Jul 26, 2010 4:00 AM AWST

A Matter of Cost Comparing Labor Prices in China & India

One of the most frequently asked questions about China is an attempt to verify the competitive cost structures variables for sourcing business consulting, IT consulting, applications development, maintenance and management or some type business process management services. And more specifically, many clients ask about labor costs as it is one of the single largest components of total cost of sourcing calculations. A comprehensive analysis of the total cost of sourcing for a business or IT process involves an analysis of two components: standard costs (such as labor, real estate, telecommunications and project management) and incremental globalization costs (such as remote management, communications, project trips and incremental legal costs).Also, enterprises should consider the costs of managing or mitigating potential risks (such as country risks, security risks or maturity risk) to arrive at a risk-adjusted total cost of sourcing.

Gartner's analysis of a comparative cost structure assessment between India and China reveals that a total cost of sourcing business case for a vendor or a captive center varies widely depending on enterprise specific business and IT requirements, scope, scale and appetite for risk.The variability is based on city locations (where coastal China cities might be as much as 30% more expensive than inland China locations), availability of specific skill sets, risk factors (country, security, competency, and maturity risk) as well as available vendor options.

Based on analyzing over 240 business case analyses over the last 2 years, Gartner research shows that there is not a simple or absolute ranking of global sourcing country locations by cost.Furthermore, given the current volume levels for China global sourcing, there is not enough critical mass of completed deals, or a critical mass of established vendors with extensive track records, and authenticated data.However, based on extensive analysis including breakdowns of major variables of costs, Gartner has concluded that the cost structures in China for the largest components of standard costs (namely, labor, real estate, telecommunications) are indeed within an extremely competitive range relative to many of the leading global delivery locations (including India). Therefore, the continued "cost is king mentality of clients will inevitably continue to drive interest in the analysis of China as a global sourcing destination. Unfortunately, there is no clear yes or no answer as to whether China is cheaper than India, the answer is deal specific and primarily driven by scope, scale, skill set requirements, language requirements and risk thresholds.

A more detailed look at costs reveals that there a several factors that have a large variability across city locations in China, therefore, it is imperative that enterprises understand the factors with extensive hi-low ranges. These factors include: (1) the variability of wage rates and attrition across various cities in China (2) the short versus long term cost of real estate as rates vary dramatically over multi year periods given short term government or technology park subsidies (3) large standard deviations in the investment ranges required for human resources readiness (technical, language and soft skills training) as well as IT Services process business models (4) economic variations based regulatory requirements (5) government and legal requirements to manage risk (6) security issues (7) additional investment needed for low English speaking capability and/or cultural affinity.

Clients must explore and ensure deal-specific due diligence for the incremental globalization factors and analyze risk management costs. Clients need to ensure they assess a thorough total cost of sourcing analysis over a multi-year period in order to determine cost benefits and manage risks.

Common Mistakes

The five most common mistakes enterprise buyers with regard to cost comparisons are as follows:

1) Enterprise buyers (especially those who have sourced work in India) often compare a rate card from a Tier 1 vendor with operations in India (I.e.IBM, Accenture, Tata, infosys or Wipro) to a rate card of a tier 3 or tier 4 vendor in China. Simply comparing a rate card for a specific skill set is not a proper comparison because the elements built into a rate that is quoted by a vendor include elements of disaster recovery, and business continuity

2) Comparison of pure wage rate charts. For example, if you look at some wage rate charts in China, you may see a quoted number such as 9K per year for specific for a programmer. However, the total cost to the employer is far more because China has a federal tax that is required (similar in nature to US social security taxes) which are currently 50%. Therefore, the cost to the employer is actually 13.5 K (9K plus 4.5K). Beyond that, if the programmer requires a certain level of English proficiency, a premium of of 10 to 15% must be factored into the wage rate above and beyond the market based rate.

3) Assuming competency and skill sets in China and India are equivalent. A project manager or business analysts or even a programmer as designated on an human resource inventory in each of the respective region are not at all equivalent. Project management expertise is quite different. For example, at this particular juncture, a "experienced' project manager in India can claim a track record of projects involving significant complexity and project size that simply has not yet materialized in China as of yet. Also, the label of of progammer or software engineer in China often refers to someone with experience with embedded (R&D) engineering expertise versus the more commonly used reference in India is related to Enterprise Apps skills.

4) Assuming that there is one singular China cost structure. China is a vast country with over 20 designated hub cities. Cost structures across these various cities may vary by as much as 30%.

5) Incorrect Calculation of total cost of sourcing or risk adjusted total cost of sourcing. Quite often enterprises do not properly account for or comprehensively analyze the following:
. multi-year sustainability of cost structures
. do not include differentials in program and project management overhead costs
. cross cultural communications cost impacts
. vendor competency/execution differentials
. risk mitigation and/or management costs
. potential currency rate fluctuations