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Outsourcing helps Indian firms survive and thrive, shows study

"All our customer care executives are busy. Please wait until we assign the next available executive to help you"—does this sound familiar?

From banking queries to ordering pizza—customer call centres in a wide range of industries work similarly. Wonder why? Because most firms delegate or “outsource” specific functions, like customer service, to other companies that specialise in it. This decision helps these firms save considerable costs and focus on their core competence. In a recent study, researchers from the Centre for Studies in Social Sciences Calcutta, Kolkata, and the Indian Institute of Technology Patna, have examined this practice in the Indian context and have found that the outsourcing model helps companies remain viable, particularly during economic crises.

India has many such service-based companies that handle outsourced services. In 2017 the outsourcing industry in India employed over a million workers and generated a revenue of USD 28 billion. Apart from services, some manufacturing firms also outsource the production of specific components, such as automobile parts. In this study, published in Arthaniti-Journal of Economic Theory and Practice, the researchers have examined the link between outsourcing and productivity in the Indian context.

The study used financial and production data of a panel of manufacturing firms from the Centre for Monitoring Indian Economy (CMIE) database for the years 2010 to 2014. This period was chosen because the global economy was in crisis at the time and India’s GDP took a turn southwards. The researchers further classified the firms into subcategories like food and beverages, textiles, chemicals, metals and metal products, machinery, among others. They found that approximately 70% of these firms were outsourcing. The researchers then constructed an analytical model to understand how outsourcing impacted their productivity and revenues.

The model found that outsourcing unambiguously increased the productivity of the companies. Although wages of workers in smaller firms are generally lower than their counterparts in larger firms, outsourcing might lower this inequality since wages tend to rise more for smaller firms. The researchers also observed that Indian firms that outsourced locally raised the average productivity of all workers. Although a firm’s profit after tax (PAT) is a function of the business environment, Prof. Kar explains that “the model suggests that outsourcing raises productivity after controlling for PAT that varies across firms”.

One approach to improving productivity in firms is to reduce manual labour using technology; like robots which can replace humans. The other is to outsource the production of intermediate, labour-intensive inputs. This approach provides flexibility to companies, mainly to hire workers. The researchers noted that in general, firms in the Indian organised sector hesitated to expand employment because it is difficult to lay off workers due to stringent labour regulations. Hence, they focus on the redeployment of labour from the organised sector to the unorganised sector consisting of individual businesses with fewer than ten employees. This ability to outsource and the resultant productivity gains, the researchers say, might help larger firms remain viable during economic downturns.

On the other hand, the outsourcing–productivity link has important implications for the Micro, Small and Medium Enterprise (MSME) sector. The researchers note that the lack or loss of jobs in the larger firms, whether due to reluctance to hire or by retrenchment, may be partly offset by the employment generation in smaller firms due to outsourcing. The study concludes that MSMEs can gain enormously from the transfer of resources and technology from larger firms to the extent they are recipients of outsourcing, as they enhance their capital base and invest in manufacturing assets. A productive SME sector can, therefore, compete in the global outsourcing marketplace as well as cater to the demands of large local firms.

Productivity is vital for India’s growth and competitiveness since a robust industrial ecosystem with large and small corporations result in employment generation and economic activity. In the future, the authors of the paper expect to examine the impact of the Goods and Service Tax (GST) on outsourcing to the erstwhile unorganised sector. Further research in the outsourcing-productivity link can aid policy planners in creating a conducive environment for SMEs with access to capital, infrastructure and transparent labour laws.