The history of outsourcing to India is one of rapid growth and transformation. Manufacturing outsourcing, the import and export of products, goes back to almost the start of recorded history, but the extension to services is a relatively new phenomenon. Services outsourcing started in India in the mid 1980s and rapidly accelerated in the 1990s.

The internet and telecommunications booms of the late 1990s had a twofold impact on offshore outsourcing. First, the new telecommunication infrastructure significantly reduced the cost and risk of working with distant colleagues. Second, the demand for technical services exploded with fears of the Y2K bug and the internet bubble. Western firms now had both the ability to go offshore and a huge demand for new talent.

With a large, English speaking, low cost workforce, India was well positioned to take advantage of the trend and the sector has been growing at astronomical rates. The first part of this decade saw growth of 40-50% and the Indian outsourcing sector is now approaching revenue of $30 billion. Recent wage inflation and the global financial crisis are putting a dent in this years growth numbers, but the industry is still expected to post double digit growth in 2008 and 2009. Run away growth may be slowing but the Indian outsourcing sector will continue to expand for years to come.

Drivers of Offshore Outsourcing

The modern services offshoring trend was first enabled by progress in telecommunications in the second half of the 20th century. Prior to low cost telecommunications and the internet, managing services in distant locations was too costly, difficult, and risky. Well trained low-cost workers were available in the global market, but western managers did not have the tools to effectively tap into the resources. During the 1980s it began to change. Modern conveniences such as inexpensive telecommunications and air travel, and rise of the personal computer and internet completely transformed the cost-benefit equation.

The second key piece of enabling infrastructure was new thinking about corporate organization. Historically, most large companies tended to manage most activities in house. In the 19th century, firms focused on vertical integration for economies of scale. In the first part of the 20th century firms used vertical integration to secure inputs and reduce costs of interacting with suppliers. However, the concept of vertical integration lost its luster in the 1980s, and in 1990 C. K. Prahalad and Gary Hamel published the Core Competence of the Corporation.

Prahalad & Hamel defined a core competency as “an area of specialized expertise that is the result of harmonizing complex streams of technology and work activity.” Others have built on this definition and indentified core competencies as the key capabilities that strategically different companies and drive much of their value. The practical outcome of focusing on core competencies has been an acceleration of outsourcing. Firms want to focus on what they do best and outsource undifferentiated activities.

Outsourcing has two key benefits. First, it frees a firm to focus on where they best add value. Second, companies gain the benefits of working with a best in class partner that is focused on the outsourced activity. Jack Welch, long-time CEO of GE, is often quoted as stating he is happy to turn over his back office activities (i.e. non core) to partners where it is a front office activity (i..e. core).

Enabling Indian History

India’s basic demographics and history positioned it well to take advantage of the new global services market. The seeds were planted early with the annexation of much of the subcontinent by the British East India Company in the 18th century. While colonization had many evils, the act bound together a number of previously independent nations and thus set the foundation of a massive national economy. Second, British colonization brought the English language, which has become the global language of business and a huge advantage to Indian firms.

At the start of the 19th century, India had one of the largest economies in the world, second only to China. However, over the coming years the economy stagnated while others grew. In 1947 the subcontinent achieved independence from the British and was partitioned into India and Pakistan. Partition triggered significant turmoil and dislocation which helped drive the Indian economy to a low point in 1952 when it was approximately 7% of the size of the US.

The post independence period has had its economic ups and downs. In the decades immediately after independence the Indian state exerted significant control over the economy. It was not the extreme style of the Soviet economy, but nevertheless constrained growth. By the late 1980s the government started easing restrictions and liberalizing the economy and since 1990, the country has seen rapid economic growth typically in the 7-8% range.

The education system also played a key roll in developing the skilled workforce required to capitalize on the wave of offshore outsourcing. India has a long history of organized education that goes back thousands of years. Prior to the British, India had a well developed region system. Much of this was uprooted and replace with a more western structure and content. While much was lost in the transition, India emerged with a world class set of universities including the famous India Institutes of Technology (IIT). While producing a limited number of graduates, IIT is considered one of the top technical universities in the world and by some metrics, the most difficult to get into.

Key Outsourcing Events

Pinpointing the exact start of the offshore outsourcing industry in India is an art, but is generally recognized as starting in the 1980s. British Airways and other global airlines started conducting back office operations in New Delhi in the mid 1980s. They were quickly joined by firms like American Express that consolidated regional back office operations. In 1985, Texas Instruments set up the first multinational technical design center in Bangalore.

In 1989 Jack Welch, CEO of General Electric, visited India and was awed by the opportunity. GE already had significant operations in India, but they were largely focused on the Indian market. Welch’s visit triggered a rapid growth of captive services for non Indian operations and the start of the first large offshore operation in India.

By the late 1990s, fears of the Y2K bug and the internet boom drove demand for IT services. At the same time, the telecom bubble drove investment in fiber optic infrastructure which helped drive up communications quality and drive down cost. Ironically, the following telecom & internet bust in 2001-2003 also drove growth in offshoring to India. The big push in the 1990s was to find resources at any cost, but now western firms were looking to cut costs and offshoring to India was a great cost saving opportunity.

The following years have seen continued rapid growth. Infosys, one of the largest Indian outsourcing firms, is a great case study. Infosys passed the $1 billion revenue mark in the middle of the decade and they are closing in on $5 billion. Infosys revenue growth for the last fiscal year ending in March 2008 was a torrid 35%. The current global economic down turn is having an impact, but Infosys is still projecting 16-18% growth this fiscal year. Outsourcing in India is taking a hit, but is here to stay.