Dog Chasing Tail

Chasing Labor Arbitrage’s Tail

Dog Chasing TailThe world is shrinking.  Network bandwidth and performance around the globe is making the choice of placement of a data center or access to a cloud-served function more a choice of politics than response time.  This makes many look at how they can save money on how their IT services are provided — which, in itself is no bad thing.

When looking at how much IT costs, the actual hardware and software licensing is, in reality, a relatively small part of the overall cost.  Energy costs are of a pretty major concern, due to how variable they tend to be, combined with an inexorable trend upward.  Most organizations are addressing this through greater use of virtualization and consolidation, along with newer approaches to cooling so as to minimize energy usage.

The really painful expenditure comes from more localized costs.  For example, a data center facility in Manhattan is likely to cost a little bit more than one in Marrakesh; the cost for a skilled workforce is going to be more in Tokyo than it is in Timbuktu.  Both tend to be interlinked, and some organizations have been tempted to chase the money and look to countries where property prices and the cost of labor are cheap.

From an HR point of view this is known as “labor arbitrage” — arbitrage means taking advantage of a difference in price for an item across two locations.  However, such an approach can be fraught with danger.

Firstly, consider the late 1990s.  At this point, the main countries for labor arbitrage were the Philippines, the Netherlands and Ireland — all based around these countries being used for contact centers.  The Philippines started to lose out as the Netherlands and Ireland pumped money into their respective markets through advantageous tax positions funded through the EU.  Ireland — a country of 4 million people — was soon saturated and had to encourage non-Irish inward migration by offering high salaries, which sort of defeated the object.

Then, India came in.  With minimal government funding, the massive difference in salaries between an EU employee and an Indian one meant that the cream of Indian university graduates could be paid to work in contact centers, whereas such a position in the West was seen as a job, not a career.

However, many Western companies looking to India for a cheaper contact center then fell into the misperception that, as there were close to a billion people in India, there was an inexhaustible pot of skill to draw from.  Unfortunately, a large proportion of the billion have barely seen any education, never mind university, and the available resources were soon used up.  This led to salaries rising rapidly — in the case of some regions (such as Mumbai and Pune), salaries rose by up to 85% per annum.  In combination with the emerging middle classes in India driving up property costs, India became less of an arbitrage target.

This left Indian companies with two choices — look elsewhere around the globe to maintain arbitrage, or go for the next level down for Indian skills.  The former has led to Indian companies such as TCS setting up offices in other countries to maintain a level of labor arbitrage.  The latter has led to a collapse in the quality in Indian call centers.

As this happened, other countries were pitching for business:  Kenya is a well (internet) connected country with good skills; Egypt made a bid for being the next country on the map.  However, political issues with many arbitrage options has led to companies finding that they have to enact a “Plan B” to extricate themselves and redeploy elsewhere.

Ultimately, doing things effectively will result in cost savings — and it may be effective to move certain functions to a different part of the globe to make use of available skills or for political or other reasons. The fact remains that chasing cost savings through arbitrage is the wrong way of doing things.

What should not be surprising is how cyclical everything is: the Philippines has made a reappearance on the radar for many US-based companies, while Ireland has reappeared in the EU as its economy has tumbled and resulted in a collapse in the cost of human resources.

Chasing labor arbitrage is a fool’s errand — just do it right through investing in a flexible IT platform from the start.

Image credit: Lil Shepherd (flickr)

About the author
Clive Longbottom