IT IS 8 A.M IN CALIFORNIA. ABOUT 200,000 knowledge professionals in India are still at work either answering customer calls from the U.S. or processing a transaction for a U.S. client. In the next five years, it is likely that one million more professionals will join their ranks. While the professionals are at work, their bosses are busy signing up deals. Currently deals worth $1.5 billion are being negotiated by the top 20 Business Process Outsourcing (BPO) providers. What does this say of an industry that is less than five years old?

In the last four years the IT Enabled Services (ITES)-BPO segment in India has grown from $565 million to $2.5 billion. Nasscom and McKinsey expect that this number will increase to $21-24 billion by 2008. McKinsey estimates that the internal business processes of global companies account to $3 trillion, of which only 5 percent is outsourced. And it this 5 percent market that has Indian companies jostling for, of which India has a market share of just 2 percent. The global top five service providers, however, enjoy 18-36 percent. Even as Indian companies gear up to provide BPO services, multinationals like Amex, GE Capital, Citibank, HSBC, AOL and Standard Chartered, Dell, Hewlett- Packard, Accenture, EDS, PwC (IBM) and Convergys have already set up captive centers in India for BPO.

Each of these is a success story in itself. Take for instance Accenture. The company’s revenue grew 2 percent from $11.4b in 2001 to $11.6b in 2002. Of this, revenues from BPO, which stood at 17 percent in 2001, grew by 50 percent. Today, 25 percent of Accenture’s revenue comes from BPO. From its success in India, the company has aggressive expansion plans. It will be increasing its workforce from the present 1000 to 2500 by 2004. What does it mean to the industry as a whole?

More companies are going to set up captive centers or outsource their business process to Indian vendors. “Every customer we know that has outsourced offshore is satisfied and wants to look at other services that the vendor can offer them. That is essentially BPO. If there are cost savings, risk mitigation and value-add, they will be happy to start experimenting with BPO,” says Rita Terdiman, Vice Pesident, Gartner.

“Customers, today, are moving from tactical to strategic outsourcing," says Noshir Kaka, Principal at McKinsey & Co. The decision making process, which took place at business heads and IT managers level, now take place at the board level. At the same time there is shift from project/activity based decisions to organization-wide decisions. It is great news to India because it means higher revenues and more demand for third party Indian vendors. But on the other hand it means that Indian BPO players have to demonstrate vendor maturity.

And indeed, vendor maturity is the crux of the issue. “Vendors need to showcase their ability to take up entire processes. For instance, instead of saying they handle inbound and outbound calls, they need to demonstrate how they can deliver business value by taking over the entire gamut of customer selection, customer acquisition, customer retention, and customer extension. They need to evolve their capabilities to higher levels,” says Ravindra Datar, Principal Analyst, BPO - Asia Pacific, Gartner.

“As vendors acquire new capabilities, they need to understand that the labor arbitrage game is far from over. We believe labor arbitrage is getting commoditized. Now, how can you compete in a market that is essentially commoditizing your biggest advantage?” questions Kaka. Does this mean the BPO boom in India will be short-lived? Kaka believes that even at a commoditized rate, vendors can make 30 percent margin with capital efficiencies. Vendors need to put multiple capabilities on the table if they have to remain in the game. They have to choose their niches carefully and create efficiencies in them.

End-game models
It may sound absurd to talk about end-game models in an industry that is still emerging. But in reality, the Indian players have to get their act right if they have to compete in this space. According to McKinsey, Indian third-party service providers follow replication-based execution and activity-focused model that may not be sustainable. It could be best characterized as an offshore based replication of onsite or onshore activities.

The U.S. call centers have gone out of business because their execution model was not sustainable. However, one or two players like Convergys made the transition to a more sustainable model. Indian players should do just that, he says. How do they leapfrog to superior models? First, deciding where to compete. From focusing on a single activity (HR, finance and accounting) Indian players have to diversify into end-to-end processes or multiple processes and functions, in order to succeed.

Second, how to compete? “Replication by itself offers very little benefit. If done onshore, as done by call centers in the U.S., the benefits are less compared to the same service being offered from an offshore location like India. In an offshore model, the companies can enjoy the initial band of labor arbitrage. However, the sweep of labor arbitrage will not last longer because the speed at which the industry is ramping up indicates that it is getting commodotized,” says Ramesh Venkataraman, another partner at McKinsey & Co.

Datar concurs with this view. He says, “Most Indian companies are still in the ‘Task’ game and there are miles to go before getting into the ‘Strategic Partner’ seat. The Indian industry is mid-way through the proving phase and have to move from using pure labor arbitrage-based cost savings to building more value into their offerings where the pricing will be more value-based and less cost-based.”

In a custom-based execution model, the service provider needs to innovate, automate and reengineer business processes over the lifecycle of the customer relationship. For example, Exult provides its clients a custom solution based around its proprietary insight into HR processes. This is quite different from what ADP does. Based on its proprietary approach for payroll processing, ADP has built a platform to which all its customer processes are migrated. In most of the cases, it turns out that the custom or platform solutions are better than the way customers execute their processes! So in a custom-based or platform-based model, the service provider has technology capabilities that are superior typically to what most Indian companies are offering today.

The Indian Model
Indian companies have to choose the model based on their capabilities. They have to look at what kinds of processes are being offshored within customer segments they are focused on.

What Indian players should understand is that key success factors for each model are different. One of the reasons for the success of Accenture is its broad set of processes and functions. Exult’s success is due to its deep functional HR knowledge. Platform-based players like ADP or FiServ have built a platform that reflects years of learning that helps them offer the best-in-class processes for a vast majority of companies.

According to McKinsey, the potential end-game model for Indian call centers and pure play BPO providers is similar to what Convergys and ACS have successfully executed.The BPO industry may see some major changes in business models not just in India but at a global level.

“The industry is still in an evolutionary phase,” says Datar, “and it will be hard to pin-point any one model as the winning model. However the general direction is towards packing more strategic value into competitive differentiation and focus on core competency. There is a trend towards verticalization while there are many vendors that are focusing on process expertise across verticals. All of these models will survive and co-exist since there will be demand for all kinds of offerings.” Whichever end game model the Indian players choose requires a significant transformation from where they are today. They need to change both their delivery and business development models, says Venkataraman.

The evolution of BPO is not over yet. If anything, this is just the end of the beginning. The real BPO wave is yet to unfold in India.