The Everest Research Institute has eliminated the drawbacks of the currently used measurement mechanisms by developing a methodology for calculating the annual wage inflation that uses blended or weighted salary costs for organizations. As a first step, the blended salary for an organization is measured by calculating the weighted average salary across levels, where the weights given to the salaries are based on the percentage of the workforce at each corresponding level. Thereafter, the difference between the blended salaries for two consecutive years provides the annual wage inflation for the organization (See Chart 2).

This methodology gives a better estimate of the wage inflation because, by assigning weights according to the percentage of the workforce in a role level, discrepancies due to large wage increases at one particular level containing a small portion of the workforce are eliminated. For example, in typical IT ADM organizations in India, approximately 84% of the employees who are at the software or senior software engineer levels saw an increase of 11%–12% in 2005. This was much lower than the 15% inflation enjoyed by the team lead/module lead level, but that group typically comprises only eight percent of the total employees, and thus has a much smaller impact on the overall inflation.

Using this methodology and data obtained from a wide variety of sources, the Everest Research Institute calculated the blended costs for the IT ADM area in India, and arrived at a cumulative average growth rate of 9.4% for 2002–2005. For the skeptics who believe that wage inflation is a recent phenomenon, even the 2004–2005 number stands at only about 11%. The corresponding number for call-center services was even lower at about eight percent.

The importance of calculating wage inflation correctly is well exemplified by its impact on estimates of longevity of labor arbitrage. For instance, we expect the offshoring labor arbitrage to be meaningfully comfortable for nearly 20 years when it comes to offshoring of ADM services from the U.S.A. to India. If, however, the reported 15%–16% market numbers are to be believed, the sustainability almost halves to about 10 years. While neither number is in the immediate future, the difference is stark enough to impact long-term strategies for companies participating in the offshoring game.

Labor arbitrage, while important, does not offer the sole value proposition for offshoring of services. The value proposition for offshoring is expanding beyond labor arbitrage to include factors such as productivity enhancements and quality improvements. Given this, we believe that the sustainability of offshoring is likely to be even stronger than the sustainability of labor arbitrage, and that there is little cause for any genuine concern today. Having said that, it is imperative that suppliers work proactively with governments and industry associations to ensure that the situation does not go out of control at any point.