A common critique of offshore outsourcing is that wage inflation in India is quickly shrinking the value of labor arbitrage. However, this analysis is based on three myths:
- Myth #1: All Indian IT Wage Levels are Going Up at a Dramatic Pace
- Myth #2: Increased wages in India translate directly to increased costs for U.S. buyers of IT services
- Myth #3: The cost savings from labor arbitrage in India will be lost in the very near future
This post exposes the flaws in the first myth and explains how outsourcing professionals can leverage the truth to improve decision making and negotiations. Future posts, will explore Myths #2 and #3.
Myth #1: All Indian IT Wage Levels are Going Up at a Dramatic Pace
In 2011, AON Hewitt reported that overall wages in the Indian IT industry grew by 12 percent and projected increases of 12 – 15 percent for the next year. fn1 Anecdotally, many buyers of India-based IT services, whether in-house or outsourced, reported compensation increases of 15 – 20 percent for individual Indian employees in their teams. These are dramatic numbers that global services managers cannot ignore, but the discrepancy between overall wage increases and individual salary raises highlights two aspects of Indian IT employee compensation that IT services buyers need to understand.
Reality: Entry-level IT wages have been stable for the past three years
While there’s been extensive news coverage of wage inflation in Indian IT services, one key piece of data has not received as much attention: Entry level wages are not going up. In fact, wages for “freshers” (the term for Indian employees in their first year or “freshly” out of college or engineering programs) have been stable for the past three years, at 3 lakh rupees (about US$5,700 at an exchange rate of 53 Indian rupees to the U.S. dollar).
Furthermore, there’s reason to believe that this stability in entry-level wages is likely to continue. Demand for IT employees continues to grow, but according to NASSCOM, the pool from which Indian IT employers are recruiting is also expanding.fn2 The number of technology graduates in India continues to increase year over year, and the large technology employers are recruiting from more schools in more locations, including tier II, tier III and rural locations in India. As long as young Indians continue to favor IT services jobs upon graduation, there is little reason for IT services companies to increase starting salaries. India-based companies are also expanding their international locations, and using them for both low cost offshore labor sources and onshore employees in client markets.
Reality: Average raises for Indian IT employees are higher, on a percentage basis, than average raises for U.S. IT employees, but wage levels are still much lower
What is true in the media coverage of increased wages in India is that average raises for Indian IT employees are higher, on a percentage basis, than average raises for the U.S. IT workforce. This difference in rates of salary increases is due partly to different levels of economic inflation, but it is also due to the different demographics of the two workforces and the related shortage of experienced employees in India. The majority of Indian IT employees are young and seeking to climb the career ladder as quickly as they can, while the American IT workforce has a relatively higher proportion of older employees who have already achieved mid- or senior-level roles and expect to receive smaller percentage raises at later stages of their careers (and in the current U.S. economic environment). In addition, the Indian IT industry is itself quite young, so the demand for experienced, knowledgeable employees for roles such as software architects, business analysts, team leaders and managers, continues to outstrip the supply, resulting in higher raise rates. In fact, at the most senior levels, Indian executives with technical, domain and global business management experience may command salaries as high as or higher than their U.S. counterparts.
However, the rate of raises for experienced employees will likely stabilize and slow in the next few years. The availability of more experienced employees will continue to grow rapidly, in line with overall IT labor force growth of 5 – 10 years ago, as those earlier employees move up the ranks. Meanwhile, the number of senior positions will grow at the lower current demand rates, and the two curves will likely close or cross in the next few years.
Yet even if annual raises do continue in the 15 – 20% range, the low starting point for Indian IT wages means that wage levels still remain significantly below U.S. wages until all but the highest levels of management. It would take more than 13 years for a software developer hired today in India to reach 80% of the wages for a comparable employee hired in the U.S. today, assuming 18% annual raises for the Indian employee and modest 3% raises for the American employee. (See exhibit 1 below.)
Comparison of Projected Salaries for India and U.S. Software Developers Entering the Workforce in 2012 (with 18% annual raises in India and 3% annual raises in the U.S.)
Source: Red Bridge Strategy Analysis
This comparison assumes a starting salary for the U.S. software developer of US$45,000, on the low end of the range among our clients, and that U.S. raises will stay at about 3% – an assumption that is likely to change as the U.S. faces a continuing shortage of IT talent (and hopefully an improving economy). It assumes a starting salary for the Indian software developer of US$5,700, with annual increases of 18%. Should U.S. wages or annual raises increase, or India raises decrease, the time for a new entry-level employee in India to reach 80% of the cost of a parallel employee in the U.S. will be longer than 13 years.
In the next post, we will explore how the relationship between increases in Indian wages and increased costs for U.S. buyers is not as direct as it may seem.