approach

Dr. Suman Modwel, Ph.D. Professor and Director of Research, Chargé Mission Inde, School of international Management, Dr. Tawfik Jelassi, Ph.D. Professor and Dean School of international Management Ecole Nationale des Ponts et Chaussées (ENPC) Paris, France

Abstract:

Keywords:

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Table of Contents

Abstract:

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Keywords:

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Table of Contents

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1.

Introductory

3

2.

IT Offshore Outsourcing in India

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Rapid Growth in Key Business Infrastructure

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Enabling Business Policy and Regulatory Environment

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Abundant Talent

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Cost Advantage

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Emphasis on Quality and Information Security

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3.

Sample Size, Methodology and Scope of the Field Research

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4.

Zooming in on Indian IT Offshore Outsourcing Firms

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5.

Company Descriptions and Analysis

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Infosys

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Wipro Technologies

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Tata Consulting Services

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Metacube

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Axis IT&T

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Alcatel Lucent Development, Chennai

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6.

Cross Comparison Between The Big Three

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7.

Concluding remarks

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Annex

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Agenda For Discussion During Company Visits

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Wage Trends

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Productivity Related Issues

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Competitiveness Issues

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Sample Estimation Sheet

III

Total Factor Productivity (TFP)

IV

Where does the 0.3 come from?

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EVA and TFP contrasted Company Specific Estimation Sheets

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

1. Introductory The rise of India as the leading destination for IT offshore outsourcing has made it a rich field for discussion, surveys, articles in scholarly journals, case studies for business education and prolific discussion in the popular media. Of late, there has been some speculation about the sustainability of India‟s competitive advantage because of rising costs of skilled labour and emergence of several other low cost competitors, with China the closest behind it. The authors too joined this discussion and presented a paper on the sustainability of India‟s comparative advantage in offshore outsourcing at the European Conference of Information Systems (ECIS) in Gothenburg (June 2006)1 . That paper presented the benefits and concerns in IT offshore outsourcing and discusses the sustainability of the comparative advantage that India has as the leading offshoring destination in the world. It argues that the currently low wages of skilled IT staff in India may be eroding over time and companies will be shifting their attention to other value-adding benefits as opposed to looking in offshoring countries for just lower cost provision of IT tasks and services. The dynamics of supply and demand of labour have been made and the dramatic reversal of roles of some labour costs in the Indian economy, ranked amongst the lowest wage economies, to the most expensive one (in purchase price parity terms) for senior managers in "hot Indian spots" like Bangalore and Mumbai demonstrated. At the same time, the argument has been developed that nevertheless if Indian offshoring capabilities concentrate more on high value-added knowledge processing services leveraging on the well recognised skills of its senior managers in the IT and other service sectors, then it can retain its competitiveness. Comparisons of health care costs between the US, India and some other countries were used as an illustration. The question whether rising labour costs can be matched by rising productivity (total factor productivity at the firm level) in order to retain India‟s leading position in offshore outsourcing needs to be answered at the micro level by profiling across time the movement of some key indicators in a sample of a few firms, e.g. total revenue in value added terms, wage costs, output per worker, capital per worker, nature and extent of capital and technology used in different locations in India, including Bangalore. Even though the sample would not be truly representative, the data furnished by the firms enriched by discussions with senior managers of these firms could provide insights. Additionally, a typology had been attempted by the authors of the ECIS paper separating the price sensitive low added value offshoring services from the sophisticated price inelastic ones. It was hypothesised that the former category cannot be competitively provided in these high cost centres, whereas the latter type do require to be located at these hot spots like Bangalore to exploit learned externalities. It was thought that these assumptions also need to be tested in the field. This could be the second aim of a field-study based project. The ENPC School of Management and the Groupe d‟Economie Mondiale of the Sciences-Po accordingly commissioned a project with these objectives. 2. IT Offshore Outsourcing in India As an industry-leading supplier of IT offshore-outsourcing, India maintains to attract the investments of multinational corporations (MNCs). With a growing market for outsourcing services, India matures towards achieving a globally sustainable and unique-value proposition. 1

Tawfik Jelassi & Suman Modwel, “The Sustainabilty of India‟s Comparative Advantage in IT Offshore Outsourcing“, European Conference of Information Systems (ECIS), Gothenburg, 12-14 June 2006

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Double-digit revenue growth mirrors this trend and underscores India‟s cost competitiveness and quality of talent when it comes to offshore outsourcing. Offshore outsourcing refers to a broad spectrum of services ranging from (1) traditional IT outsourcing services (ITO), to (2) business process outsourcing (BPO), (3) the outsourced development of packaged software and (4) outsourcing of R&D and engineering. 2 By definition business functions in these areas are contracted to external organisations in countries with a preferably lower wage level than the one in which the final product or service will be consumed. The term “offshoring”, in contrast, refers to the outsourcing of services to foreign subsidiaries of the same firm and therefore does not involve external organisations.3 Although figures and trends speak for India as a destination for offshore outsourcing, worldwide competition continues to grow. In order to maintain its competitive advantage, India needs to strengthen and reinforce its value proposition by actively responding to a very dynamic and continuously changing macro-environment. There are still untapped market opportunities in terms of size and scope, which India has to take advantage of in order to successfully compete with other low cost outsourcing countries such as China, Indonesia, Philippines, Romania or Czech Republic. The penetration of new markets as well as intensification of contracts with existing clients furthermore will boost revenues and will allow Indian firms to deepen their service offerings. Multi-location delivery already adds to India‟s value proposition and the domestic markets gain on relevance with software and service growth surmounting hardware linked growth for the first time.4 For FY2007 the Indian IT-BPO business was projected to grow by an estimated 28% reaching USD 47.8 billion in revenues, which is almost a 1.000% increase over the last nine years (FY1998: USD 4.7 billion). Given this, the growing sector represents app. 5.4% of India‟s national GDP. The industry is primarily dominated by services and software exports to the US and UK which represent the main markets. Software and Services export revenues alone are estimated to grow over 16-17% to reach USD 47 billion in 20095. Banking, Financial Services and Insurance as well as Technology already account for the majority of revenues, while Manufacturing, Retail, Media, Utilities, Healthcare and transportation follow behind with rapid growth. Given these trends, one can relate to the fact that India‟s global share has risen to 65% for ITO and to 45% for BPO, again backing up the country‟s sustainability and main differentiators. In this respect, India‟s comparative advantage is based on five factors according to NASSCOM6: (1) India‟s rapid growth in key business infrastructure (2) enabling business policy and regulatory

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cf Strategic Review 2007, “The IT Industry in India“, NASSCOM, p.30 cf. Source Paradigm Limited (2007): “Risks, Rewards, Challenges and Opportunities in Offshore Outsourcing”; White Paper, February 2007. 4 cf. Strategic Review 2007, “The IT Industry in India“, NASSCOM, p.8 5 NASSCOM Strategic Review 2009 6 cf. Strategic Review 2007, “The IT Industry in India“, NASSCOM, pp.9 - 13 3

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

environment, (3) abundant talent, (4) cost advantage and (5) an emphasis on quality and information security.7 Rapid Growth in Key Business Infrastructure High quality telecommunication connectivity throughout the country is a fundamental driver for India‟s success as offshore outsourcing destination. With declining telecommunication costs and improving service quality, the IT sector is in favour of a supporting technological infrastructure. While the landline penetration is already moving at high levels, India is picking up on wireless telephony. In addition to the telecommunication infrastructure, the physical and real estate infrastructure including roads, air travel, hotels and office facilities is growing at high rates and power as well as water supply has proven to be reliable. Enabling Business Policy and Regulatory Environment In combination with India‟s well-established technical infrastructure, India‟s policy environment is supporting and encouraging the IT sector through fiscal and procedural incentives. Furthermore, the government has made infrastructure development a key priority in order to avoid socioeconomic problems which will make a big call for IT services. In fact, with the general economic downturn following the global financial crisis, the Indian IT industry will have to turn more and more to the domestic sectors, including manufacturing and agriculture too, in order to reduce its dependence on exports (especially to the US and Europe). Abundant Talent Already today, more than 50% of India‟s population is younger than 25 years and academically well-educated in light of a dense academic network. Direct employment is expected to reach nearly 2.23 million in 2009, an addition of 226,000 employees, while indirect job creation estimated at ~8 million.8 Furthermore, due to the legacy effects of British colonisation there is a large pool of English-speaking recruits whose skills are once-more nurtured through firm-internal initiatives. The abundance of English-speaking talent is a main differentiator in comparison to other low cost outsourcing destinations, which often lack this key asset.

Cost Advantage The absolute cost advantage of Indian wages over wages in developed countries continues to be present, though diminishing in its contribution as a competitive advantage. Yet there is potential

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The year 2008 witnessed the effects of the global finacial crisis. Despite the unprecedented economic downturn NASSCOM (NASSCOM Strategic review 2009) predicts that the IT industry will still witness sustainable growth estimated to reach USD 71.7 billion accounting for 5.8% of India‟s GDP; software and services revenues aggregated to about USD 60 billion.

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NASSCOM Strategic Review 2009

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

for further decreasing infrastructure and overhead costs. Studies show that operational efficiencies can be further driven down through the adoption of industry best-practices, which is especially important in light of rising wage inflation which in turn could erode the sustainability of India‟s cost advantage in the long-run in comparison to competition from China and elsewhere9. Both, in India and China, “double-digit growth rates have fuelled wage inflation, with average compensation costs for sample functions rising by around 30% in China and around 20% in India. But these cost escalations have been matched by corresponding increases in skill supply and quality indicators. … For all the concern about overheating, wage inflation and service levels, India still offers an unbeatable mix of low costs, deep technical and language skills, mature vendors and supportive government policies.”10 Emphasis on Quality and Information Security India focuses on compliance with international standards in order to keep up its high reputation of high quality services. The number and level of quality certifications achieved surpass the number of other countries certifications underlining that India‟s service offerings are top-notch and ubiquitous. NASSCOM states that the Indian IT-BPO industry actively tries to extend the emphasis on quality on information security which is a global issue. By engaging key stakeholders, educating industry constituents about policies and practices, enactment of policy reforms and assisting in the effective enforcement, the objective of information security is addressed.

3. Sample Size, Methodology and Scope of the Field Research Having laid out the macro picture, one has to remain very modest in the descent from the macro level discussion, as further discussed in our ECIS paper, to micro (firm) level investigation because of the limited resources and time at our disposal. Hence the sample of companies was limited to six. Through the contacts of one of our authors we could arrange for interviews at CEO or top corporate level with the following companies: The “Big Three” Bangalore

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, namely Infosys, Wipro Ltd and Tata Consultancy Services (TCS) at

AxisIT&T, a merger between an Indian and US company dealing in engineering services and interactive voice services (VOIP) at Noida and Gurgaon around in the Delhi national capital region (another “hot spot” like Bangalore), much smaller in size

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Studies refers to: “Ensuring India’s Offshoring Future” in The McKinsey Quarterly 2005 special edition: Fulling India‟s; Promise, Grossman, Rossi-Hansberg (2006): “The Rise of Offshoring: It’s not Wine for Cloth Anymore” in Paper prepared for the symposium sponsored by the Federal Reserve Bank of Kansas City on “The New Economic Geography: Effects and Policy Implications,” Jackson Hole, Wyoming, August 24-26, 2006. 10 AT Kearney Survey (2007) 11 The reference is to Indian companies – Some multinationals like IBM India and Accenture that have offshoring operations in India are bigger.

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Alcatel Lucent Development, Chennai, an internal testing facility of Alcatel-Lucent. This was the sole sample of an offshoring (not outsourcing) facility of a big European group Metacube, Jaipur, a small sized software development company in a “second tier” city. As preparation for this primary research we developed a discussion agenda sheet and a total factor productivity (TFP) estimation sheet which we sent to the companies in advance 12. It would be seen from the agenda sheet that the discussion was sought to be focussed on wage trends (their effect on changes in products and services offered, attrition rates, etc.); productivity related issues (upgradation and improvements in technology and processes; HRD policies to enhance skills and motivation levels of employees; positive and negative externalities impacting on productivity); competitiveness issues (reflections on how to stay on top of it); and strategic options and future perspectives (A free ranging discussion was suggested - strategies that may enter in the conversation may include looking at alternative lower cost locations (the so called second/third tier cities); performing only high value sophisticated jobs for select “star” clients to whom quality and security concerns override cost; looking outside and acquiring outsourcing facilities in other low cost economies or in those locations “nearer” to clients (geographically, linguistically, culturally); reverse offshore outsourcing to US and Europe; capital deepening (making the service less labour intensive through more capital inputs (technology, automatic processes). The second instrument (TFP estimation sheet) did require some effort and goodwill on everyone‟s part to understand and appreciate its purpose! As can be seen from the sheet, the numbers are meant to trace out across time (we suggested a 2003-2007 span) the changes in value added (Y), i.e. operating income less expenses on bought out materials and services (excluding wages and salaries), numbers of employees (L), expenses on wages and salaries (W); capital employed (K) which includes all the technology that comes with it; and capital employed per unit labour (K/L). In simple conceptual terms without getting into complexities of growth accounting13, and staying close to the businessperson‟s vocabulary of performance metrics, the idea was not only to look at the well accepted proxy of productivity, value added per unit labour (Y/L), but go a little deeper and look at what was responsible for its increase (or decrease). What for example was the role of capital deepening i.e increasing K/L? How did, to take an hypothetical example, overall productivity (Y/L) increase despite resources of labour (L) and capital (K) remaining constant? The intuitive answer of course lies in the quality and efficiency of labour, their skills, motivation, learning culture of the company, supportive business environment, etc. – all these combined to make them work “faster and better” despite resources remaining the same. These are all the notorious “grey box” areas, difficult to extract and measure accurately both at the macro and micro level. Nevertheless, the TFP approach, with all its caveats and limitations does go some way in at least pointing at some trends in a relative sense whether countries, or firms, are extracting more (or less) out of given quantities of capital and labour resources over time. TFP derives its definition 12

See Annex for further reference. Attributed first to Solow and Swan (1956). Total Factor productivity (TFP) or Multi-factor productivity (MFP) is “measured residually as that change in output that cannot be accounted for by the change in combined inputs of labour and capital (OECD Glosary of statistical terms)” 13

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

from the growth accounting literature in economics attributed to Solow. Evidence was shown that countries grew wealthy mainly through corresponding increases in TFP. This logic would argue that growth in TFP is the critical lever for sustained growth of firms too. The basic equation that we used to measure TFP is: TFP = Y / [L0.7 × K0.3], where L is the number of employees and K is the value of the firm's capital. The exponents represent the fraction of the firm's value added contributed by labour (0.7 or 70%) and by capital (0.3 or 30%) -- taken as the general average for the services sector which is considered more labour intensive. We use the sector averages or the economy-wide average, since the data needed to compute this parameter for each firm is normally not publicly available. Unfortunately the sector averages for India are also not available so we have taken the averages for other economies e.g Canada, where figures are available. A little mathematical manipulation (taking logs and differentiating across time) yields the equation used in the estimation sheet: % change in TFP = %change in productivity per worker – 0.3* %change in contribution of capital per worker We elaborated a short note on TFP explaining all this for the benefit of the sample companies14. In this we noted that “Economic Value Added (EVA) has become a widely used measure of firm performance. It is however criticised by some on the grounds that it measures the productivity of capital alone, measuring its return against a benchmark, cost of equity, to see if value has been created. The advantage of the TFP measure is that it takes into account both labour and capital in measuring productivity. This could be more meaningful for firms operating in economic sectors (like IT related services) where human resources play a key role in driving performance”. We did caution that “it would be unwise to abandon one measure favouring the other. Juxtaposing both tools side by side may lead to more insights. For example strong EVA and negative TFP may lead to reflections whether economic value is being created in the short term but managerial performance shows scope for improvement (for long term sustainability). The opposite may be the case where TFP growth is robust but shareholders are not happy with the returns to their capital. Thus it would be best if firms use both the EVA and TFP tools, with plenty of “footnotes” in their calculation sheets to explain deviations in particular years that neither of these tools can properly capture (e.g. .abnormally high investment periods requiring long gestation or surges in fresh recruitment that will yield output in later years but will depress TFP in the short term).” In the event, we did notice such unusual deviations from normal trend in our analyses of the estimation sheets of some companies as discussed below, and have properly explained them.

It may interesting to observe here that in the process of navigating through, and pushing the companies to navigate through and plug in the numbers (or check what we put in based on their public documents like annual reports), and make the calculations a very brisk and lively exchange 14

See Annex for further reference.

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

of emails, telephone and skype calls took place with each company after our return from the field trip (September 2006). This in itself was an unanticipated experience of trying to extract primary data with appropriate comments from the sample companies for our research. One such sample correspondence is given below: E-mail exchange with a company correspondent, with author‟s responses in brackets: ---------------“Dear Suman, 1. What is the logic of TFP ? What statistical behaviour does it represent ? (Thanks for this question which prompted me to write out a short piece on TFP, contrasting it too with the EVA tool, as attached. Please do give me your comments on this); 2. How have you computed Wages & Salaries to include benefits etc. ? (We just took the figures in the value added statement, e.g. on page 140 for the AR 06-07, and assumed that they included benefits etc). 3. How have you computed Operating Expenses minus Wages ? (Indeed, we left this row blank because we were not sure whether extracting out the salaries and bonus values from the expenses relating to software development, general and administration and selling and marketing expenses (pages 51-53) would get us the right figure. We therefore just took the value added figures from the value added statement. The head-count also includes employees already hired but still under training. Example - FY07 Annual report (Page 55) mentions utilization factor including and excluding training. Given that about 70% of our new hires undergo a 4 month training and are not deployed until then, would you want to take that into account while calculating productivity. The annual report 2006-07 on p55 mentions about SEZ, Exceptional Items etc. so we were not able to find this reference. You raise a good point – would it not be possible to calculate a broad average of the head count adjusting downwards the labour force (by 70%*new hires*8/12months or something like that)? What would be important however is to do it consistently for all the years. (Incidentally, it would also be interesting to discuss the age profiles of the work force. The picture for 2006 and 2007 is in the 06-07 annual report (p.131) which shows that the %share of the 20-25 age group increased from 58.8%. to 59.7%. Could you give us the earler years' fgures? It would be interesting to see whather this group is increasing its share steadily.)

Warm regards XYZ”

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

4. Zooming in on Indian IT Offshore Outsourcing Firms After the description of India‟s unique value proposition which determines India‟s success as an offshore outsourcing destination on a macro-scale and the description of the TFP concept, it becomes apparent that on a micro-scale a firm‟s contribution to the whole industry‟s productivity is especially dependent on the productivity per employee and the relative cost (wage) for it. Therefore this paper will look in detail at the firm specific total factor productivity, which depends on working capital, the size of the workforce and their respective wages. The focus of this study will be on six companies which can be categorized according to their size, their offered service portfolio and the tier they operate in. “While the larger players continue to lead growth, gradually increasing their share in the industry aggregate; several high-performing SMEs also stand out.”15 While companies such as Wipro, Tata and Infosys dominate the IT sector in terms of revenues and value-added, smaller players such as Metacube, Axis IT&T and Alcatel Lucent impress with their growth performance and productivity measures. Service-wise, as an offshoring company servicing its parent, Alcatel Lucent stands apart from the other two. These sample companies are located in different “tiers”. Bangalore, Mumbai and Delhi (Gurgaon and Noida) are the so-called first tier (tier 1) regions in India. Their attractiveness is determined by a high development of the value-adding characteristics, with higher (burgeoning) costs on the flip side. Hyderabad and Chennai, for instance, are cities which pick up on these characteristics and are therefore called tier 1-1. Cities such as Kalkota belong to tier 2, less of both valued added sophistications and costs, but still have reasonably good value propositions. Jaipur could also be classified as tier 2. Ahmedabad is part of tier 3 cities which have expressed (with strong encouragement and support from the local authorities) a vision to become an attractive location for the IT industry, relatively lacking in availability of skilled labour and other externaliites that exist in tier 1 clusters, but with even lower costs. They have not yet realized this vision.

5. Company Descriptions and Analysis In the following we will discuss the companies which are part of our study: Wipro, Infosys, Tata, Metacube, Axis IT&T and Alcatel Lucent. During these descriptions we will portray the company‟s performance regarding size, service portfolio and tier. Furthermore, this discussion will be fuelled by critical remarks as well as critical claims by company representatives from our interviews during the field visits in September 2007. Infosys16 Infosys started in 1981, went public in 1992, and has been registering hundred percent growth year on year. Infosys has a large number of Fortune 500 clients, and the challenge is to “retain” their loyalty by providing higher value in terms of quality, delivery and security. Software is looked upon as a service, using the SAS business model where the client is not the proprietor of 15 16

Strategic Review 2007, „The IT Industry in India“, NASSCOM, p.8 Interview with Vinay Rao, Office of the Co-Chairman, 17/09/07.

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

the software, instead buys the outsourced “solution” that is delivered remotely by the application service provider (ASP) over a network. The central objective is to deliver credible value to the client creating outcome based revenue, finding and plugging revenue leakages. As Rao, Assistant of the Co-Chairman, put it, “We try to understand the business of the customer, not only the technology he uses”, and they do not hesitate to enter into transaction based and revenue sharing pricing arrangements with their clients. Supply side challenges of getting, training and retaining the right talent are a major challenge, with entry of foreign players too as suppliers of outsourcing services adding to the ferocity of competition. Furthermore, to manage a workforce of nearly 80.000 employees adds to the complexity of the business. Infosys emphasizes the importance of training at the “bottom of the pyramid”. The company has a huge facility in Mysore with more than 5.000 classrooms where intensive training for 4 months is imparted, including short duration domain specific modules for which certification is also provided. The performance appraisal system is unrelenting. A key insight that emerged in our discussion was their hiring policy. Infosys focuses on hiring smart people, regardless of their background. They do not need to be engineers, they can be medical doctors with MBBS degrees and even about 70% have no prior experience. The average age of the work force is about 26 years. This recalls to one mind the model that existed amongst several multinationals like the oil companies or the Detroit big three motor companies, GE, Unilever, et al, in the middle decades of the last century: “Catch „em young, mould them, and hopefully retain them for life!” The ability to learn and problem solving were the mind-sets and skills that were solicited and fostered. Vinay Rao is optimistic that the private sector will play a much stronger role in the future, despite current government policies which are not very friendly towards privately run engineering colleges and which are downright hostile to foreign institutions entering the supply market in the higher technical education sector. Hence the demand-supply mismatch, much commented upon and lamented by business (NASSCOM) analysts and media alike is likely to ease in the not too distant future according to him. Meanwhile, however, high attrition rates and body-snatching amongst the IT companies is a problem. Infosys has a 11 ½ % annual attrition rate, which is half of the current industry average, according to him. Infosys salaries are not any higher than the general norm, and they are comfortable losing 5-6% annually to competition.17 Infosys is evidently not relying on the wage factor for employee retention, rather playing its brand card, its well known quest to capture the “mind” of the employee. Narayana Murthy, first CEO, and an icon of the IT world puts it: "Our assets walk out of the door each evening. We have to make sure that they come back the next morning.” One could see what he meant as we toured through their huge campus with all the facilities and landscaped parks and greenery for leisure, sport, special events including family gatherings, 17

“I can get 2 to 3 times higher pay outside Infosys”, say these quitters.

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

restaurants, and bicycling employees. These amenities rather resembled a five star luxury resort sitting rather bizarrely alongside huge amphitheatres and conference rooms fitted with multiple screens where state of the art communication and control systems operate at the service of their clients world-wide in real time. In light of the recent rise in salary costs coupled with another appreciation of the Indian Rupee against the US$18, Indian IT companies face financial challenges. However, in the case of Infosys, 90% of billings are repeat business and the company successfully leverages their long term client-supplier partnership, as discussed above, such that the price of their product and service becomes relatively “inelastic”. In other words, the more important considerations to the client are the continued quality and reliability of the solution proposed in the supply offer and its perceived potential to increase revenues (or decrease internal net costs). As long as the client is assured of this, the increased billing rate, if any, is implicitly factored into the package. In addition, it is significant to note that in any case the average salary per employee is steady over the last 3 years at almost Rs. 1 million per annum. This would point to a trend of new hires at relatively lower levels (hence lower starting salaries), compensating for the salary hikes at higher levels. Infosys seems to intensely leverage technology and automation rather than the cost-effectiveness of Indian IT skilled manpower. This is startling since it is counter-intuitive for an IT player in India. Vinay Rao says: “Our defining process is through increased automation and labour arbitrage is only 25% in the product/service.” At a very broad level this may mean, whatever be the final consequences which we cannot predict, that the company is placing its bets on the technology factor to remain on top of competition. This seems to be consistent with, and validates, the numbers in the Infosys estimation sheet 19 . The tables show that the capital/labour (K/L) ratio is very high, Rs.1.27 million per employee in 2007, and much higher than the one for the other two big players in Bangalore, Wipro and TCS. The total value added per employee (Y/L) is actually very respectable (Rs.1.59 million), and higher than for WIPRO.20 However, we find a negative trend for TFP (-11.2% in 2007 as compared to 2003. But TFP comes back into positive territory when we compare it with the previous year 2006 (4.5%). In simple words, all this implies that the major determinant of productivity per capita (Y/L) is the high capital available per employee, not the growth rate of the efficiency of labour (TFP), which in fact is decreasing after 2005. The merit of the TFP approach lies in trying to answer the question whether a company increases its productivity through increasing unit labour efficiency without additional capital. Apart from the role of capital deepening (K/L) in making workers more productive, productivity may increase through the growth in the efficiency of labour without additional capital investment. Thus the TFP measures a sort of “free lunch” enjoyed by the company.21. 18

about 12% over the last 12 months See Annex for further reference. 20 See the section below on the comparisons we made of the big three for more discussion on this. 21 The expression is used by some researchers like Shlomo Maital and Brendan Cahill 19

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

It is however important to note that no conclusions beyond this simple observation can be drawn without going deeper into the matter, which is beyond the scope of this paper. It may well be that Infosys will later reap the fruits of this high capital deepening when the skilled manpower goes down the learning curve of such sophisticated automated processes and delivers the “free lunch” at an increasing rate. Such caveats22 are an essential aspect of the TFP model of looking at the determinants of productivity. Making judgements based on the present data in the estimations sheet could be misleading. What can be said is that TFP holds up a mirror, perhaps sometimes distorted, that is neither a messenger of good news, nor of bad news, but an invitation to go through further analysis of the data to explain and understand real trends and their implications. Wipro Technologies23 Wipro is another firm among the big three Indian IT software companies, alongside TCS and Infosys, owned largely by Aziz Premji. Its organisational structure comprises the following units: IT Services; Product Engineering Solutions; Technology Infrastructure Services; Business Process Outsourcing (BPO) like Financial, Banking, Insurance, Health and Travel Services; and Consulting Services (Business, Process, Technology and Quality consulting) 24. These units share common services like HRD, Finance and Marketing but otherwise operate as autonomous profit and loss centres. Like Infosys, Wipro‟s hiring policy does not target engineers only, despite an engineering bias of 90% in the IT sector13. In Wipro too the hunt is on in full cry for what Vinay Rao of Infosys termed “smart people”, whatever their background may be. The intensive in-company training, makes it possible to hire B.Sc graduates, which can then deliver the same quality and quantity of output for certain jobs, but with 50% less pay. This means in turn that there is no need to employ traditional engineers for these kinds of jobs. Wipro is recruiting not only science graduates but generalists, including MBAs, in increasing numbers. The company has cast its net wide, not restricting itself only to the top Indian Institutes of Technology (IIT) and Management (IIM). Desired qualities they look for include self-initiative, ability to work creatively in unstructured environments where tasks are not always “given, to be done as prescribed”. Employees with such potential picked from the less perceived technical institutions and universities (about 1600) often feel that they are as good as those graduating from prestigious schools such as IIT and IIM and are “hungry to prove themselves”. Wipro gives them an opportunity to do so. The changing demographic profile of their human resources is another factor working for them in holding salary costs from rising too sharply. Wipro provided a detailed breakdown of different

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See TFP note in Annex for further reference and explanation. Interview with Pratik Kumar, Senior VP, HRD on 18/09/07. As we entered their premises we could not help comparing them with Infosys. The layout of their buildings where their different units are lodged were elegant and pleasing in their design but less impressive in their grandeur, with modest landscaping surrounding them. We were not invited to take a tour. This was in contrast to the “bells and whistles” show window approach of Infosys. The human resource perspective, with their almost 90000 strong work force, naturally dominated our discussion and much useful information and insights emerged which we weave into the numbers in the TFP estimation sheet furnished by them. 24 www.wipro.com 23

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Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

age groups for the years 2003-2007 as shown in the table below. The major change between 2003 and 2007 is the proportional rise of the first and the decrease of the second category. While there is an increase from 23.6% to 38% of the population “less than or equal to 25”, there is a decrease from 49.2% to 33.7% in the “26-30” age category. This has had an effect in dampening the total salary bill because obviously the juniors get less pay. We can see from the data in the estimation sheet that the mean salary (total salary costs/number of employees) has gone up from Rs. 0.79 million in 2006 to Rs. 0.85 million, i.e. a rise of about 8% whereas at the macro level surveys report much higher wage hikes as we brought out in our ECIS paper. The following section on comparison of various indicators between these three big Indian companies also shows that Wipro has, and always had since 2003, the lowest mean salary of the three. Age profile (Numbers and percentage-WT population) March 2003

Age Category Less than/ equal to 25 3162 26-30 6601 31-35 2669 36-40 690 41-45 216 46-50 60 >50 22 Grand Total 13420

March 2003

Age Category Less than/ equal to 25 23.6% 26-30 49.2% 31-35 19.9% 36-40 5.1% 41-45 1.6% 46-50 0.4% >50 0.2% Grand Total 100.0%

March 2004

March 2005

March 2006

March 2007

5468 8640 3548 930 317 77 34 19014

8326 10865 4890 1243 383 108 46 25861

13077 13467 6973 1849 484 189 62 36101

18589 16491 9696 2796 807 364 125 48868

March 2004

March 2005

March 2006

March 2007

28.8% 45.4% 18.7% 4.9% 1.7% 0.4% 0.2% 100.0%

32.2% 42.0% 18.9% 4.8% 1.5% 0.4% 0.2% 100.0%

36.2% 37.3% 19.3% 5.1% 1.3% 0.5% 0.2% 100.0%

38.0% 33.7% 19.8% 5.7% 1.7% 0.7% 0.3% 100.0%

Infosys claims to have a uniform pay policy in all their units across India. However, the salaries for Wipro are lower in their tier 2 locations, e.g. Bhuvaneshwar (in the state of Orissa), justified on grounds of lower cost of living in such smaller cities adjoining the rural countryside. Regarding attrition rates, the “less than one year category” departures have increased from about 8% in 2003 to 13% in 2007. This appears to be below the industry average. Although there are no authentic statistics regarding attrition rates in the IT sector, many leading businessmen voice their estimates. For instance, at NASSCOM's ITeS/BPO Summit held in Bangalore in August 2007, Mr. Bhasin, CEO of Genpact was quoted as saying, “According to industry estimates, attrition 14

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

rate in voice-based BPO is in excess of 50%. Also the attrition rate in non-voice BPO ranges between 20-30% as reported in the “India Edunews”25. Value added is a finer measure for output as it nets out bought out expenses from revenues. Wipro‟s value added increased by almost 500% during the period of review (2003-07) and this increase was much faster than the increase of mean salary (145%) and the head count (265%). This yielded a growth rate of 61% in value added per employee (Y/L), the generally accepted measure of productivity. As discussed earlier in the case of Infosys, the TFP approach attempts to explain where most of this productivity increase came from. We can observe from the WIPRO estimation sheet (Annex 16) that year on year, there was a hefty increase in TFP growth (78%) in 2005, followed by a negative rate (-5%) in 2007 for which a disproportionately large build up of capital employed (77% increase) appears to be responsible. Overall, however the 4 year trend rate of positive TFP growth of 50% registered by Wipro could certainly be a cause for celebration. The attached note on TFP deals however with some caveats and further cautions against jumping to conclusions based on TFP trends. It is always advisable to consider as large a set of historical data as possible in order to smoothen out abnormal incidents in particular years. Incidents include, for instance, a large injection of capital, or spurt in hiring, all of which require many years to amortise and yield results. Unexpected fluctuations in revenues and salary costs too affect the value added (Y), with consequent effects on TFP. Tata Consulting Services26 We were not quite clear how many offices TCS has in Bangalore itself. Dr Desai received us in a medium-rise building surrounded by other equally drab surroundings in a congested part of the city. Apparently TCS has yet to decide to define its personality with its own “campus” as Infosys and Wipro have done. Tata Consultancy Services Limited (TCS Limited company), a part of the gigantic empire of the Tata group, is one of the world‟s largest providers of information technology, consulting, services (system integration and testing solutions), software application development and business-process outsourcing. It is Asia's largest and has the largest number of employees among the Indian IT companies with strength which has crossed 100,000 by the end of 2007, with IT consultants in 47 countries (source: Wikipedia). The company generated consolidated revenues of US $4.3 billion for fiscal year ended 31 March 2007 (written Rs. 186 billion in our TFP estimation sheet discussed further below). The discussion started with Dr. Desai mentioning that their revenues are 9% from India, 30% Europe, 51% US, and the rest other regions including Latin America and China. TCS is the world‟s first organisation to achieve an integrated Enterprise Wide Maturity Level 5 on both the Capability Maturity Model Integration(CMMI) and the People CMM appraisal system. CMMI, developed by the Software Engineering Institute of Carnegie Mellon, “helps integrate traditionally separate organizational functions, set process improvement goals and priorities, provide guidance for quality processes, and provide a point of reference for appraising current processes”, whereas “the People Capability Maturity Model (People CMM) is a framework that helps organizations successfully address their critical people issues.” Based on the best current practices in fields such as human resources, knowledge management, and organizational 25 26

website http://www.indiaedunews.net Interview with Dr. Pradeep Desai, technology Head, TCS Financial Services on 17/09/07.

15

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

development, the People CMM guides organizations in improving their processes for managing and developing their workforces.” (source: http://www.sei.cmu.edu/tools-methods/process.html). Dr. Desai observed that TCS “is a strong tech company trying to get to the business side”, with its products and consultancy business growing but the services segment dominating. On the human resources side, the challenge of managing a workforce touching 100000, growing every year by 30000 or so, was underscored. There was a wide gap between the skilled and semiskilled, younger, work force and confirmed that this seems to be a major factor pushing IT companies to broaden the pyramid base to keep HR costs in control. He hinted that this was influencing the shift to more “automatic processes”, quite apart from the latter being an imperative per se, as all IT players that wish to remain globally competitive are realising. This gap in productivity between the two levels is being diminished by providing intensive training for 3 months on entry at their about 8 training sites. Their facility in Souzhou, China, was mentioned in this context: “To go out from China may be easier than from India”. A strong appraisal system, for which the People CMM mentioned above, is undoubtedly being put to use is in play: “What value do you bring to the company?” is the hard question that has to be convincingly answered. Interestingly some of these observations sit well with the trend analysis we make of the data in the their TFP estimation sheet27*. We see that while there have been heavy injections of capital in 2006 and 2007 giving an overall trend of 126% for the period 200-2007, the work force increased more impressively (184%). The resulting capital employed per employee (K/L) was negative at 20%. The work force increase was also more than the increase in value added (169%) over this period, hence output/employee (Y/L), widely accepted as a broad measure of productively went into negative territory (-5%). The TFP approach discussed earlier in the paper and elaborated in the note in the annex seeks to look deeper at the respective contributions of capital (K/L) and worker “efficiency” (TFP), which discounts the role of capital, in the increase (or decrease) of the overall productivity trend rate. We see then that the negative role of K/L was compensated by a modest, but positive trend of TFP (1%). In fact, the year 2007 could be signaling a turnaround as both K/L and TFP turned positive, giving a positive growth of 5.3% over 2006 of Y/L so one could even tentatively conclude that recent integrative and appraisal measures on the management and HR side and automotive and other processes on the technology side are beginning to give their fruit. We should also remember that negative exogenous changes in Y i.e. revenues in value added terms, also affect productivity negatively. The 12% appreciation of the rupee against the dollar during 2007 has undoubtedly caused unexpected pain (the rupee has historically only rarely appreciated in the past) as most of the billings of these IT companies are in dollars, and many IT companies, and NASSCOM on their behalf too, have expressed concern from time to time over the drop in export earnings resulting from such currency changes. Decreasing L, the work force to maintain the ratio. Albeit for reasons of poor performance, media reports of TCS‟ dismissal of 500 employees are significant in this context:

27

See Annex for further reference on TFP calculations. Regrettably however we should point out that Dr. Desai declined to furnish these figures, which was puzzling as they are all extractable from several different sources like annual reports and quarterly “results” all in the public domain in their website (www.tcs.com), which we in fact did ourselves. These are therefore not verified by the company. Moreover, as we could not easily locate the numbers for 2003, we left that year out, considering only the span 2004-2007. *

16

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

After cutting down on variable pay across the board, Tata Consultancy Services has shown the door to 500 employees, citing poor performances as the reason. India’s largest private sector employer and Asia’s largest software exporter has been going through a lean period because of external business dynamics. The rising rupee viz-a-viz the US dollar has been building up the pressure on margins and revenues. Another factor that has been bothering IT companies is the signs of a slowdown in the US economy, the largest spender on IT systems and outsourcing. (Times of India, Mumbai edition, Feb 6, 2008)28 Metacube29 Meta cube is an IT solutions and services company developing enterprise software applications. It is Metacube‟s business model to develop and sell these applications to software companies which in turn offer their final software services to their clients. Metacube has many clients in the trade management sector. One of their important clients is Tradebeam, USA, for instance, a global logistics company that delivers an “end-to-end solution across order, logistics and settlement to improve global trade operating efficiencies and cash flows”. Metacube has an ongoing relationship with them with a dedicated team of 30 engineers and has developed a global trade management software, TradeBeam 3.0, that allows for streamlining global trading processes. Another important client is Valdero, a leading provider of enterprise class software solutions for real-time supply and demand chain execution, with whom Metacube is in an ongoing relationship with a team of 14 engineers providing development and quality assurance services. The company is situated in the Jaipur Software Technology Park which is currently under development. Jaipur is one of the “tier two” cities about 350km from New Delhi that are coming up as alternative options to the “hot” centres like Bangalore, Mumbai, Gurgaon, NOIDA where salaries, especially of skilled IT engineers are exploding and the infrastructure deficit is challenging. The work-in-progress atmosphere mirrors the characteristics of typical tier 2/3 regions. The poor infrastructure, the few learning opportunities (externalities), the still scarce availability of skills are all challenges Metacube has to deal with despite a growing quality of life and a growing political support. On the supply side Sharma, CEO of Metacube, estimates that of the graduating engineers from about 50 regional colleges in Rajasthan state (of which Jaipur is the capital) about 40-50% get placed in software development companies, the rest in BPO call centres and other lower value added IT related activities. Sharma also has an IT background and shares the opinion of colleagues (see the section on Infosys) that the private sector is resolutely marching in with projects to open more and more regional engineering colleges to restore the supply demand

28

At the time of submission of this paper (Sept 2009) the Rupee is back to its weak level hovering around Rs. 49 to the US$. The arguments can thus be run in reverse! Implications of the weakening Rupee could have many implications, Indian offers becoming less uncompetitive, being only one oft them. These would have to be set against many challenges other challlenges such as demand becoming more price inelastic and slackening more because of re-awakening resistance to outsourcing in the wake of this slowdown in the US and other developed economies. 29 Discussion with M. Keshav Sharma, CEO on 24/09/07.

17

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

equilibrium. The activity of the private sector grows, despite the fact that state authorities do not yet recognize the degrees. The TFP calculations point to quite an impressive picture, which does not mirror the otherwise dull appearance of the physical location. Albeit starting from a very small base, the income from operations and value added (Y) has leapt by more than 1000% by 2007. Work force grew by 62% over the previous year with 133 as the present head count (it is significant to note that the CEO does not want the company to move beyond 400 employees). The even higher growth of wages and salaries (1189%) was evidently neutralised by corresponding increase in business volume and hikes in billing as income also showed high growth (940%). Overall there is a clear and impressive increase in value added per employee (185%) and TFP (142%)30. The latter figure shows that growth of value added per employee was not just owing to more capital (technology, improved software and processes) but also because of “better and faster” performance of its work force with these (capital) tools. It is relevant in this context to recall the CEO‟s emphasis on mentoring by senior staff. Their staff has an average of 3 years experience, salaries ranging from Rs. 600000-800000 p.a. Those with 6/7 years earn around Rs 12 million p.a., some even Rs. 2 million. Keshav Sharma, CEO of Metacube, underlined the “huge and identifiable” difference in productivity between the junior and more experienced staff. In this context, he laid special emphasis on mentoring by senior staff as a critically important HR policy in their company. Attrition rates were of the order of 10/15% p.a, the majority of those quitting in the 2-4 years experience range. Axis IT&T31 Axis, a US company and IT&T merged in 2003, the latter taking over the former. The AXIS IT&T group now comprises AXIS-IT&T Limited, Axis Inc. and Axis EU LimitedEngineering. It considers itself to be a design and business process outsourcing (BPO) services provider. AXIS IT&T operates in the USA, UK, Europe and India through the offices of its group companies in Illinois, Leicestershire, and Noida.. Services Offered include Engineering Design ServicesProduct Design, 3D Modeling and Assembly, Drafting & Detailing, FEA, Reverse Engineering and NC Programming. Back Office Services such as Content Development & Data Conversion, HR Services are also provided. In Software Development they are active in Product Development & Maintenance, Software Re-engineering. Amongst the major clients Caterpillar, Cummins, Intervoice, were cited. A particular challenge that they faced was illustrated by recalling the three stages involved from original conception (styling) to assembly/manufacturing, with engineering design in between. In the 3-stage development of superbikes, for instance, AXIS IT&T converts blueprint drawings for the engineering process. The conversion takes place between the actual design of the superbikes and the assembly and manufacturing phase which are done by other parties. They are thus caught in the middle of the chain between styling and assembly/manufacturing. Zero defect and zero delay performance becomes even more crucial because of this. 30

See Annex for further notes on TFP calculations. Meeting with Rohit Chand, Chairman and his colleagues (20 Sept 07) as well as website information: http://www.axisitt.com 31

18

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

For the purposes of analyzing the movements of value added, wages capital employed etc. it was agreed that only the figures for the company‟s India operations would be considered. It was pointed out that figures for 2003, before the merger, in the TFP estimation sheet are really not comparable with later years, as income and salaried staff sharply decreased. According to Rohit Chand, salary-costs increased by app. 15% on average last year (40% in low, 20% in middle, and 8-10% in senior staff). Their fresh hiring intake is of engineers with 2 years experience on average. With a 12% appreciation of the rupee and no corresponding increase in billing rates, this represents a major challenge for a small B-to-B company such as AXIS IT&T. The attrition rate was estimated at 35-40% per annum. This was a higher figure than that disclosed by other companies we visited, but those were in other locations like Bangalore, Chennai and Jaipur. It is likely that the Noida and Gurgaon areas around Delhi area are facing even more pronounced boom conditions. Additionally, small companies without the same “brand pull” as the big Indian and foreign players face even greater threats of attrition. TFP figures in the estimation sheet need to be interpreted keeping in view the fact that there was significant increase in salaried staff starting from a small base in 2004 after the merger, while the capital employed (rather large!) remained basically unchanged 32 . Furthermore, taking note of remarks in footnote c) in their estimation sheet regarding the structural changes that took place during 2003-05, with unusual variation in figures, we have added a column tracking % changes from 2005 to 2007, rather than from 2003. This may be a fairer comparison – it shows that value added increased hugely (268%), with the increased workforce (195%) giving better overall productivity as the value added per employee too showed an improvement of 25%. There was hardly any change in capital employed which appears unusually immense compared to turnover (Rs.200 million vs. Rs.55), perhaps a “legacy” of the merger and re-structuring in earlier years. The result was that the capital per worker decreased by 64%. The impressive increase in value added per employee on the one hand despite no addition to capital employed on the other can be interpreted to mean that the work force performed with relatively greater productivity with the same capital inputs. The TFP score of 44% validates this interpretation. Rohit Chand had observed that the triple blow of increase in salaries (15% as estimated by him), the 12% appreciation of the Rupee against the US$ and constant billing rates has affected their profitability. However this does not appear to be borne out by the numbers in the estimation sheet. Value added (Y) increased faster (268%) than wages (194%) over the period 2005-2007. And over this same period the average salary (wages/employee) remained steady (Rs.0.31 million). This could mean that, as for the Bangalore companies, the age of the work force is decreasing, with new hires at comparatively lower salary ranges compensating for the wage hikes at higher levels. Additionally, it is interesting to note that the mean salary of the big three at Bangalore is of the order of Rs. 1 million, three times more than that in small companies like Axis IT&T and Metacube.

32

Figures for 2003, before merger, are really not comparable with later years, as income and salaried staff sharply decreased.

19

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Alcatel Lucent Development, Chennai33 Alcatel mainly focuses on product testing, broadband wireless access solutions like WiMAX, and product development. In this regard Alcatel filed 39 patents in 2007 as compared to 11 in 2006. Alcatel‟s software development centres are located at Gurgaon, Noida, Chennai, Bangalore and Hyderabad. Today, Alcatel-Lucent technologies make up 50% of India‟s fixed and CDMA wireless lines.34 The company entered the South Asian market in 1982. In cooperation with ITI Ltd., Alcatel-Lucent became the first company to manufacture digital switching equipment in India significantly fostering the development of the Indian telecom market. As the estimation sheet depicts35, the work force growth has been very high (356%), but value added per employee (Y/L) has also shown impressive growth (78%), thus predictably showing impressive TFP growth too (57.8%). Alcatel‟s key objective is to adhere to the delivery date of tested products within a set of rigid parameters of early defect removal. Furthermore, quality predictability, decision review schedule adherence and content adherence represent major goals. Attrition rate was estimated at 10-14% compared to about 22% in the region for similar IT companies36. The average age per employee has been constant during the last two years. This observation is contradictory, given the big wage hike of the last years37, but again the explanation is the fact that the work force is progressively getting younger and is being paid proportionately less. This trend is borne out in the figures in the estimation sheet for the years 2005 and 2006 and can be confirmed by the big three companies in Bangalore as well. One could argue, as some members of the team we interacted with felt, that the TFP measure for the centre in Chennai is not applicable since the centre is an internal facility generating no revenues from direct clients. Rather the company itself pays the centre for jobs done on a cost plus basis, and there are no sales and marketing costs. But, as we explained to them, this is irrelevant to the basic task underlying the TFP concept of analysing where the increase (or decrease) of output in value added terms per unit labour comes from, no matter whether the output is related to external sales in the market or internal payments by the parent for services rendered. 38

6. Cross Comparison Between The Big Three

For obvious reasons, it will be meaningful to make a comparison of the big three Bangalore companies, as the other three – Axis IT&T, Metacube and Alcatel-Lucent - are all so different in their characteristics. The two charts in the following page help us in making some comparisons and contrasts in the performance metrics indicated in the respective estimation sheets of TCS, Infosys and Wipro.

33

Chennai center visited on 19/09/07. Interview with the MD, BVS Krishnamurthy and his colleagues. Cf. website : http://www.alcatel.co.in 35 See Annex for further notes on TFP calculations. 36 according to the MD 37 see footnote 2 38 All values in the ratios are Rs.Million 34

20

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

The Big Three: Value Added/Employees (Y/L) & Capital Employed/Employees (K/L) Ratios

Rs. Million

2,5

TCS

2 INFOSYS

1,5 1

WIPRO

0,5

TCS

0 2003

2004

2005

2006

2007

INFOSYS WIPRO

Bars = Y/L; Lines = K/L

Big Three: Mean Salary (Salary Costs/Employees), W/L

1,40 Rs. Million

1,20 TCS

1,00 0,80

WIPRO

0,60 0,40

INFOSYS

0,20 0,00

2003

2004

2005

2006

2007

Value- added per unit labour (Y/L): This is the broad measure of productivity. Wipro (1.29, 2007) appear to be closing in on Infosys (1.59, 2007) as the years go by, although both are still behind TCS (1.73, 2007), which is the clear leader. In absolute income values WIPRO has almost caught up with Infosys, but the gap between the two is still perceptible in value added per unit labour terms. TCS‟ value added per capita ranges between 1,89 and 1,64, while Infosys‟ numbers range from 1,49 to 1,92 and and Wipro‟s between 0,64-1,29. Despite a certain volatility, Infosys is seent to be moving moves towards TCS.

21

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

A certain volatility in the companies‟ performance growth covered during the years 2003 to 2007 can be seen. In general TCS shows steady growth of figures and maintains its high level (Y/L: 5,29% 2007/2004). Infosys‟ value added decreased by -17,13% between 2003 and 2007, which is mainly due to a relatively high drops in 2004 and 2006. Wipro managed to steadily grow, increasing Y/L by 60,94% between /2003 and 2007.

TFP and Capital Employed per Unit Labour (K/L): This is a measure of the capital intensity of the firm, and in the TFP context, indicates the contribution of capital to total productivity per capita (Y/L). In absolute terms, Infosys has the highest amount of capital employed representing almost twice the amount that Wipro employs in 2007. The K/L ratio reflects this contrast between the two companies. Both Infosys and Wipro have the same level of workforce (around 70000), but the K/L ratio by 2007 for Infosys is much higher, making it perceptibly more capital intensive in its operations. Some may argue that for this reason Infosys appears to have the highest growth potential and could therefore deemed to be more sustaining in the long run, others may look at the consequent negative TFP growth rate and hold that that is responsible for the decreasing trend in its value added per unit labour, which is the overall productivity measure. In contrast, Wipro emerges as the clear winner in terms of positive TFP growth (49.48%) over the period 2003-2007. As for TCS, its capital employed in 2007 (Rs. 72 billion) is between the two, and its K/L on par with that of Wipro. Its TFP growth remains constant over the period 2004-07. Wage trends and Mean Salary (W/L): TCS has the largest workforce over the covered period of time (85.500, 2007), whereas Infosys and Wipro have the same level (around 70000, 2007). Wipro has the lowest mean salary level, Rs. 0.85 million (2007) although a rising trend can be seen. It can also be seen that Infosys and Wipro have managed to remarkably contain mean salary ratio over the period 2005-07 despite the sharp hikes in wages and salaries during this period. This validates the discussion in previous sections on the work force becoming younger and younger, thus dampening the effect of sharp wage hikes at senior levels. 7. Concluding Remarks

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22

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Annex Agenda For Discussion During Company Visits To facilitate an efficient interaction during our visit to your company the following anchor questions/points are listed around which discussions could focus. These are by no means exhaustive – discussions would undoubtedly bring out more insights. Having supporting data ready at hand (apart from the TFP related data solicited in the second excel sheet document) would be helpful. Wage Trends What has been the impact of the rise in salaries and wages of skilled and semi-skilled workforce in the last five years? On changes in your target market (client profile). Less clients, more preference for projects requiring higher skills? Upward changes in prices? On changes in the products and services offered (or tasks entrusted to your offshore location by your parent company headquarter) On attrition rates On HRD policies (hiring, training, employee retention measures to combat competitive body snatching etc. in the light of the acute supply-demand mismatch.) On provoking specific “economy drive” measures (not related to productivity enhancement, which are mentioned in next section), e.g restrictions on travel, changing mix of permanent and casual staff, etc. Productivity Related Issues At a crude level, one can state that wage cost escalations need to be matched with productivity (output per unit input) improvements to retain cost competitiveness. Productivity improvement could come through superior and more cost effective technology, or more efficient use of existing technology, or both: What upgradations in technology and improvements in processes have been implemented recently? Faster communication links, application of next level of software, process and cycle time improvements, six sigma etc.(Improving “capital productivity”) What measures to enhance the skills and motivation levels of the workforce have been initiated in the recent past? (“Better and faster with the same tools”). Supply side issues such as increasing I

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

labour scarcity (supply-demand mismatch) and inadequate quality of graduating engineers from regional colleges, high cost of IIT graduates etc. could be discussed here. What positive and negative externalities do you perceive that impact on company performance (role of government and its policies, business climate and culture, infrastructure issues) Competitiveness Issues How do you assess the threat of foreign competition, especially in a dynamic, evolutive, sense? What would be your strengths (tied relationships with loyal client base, English speaking staff, all that is positively perceived about India) and weaknesses (escalating wage costs, appreciating Rupee, all that is negatively perceived about India) in facing it? Strategic Options and Future Prospectives: A free ranging discussion would be appropriate. Strategies that may enter in the conversation may include looking at alternative lower cost locations (the so called second/third tier cities); performing only high value sophisticated jobs for select “star” clients to whom quality and security concerns override cost; looking outside and acquiring outsourcing facilities in other low cost economies or in those locations “nearer” to clients (geographically, linguistically, culturally); reverse offshore outsourcing to US and Europe; capital deepening (making the service less labour intensive through more capital inputs (technology, automatic processes).

II

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Sample Estimation Sheet ESTIMATING TOTAL FACTOR PRODUCTIVITY

... Company:

2003

3

%change 2004 %change ...

%change 2007/2002

Income (from operations) - A Less: All operating expenses except wages and salaries - B Value Added (A - B) = Y Work Force (no. of employees)1L Wages and Salaries2 (W)

Value Added per employee Y/L Capital Employed (net assets, book value) - K Capital per Worker - K/L Total Factor Productivity (TFP) [%changeTFP= %change Y/L %change K/L*0,3] Notes: 1. Apart from permanent employees, part time resources may also be counted with suitable co-efficient 2. From employer's perspective, i.e. include social benefits, pension contributions, bonuses etc. 3. If 2002/03 is the actual reference period, please clarify this in this footnote

III

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Total Factor Productivity (TFP) Productivity, especially labor productivity is a critical indicator of efficiency and progress, both at the macro level (GDP per capita is a good proxy) and at the firm level (output per employee). However, it should be even more vital for managers, investors and for stockholders to know why labor productivity (value added per employee) has risen, or why it has not, and its behaviour across time. Value added per employee for firms, as for countries, grows either because a) capital investment (in which technology is embodied) makes workers more productive, or b) better methods, technological processes, incentives, education level and skills, motivation, etc., makes workers more productive WITHOUT additional capital investment. This b) is the TFP factor. Without getting into complexities TFP derives its definition from the growth accounting literature in economics attributed to Solow and Swan in 1956 and then developed by many others (not entirely free of controversy!). Evidence was shown that countries grew wealthy mainly through (b), TFP. This logic would argue that growth in TFP is the critical lever for sustained growth of firms too. An example could help in understanding TFP: ABC Corporation 2004

2005

% change

Sales - Cost of Raw Materials

$110M. 30M.

$125M. 35M.

%13.6

= Value Added (Y)

80M.

90M.

12.5%

Labor (no. of employees) 400 (L)

420

Value added per employee $200000 (Y/L)

$214286

Capital Employed (K)

$35M.

$37.8M

Capital per employee (K/L)

$87500

$90000

+7.%

+2.8%

IV

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Consider the % change in value added per employee, 7%, which is the measure of labour productivity. The question is, why did labour productivity rise by 7%? Was it because of 'capital deepening' -- each worker had more capital during the year 2005 than during the year before (i.e. more software, machines, computers, IT, etc.)? Or was it because of non-capital factors, such as management, motivation, efficiency and skills, product innovation, more supportive external environment, etc. To find the answer we subtract from the %change in value added per worker (Y/L) i.e 7%, 0.3 times the %change of contribution of capital per worker (K/L), 2.8%. We are in effect removing the productivity growth caused by increased capital per worker from the total productivity growth equation: % change in TFP = 7% - 0.3*2.8% = 7% -0.84% = 6.16% The 0.3 is the 'weight' or 'contribution' of capital to value added, or the fraction of value added attributable to capital (the corresponding weight or contribution to value added of the other factor, labour, would be 0.7 assuming no economies of scale,) Conclusion: ABC Corp managed to boost its sales, production, and productivity, not so much by using costly shareholders' capital but mainly by 'free lunches' -- increasing the motivation, efficiency, and energy of workers, and the competitiveness in the marketplace of its products. Where does the 0.3 come from? Total Factor Productivity is defined as the ratio between output and a 'package' of inputs (labor and capital). The package of inputs is a geometrically weighted average. Thus: TFP = Y /[L0.7 × K0.3 ], where L is the number of employees and K is the value of the firm's capital. The exponents represent the fraction of the firm's value added contributed by labor (0.7 or 70%) and by capital (0.3 or 30%) -- taken as the general average for the services sector which is considered more labour intensive. We use the sector averages or the economy-wide average, since the data needed to compute this parameter for each firm is normally not publicly available. Unfortunately the sector averages for India are not available so we have taken the averages for other economies e.g Canada, where figures are available. A little mathematical manipulation (taking logs and differentiating across time) yields the above referred equation: % change in TFP = %change in productivity per worker – 0.3* %change in contribution of capital per worker The rate of change in TFP could thus be interpreted as the rate of change of overall productivity per worker after netting out the contribution of capital per worker in causing this overall productivity change.

V

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

EVA and TFP contrasted Economic Value Added (EVA) has become a widely used measure of firm performance. It is however criticized by some on the grounds that it measures the productivity of capital alone, measuring its return against a benchmark, cost of equity, to see if value has been created. The advantage of the TFP measure is that it takes into account both labour and capital in measuring productivity. This could be more meaningful for firms operating in economic sectors (like IT related services) where human resources play a key role in driving performance. However it would be unwise to abandon one measure favouring the other. Juxtaposing both tools side by side may lead to more insights. For example strong EVA and negative TFP may lead to reflections whether economic value is being created in the short term but managerial performance shows scope for improvement (for long term sustainability). The opposite may be the case where TFP growth is robust but shareholders are not happy with the returns to their capital. Thus it would be best if firms use both the EVA and TFP tools, with plenty of “footnotes” in their calculation sheets to explain deviations in particular years that neither of these tools can properly capture (e.g. .abnormally high investment periods requiring long gestation or surges in fresh recruitment that will yield output in later years but will depress TFP in the short term).

VI

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Company Specific Estimation Sheets INFOSYS ESTIMATING TOTAL FACTOR PRODUCTIVITY 3

Company :Infosys

Yr.ending March 31,

Fig in Rs. Million

2004

%chg

2005

%chg

2006

%chg

2007

Income (from operations) - A

36.540,00

47.860,00

30,98%

72.540,00

51,57%

95.210,00

31,25%

138.930,00

45,92%

280,21%

Less: All operating expenses except wages and salaries - B

6.040,00

6.020,00

-0,33%

12.010,00

99,50%

16.700,00

39,05%

23.920,00

43,23%

296,03%

Value Added (A - B) = Y

30.500,00

41.840,00

37,18%

60.530,00

44,67%

78.510,00

29,70%

115.010,00

46,49%

277,08%

Work Force (no. of employees)1- L

15.876,00

25.634,00

61,46%

36.750,00

43,36%

52.715,00

43,44%

72.241,00

37,04%

355,03%

Wages and Salaries2 (W)

16.400,00

23.770,00

44,94%

35.390,00

48,89%

48.010,00

35,66%

71.120,00

48,14%

333,66%

Mean Salary (W/L)

1,03

0,93

-10,23%

0,96

3,85%

0,91

-5,43%

0,98

8,10%

-4,70%

Value Added per employee - Y/L

1,92

1,63

-15,04%

1,65

0,91%

1,49

-9,58%

1,59

6,90%

-17,13%

24.930,00

31.250,00

25,35%

43.310,00

38,59%

61.770,00

42,62%

91.470,00

48,08%

266,91%

1,57

1,22

-22,37%

1,18

-3,33%

1,17

-0,57%

1,27

8,06%

-19,37%

4,48%

-11,32%

Capital Employed (net assets, book value) - K Capital per Worker - K/L Total Factor Productivity (TFP) [%changeTFP= %change Y/L - %change K/L*0,3]

-8,33%

1,91%

-9,41%

%chg

%chg 2007/2003

2003

Notes: 1. Apart from permanent employees, part time resources may also be counted with suitable co-efficient 2. From employer's perspective, i.e. include social benefits, pension contributions, bonuses etc. 3. May be left blank if anonymity preferred

Source: Data extracted from annual reports and website information. Figures not verified by company.

VII

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Tata Consulting Services ESTIMATING TOTAL FACTOR PRODUCTIVITY Company3:TCS

Yr.ending March 31,

Income (from operations) - A

Fig in Rs. Million

2003

2004

%chg

2005

%chg

2006

%chg

2007

%chg

55.178,60

71.227,30

29,09%

97.272,00

36,57%

132.454,00

36,17%

186.332,00

40,68%

%chg 2007/2004 161,60%

Less: All operating expenses except wages and salaries - B

16.240,00

19.929,00

22,72%

29.320,00

47,12%

38.372,00

30,87%

Value Added (A - B) = Y

54.987,00

77.343,00

40,66%

103.134,00

33,35%

147.965,00

43,47%

169,09%

Work Force (no. of employees)1- L

30.121,00

40.992,00

36,09%

62.832,00

53,28%

85.582,00

36,21%

184,13%

Wages and Salaries2 (W)

36.738,00

50.939,00

38,65%

69.239,00

35,93%

101.515,00

46,62%

176,32%

Mean Salary (W/L)

1,22

1,24

1,88%

1,10

-11,32%

1,19

7,64%

-2,75%

Value Added per employee - Y/L

1,83

1,89

3,35%

1,64

-13,00%

1,73

5,33%

-5,29%

31.910,00

32.090,00

0,56%

48.650,00

51,60%

72.220,00

48,45%

126,32%

8,99%

-20,34%

2,64%

0,81%

Capital Employed (net assets, book value) - K Capital per Worker - K/L Total Factor Productivity (TFP) [%changeTFP= %change Y/L - %change K/L*0,3]

0,78 -26,11%

1,06 0,00%

11,19%

0,77

-1,09% -12,68%

0,84

136,28%

Notes: 1. Apart from permanent employees, part time resources may also be counted with suitable co-efficient 2. From employer's perspective, i.e. include social benefits, pension contributions, bonuses etc. 3. May be left blank if anonymity preferred Special Note: Figures extracted buy authors from public documents (annual reports, "results" for various quarters) in the TCS website www.tcs.com) as company declined to furnish data

Source: Data extracted from annual reports and website information. Figures not verified by company.

VIII

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Wipro ESTIMATING TOTAL FACTOR PRODUCTIVITY Company3: WIPRO

Yr.ending March 31,

2003

2004

%chg

2005

%chg

Fig in Rs Million

2006

%chg

2007

%chg 2007/2003

%chg

Income (from operations) - A

39.848,17

51.326,81

28,81%

72.331,61

40,92%

102.271,17

41,39%

136.839,00

33,80%

243,40%

Less: All operating expenses except wages and salaries - B

24.972,37

33.094,48

32,52%

26.855,70

-18,85%

37.569,38

39,89%

49.450,55

31,62%

98,02%

Value Added (A - B) = Y

14.875,80

18.232,32

22,56%

45.475,91

149,42%

64.701,79

42,28%

87.388,45

35,06%

487,45%

Work Force (no. of employees)1- L

18.580,00

28.502,00

53,40%

41.857,00

46,86%

53.742,00

28,39%

67.818,00

26,19%

265,01%

6.424,70

8.644,41

34,55%

28.785,34

232,99%

42.790,25

48,65%

57.681,93

34,80%

797,82%

Mean Salary (W/L)

0,35

0,30

-12,29%

0,69

126,75%

0,80

15,78%

0,85

6,82%

145,97%

Value Added per employee - Y/L

0,80

0,64

-20,10%

1,09

69,84%

1,20

10,81%

1,29

7,03%

60,94%

11.206,92

19.290,66

72,13%

20.643,73

7,01%

31.953,00

54,78%

56.535,00

76,93%

404,47%

0,60

0,68

12,21%

0,49

-27,13%

0,59

20,55%

0,83

40,21%

38,21%

-5,03%

49,48%

Wages and Salaries2 (W)

Capital Employed (net assets, book value) - K Capital per Worker - K/L Total Factor Productivity (TFP) [%changeTFP= %change Y/L - %change K/L*0,3]

-23,77%

77,98%

4,65%

Notes: 1. Apart from permanent employees, part time resources may also be counted with suitable co-efficient 2. From employer's perspective, i.e. include social benefits, pension contributions, bonuses etc. 3. May be left blank if anonymity preferred

Source: Data provide by company.

IX

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Metacube ESTIMATING TOTAL FACTOR PRODUCTIVITY Company4: Metacube

Yr.ending March 31,

2003

2004

%chg

2005

%chg

Fig in Rs Million

2006

%chg

2007

%chg

%chg 2007/2005

Income (from operations) - A

8,06

29,53

266,50%

83,83

183,85%

940,30%

Less: All operating expenses except wages and salaries - B

1,98

7,50

277,77%

14,14

88,53%

612,22%

Value Added (A - B) = Y

6,07

22,04

262,81%

69,70

216,29%

1047,52%

Work Force (no. of employees)1- L

33,00

82,00

148,48%

133,00

62,20%

303,03%

Wages and Salaries2 (W)

2,88

12,33

328,79%

38,67

213,59%

1244,63%

Mean Salary (W/L)

0,09

0,15

72,56%

0,29

93,34%

233,63%

Value Added per employee - Y/L

0,18

0,27

46,01%

0,52

95,00%

184,72%

Capital Employed (net assets, book value) - K

5,27

17,55

233,08%

51,65

194,27%

880,15%

Capital per Worker - K/L

0,16

0,21

34,04%

0,39

81,43%

143,19%

-1,452

-5,077

35,80%

-15,127

70,58%

141,76%

Total Factor Productivity (TFP) [%changeTFP= %change Y/L - %change K/L*0,3] Notes: 1. Apart from permanent employees, part time resources may also be counted with suitable co-efficient 2. From employer's perspective, i.e. include social benefits, pension contributions, bonuses etc. 3. May be left blank if anonymity preferred

Source: Data provided by company.

X

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

Alcatel-Lucent ESTIMATING TOTAL FACTOR PRODUCTIVITY Company4: Alcatel India

Yr.ending March 31,

Fig in Rs Million

2003

%chg

2004

%chg

2005

%chg

2006

Income (from operations) - A

279,80

380,00

35,81%

754,00

98,42%

1.510,00

100,27%

2.323,00

53,84%

730,24%

Less: All operating expenses except wages and salaries - B

133,00

156,00

17,29%

402,00

157,69%

784,00

95,02%

1.129,00

44,01%

748,87%

Value Added (A - B) = Y

146,80

224,00

52,59%

352,00

57,14%

726,00

106,25%

1.194,00

64,46%

713,35%

Work Force (no. of employees)1- L

257,00

358,00

39,30%

758,00

111,73%

779,00

2,77%

1.173,00

50,58%

356,42%

Wages and Salaries2 (W)

96,40

94,00

-2,49%

264,00

180,85%

554,00

109,85%

894,00

61,37%

827,39%

Mean Salary (W/L)

0,38

0,26

-30,00%

0,35

32,64%

0,71

104,19%

0,76

7,17%

103,19%

Value Added per employee - Y/L

0,57

0,63

9,54%

0,46

-25,78%

0,93

100,69%

1,02

9,22%

78,20%

227,90

395,00

73,32%

846,00

114,18%

1.215,00

43,62%

1.746,00

43,70%

666,13%

0,89

1,10

24,42%

1,12

1,15%

1,56

39,75%

1,49

-4,57%

67,86%

10,59%

57,85%

Capital Employed (net assets, book value) - K Capital per Worker - K/L Total Factor Productivity (TFP) [%changeTFP= %change Y/L - %change K/L*0,3]

2,21%

-26,13%

88,77%

%chg

%chg 2006/2002

2002

Source: Data provide by company

XI

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

AXIS IT&T ESTIMATING TOTAL FACTOR PRODUCTIVITY Company3: AXIS ITT

Yr.ending March 31,

Fig in Rs Million

2004

%chg

2005

%chg

2006

%chg

2007

Income (from operations) - A

94,85

28,93

-69,50%

16,18

-44,06%

40,51

150,36%

55,36

36,64%

242,10%

Less: All operating expenses except wages and salaries - B

55,37

12,57

-77,29%

4,67

-62,83%

5,65

20,99%

13,00

129,85%

178,11%

Value Added (A - B) = Y

39,48

16,36

-58,57%

11,51

-29,63%

34,86

202,88%

42,36

21,52%

268,08%

Work Force (no. of employees)1- L

354,00

29,00

-91,81%

45,00

55,17%

83,00

84,44%

133,00

60,24%

195,56%

Wages and Salaries2 (W)

62,79

15,71

-74,98%

13,89

-11,57%

27,24

96,08%

40,88

50,07%

194,25%

Mean Salary (W/L)

0,18

0,54

205,42%

0,31

-43,01%

0,33

6,31%

0,31

-6,35%

-0,44%

Value Added per employee - Y/L

0,11

0,56

405,73%

0,26

-54,65%

0,42

64,21%

0,32

-24,16%

24,54%

259,63

189,12

-27,16%

187,49

-0,86%

208,13

11,01%

200,45

-3,69%

6,91%

0,73

6,52

789,17%

4,17

-36,11%

2,51

-39,82%

1,51

-39,90%

-63,83%

-12,19%

43,69%

Capital Employed (net assets, book value) - K Capital per Worker - K/L Total Factor Productivity (TFP) [%changeTFP= %change Y/L - %change K/L*0,3]

168,98%

-43,82%

76,16%

%chg

%chg 2007/2005

2003

Notes: 1. Apart from permanent employees, part time resources may also be counted with suitable co-efficient 2. From employer's perspective, i.e. include social benefits, pension contributions, bonuses etc. 3. May be left blank if anonymity preferred

Source: Data provide by company

XII

Productivity of India‟s Offshore Outsourcing Sector: The TFP Approach

XIII