(Forbes.com) World Economic Forum India's IT Challenge Tara Murphy, 01.25.05, 2:55 PM ET Think of India and information technology, and, if you are in the U.S. or Europe, you tend to think of outsourcing. But the world doesn't look quite as rosy from the opposite end of the telescope. True, business-process outsourcing is the fastest-growing part of the industry's revenue and is driving 30% growth in India's IT exports. But sustaining that growth rate is a challenge, and new, lower-cost rivals are going after the business. Forbes.com Editor Paul Maidment discusses these and other issues affecting the sector. Paul, what is the state of the sector? India's three leading IT companies--the giant Tata group's consulting arm TCS, Infosys and Wipro--get about 80% of their revenue from overseas sales--and 80% of that is accounted for by the U.S. But a weakening dollar and the political scrutiny in the U.S., where nine states are considering anti-outsourcing legislation, have put pressure on India's IT sector to diversify its export markets. Where else is it looking? Indian IT companies are making substantial inroads in the U.K., which is responsible for two-thirds of their European earnings. Labor union opposition to outsourcing there is diminishing. A recent IMF study found that the practice has not led to a net loss of jobs in Britain, and the U.K.'s employer organization, the Confederation of British Industry, reckoned outsourcing provided a net gain to the U.K economy last year of $30 billion. One Indian company has even set up a new call center in Northern Ireland--sort of reverse outsourcing. What about elsewhere in Europe? Much slower going than in the English-speaking world, but that is starting to change notably in France and Germany. A lack of French and German speakers is an obstacle to overcome. Most educated Indians are trilingual--speaking Hindi and their regional language. But their third language is invariably English. Some Indians working in call centers are being retrained to speak English with either an American or British accent, according the market they are serving. How is that going? Some Indian regional accents, especially those from the north, have proved easier to remodel than those from the south. The problem here is that the IT industry is largely based in the south around Bangalore, Hyderabad and Chennai. A lot of new outsourced operations have been put in the north, near Delhi and Chandigarh--where Dell put a call center--to take advantage of better accents, but they are a long way from the industry's skill pool down south. Is language a barrier to Asian-Pacific markets, too? Absolutely. Indian companies have made barely any impression on the Japanese market for primarily that reason, though there are also some taxation issues. In places like China, the Philippines and Mauritius, Indian companies are buying into local IT firms as a way to get around the language issue. What are the prospects for the domestic IT market? India is a large country with a huge and still poor rural population. Until recent economic liberalization, it was a highly protected economy. Only 1.4% of the population owns PCs. But the government has an ambitious project to wire India for broadband. It is setting up what it calls an e-communications network for government offices, and encouraging the country's small businesses to get online too. But again remember, this is in a country where basic telephone and electricity services are often unreliable. Large companies often run their own networks for both. Won't the domestic market be increasingly important to India's IT companies as they begin to face more international competition? Yes. Other countries are starting to erode India's cost advantage in outsourcing, and particularly places where English-speaking skills are available. The Philippines has become a serious competitor. China is another growing rival. It has a more comprehensive and reliable infrastructure than India. Plus the diaspora of overseas Chinese is bigger that that of nonresident Indians, particularly in the U.S. and Southeast Asia. Vietnam is an emerging lower-cost rival to Indian firms there too. Even further down the cost ladder are French-speaking ex-colonies such as the Seychelles or Mauritius. They have the language advantage in European markets, How are Indian companies tackling these challenges? Two ways: First, by moving more into R&D. Satellite-mapping technology is one area it is specializing in. Microsoft moved one of its mapping projects to India, for example. Second, by more vertical integration, to offer clients a more comprehensive range of services. That is driving some of the international acquisitions Indian IT companies are making, such as here in the U.S. with UpStream, Essar Teleholdings and Aegis Communications. At the same time, they are buying outsourcing operations in lower-cost countries such as Mauritius and the Philippines. Will it work? Not sure. Many multinationals now pick and choose the services they buy from many international markets and have the reach and scale to make that a cost-effective way of doing things. Why buy outsourcing from an Indian firm that will only outsource the work to the Philippines when a GE or a Siemens can go direct and cut out the middle man? Plus there is the perennial danger of vertical integration: A company's reputation is only as good as that of its worst business. ------------------------ Yahoo! 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