The Rupee’s Rise, the Dollar’s Demise and You: Managing Currency Risk in Offshore Outsourcing

The rise in value of the Indian rupee, while a signal of the increasing strength of India’s economy and potential boon for the general population, is being treated as bad news by Indian outsourcing providers and their customers. So far this year, rupee appreciation has eroded about 11 percent of the dollar’s purchasing power in India, impacting Indian IT services providers, who make an average of two-thirds of their revenue in U.S. dollars but incur more than half their costs in rupees.

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The inflow of dollars to India is at an all-time high, creating a surplus, says Sumeet Salwan, director of supplier relations for offshore outsourcing advisory neoIT. As of Oct. 1, 2007, one U.S. dollar was worth 39.65 Indian rupees, more than 10 percent less than its worth (45.79 rupees) a year ago. And experts do not expect the Reserve Bank of India to do much more to stem rupee appreciation because of inflation fears. To put the currency situation in historical context, the dollar hasn’t dipped this much against the rupee since 1996. The dollar’s fall is part of a larger trend of dollar weakness against a host of currencies around the globe.

Offshore vendors in India specifically are struggling to find ways to counter the currency imbalance. The rising rupee is hitting midsize Indian providers—such as Syntel, Polaris, Mastek and iGate—the hardest because their margins are much slimmer than those of the bigger Indian outsourcers. “Losing 3 or 4 percent from 25 percent profits is one thing,” says says Sudin Apte, Forrester Research analyst and country manager for India. “Losing 3 to 4 percent from 9 or 10 percent profitability is another.”

For the first time, some vendors are coping by charging non-U.S. customers in their local currencies rather than in U.S. dollars. IGate, for example, is billing Japanese customers in yen, Swiss customers in Swiss francs and Canadian customers in Canadian dollars, although it still garners the majority of its revenues in U.S. dollars.

Many providers, including Infosys, Wipro, and Satyam, have also worked to improve their employee utilization rates—the average percentage of employees who are billable. “As people move on and off of projects, there is a natural ‘waste’ that occurs,” says Dean Davison, vice president of research for neoIT. “It is considered very good to be 80 percent utilized.” Major Indian vendors have announced utilization improvements of 1 to 4 percent, and Davison expects more improvement in this area.

Passing On Rising Costs to Customers

But those efforts help only so much. Indian vendors and global suppliers with Indian subsidiaries will pass on their increased costs to their customers. Perhaps it’s only fair, given that those customers were beneficiaries of the weakness of the rupee in years past. The currency situation is going to affect all customers regardless of the pricing terms of their outsourcing deal, says Salwan of neoIT. Those with fixed-price contracts are no safer than those paying on a time-and-materials or cost-plus basis. “Every CIO will see the effects,” Salwan says.

Some things for American IT outsourcing customers to look out for include:

Increases in billable hours. Vendors may bill for hours worked that were previously ignored (additional costs for overtime or holiday pay), pressure employees to bill for nine-hour days instead of the standard eight, include an employee’s vacation time as billable hours in contracts where terms are ambiguous.

Slower response times and less interest in R&D projects. Efforts to increase employee utilization rates lead to a smaller bench of developers, project managers, and others, impacting response times and reducing R&D efforts, says Salwan.

Personnel changes. Be wary of providers’ possible intent to dilute skill level and quality to cut costs on projects, advises Forrester’s Apte. Vendors may try to increase the ratio of junior staff to senior staff from the typical 8:1 to 9:1 or 10:1. They may also reduce the ratio of onshore to offshore talent.

Bill collection. Suppliers may seek to enforce 30-day net payment terms (that is, payment is due within 30 days of the date of the invoice).

Early renegotiation. Some Indian companies may play hardball, pushing for renegotiation on projects where the client seeks to change scope or specifications.

Unsolicited proposals. Vendors may try to drive revenue by pushing new projects.

Expect to Renegotiate Contracts

IT leaders with Indian outsourcing contracts up for renewal should expect their providers to renegotiate contract terms and pricing. “All new contracts will be at higher price points,” says neoIT’s Salwan. Most major Indian suppliers publicly acknowledged labor rate hikes between 1 and 5 percent last quarter, says Salwan. In addition, large contracts may contain a currency fluctuation clause that enables the supplier to share the risk associated with dramatic shifts in exchange rates with their customers, Salwan says.

The dollar’s depreciation against the rupee, expected to continue at least through the end of the year, ultimately reduces the “labor arbitrage” effect for India. But, Salwan insists, “the arbitrage [possible by outsourcing to India] is still very competitive against other outsourcing destinations.”

Forrester’s Apte says IT leaders should look at the rising rupee as an excuse to step back and reevaluate offshore contracts. “Instead of outright rejecting pleas to increase rates, [IT] professionals should give an ear to their suppliers in order to understand their plan to handle the fluctuation,” says Apte. “Use this opportunity to reassess the entire relationship, taking a realistic view based on the relationship’s criticality, work complexity and the provider’s ability to digest the impact of the rising rupee.” The net results may not be all doom and gloom. IT leaders may find that they’re able to trade rate hikes for higher value service from suppliers, for example.

If nothing else, managing the risks of the rising rupee will be good practice for IT leaders offshoring work globally. The Chinese yuan has appreciated nearly 3 percent against the U.S. dollar this year, the Euro hit a record high against the dollar last week and the Canadian dollar recently topped the American greenback in value.