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In the global services industry, cost benchmarking is a method enterprises use to compare their outsourcing cost competitiveness against those of similar organizations. Yet, in Everest Group’s experience and observations, businesses all too often erroneously view salary benchmarking as indicative of overall expenditures.
While salaries constitute the biggest component (60-70 percent) of operating costs, salary benchmarks fall short of providing the requisite insights, as higher salaries don’t necessarily mean higher overall costs. There are multiple other factors driving costs. The top three factors driving outsourcing operating costs, other than salaries, are:
These factors are specific to companies’ context and typically depend on their positioning. In addition, there are market-driven forces impacting costs, such as attrition, wage inflation, and the exchange rate in different countries.
A typical benchmarking exercise takes all these factors, and others, into consideration.
Following are three cost benchmarking best practices.
Cost benchmarking should consider a comprehensive set of factors effecting cost. Everest Group classifies these components into three broad buckets:
An ideal cost benchmarking takes a holistic view across all three categories.
By definition, cost benchmarking determines differences within the market. However, on their own, these differences offer limited insights. To discover opportunity areas for cost optimization and subsequent calibration, enterprises need to identify the underlying drivers of differences.
For example, if an organization’s real estate costs are higher than the market average, benchmarking should identify whether it is due to rentals, space per seat, seat utilization, or a combination of these factors. Similarly, for companies with higher support staff costs, benchmarking should identify if it is driven by higher support staff salaries, skewed support staff ratios, or both. There are multiple such costs elements (e.g., transportation, recruitment, training) for which benchmarking could help identify the underlying drivers for calibration.
Even in situations where cost drivers are identified, it is critical to ensure like-to-like comparisons in order to derive meaningful conclusions. For illustration, in the real estate example above, economies of scale can result in different real estate costs for a 100 seat center and a 1,000 seat center.
Thus, organizations should normalize data along key dimensions impacting the cost. Typical dimensions to normalize include:
Cost benchmarking is not an easy, close your eyes and toss the dart exercise. Benchmarking that fails to take a comprehensive view of cost, identify underlying drivers, and normalize data runs the risk of making misleading comparisons that may lead to flawed results.
After several years of believing that discretionary spend would come back into the marketplace, it appears that we are, in fact, experiencing an uptick. This increase in demand is definitely welcome after recent years of suppressed demand.
The question is: How long will this trend continue and will we move back to the heady growth of days of yore?
The answer is yes and no. Yes, the growth trend is likely to continue. We seem to have an improving economic condition in both North America and Europe for both structural outsourcing as well as discretionary spend. I think we can look forward to modestly improved growth rates.
However, we need to remember that we’re at a very different level of market saturation for outsourcing services than we were five years ago. It seems unlikely that the market will return to the 20+ percent growth rates. I think what we’re looking at today is a small increase in growth, not a large one.
Having said that, let’s take what we can get and celebrate! As the French Mardi Gras saying goes, let the good times roll — but not to the point that we wake up with a reality hangover.
Related: See our latest thought leadership on GICs
When we began conducting webinars for Market Vista when it was launched in 2008, one of the most common questions we received during webinars was “what is a captive?” I even recall one attendee leaving me a voicemail within 10 minutes of a webinar concluding that basically said, “You guys suck because I can’t understand what you mean by ‘captive’ – isn’t it just a shared service center?”
In recent times, I am less frequently asked to explain what “captive” means and, in fact, generally find that most industry insiders all understand and use the term clearly.
So what explains our decision to stop using “captive” and instead use “Global In-house Center” or “GIC”?
Have bath salt-inspired zombies eaten our brains? Do we strangely enjoy having to invest 5 minutes defining terms simply so that people can understand what we are talking about? Or are we just desperate for topics for our blogs?
Nope. None of those.
We did it for the children. (Insert ohhhh and ahhhh here.)
The image of the slide below explains the full rationale for the change and you should be prepared to see it A LOT – in webinars, reports, conference presentations, etc.
Yes, we know that “captive” is easy to write and say. It has many things going for it.
However, it is a poor word. Quite simply, does anyone associated with a “captive” want to refer to it as a “captive”? Does any bright-eyed recent college graduate run home excitedly yelling “Mom and Dad – I got a job at the captive!” Does the word “captive” inspire anyone, or is it a negative-tinged and off-putting word? Is this really a helpful word to be using 5, 10, or 20 years from now?
As we were contemplating this potential change, I asked a number of my contacts how their organizations refer to internal delivery center organizations. None of them use the term “captive.” Further, all found that they had to explain what “captive” meant to new business users becoming more involved with global services. It is simply not a term that was widely adopted by the people it is intended to describe. In my mind, clearly it is a poor word.
The only arguments for keeping it are inertia and laziness. If we want to find something better, we have to get started at some point, and we agree with Nasscom (India) and BPAP (Philippines) that point is now. And tomorrow. And next month. And next quarter. And next year. And…well, you get the idea.
So we enter a long and painful process of using and advocating for Global In-house Center (or GIC – “Gee-Eye-Sea”) to replace captive. And it will be a journey with lots of opportunity to annoy and “correct” people.
Is “Global In-House Center” (GIC) any better? My view is that it is a good alternative simply because it does not try to go beyond the facts while also being clear. It avoids the temptation to “judge” these centers by referring to them as “innovation hubs,” “Centers-of Excellence,” or other terms that may match intent in some cases but are not clearly and universally true. Global In-house Center is largely self-defining – “in-house” pretty much gets the point across. “Global” hints at geography but gives room to expand the application (All business units? All locations?).
But we do have to learn a new acronym – GIC. Global In-house Center is a mouthful and will have to be regularly shortened to GIC. But we are all pretty good at learning acronyms…so add it to the list. GIC…and ERP, O2C, ITO, BPO, FAO, HRO, CRM, SCM, ITIL, COLA, CAGR, ROI, TCO, MSA, SOW, and more…
In our last Market Vista webinar, we asked the audience to share its perspective on what is likely to happen with offshore demand as the election season in the United States concludes. As shown in the poll results below, few expect much to change after the election season – the votes are tightly clustered around slight change or no change.
Although the results are consistent with my own personal view, it is certainly in contrast to the number of times I am asked about this topic by the media and other industry observers.
So why is there more noise than substance? Why does the global services market see the political rhetoric as largely irrelevant?
Three fundamental facts largely explain it:
Stepping back, we must bear in mind that politicians are typically speaking to their audience through mass media and messaging accordingly. In other words, what we hear is dumbed down and intended to grab emotions and headlines. However, outside of the noisy rhetoric, top politicians and policy makers do understand the fundamental forces shaping the U.S. and global economies and are unlikely to meaningfully influence the evolution of global services and associated offshoring – regardless of whether Obama or Romney wins the U.S. presidential election.
A recent article in BusinessWeek, Argentina Tries the Chavez Way, triggered my thinking about the increased role of geopolitical risk in location selection and overall risk mitigation. In the last decade, Argentina became the “darling” of global services given considerably lower resource prices than in neighboring Brazil, a stable society with deeply rooted democratic principles, etc. But the country’s geopolitical risk profile substantially changed recently. Its economy has stagnated from defaulting on its national debt, pseudo-populist movement groups are promising “quick and easy” fixes to the existing problems, and the trend of nationalizing privately owned businesses is expected to continue, given the views of the current political leadership. None of this yet puts Argentina’s geopolitical risk profile outside of the acceptable range. But we’ve seen from examples around the world that, in the absence of more efficient measures, it may be very tempting for a government to divert public attention from internal problems to some newly introduced external threat. For instance, consider what would happen to the country’s business environment if something similar to the almost forgotten conflict over the Falkland Islands suddenly escalated.
Now think about Colombia, whose geopolitical risk is moving in the opposite direction. While 15 years ago it couldn’t have bought a place on the global services location map, for the last two years its stock market gained an impressive ~50 percent due to various successful measures against FARC, drug cartels and other instability factors. Now, BPO and IT delivery centers are mushrooming in Colombia, driven by an abundance of relatively inexpensive but highly qualified labor resources. Given the large size of the young population in Colombia, as well as steady adherence to open market principles, it is believed the country will continue gaining attractiveness as a global services hub. And it is already considered the second largest IT services market in Latin America.
The point of this blog is not to discuss specific country’s risk profiles, but rather to remind readers that such wild swings must be factored into location analyses, similar to how attorneys approach terms and conditions from a worst-case scenario.
Although labor arbitrage was the primary driver – and continues to be important – in offshoring location decisions, typical global firms are becoming increasingly ready to exploit economies of scale. If a company’s offshore delivery is currently split among several locations – say, Argentina, Philippines, and Romania, each serving a respective region – it is quite tempting to consider some consolidation initiative through formation of a mega-large shared services center, and that’s where increased exposure to specific location risk kicks in as a decision factor.
Obviously, increased volatility in geopolitical risk is just one of many aspects an organization should factor into cost/benefit analysis, and the analysis must be tailored to each organization’s specific situation. That said, here are several general thoughts to consider:
For those tracking the global service market, reports of 10-15% salary increases in low-cost countries is almost expected. For executive management not familiar with the offshoring of services, seeing these headlines in the business press is unnerving.
But should it be?
I am not arguing that wage inflation in low-cost countries is equal or lower to high-cost countries, but it is clear to me that those in high-cost countries significantly lack perspective on how to interpret these numbers.
(For a more comprehensive perspective, checkout our webinar on labor arbitrage sustainability or our recent joint study with NASSCOM on Global In-house Center (GIC) cost competitiveness.)
Let’s start with a simple exercise (yes, you can count this towards your daily mental fitness goals).
First, recall your starting salary out of college.
Second, recall your salary in the fifth year of being in the work force (the fifth year is fourth salary increase if you received increases annually). If your salary changed currencies or you jumped to business school, you are disqualified from further playing this game.
Two numbers…now divide the fifth year salary by the first year to get a ratio (this should be greater than 1.0 and generally less than 3.0).
Now compare against the table below to get the annual percent increase in your salary across those five years. For example, if the ratio is 1.5, then the average annual increase was 10.7%.
| Ratio | Annual % increase |
| 1.00 | 0% |
| 1.25 | 5.7% |
| 1.50 | 10.7% |
| 1.75 | 15.0% |
| 2.00 | 18.9% |
| 2.25 | 22.5% |
| 2.50 | 25.7% |
Most people find the annual percent to be higher than they expected. And often surprisingly close to the typical reported increase in offshore salaries.
Why? The perspective that most people miss is that the growth in salary for an individual is different than pure salary inflation. Salary growth of an individual reflects both pure salary inflation (what an entry-level developer will earn) and the impact of their career progression (being able to deliver more value). In other words, salary growth also reflects being paid more for playing a slightly more valuable role – even if that does not include a formal promotion.
This picture becomes even more skewed if you consider total compensation (salary and bonus), which tends to grow even faster early in a career.
Many of you are probably now thinking, “Wait, my salary has not been growing that fast recently!”
True – and salary growth in percentage terms slows as individuals reach 10, 15, and 20 years into their careers. Much of the growth in salary in the early portions of the career is due to steady progression in being able to play a more valuable role – taking greater ownership, requiring less quality review, increasing domain knowledge, and other factors. But the benefit of further increasing these skills diminishes beyond a certain point, and salary growth is then predicated on other factors such as impact, leadership, and overall labor market rates for fully developed skills.
These same things are at play in offshore labor markets and much of the labor force is in the first 5-10 years of their careers due to the labor pyramid – so much of the workforce should be seeing “high” salary increases. At more senior roles, salary increases tend to moderate on a percentage basis.
Give this exercise to others – and potentially to that executive who feels 10% salary inflation is far different than what happens in the United States.
Tuesday, October 18, 2011 | 9:00 AM CDT
Global sourcing is a well established phenomenon. The industry has witnessed rapid growth over the past decade, and has now exceeded US$110 billion in annual revenues. The key growth drivers have predominantly been the opportunity for labor arbitrage and the availability of skilled talent pools in offshore locations.
However, given increasing cost pressures in leading offshore markets, such as India and the Philippines, companies are questioning the sustainability of the offshore proposition. In addition, fluctuating currencies are posing challenges to the predictability of arbitrage in many locations, such as Poland and Brazil.
With these dramatic changes in market dynamics, global organizations must take an integrated, multi-location portfolio view in assessing the sustainability of their global services programs.
Everest Group invites you to join us for an insightful, one-hour webinar that will answer the following questions:
Webinar attendees will receive a complimentary arbitrage sustainability diagnostic assessment for three countries from an extensive list including Brazil, China, India, the Philippines, South Africa and more. Please select your preferred countries during the registration process. An Everest Group analyst will supply you with your individualized assessment within two weeks of the webinar. You must attend the event to receive the complimentary assessment.
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