Commoditization Of Outsourced Software Development

For a few days now, I’ve been trying to wrap my head around how small startups in India are actually having any margins in the outsourcing development business. Challenges seem to be plenty, and a lot of people seem to be getting into it these days.

For instance –

  • Sticker-price for developer hours seem to be in a downward spiral – it’s not hard to see either freelancers or small companies offering development resources at as little as $12/hr. Of course quality is generally suspect, but customers who blindly compare hourly rates couldn’t care less. What’s worse, is that the experience they have (with poor quality deliverables) is often extrapolated to the entire industry.
  • Industry-wide salaries seem to be increasing – sometimes even unreasonably so. A side effect of everyone trying to start this business, is that there is intense competition for resources – so much so that a lot of average or under-average software engineers also tend to get paid a lot. Competition is intensified with even product-based, ecommerce or other VC-funded businesses coming into the picture. There is almost no correlation between the salaries for Software Engineers compared to other jobs requiring similar skill levels in other industries, which is a worrying trend.
  • Increasing salaries is drawing almost everyone into the software industry – engineers are blindly getting into software companies irrespective of their majors – more a rule now than an exception. And a mediocre software developer is almost an expectation these days – it’s *almost* impossible to find fresh graduates who actually *love* developing software
  • We are actually running out of resources – large companies have started hiring BSc graduates instead of Engineers for instance, and are lowering their filters to ensure that they are able to staff their work-force.
  • Giant outsourcing successes such as Infosys, TCS, Wipro, Cognizant, IBM seem to be the ideals that a lot of entrepreneurs strive for – without realizing that these were started in a different age, and it is nigh impossible to replicate such a feat with the current market dynamics, especially as a startup

The Industry might seem great for an economy like India – lots of jobs created, good amount of exports generated, talent pool created within the country and so on – and indeed in many ways it has contributed to the bulging middle-class in the country. But the fact remains that a lot of Indian companies do not do any “high-end” technology work – or focus on finding a niche that they can truly do justice to. To top that off, high stress levels, 60 hour work weeks, high attrition levels, etc. seem to be just getting factored into the business plan – a very worrying sign indeed.

Now don’t get me wrong, there are some companies that understand the need to differentiate themselves, take care of their employees and ensure that they create unique value for their customers, but this is not true about the industry as a whole.

These problems are faced by large companies as well – for instance, Infosys is very stringent about the margin for any new business they take up, but it was recently overtaken by Cognizant in terms of revenues. Cognizant is known for their lesser margins, and still lag Infosys in terms of net-profit. So does this mean that the only way to keep growing here is through reducing margins?

What is the end-game to all this? Will the industry just implode onto itself when this becomes unsustainable? Or will it grow out of pure-outsourcing and focus on consulting, product-development, platforms and other high-margin services that offers more differentiation opportunities? And what about startups, where all these problems get compounded several times?

I think it’s time we stop thinking of software development as an arbitrage business and start focussing on providing value that rivals the best consulting/development firms in the world. Competing on price alone seems to be a strategy doomed to failure in the long run. And if you are a start-up trying to get into the services business, you better have a differentiator/niche that allows you to charge more than the market rates. Else your business is will either fail or may become a mediocre success at best.

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