2. Rising Costs
The economic laws of supply and demand are beginning to work against buyers and sellers of IT services in India.

Take the currency situation. For some time, the Indian IT services industry has collected most of its revenue in U.S. dollars. Today, the inflow of American greenbacks is at an all-time high, creating a surplus of dollars versus Indian rupees. The value of the rupee is rising. Good for the local population. Bad for IT leaders outsourcing work to India. So far this year, rupee appreciation has eroded about 11 percent of the dollar's purchasing power in India. And although Indian outsourcers are touting their internal efforts to manage the ill effects of the currency situation, they will pass on the pain to their customers. (For more on how to deal with currency risks when outsourcing to India or elsewhere, see "The Rupee's Rise, the Dollar's Demise and You: Managing Currency Risk in Offshore Outsourcing.")

The sinking value of the dollar isn't the only reason for price inflation. There are also increasing salaries. "Demand has outstripped supply, causing labor rates to go up so dramatically," says Horowitz. "Salaries in Bangalore are increasing at 12 to 14 percent a year and there's no relief in sight."

"Rising costs are inevitable, and the fall in the dollar (if it's permanent) really changes the cost equation. Rising costs also reflect a crunch in supply, which is very real," says Cynthia Beath, professor emerita at the McCombs School of Business at the University of Texas-Austin, who studies outsourcing. "I think the main issue is that 'true costs' are very hard to nail down. The savings in terms of lower programming wages may be eroded by the tangible and intangible costs of new managerial-level activities—communications, rework, contracting, coordination, learning, knowledge transfer, travel and equipment."

Need more proof? Look at the Indian vendors themselves. "Major margin compression is occurring within the traditional India-based outsourcing model and is well recognized by these firms, says Steve Brown, IT consultant and former CIO of Carlson. "In fact, it is dramatic—so dramatic that these companies are looking to diversify their business models." Indian IT service providers are also diversifying geographically to maintain their profit margins, setting up shop from Buenos Aires to Beijing, and everywhere in between. If Indian providers are shopping around, maybe you should, too.

3. High-Touch or High-Value Activities
If your IT work requires a lot of back-and-forth between the provider and a U.S.-based location, India is probably not the best choice. "Time zone differences impede the relationship when frequent meetings are needed to communicate requirements and to coordinate work," explains Mary C. Lacity, professor of information systems at the University of Missouri-St. Louis's College of Business Administration.