Outsourcing and Technology Companies at Risk!

Implications: Many technology companies depend on cheap offshore labor to control their labor costs.  As the dollar continues to weaken those costs are escalating.  Similarly, offshoring companies depend on selling services in the US, and the weakening dollar makes those services more expensive and will inevitably limit their revenue.

Analysis:  As is noted in the referenced article, a disproportionately large number of technology companies make use of offshore resources.  The entire cost structure of many of these companies is based on the idea of cheap(er) labor from India or China.  Since many of these companies are at best barely profitable today, any increase in costs will have a major impact on their P&L.  Combine that with the fact that in many of these companies the single largest cost is for labor, and suddenly the impact of the weak dollar becomes huge.

The very large tech companies, such as Cisco or Oracle, are probably reasonably well insulated from dollar issues.  It may well hurt them, but the extent of the pain will likely be no more than a reduction in profits.  Smaller tech companies, on the other hand, are more vulnerable.  Many of these companies have been able to grow and survive only because they were paying labor costs in India or China that were 20% or 30% of similar costs in the US.  The entire business model for these companies is based on this assumption, and when the assumption fails so will many of the companies. 

Much has already been written about the escalating salaries in Bangalore, less about the escalating real estate costs and other business costs, and very little about the impact of the rupee versus the dollar.  Yet the latter may become the biggest issue of all, since no amount of cleverness can avoid the problem.  Companies can address salary issues by searching farther afield for candidates, the real estate costs by moving to another location or city, but wherever they go or whatever they do in India the rupee/dollar problem will still be there.

Unless the slide of the dollar is reversed relatively soon, the impact will start showing up directly on the bottom line of most US companies, with particular emphasis in tech companies.  Larger companies that have signed long-term outsourcing deals will be impacted less, since they already have contracts in place.  Further, if those contracts stipulate payment in dollars the impact will be much less.  Until recently most outsourcing companies preferred payment in dollars.  Although they have now changed to requesting payment in rupees, existing contracts will likely not change.  

On the other side of the coin, the impact will also be felt by the large outsourcing companies (Wipro, Infosys, TCS), which depend heavily on US contracts for their revenue.  As the cost of the services escalates US companies are less able to buy more services, which will curtail growth in the outsourcing companies.  Worse yet, further weakness in the dollar means the existing portfolio will be bringing in less and less revenue.  Not only is future growth at risk, but even maintaining existing levels will be at risk for outsourcing companies with a heavy exposure to the US.  These large outsourcing companies are the ones that tend to have the large, long-term contracts that in many cases stipulate payment in dollars.

The continuing slide of the dollar is jeopardizing the ability of US-based technology companies to remain profitable.  Similarly, the ability of large India-based outsourcing firms to continue growing is at risk.