12/24/2006

Sifting KPO from BPO services

In the growing world of IT-enabled services, there is a lack of clarity as new services emerge, appearing to some like old ones. Business Process Outsourcing (BPO) is a common enough term now to describe services that are repeatable, scalable and executable from a remote offshore location like India. A Knowledge Process Outsourcing (KPO) business requires substantially more domain expertise — or specialist knowledge — unlike BPO where skills can be taught in a matter of days. KPO also requires continuous upgrade of knowledge: Doctors may learn new treatments, lawyers may learn new interpretation or laws. Hence it is not surprising that training in KPO can range anywhere from two months (in market research) to eight months (in intellectual property). More than size, what matters for a KPO firm are the depth of knowledge, experience and the judgement skills of its professionals.

Not surprisingly, experienced professionals generate more revenues for a KPO firm, which can earn anywhere between $80 and $600 per hour in the US and $20 and $80 per hour in India. An Indian telecoms expert with ten years behind her can get as much as $100 an hour, while one with only two years behind her can fetch about $30 an hour. Since domain expertise is the key factor, not only can a company easily differentiate itself from another but also one country can distinguish itself from another. The countries that will emerge strongly in the KPO business are those that have large numbers of engineers, medical doctors, graduates in sciences and technology (e.g., biotech, pharmaceuticals), MBAs, Certified Public Accountants, Financial Analysts, Statisticians, high-end IT professionals, lawyers, etc. The low-wage countries that seem to have these professionals in large numbers include India, China, Russia, Poland, Hungary, and some former Soviet republics.

As specialists are key, KPO teams are typically only a fifth or tenth of the size of a BPO firm. A key facet of the KPO business is scalability like a BPO but there is a premium placed on domain expertise. In contrast, research and development departments of high-technology companies (e.g., IBM Research) and consulting companies cannot be included as KPO firms and not surprisingly such organisations take substantial time to reach scale. For example, IBM Research took nearly 50 years to reach 3000 researchers and McKinsey took 75 years to get to 6000 consultants. In contrast, a KPO firm like Evalueserve may only take ten years to reach 5,000 professionals. Finally, in KPO, the client is involved during the entire process of service delivery. The offshore KPO company may only contribute 80 to 85 percent of the work whereas the client may contribute the remaining 15 to 20 percent.

To the best of my knowledge, the first two companies to set up KPO centres in India include General Electric and McKinsey and Company. Finally, I may add that the term KPO was coined by Ashish Gupta, the chief operating officer of Evalueserve in October 2003, mainly to help differentiate the service from BPO activities like call centre services and credit card processing.

HCL's Shiv Nadar: 'When Someone Brings China and India Together, It Will Be a Big Story'

HCL's Shiv Nadar: 'When Someone Brings China and India Together, It Will Be a Big Story'

Published: September 27, 2006 in Knowledge@Wharton
Shiv Nadar was 22 when he saw his first city. Now, as chairman and CEO of HCL Technologies, he is worth some $3 billion, according to a Forbes magazine estimate last year. In the second of a two-part interview with Knowledge@Wharton and Ravi Aron, a senior fellow at Wharton's Mack Center for Technological Innovation, Nadar discusses the challenges confronting Indian manufacturing and potential synergies between Indian and Chinese business.
Aron: Infosys, Wipro, Satyam and TCS are the big four Indian software firms. How do you distinguish HCL from them?
Nadar: HCL is drastically different. If you look at the leading Indian IT companies, Cognizant is not active in business process outsourcing (BPO), and neither is Satyam. Wipro is strong in BPO, but for TCS, compared to its software business, BPO is very small. Even Infosys' BPO operations are minor in relation to the rest of its business. But if you look to the future, BPO will outpace software.
Globally, as work is re-distributed to various countries, infrastructure will have to be managed remotely. We created that industry. The Gartner Group has acknowledged that HCL is a world leader in that business. We run the National Stock Exchange remotely; that represents the third-largest number of trades in the world. We run about half a million servers remotely.
Another factor that makes HCL different is R&D outsourcing. You can do that in at least two ways. One is to take a design for an operating system and say, "Let's maintain that." Another is to take an operating system, and in addition to maintaining it, to develop it further by adding new features and making them available to the end users. Under the second model, we might go to a client and develop progressively sophisticated products, against whose sales HCL receives a royalty. We may even hold the patent jointly, so that no one else can use those products. So, now HCL is at the edge of R&D where we create patent-yielding products for others. For example, we have worked actively with Boeing on the 787 Dreamliner. This is different than what other Indian IT companies are doing.
Aron: I have some questions there. Let's take R&D for a moment. About 65% of your business comes from software product engineering and some 35% from hardware and mechanical engineering. Did the 65% grow and exceed the hardware and mechanical engineering in the past two or three years?
Nadar: It's the other way around. Mechanical and hardware engineering have started coming into play now. Our entire aerospace initiative is a mechanical engineering project. We also are doing interesting biomedical work -- it is a hardware engineering project. There is a product we are building...do you know about the insulin pump?
Aron: No.
Nadar: Let me tell you about that. Some diabetics need insulin every day, and as a rule it is injected into the bloodstream. The amount of insulin that can be injected into the bloodstream is close to 100 times higher than if it could be done through the nervous system. But to inject insulin through the nervous system, you would have to do it through the spine, which is not only excruciatingly painful but almost impossible to do on a daily basis, because before the injection you have to measure a series of parameters.
The system we have built begins by measuring the parameters. This comes from first making the chip that measures how much insulin needs to be injected. It is a very small amount. You plant a pump to release the insulin and leave it inside the body.
Aron: So you do real-time biometrics and then the pump responds...
Nadar: Oh yes. And it can be kept inside the body for seven years. That's why I said the kind of engineering we are doing and technology with which we are working is seriously advanced. We are working on this project with a collaborative partner.
Biomedical engineering is an evolving field.
Aron: Before we come back to collaboration, I wanted to ask about HCL's approach to BPO. About 26% of your revenues come from technical support, 37% from customer contact services, and finance and accounting account for about 20%. One issue that Indian companies are facing -- which Knowledge@Wharton had written about four years ago -- is that the low-margin, high-volume inbound call voice-based business is highly nomadic, though it generates revenues per employee of between $8,800 to $11,400. Today it's in India, tomorrow it could move to Vietnam, Morocco, Mauritius, or Cambodia.
Nadar: Wherever it's 50 cents cheaper.
Aron: Right. Companies move for a 50-cent advantage. Was there a deliberate decision on your part not to touch this business?
Nadar: No, we ventured into it because we wanted to wet our feet. We wanted to see for ourselves whether BPO was interesting. We could not just say we had decided to stay out of it because it's too large. We saw a migration of work taking place, and it would have been too early to stay out of the migration.
Aron: Is BPO slated to become one of your major business lines?
Nadar: If you want to know what will become not just one of our biggest business lines but also among the most profitable, that is our technology business. It will provide the maximum yield to shareholders. That is the kind of work we are doing with companies like Deutsche Bank and Boeing. That won't go away for 50 cents less.
To do such work, HCL has to become a partner, a strategic partner, to our clients. We can't remain just a vendor. Frankly, out of 500 organizations for whom we work, we are bound to be vendors to some 450. If we don't work for them, somebody else will. But to the other 50, we make a real difference. Those 50 firms cannot do without us because we are their strategic partners. That's not a very comfortable statement, but it is true -- they cannot do without us. Does it mean that they are prisoners of HCL? They are not prisoners, but they have stopped doing the work that we do. There's a huge amount of trust. Annual contracts are no longer necessary or even relevant.
Knowledge@Wharton: How did the transition from vendor to strategic partner happen? Is this something you consciously sought, or did it evolve?
Nadar: We consciously worked for it. Over the years HCL has turned down lots of business. We've just walked away, and we have learned to say, "No."
Today, when I look at software business, it's much simpler than it was in the early days when we were building HCL. Saying "no" had to come to us. It's a matter of vital importance. You have to say "no" if the machine is not going to do the job. Otherwise, for that one customer you could lose ten. And, to be perfectly frank, there was a period when we said "yes" to just too many things. In the past 30 years, at least two years had to be written off because of that.
Aron: Did you consciously train your managers to look at customer size and intent and turn away piecemeal jobs that lacked a strategic component?
Nadar: Our managers needed re-orientation because most of us are very bad at saying "no." When Laxmi [the goddess of wealth] comes to your doorstep, it is difficult to close the door and say no to new business. We had a conversation with a client who needed help with high-precision manufacturing for aircraft class aluminum. We initially tried to turn them down because we did not know metallurgy, but it turned out to be enormously profitable. Unknown business does not scare us because that's what we've done all our lives. But if a business opportunity does not use our strengths, we have to say no.
Aron: Did you train your managers to be partners, i.e., treat HCL's business of Boeing as an extension of Boeing itself? How did you go about that?
Nadar: That is very difficult. Most people make poor partners because their mental script has a defect. They believe focus means looking after their own interests. It's a script error. Someone at Wharton should find out how to correct the script.
Aron: But HCL has a long history of partnering with companies like Hewlett-Packard, Boeing and Deutsche Bank. You have chosen organizational forms that other Indian companies did not opt for until the late 1990s. Your partnerships involve redistribution, contract engineering, original engineering, patent-yielding products, and so on. This is very different from partnerships as Indian companies have traditionally done them. Where did that come from?
Nadar: I suppose the fact that HCL was a partnership of its founders may have taught us how to work with others. That's all I can think of.
Knowledge@Wharton: A lot of partnerships and alliances end up destroying value. How do you manage partnerships to create value instead of destroying it?
Nadar: Toshiba has been our partner for 25 years. The highest market share they have anywhere in the world is 2%; in India it is 27%, which is higher than Xerox. (Xerox is at 24%; this is possibly the only country in which Xerox is behind anybody.) We decided to do business in this area together. They have notebooks, we distribute them. At one time, Toshiba was the leader in mobile computing, but unfortunately, they fell by the wayside. We were patient with them. I suppose it's got to do with our mental makeup. We may be bad businessmen, but we don't look at leaving our partners as a possibility. We try to stay with them, unless the partnership has an end-date written into the contract.
Aron: I have a question that will take us into the Indian policy environment and its impact on HCL. I once had an interesting conversation with a well-known policymaker and he said, "Chinese manufacturing succeeds because of China, while Indian entrepreneurs succeed in spite of India." What do you think?

Nadar: The classic experience I have is based on the fact that our company was involved in manufacturing. We would get so tired sometimes and wonder if we should stop manufacturing, but we persisted because people wanted to buy our products. Manufacturing in that environment, year in and year out, was extraordinarily difficult. For example, we needed a license that allowed us to import 1,753,348 integrated circuits, and we were supposed to keep count and give the reconciliation to the government every year. It was an impossible, very nasty, very hostile set of conditions. It had to give way; it had to break. This still exists in some places, this control-orientation, and it creates suicidal conditions for many industries. If the government lets it go, it will be a different world.
Aron: You think manufacturing employment and activity in India would pick up significantly if regulations were relaxed further?
Nadar: That is correct. If you take any sphere of manufacturing, the input controls are crippling. India is possibly the only country in the world that taxes manufacturing. Is there any other country where it is taxed? Manufacturing is an activity that creates jobs, so why should it be taxed? If you were to go back to the Indian Salt and Excise Act of 1928 and 1932 -- I have read it -- it imposed taxes because the colonial British government wanted to discourage local manufacturers. That is how that taxation got started. But today, at a time when the Indian government wants to encourage economic activity, why should such taxes have any role? It does not make any sense. Why should India still behave as if it were a colony?
Moreover, there is a cascading impact on materials, which are taxed at so many points. If you were to take a paper cup, everything that goes into it -- the paper, the pulp, the wood shavings -- is taxed. The way the VAT (value-added tax) system is set up, it's like taxing your own prosperity.
Aron: Now let us turn to the infrastructure. In electricity, for example, it is estimated that $8 billion to $10 billion a year needs to be spent to bridge India's power deficit. Isn't the infrastructure adding an invisible cost to Indian manufacturers?
Nadar: Ah yes, it is terrible. We require $200 billion to cover India's electricity needs in the next five years. We don't have the kind of project management skills needed to build these power projects, so many of them will have to be constructed on a build-operate-transfer basis. I suppose they are on their way. That is my hope.
Aron: How about feeder industries like surface transport, electricity, and airports? Three things are needed here: Allow foreign investment, allow private production, and take the controlling hand off distribution. Do you think any of this will happen in the near future?
Nadar: When I talk to senior ministers privately, they all want to do it. This is true of the present government and the previous government. They want to do it, they know what needs to be done, and everyone knows the steps.

Knowledge@Wharton: What's holding them back?
Nadar: We need more political cohesion. I suppose that still eludes us.
Aron: Let me ask about entrepreneurship in India. You have been an entrepreneur for more than three decades. Is there a change in young people, the way they think and the things they want to do?
Nadar: I don't know, but I hope so. If you were to ask me who will be the world's wealthiest person in 2015, I would say I don't know. Possibly Bill Gates may continue to be, but he may give away his wealth. It's difficult to judge. If you ask about 2025, that too is very difficult to state. But if you were to ask about 2055, you can have a very definitive answer: That person isn't born yet.
In the same way, today trade between Japan and China is possibly the largest in the world. But who will be the biggest trading partners in 2025? Already people say it will be India and China. Now, today Indian distribution companies are going very cheap, whereas there is a huge unused manufacturing capacity in China. I don't know why young entrepreneurs don't put these two pieces together. You don't have to build a brand new operation, the parts already exist -- and there are plenty of private equity guys around whose money is looking for a home. Some young entrepreneurs should just put these pieces together and put their career on hold for five years. I don't know why business school students don't do this, particularly those who come from India. They should go to China, match the parts, and when the market explodes, in five years they could take the company public and make a killing. Not enough people are contemplating this. To me it's so clear it may not be visible only to a blind person. When someone brings China and India together it will be a big story, and one that's worth a lot of money in a public company.
Knowledge@Wharton: When you look back on your career, what would you have done differently?
Nadar: I would have organized things differently. I have always run the company hands on. As the CEO of HCL Technologies, I was a hands-on CEO. For 18 years when I was CEO of HCL Infosystems, I was hands on. I could have taken my hands off the steering wheel a lot earlier and delegated more authority than I did. I did delegate authority, but I could have done more.
Aron: Let us go back to the beginning for a moment. You must have been one of the very few Tamilians who decided to go into business. You settled in New Delhi and went into the computer business. What was the cultural construct here?
Nadar: My father was a judge, so he was located in various places as his postings went around. I come from rural stock. I studied in Tamil, never in English. I got my PhD in engineering in Coimbatore [in southern India]. I first saw a city when I was 22. I went to work in Delhi at 23, and fell in love with my wife, who is a Punjabi and therefore completely different in terms of language and even racially different.
Knowledge@Wharton: HCL has just turned 30. So what's in store for the next 30 years?
Nadar: Whatever life turns out to be, that is a challenge for the next leadership team. Our next leadership team has plenty of time to make an impact. I see a difference in their way of thinking. They are a lot more aggressive than I was.

Look Out India, China is Gaining on You



By sheer numbers, China's ascent to the top of the IT outsourcing world seems inevitable, but plenty of challenges remain

BY ANTHONY BALDO

India may be the lightening rod for policy wonks and unions who blame offshore outsourcing for the loss of huge numbers of US jobs.

However, while India is still the most popular overseas haven for sending software development, call center and telemarketing functions, China is rapidly moving up in popularity.

For any US company considering outsourcing its information technology development work to China, the numbers can be alluringly mind-numbing.

An 82% literacy rate. Wage rates as much as 40% to 50% less than India’s. Some $50 billion in direct foreign investment in 2003. The prospect of graduating 200,000 IT professionals from colleges annually, starting two years from now.

Some outsourcing pundits feel that if China’s time hasn’t yet come, it inevitably will. “China and India are in a dead heat,” argues Howard A. Rubin, executive vice president of Meta Group, a Stamford, CT, technology research and consulting firm that evaluates outsourcing nations using several variables, such as political stability, government policy and available talent.

Other experts are a little more reserved. “India is a sneak preview of what China will be in five years,” insists Gordon Brooks, CEO of Waltham, MA-based E5 Systems Inc., which has two facilities in China and one in India to which US companies outsource.

Outsourcing Essentials

Perhaps India should turn tail and run right now. But China still has plenty of outsourcing issues to work out, namely the language and cultural barriers. The betting is that China will figure it out. It’s actually starting to. Even so, for the high-end IT work-call centers, project management-India is still the place to be.

“India has been attractive for awhile,” says Savio S. Chan, the president and CEO of Melville, NY-based US China Partners Inc., which helps US and Chinese companies develop business in each other’s country. “But China is becoming more attractive. In about 10 years, it’ll pass India.”

Fair enough. But how is it that China, historically known as the place of choice for outsourcing for US manufacturers, seemed so suddenly to burst on the scene as an IT venue?

Actually, China has always had the natural resource necessary for low-cost outsourcing-masses of humanity. It has one billion literate people. And Brooks notes that 90% of E5 Systems’ customers want scale. They need more people for the buck to keep up with demand without adding huge labor costs. In China, that calculus is easy.

Just ask John McGregor, the CIO of Sweetheart Cup, a $2 billion-in-sales maker of plastic-ware for fast-food chains such as McDonald’s Corp. For the past eight months, E5 has been developing a system in China that Owings Mills, MD-based Sweetheart can use to track production processes at its 14 North American factories.

“We figure it saves 40% by sourcing in China rather than India,” McGregor says.

Cost, however, isn’t the only thing that has made China bloom. Oddly enough, the nation’s government has actually been a major factor. China became a member of the World Trade Organization in December 2001, meaning it had to comply with certain civil rights and other standards that once marred the communist government in the eyes of the US.

What also helped was that in January 2002, the US government issued regulations that made transferring technology easier and more transparent, so companies could more freely outsource IT elsewhere, Chan notes. And as it happens, protections for intellectual property are no worse in China than they are in India.

The Chinese government also came up large in another way: economic incentives. E5 has received tax abatements, free rent and financial assistance for worker certifications, enabling the company to pass on its cheaper costs to its American outsourcing clients. India used to provide such inducements, too, but no longer does.

As a result, China’s political situation has actually become a plus. Meta, which collects data from 10,000 companies in 100 countries to create a global index that ranks nations on their outsourcing potential, has India and China running neck-and-neck for the top spot. “But as far as political stability goes, we put China ahead,” says Rubin, citing India-Pakistan border problems as one reason.

Some of China’s momentum of late also stems from India’s maturity. “India is getting expensive,” says E5’s Brooks. “It’s pure demand. Office space is hard to find. The lemmings are heading to India, which has great people and great resources. But there’s more job-hopping now.”

India still has more experience with the scale and deliverability of projects than China does. “India has more talent and more management capability,” says Rubin.

A major reason for that is language. India is an English-speaking nation. China isn’t, though higher English proficiency standards are on the way. “China is not even a contender at this point in the English language outsourcing market,” says Partha Iyengar, a Gartner Group analyst specializing in outsourcing. “They have too many language challenges to overcome at this point, in addition to the process capability issues they are grappling with.”

Chinese companies are making better headway with attracting Japanese outsourcers, he explains, since some of their provinces have native Japanese-speaking populations, like the one in Dalian. That provides an advantage over Indian rivals.

US companies are really looking at an India-plus-China approach, Iyengar explains. “Companies that want to have a base in China are either asking their Indian providers to establish this base for them, such as General Electric Corp., or else setting up captive centers in China, in addition to either captive or outsourced centers in India.” he adds.

But the language barrier hasn’t daunted Sweetheart. In fact, several years ago, Sweetheart brought in contract consultants from India for an enterprise-resource-planning project. The project struggled because of communication problems related to cultural differences. “There was a lot of rework, and you’re still paying guys by the hour,” says the company’s McGregor. “It just manifested into a big problem. That was a big takeaway for us.”

Language hasn’t been problematic in China yet for the company. “We let all interaction flow through the E5 team, some of whom speak Chinese,” he explains. “We rely on E5. We’re not putting ourselves in the position of having to translate communications.”

Even Iyengar notes that the language issue isn’t intractable. He says Gartner estimates it’ll take Chinese companies two years to reach where India is today in addressing the English-speaking markets.

What does worry him, however, is that cultural differences between China and the US, which bleeding-edge companies tend to overcome because of the bigger technological goals involved, could hinder a second wave of outsourcers. In other words, companies such as GE will spend the money to make the arrangement work. But, now companies much smaller are considering outsourcing overseas.

“The breed of companies looking at offshore [outsourcing] now will not have this capability of high levels of investment to mitigate for some of these shortcomings,” Iyengar explains. “If the Indian or Chinese service providers are to have the same level of success with this ‘second batch’ of companies, they will have to start addressing some of these cultural differences.”

Certainly, the emphasis on education isn’t one of those cultural hurdles. Nor is the societal focus on infrastructure. China now has 175 million phone lines compared to India’s 34.5 million. Bandwidth in China is now 7.5 gigabits per second, according to Dataquest, a research firm. In India, it’s 1 gigabit per second.

And then there are the people. Some 50 million Chinese workers are added to the workforce every year. Already, China has 400,000 IT professionals, the same as India and just 100,000 short of what the US has, says US China Partner’s Chan.

The world has always waited for China to awaken to become a foremost economic power. It’s not there yet; Chan estimates that the nation’s software outsourcing revenue will more than double, to $5 billion by 2005. But by 2007, Gartner predicts that China will generate $27 billion for IT services, including call centers and back-office space.

Chan even predicts China will surpass India as the world’s foremost IT outsourcer by 2010. Far-fetched? Hardly.

Stranger things have happened. And with this being the year of the monkey on the Chinese calendar, we’re supposed to expect the unpredictable.

What's Ahead for 2007?

On the financial front, 2006 has been a pretty good year all around. Stock markets in many countries have rallied, energy prices have fallen, inflation is relatively low and growth in GDP ranges from respectable to robust. But the economies of most countries also face a number of threats -- some predictable, some not -- that could derail recent gains in our increasingly connected global markets. What's ahead for 2007 in the U.S., India, Europe, Latin America, China and other parts of the world? We offer a roundup of reports from the Knowledge@Wharton Network, including India Knowledge@Wharton, Universia Knowledge@Wharton and China Knowledge@Wharton.

In U.S., Housing Slump Tempers Upbeat View

The outlook for 2007 in the U.S. is generally good, according to a number of Wharton professors, although some worry about the falling housing market and a protectionist bias in the Democratic Congress. Then, too, an economic snag in China could ripple around the world. Moves to the political left could hamper growth in Latin America, while red tape could entangle progress in India, where stocks may be ready for a pullback.

In the U.S., "I see lower GDP growth, about 2.5%" for 2007, predicts finance professor Jeremy Siegel. GDP grew at an annualized rate of 5.6% in the first quarter of 2006, then fell to 2.6% in the second quarter and 2.2% in the third. "I look for the markets to be fairly good. I could see [U.S.] stocks up 10% next year. I think interest rates will stay stable -- I don't think the Fed is going to reduce rates very soon, probably not until the second half of the year. I think the dollar will be on the soft side, but I don't see anything like a big crash." Foreign stocks are also likely to do well, he says. That will be especially good for American investors, as a falling dollar makes foreign holdings more valuable in dollar terms.

"I think the biggest positive for the stock market is low interest rates," adds Siegel. "We have good emerging markets growth, decent European growth. Japan is sputtering right now but it's not as bad as it used to be."

While there are threats to this upbeat view, none look too serious, he says. With Democrats in control of Congress, there is the potential for tariffs and other protectionist measures, but the prospects do not seem very serious. Even raising the minimum wage would not threaten growth in the U.S. Democrats are not likely to extend the Bush tax cuts enacted early in the decade, Siegel adds, but this will not be a serious matter in 2007 because the cuts do not expire until the end of 2010.

"Overall, things are looking reasonably good for the near future," agrees finance professor Richard Marston. Most economists, he says, put the prospects of a recession at about 30%, which is not alarming. The jump in energy prices in 2005 and early 2006 proved that this sector alone cannot cripple the economy the way it once could -- and energy prices have since fallen.

But Marston is very concerned that the slump in the U.S. housing market could undermine consumer spending, causing real economic trouble. "I really think this is going to be a more prolonged decline than other people think," he says, noting that after real estate prices dropped in 1989, it took many parts of the country until the mid-1990s to recover.

The housing sector is especially risky because of the mushrooming use in recent years of adjustable-rate mortgages and sub-prime loans, he adds. Many of the variable-rate loans issued in recent years are now adjusting to higher interest rates, causing borrowers' monthly payments to soar. "What we've done is made our financial markets efficient enough to let families dig holes to bury themselves."

Recessions often come in the wake of big gains in asset prices, Marston notes. The recession of 2001, for example, followed the big stock gains of the late 1990s. In recent years, the asset-price gains have been in housing. On the other hand, inflation does not appear to be a serious threat, he says, so the Federal Reserve may be able to cut short-term interest rates in 2007, helping stimulate the economy to offset damage from the housing sector.

Finance professor Franklin Allen also is concerned about threats from the housing sector. In recent years, much of the crucial growth in consumer spending has been fueled by money from mortgage refinancing made possible by soaring housing values. Now that housing prices are dropping in many parts of the country, fewer homeowners are likely to refinance, closing the spigot on this source of consumer spending. "The savings rate has been very low for a long time, and many say it's because people have been making money on their assets," he says. "The main asset is housing. If that reverses, it's not a good sign."

Despite this concern, Allen is generally optimistic about 2007. He thinks the dollar will continue to fall and interest rates and inflation could rise, but not enough to do serious damage. Nor does he expect Washington to enact the kind of dramatic shift in economic policy that can roil the markets. "It will probably just go into gridlock, which is probably a good thing," he says.

The biggest issue in the U.S. for 2007 may be China's economy and currency policy. Many U.S. politicians want China to let its currency, the Renminbi, or RMB, appreciate against the dollar. That would make Chinese goods more expensive to foreigners, allowing other countries to compete better with China's low-cost producers. China has resisted any major appreciation of the RMB.

Management professor Marshall W. Meyer thinks the Chinese government will let the RMB strengthen, but only a "little bit" in the near future, and only when the issue is in the spotlight -- during U.S. Treasury Secretary Henry Paulson's visit to China this week, for example.

Marston suggests that China may eventually let the RMB rise further in response to international pressure, and he thinks "Paulson is the perfect person to get this view across." Not only will this be good for other countries competing with China, it is likely to be good for the Chinese as well because it will reduce their incentive to plough surpluses into U.S. Treasury bonds. Instead of earning a poor 4.5% on Treasuries, the Chinese will invest at home, he predicts.

But he cautions that should China let the RMB float freely, the results might be disappointing for the rest of the world. China would continue to be a tough competitor even if the RMB rose 30% or 40% against the dollar. "I think the Chinese economy is so competitive that it's a little bit frightening in terms of what it has done to other countries in the world." Indeed, much of the current economic weakness in Mexico and other Latin American countries comes from their inability to compete with China, Marston says. "The Latin American economies are basically dead in the water."

Yet as formidable as it is, the Chinese economy is not without problems -- some severe enough to pose a potential threat to the rest of the world, according to Meyer. Capital markets are stalled on the mainland, with most Chinese companies raising money instead in the Hong Kong markets. As a result, Chinese people do not have many opportunities to invest in ordinary goals, like paying for higher education or retirement. They settle for bank savings offering low returns.

And many Chinese banks are shaky, Meyer adds. Banks have not been modernized to the extent many other industries have. As a result, politics drive many loan-making decisions, and Chinese banks have lent enormous sums that may never be paid back. "The magnitude of non-performing loans may or may not be a lot greater than has been reported," Meyer notes. "Whatever the number is, it's not going down. It's going up."

In recent years, the government has allowed its citizens to move larger sums of money out of the country. In the worst case, that could cause worried people to take money out in search of safer investments, which, in turn, could cause a run on the banks similar to the ones that occurred in other Asian countries in the 1990s. The government then might resort to raising money by selling the enormous reserves it has placed in U.S. Treasury bonds, causing interest rates to soar in the U.S. and other countries. "I think the odds of this are not high," Meyer says. But the odds may be growing because the banks have failed to get control of the bad loans, he adds. While the Chinese government is not in denial about this problem, it is not clear whether it will be able to act quickly enough in a crisis.

Elsewhere in the world, Allen worries that continuing problems in Iraq and the rest of the Middle East could create surprises that are more likely to be bad for the financial markets than good. India's economy and financial markets have been developing impressively, Siegel says, but there is still much need for reform. Restrictive regulations have been relaxed somewhat, and it is now easier for new companies to get started. "But there still is a lot of red tape in India," Siegel notes. Indian stocks have done very well, and prices are now high enough to be vulnerable to a pullback.

He also worries about Latin America, where a trend toward the political left could discourage needed investment. For Latin America, as well as the rest of the world, the bottom line is simple, Siegel says: "You have to be capital-friendly in today's global economy."

India Is Rocking

India's stock markets seem to have everything going for them, from robust GDP and FDI growth to buoyant corporate earnings and a reasonable inflation rate. The bellwether Bombay Stock Exchange Sensex has more than doubled in the past two years, and cheerleaders are talking of another doubling six years from now.

Specifically, India clocked GDP growth of 9.1% in the first half of the current financial year, foreign direct investment is at an annual run rate of $12 billion (compared to $7.7 billion last year), corporate earnings are set to grow 25% this year and foreign institutional investors are thronging India's bourses. The Sensex shed more than 800 points in the first two days of this week but reclaimed 186 points on Wednesday to close at 13,011.

Most investment banks and brokers share a bullish outlook for Indian stock markets in 2007. Citigroup research analyst Ratnesh Kumar, in his latest outlook for the equity market in 2007, says the premium for Indian stocks is expected to be sustained because of the "widespread belief in the long-term structural growth story in India and robust fund flows." He sees FDI inflows averaging $10 billion annually from the current three-year average of $5 billion, driven by "positive economic growth momentum and relative insulation to a global slowdown," aided by continued economic liberalization moves by the government and an optimistic outlook for the BPO industry. "The impact of a scale change in FDI inflows ... will further strengthen India's ability to withstand oil price spikes and volatility in portfolio inflows," says Kumar.

The stock market rally has been across the board, with impetus coming from the IT, automobile and commodities industries. Arjuna Mahendran, chief economist and strategist, Asia-Pacific, at Credit Suisse in Singapore, says there has been a shift since 2005 in the underlying fundamentals of the economy, with the service sector providing much of the incremental growth since 2005. The current rally, he notes, is driven by the earnings growth at Indian publicly held companies. Indian-listed companies last year posted an average earnings growth in excess of 23%, the highest in Asia, he says.

A benign global interest rate scenario and technological advances that helped India's business process outsourcing industry are key to the stock market boom, says V. Anantha Nageswaran, head of investment research (Asia-Pacific and Middle East) at Bank Julius Baer in Singapore, a wealth management firm with global headquarters in Zurich, Switzerland. "One should not underestimate the beneficial importance of these two last two serendipitous factors from the Indian standpoint."

Mahendran believes that Indian companies will not only retain their earnings growth, but also increase market share. Citigroup's Kumar echoes this view, noting that Indian companies will post earnings growth of 25% up to March 2007, and then 15%-20% for the rest of the year. He says that moderation in credit and higher interest rates will be among the chief factors tempering growth in corporate earnings in the latter half of 2007.

Could it be that funds are chasing all available assets and currently, India is the flavor of the season? Not really, says Nageswaran, pointing out that stock markets have been booming also in countries that do not boast India's growth numbers. Yet, foreign institutional investors are not expected to raise their allocation for India in 2007. Mahendran says the rise in allocations has already happened. "They are now likely to reassess the situation."

In that reassessment, most market players will keep a keen eye on the direction of U.S. interest rates. Many analysts believe that the stock markets have already factored in a Fed rate cut in the U.S. in 2007. Julius Baer's Nageswaran suggests that higher U.S. rates could cause many funds to move from emerging market equities to the U.S. bond market.

It is not just long-term funds that could cause volatility in India's stock market. The huge unregulated hedge fund industry has been an important factor in countries such as India. The role of hedge funds in the global financial market, says Nageswaran, "is being understated because ... the focus [is] on their assets under management." While hedge funds are smaller compared to long-term mutual funds, he adds, they have access to relatively cheaper money. Credit Suisse's Mahendran predicts that "if the India re-rating story comes to a halt, one could see volatility rise as investors take trading calls on a daily basis."

Other negatives loom on the horizon for the Indian equity markets. Citigroup's Kumar sees India facing "potential headwind" from a slowdown in credit growth, a talent shortage, elections in India's largest state of Uttar Pradesh and the waning of global risk appetites. He says wage inflation is a significant threat to corporate profitability in 2007 and predicts that the service sectors will be most vulnerable to higher wages. But a growing talent shortage and migration of middle-management skills to the service sector could fuel wage increases in the manufacturing sector as well.

The first step towards credit moderation has already taken place, with the Reserve Bank of India last week raising the mandatory cash reserve at banks by 50 basis points to 5.5%. That move could take Rs. 13,500 crore ($3 billion) from the system, cause interest rates to rise and dissuade borrowing in segments such as personal finance, home loans and auto loans.

The prospects of a rise in interest rates seem more certain than earlier, especially as 5% inflation levels show no signs of getting out of control. The Indian government has already cut fuel prices, permitted private firms to import wheat and retained its ban on sugar exports, among other measures -- all with the objective of combating inflation. But those measures may ultimately prove inadequate to keep prices in check. "The shortage of wheat globally could stoke inflation," says Mahendran. "Rates could rise, and that would affect consumer finance."

Swaminathan S. Anklesaria Aiyar, a columnist for the Sunday Times of India, writes about possible scenarios that could spoil the Indian stock market party. "Something will give. The housing market in the U.S. could crash, leading to a chain reaction of recessions in countries exporting to the U.S. The greatest threat of all is renewed terrorist attacks on the U.S. It is only a matter of time before suicide bombers, so common in the Middle East, detonate themselves in the U.S. rather than in Palestine or Iraq."

For the long term, however, Aiyar is sold on the India growth story. "The path of the world economy and stock markets could be a roller coaster... but if you have faith in India's future, then you should close your eyes and sign up for the ride."

Spain and Europe: Banking on Continued Growth

The Spanish stock market has enjoyed four consecutive years of significant price gains. But will the market continue its run next year? Although experts have no crystal ball to predict the future, most analysts consulted by Expansión, the Spanish business daily, are placing their bets on a fifth straight year of rising prices, during which the Ibex 35 could rise by about 10%.

Altina Sebastián González, professor of finance at the Complutense University of Madrid, is optimistic about the behavior of the Spanish index. In her opinion, the Ibex 35 could rise to about 15,500 points in 2007, compared to its current level of about 14,000 points. This prediction, she says, "is based on an economy that is still growing and will continue to do so in the coming year, and on an inflation rate that shows signs of slowing down despite its dependence on oil prices." Foreign demand "will continue to be vigorous," she adds, "thanks to growth in the euro zone and in the economies of Latin America. All of these factors create a landscape where business profits will continue to behave in a positive way."

Sebastián also believes that the current wave of takeovers, initial public offerings and mergers will continue in 2007, along with the creation of large risk capital funds that are eager to make investments.

Yet Sergio R. Torassa, a finance professor at the European University, believes that "at the beginning of the new year, we may witness a technical correction of some intensity as a result of the distortions created by the change in the tax regulations that will go into effect starting on January 1, 2007. Many investors are delaying their buying decisions until after that date because [short-term] capital gains on investments covering a period of less than one year will be subject to significantly better treatment starting in January."

Looking at the various sectors, he adds, it is possible that shares of bank and insurance stocks, as well as telecommunications companies, will outperform the market. "Rising interest rates will help banks and insurance companies, along with rising demand for credit stemming from GDP growth and a low level of late payments [by borrowers]." Regarding telecommunications companies, "Their low price/earnings rations and the attractiveness of their dividends will draw attention from investors."

Sebastián and Torassa don't agree with those who argue that the real estate sector has no further upside. Both experts believe that the big Spanish construction firms have learned how to globalize and diversify their business activity. They have converted themselves into service-oriented conglomerates, as demonstrated by their investments in electric utilities and in companies that manage infrastructure. "It would be a mistake to evaluate the shares of these companies as if they were merely construction firms," Sebastián says.

When it comes to European stock exchanges, the experts are quite confident about prospects for 2007. Europe lagged behind Spain in 2006, but it is quite possible that the situation will be different next year. Analysts at Banif, a private-bank subsidiary of Banco Santander, note that "European stock prices [outside Spain] are either cheap or properly valued, while stocks in Spain are either properly valued or are expensive."

For the last two years, notes Sebastián, European stock markets have been behaving very well, with average price rises in the double digits. Nevertheless, she says, "this excellent performance has nothing to do with any risk of over-valuation because price-earnings ratios [in Europe] are far below the levels that were associated with stock prices back in 2000. On the contrary, the markets continue to show multipliers that are more than just reasonable. With the Ibex at historic heights, the price earnings ratio of the Spanish stock exchange is 15.75. When it comes to European shares, the multipliers are even lower -- 12.58 for the Eurostoxx and 12.45 for the FTSE 100."

Looking at these multiples and projecting growth in corporate profits, it seems that there is still some room for European stock prices to rise higher. The data about the economic situation, Sebastián says, "point in this direction: The latest forecasts of the European Central Bank are optimistic; for 2007 and 2008, they project higher economic growth and lower inflation than in previous forecasts."

Nevertheless, says Torassa, "In recent years, Spanish companies have demonstrated an extraordinary ability to increase their profits. So far this year, those companies that compose the Ibex [index] have earned almost 29.6 billion euros, or 33% more than they earned during the same period in 2005. Over the last three years, their profits have doubled, rising from 15.1 billion euros in 2003. The Ibex [index] itself rose by 94% from the middle of November 2003 to mid-November 2006. Although interest rates have increased by 1.25% in 2006, this sharp rise in the cost of financing has not interfered with the growth rate of business profits. If these trends continue, we could see a new fiscal year in which shares of Spanish companies outperform their counterparts elsewhere in Europe."

Both experts agree that Spanish companies benefit from another advantage: Their strategy of geographic diversification has put them in a favorable position when it comes to dealing with any slowdown in local [Spanish] markets. "Latin America brings them higher and higher rates of activity and profits. Their recent investments in Asia -- such as those made by Telefónica and BBVA -- provide these companies with access to markets that have millions of potential consumers," notes Torassa.

However, not everything that glitters is gold. There are areas of concern that the Spanish economy must address, including the rigidity of labor markets, the taxation system and low productivity. "Spain heads the list of EU-15 countries where it is hardest to dismiss workers, and Spain occupies third place (after only France and Greece) when it comes to countries where it is hardest to hire people," Torassa notes. The high level of taxation "not only has social costs but also provides a disincentive for business activity. It also contributes to fraud. Finally, there is a significant productivity gap between the United States and the European Union, and the differential with Spain is even greater."

Sebastián cites several reasons why there will not be any relaxation in the frenetic pace of mergers and acquisitions in Spain in 2007:

  • The globalization of markets demands that companies make a significant effort to become more international.
  • The creation of a single European market has yet to be fully achieved. Although some nationalistic barriers continue to exist, the logic of the marketplace and pressure from the European Union are acting as catalysts for new corporate deals, both domestic and across borders.
  • In recent years, Spanish companies have made a major effort to improve their management. Their efforts have "had tangible results," says Sebastián.
  • The growth strategy adopted by Spanish companies has been supported by a corporate policy that views acquisitions as a means for achieving operational synergies based on economies of scale and/or increased revenues.

Challenges Ahead for Latin America

Latin America is growing at a pace above its historical average, within the context of a strong global economy. The International Monetary Fund (IMF) estimates that real growth in GDP will reach an average of about 4.75% for 2006. If so, that would make this period "the most significant three-year expansion since the 1970s," notes the IMF's annual report, "Economic Perspectives in the Americas." For 2007, the organization forecasts that growth in the region will be 4.3%.

The region grew at an average rate of 2.2% between 1995 and 2003, recording an inflation rate of 13.2%. In 2004, growth amounted to 5.7%, while inflation was 6.5%. And in 2005, the economy expanded by 4.4%, as prices rose by 6.3%.

Juan Carlos Martínez, a professor at the Instituto de Empresa business school in Madrid, says that the Latin American economy is in "exceptional" condition. "Unlike earlier periods, the growth is taking place at just the right rate, and the same thing has happened with other macroeconomic variables. Inflation is under control, salaries are improving, some countries have a trade surplus, the structure of the public debt is more solid, there are no foreign exchange pressures and financial institutions are stronger," Martínez notes.

An equally optimistic view comes from David Tuesta, a professor at the Pontifical Catholic University of Peru. "In macroeconomic terms, the situation is very positive. First of all, you can observe a clear trend toward low inflation, which is a result of more independent management by central banks and more responsible fiscal policy. Apparently, the sources of growth appear to be more solid, and they are supported by reforms that took place during the first part of the 1990s," Tuesta says.

As for individual countries, the IMF has revised downward its 2007 growth forecast for Mexico, from 3.5% to 3.3%, because forecasts call for lower growth in the United States. Nevertheless, the IMF is maintaining its 4% forecast for Brazil. Argentina is expected to grow by 6%; Chile by 5.5%; Colombia by 4.5%, and Venezuela by 3.7%.

Regional economic growth over the next year will be exposed to some of the same risks that threaten the overall global economy. The IMF anticipates that those risks will become more serious. Latin America could suffer, especially Central America and Mexico, as noted above, if the economy of the U.S. slows down even more anticipated. That's because of Mexico's dependence on exports to its northern neighbor. Another risk for Mexico is that prices could drop for its exports of primary products such as crude oil, coffee and soy beans.

The IMF report also points out the possible deterioration of global financial markets. There has already been a marked decline in margin interest in the bonds issued in the region, which reached historic lows in recent years. This was produced, in part, by high liquidity levels in developed financial markets. Any abrupt decline in global liquidity or abrupt change in investors' aversion to risk could create a financial environment that is much less favorable. Nevertheless, the IMF stresses that the region "is not as vulnerable to this risk as it was in recent years. That's because of the improvement in financial balances, current account surpluses in many countries and a more appropriate debt structure."

Despite the optimistic tone of its comments, the IMF warned that, in the absence of more reforms, growth will slow down in the future. Latin America is already falling behind other emerging regions such as those in Asia. The IMF is also worried about the medium-term impact of nationalistic policies on the energy sectors of Bolivia, Venezuela and Ecuador.

Martínez cites three areas where Latin American countries need to commit to making reforms. First, "they have to modify their tax and customs policy, since tax collections are at a very low level, and that leads to low budgets, which are tied to the problem of rigidity, which does not allow them to apply appropriate spending policy." Government revenues from taxation average about 23% of the GDP compared with 26% in other emerging economies.

Second, "some governmental reforms are necessary in order to achieve more stable, and less corrupt, political systems," suggests Martínez. The IMF believes that growth in many Latin American countries will continued to be limited by the weaknesses of the state. The consequences of this weakness include deficient public services, a fragile judicial system, high rates of crime and corruption, tax evasion and a sizable informal economy.

Third, "it is necessary for South American economies to undertake reforms aimed at achieving financial institutions that are stable and solvent, both in the public and private sectors," notes Martinez. These reforms "must attempt to rid the region of the cancer of social inequality."

Hugo A. Macías Cardona, director of the CIECA research center at the University of Medellín in Colombia, agrees. "The most serious problem in Latin America continues to be the poor distribution of wealth," he says, adding that major reforms must "deal with social security, pension systems and, above all, [provide] mechanisms" for getting poor people involved in the political and social system.

"The situation is not positive when it comes to poverty," says Macías. "Although poverty rates are declining, they remain extremely high." It is estimated that for 2006, "the number of poor people in Latin America and the Caribbean will exceed 205 million people, or 38.5% of the population," he adds. "The number of people who are extremely poor will be 79 million, or 14.7% of the total population. Although these numbers are below the 209 million and 81 million figures reported in these respective categories for 2005, there is no reason for us to celebrate. The most meaningful improvements in poverty indicators have been in Argentina and Venezuela, where conditions had deteriorated more significantly in recent years."

Tuesta sees a great deal of activism among politicians when it comes to intervening in markets. He cites the examples of Argentina, Bolivia and Venezuela. "Economies have a greater propensity to intervene [in markets] when the institutional framework is not appropriate. I believe that the major reforms will be in this area," Tuesta says.

Meanwhile, data about the region's contribution to global GDP demonstrate just how much Latin America has fallen behind other emerging regions, according to the IMF. During the 1980s, Latin America's contribution to global wealth was 6.2% while China's contribution was 2.6%. In 2003, Latin America's contribution fell to 4.3%, while China's grew to 3.9%.

Carlos Esteves, an economist and professor of international finance at UCES, an Argentina university for business and the social sciences, links developments in Latin American stock markets with U.S. Federal Reserve policy in 2007. "If there is no change in the way the federal funds rate behaves, whether a strengthening or a drop [in the rate], then the future can turn out to be attractive for markets. It could also happen that, despite everything said earlier, the slowdown in the American economy is more intense [than anticipated]. In such a case, even if interest rates remain stable, there could be some disturbances that affect markets."

Esteves suggests that the most attractive sectors for investment are energy, infrastructure, communications, agribusiness, tourism and basic supplies. "There is a whole range of significant investment opportunities in the region, depending on the specifics of each country. Given stable political conditions, these trends could have an even more profound impact," he says, adding, however, that in some important countries, the electoral process of 2006 could introduce a certain degree of uncertainty.

The Outlook from Inside China

A look at China's recent economic performance leaves no doubt that this country of 1.3 billion is on a roll. The Chinese economy, now the fourth largest in the world, has doubled its output, to $2 trillion, in the five years since it joined the World Trade Organization, according to press reports this week. The country's trade surplus increased to $22.9 billion, up 32.8% from the year before.

Against this backdrop, the visit to China this week of U.S. Treasury Secretary Henry Paulson Jr., Federal Reserve Chairman Ben S. Bernanke and six Cabinet members takes on added importance. The purpose is to talk about trade issues, but high on the agenda will be discussion of what the U.S. sees as China's continuing policy of protecting key domestic industries, among other alleged trade violations.

Coinciding with this event is the release of a report to the U.S. Congress from the U.S. trade representative, which takes China to task for not doing enough to stop counterfeiting and piracy, and not opening its doors wide enough to foreign goods and services. According to an article in the New York Times, the report specifically cited "continued limits by China on sales of financial services by foreign banks, including credit cards, and limits on some sales of farm goods."

Meanwhile, predictions from economists within China suggest that their country's economy is on solid footing. According to Zheng Chaoyu, director of the Institute of Economic Research at Renmin University in Beijing, in 2007, China will experience low inflation and a 9.25% growth rate, higher than the official prediction of 8%, but not as high as 10% "because the fixed-asset investment growth rate will continue to drop, and the export growth rate will be lower due to such factors as RMB appreciation." Zheng also thinks that the government will continue its "moderate and stable finance and currency policy.... No drastic changes are expected."

According to a report he contributed to, titled "China's Macro Economy and Policy: 2006 and 2007," the annual RMB appreciation rate will be at 6% between 2006 and 2010. "Our estimation is probably too bold," he notes. "But since the beginning of exchange rate reform, the actual exchange rate change was 2% to 3% higher than many people's expectation."

Zheng believes that the upward trend of FDI in China will be sustained in 2007. "We have a huge market and cheap labor, which is most attractive for foreign investors." Labor costs, he acknowledges, are "on the rise but will not have a [negative] impact in the short term." Long term, he adds, it is unclear whether productivity growth will counteract the impact of higher wages. His report assumes that wages will be growing at 10% annually.

As for China's regulatory systems, Zheng points out that "foreigners always talk about how severe the regulations are for foreign businesses, but they are actually more severe for domestic businesses." Zheng predicts that in the future, "policy makers will pay more and more attention to compliance." Many policies, he adds, "cannot be implemented easily and they are not as tight as people assume." Zheng says he is very impressed by "the ability of foreign companies to find ways to bypass policy barriers."

Chinese enterprises will continue to expand abroad in 2007, Zheng states. The key growth areas "will be the resource sector and emerging markets. But there will not be too many companies [going abroad] since the government is concerned about capital flight, corruption and the outflow of state-owned assets." At the same time, he adds, the surge in off-shore listings will not slow down, "especially for state-owned enterprises, because of government support."

Zheng's prediction for an average 9% growth rate over the next 10 years is based on the country's rich labor resources, high savings rate and potential for technological improvement and institutional change. "The workers in Guangdong province work day and night with a monthly salary of less than $150. Frankly speaking, I don't think there is any 'miracle' in China's economy," he says, reflecting the view that China's industriousness is responsible for its rapid growth, not a "miracle," as some media like to label China's recent successes.

Scott Zhu, chief investment officer of Wanjia Asset Management Co., offers another perspective on the year ahead. The China capital markets experienced "explosive growth" in 2005 and 2006 which will "continue over the next three to five years," he says, citing three major causes for this significant improvement. First has been continuous and sustainable GDP growth for the past 25 years -- with an average 9.6% growth a year -- which he describes as "phenomenal." Many economists believe that "China's GDP will grow at least 7% annually over the next five to ten years," he adds. "Second is the growing expectation of RMB appreciation against the dollar and other currencies. Third, in 2005, the Chinese government started a program to make non-tradable shares into tradable shares. Already 90% of the market's shares are tradable."

Zhu notes other factors that he says have helped the capital markets and that signal his optimism for the stock market's continuing growth next year:

  • The return of several off-shore-listed blue chip companies to the domestic market this year;
  • Further privatization of state-owned enterprises, such as the listing of the Industrial and Commercial Bank of China (ICBC) in October;
  • An internationally recognized new accounting standard that will be in place in 2007;
  • Further regulations, to be rolled out next year, that will help companies endow senior management with stock-based options and other incentives;
  • Further expansion of the QFII (Qualified Foreign Institutional Investors) quota next year, which will open the door wider to international players;
  • The roll out, by regulators and the stock exchange, of new products, such as margin trading, warrants, stock options and index futures, all in 2007.

According to Zhu, "the amount of funds raised in China's equity markets this year was the third highest in the world. If we combine the stock markets in Shanghai, Shenzhen and Hong Kong all together, the number would surpass the funds raised in the New York Stock Exchange for the first time ever."

Another number has also strengthened his confidence in the performance of China's stock market. "Up through the first week of December 2006, the total market cap is above 7.3 trillion RMB, more than double last year's market cap and equal to about 36% of China's GDP. I would expect that by the year 2010, the total market cap of the Chinese equity market would account for somewhere around 50% of the country's GDP."

Meanwhile, for foreign investors, two developments this year are reminders of the Chinese government's continued control over sectors of the economy that have attracted interest from abroad. On September 6, China's Ministry of Commerce and other government agencies issued new provisions to regulate foreign-invested M&A transactions. These provisions, according to an article in China Venture Capital Association, make it "clear that the [government] intends to increase oversight [of] private equity/venture capital financing and liquidity events in China."

And on July 11, six governmental ministries and authorities issued measures designed to regulate and supervise foreign real estate investors in China. The new rules are aimed specifically at curbing property speculation by outsiders and preventing excessive investments in the property sector. According to an article in China Law & Practice, these measures are seen by some as a statement against foreign investors, who have been increasingly active in this area. Other observers, however, view the measures as one of many introduced by the government to cool the real estate market and the economy overall.

Ethics of Outsourcing

Mankind has come a long way from clustered, isolated, self-sufficient early civilizations to the present time of globalization-driven advanced societies. We have learned new things, forgotten old skills, and invented new words and technology, or in many cases we have redefined old words.

Ethics is one such word that bugs us at times, as the old generally accepted definition is continuously clashing with what's seen all around or reported because of the unprecedented rise in the income divide both between and within countries, and with the growing acceptance of the “market knows best” principle.

David Ricardo came out with comparative advantage theory in competitive economies between Portugal and England, and showed how Portugal could be better off producing wine using all its resources, whereas Britain would be better placed in utilizing all its assets in producing clothes, in a two-product production and trade scenario. There was no debate of ethics then; it was pure economics leading to comparative advantages and then to absolute advantages.

However, if we look at the “oldest profession” of mankind, that of prostitution, a consensus has yet to emerge about its ethical rightness. Market forces apparently being stronger than administrative forces, irrespective of whether in a conservative or liberal society, prostitution has been there since ancient times.

Simple logic fail us in uniformly defining ethics, which increasingly is at odds with our internally evolving definitions within a changing society. One can argue that when one can trade (or use) his brain (take knowledge workers) or labor (physical worker), why should not some use their body (sexual workers) to earn a living? Society has not been able to apply such simple logic in justifying prostitution uniformly; however those who did not agree about its rightness could not control its spread, and thereby made the lives of those sexual workers difficult by harassing them on some pretext or other.

Society feels sex in married life is not wrong because through marriage, we form a union. It's a legally and socially accepted partnership where sex is no longer outsourced, but rather a self-sufficient body called a married couple is formed to take care of that need.

Modern times have brought more ways for a person to use their body for commerce. CNN some time back showed rapidly rising cases in India where mothers rent their wombs to would-be parents from developed nations for a fee. There have been reports of increased demand for wet nurses in China. In-spite of communist policies, the income divide now allows the rich to practice what emperors used to do. An eight-times salary difference for people who live on less than $1 or 2 a day is too much to resist. And before that there were stories of sweatshops in China to gain its manufacturing competitiveness, which any citizen from and developing world have seen stories on umpteen times. There's the case of child labor (also used by upper class people as maids) in India, which has been banned by law, but still is widely practiced by many Indians due to the benefits it brings.

The question that confuses many of us is how many of these are ethical and how many are not. The root cause of all these are the rising income divide. There's nothing intrinsically wrong with that, as long as no one lives in abject poverty where they can be expected to do anything for money.
Unfortunately a great number of people in the world today live still in abject poverty. Nearly half the world lives on less than two dollars a day. A recent report by the Helsinki-based World Institute for Development Economics Research showed that the richest 1 percent own 40 percent of global wealth, and the richest 10 percent owning 85 percent, whereas the bottom 50 percent barely manage 1 percent. One of the authors of the report, James Davies, a professor of economics at the University of Western Ontario, stated, "Income inequality has been rising for the past 20-25 years and we think that is true for inequality in the distribution of wealth."

With the vast majority of the poor, it's not a question of accumulating wealth; it's rather a question of surviving with a full stomach this day, the next day, and the day after. This was shown in a piece on CNN on Dec. 12 about the plight of poor people of Congo involved in the diamond trade. For some, the diamond is a precious jewel; for others it brings them a loaf of bread for their family by extracting it from the ground.

So is renting a womb ethical? Is hiring wet nurses ethical? Is hiring child labor ethical? There can't be any black and white answers to these queries. Government -- more so government of third world nations -- at most make policies that they can't implement. Banning child labor is a glaring example of that in India. It's still prevalent across all cities, towns, and villages. We just observe this and wonder what should we do to be responsible citizens to free India from this phenomena called child labor -- be it in a roadside restaurant or in a brick-making unit or as domestic help.

The simple fact is that the parents of the unfortunate child in most cases are happy, as the child is ensured of two square meals, and thereby increases the chances of survival for the rest of the family members. In India, there still is no legal norm on family planning. It's still is voluntary; however voluntary refers to people who have a choice. In India, people with larger family sizes come from the lowest strata of society, who don't have much of a choice.

Considering the gray nature of the problem, we can't take a unilateral position. For any parent who can't have kids of their own due to health reason, for mothers' who can't feed their new-born baby because of some medical problems, one won't question their ethics that much. However when it's done for money, at some point of time we need to answer that question.

Otherwise, unlike in the example of Portugal and England following Ricardo's theory, in the future society may be divided between lactating mothers and baby-bearing mothers, but no absolute advantage will be gained as only a very few limited privileged ones will benefit.

It would be unfair to touch upon few more prominent cases of outsourcing in the present global economy that offer an opportunity for few, but come at the cost of job losses for others. This is the case with IT/services outsourcing (BPO) from India and manufacturing outsourcing from China and many other export-driven economies. We aren't sure how far it can go because it has potential to reach all frontiers of the economy. What we see now could be the tip of the iceberg; however the pain it causes can already be felt in certain sets of economic data in affected economies.

Are business organizations ethically correct in outsourcing? Ask this question and you are bound to get more than two answers: one from affected employees in the developed world; one from the developing world where that new job may be getting created; and more from shareholders, economists, policymakers, etc.

We again hope that market forces would help us reaching equilibrium here too. However the way the income divide is growing, this does not look likely in the near future.

From outsourcing emerged the theory of core competency. And any theory in management and business is bound to be replaced by new theories that changing times demand. The idea of core competence resulted in the present superpower, which has been the defense outsourcing partner for countries like Japan, South Korea and a few others. So the root of outsourcing is ubiquitous, and it affects all strata of people.

The question is, will the market again determine what's ethical and not in these rounds of market-forces driven outsourcing? Or is it us who should try and define the line beyond which as a society we should know where to stop?

IT Trends for 2007: Process Improvement Leads the Way

Strategy
1. Process improvement will be job No. 1
2. IT works on closing the sale
3. Companies make their Web sites more engaging
4. Customer service gets a tune-up
5. Companies put their mounds of data to work
6. Information governance gains momentum
7. CIOs strive to be strategic

Management
8. The division between IT and business will diminish
9. CIO compensation keeps climbing
10. IT organizations will keep growing
11. CIOs struggle to find business-savvy technologists
12. Outsourcing changes IT management
13. Outsourcing growth slows
14. Offshoring shifts from India
15. Companies invest in IT leadership
16. Demonstrating ROI will remain a struggle

Security and Risk
17. No abatement of IT security threats
18. Security concerns turn users away from Windows
19. Security morphs into risk management
20. Compliance achieves what government intended
21. Compliance spurs financial process improvement

Technology
22. The move to a new architecture marches on
23. Enterprise applications start losing their luster
24. Data quality demands attention
25. IT reluctantly embraces Web 2.0
26. IT innovation loses traction
27. Business process management services and software will frustrate users
28. For business intelligence, the best is yet to come
29. IT organizations start going green
30. Dissatisfaction with vendors is on the rise

Have they forgotten anything?

Talent management. Not one mention of how finding and keeping talent is possibly the critical competence for IT, whether in the US, Europe, or India. Why is that? Because people are never a management priority. Come to think of it, wasn't that the problem with re-engineering?

End of big outsourcing deals on the horizon

Multimillion-pound outsourcing contracts are set to be a thing of the past, according to research published this week.

Sourcing advisory firm Morgan Chambers predicts that the £7bn worth of contracts up for renewal before 2008 will be broken up from big, high-value outsourcing deals and distributed among smaller suppliers.

Phil Morris, chief executive of Morgan Chambers and author of Outsourcing Service Provider Performance 2006, says companies are dissatisfied with large outsourcing deals.

‘People are seeing that the perceived advantages of a consolidated contract do not come to fruition,’ said Morris. ‘Smaller contracts are better value.’

Morris says five per cent of total cost of an outsourced project will be required to cover the increased complexity of managing multiple contracts. However, this money is likely to be recovered by a cost reduction as a result of better-value contracts.

The break-up of large contracts will provide more opportunities for smaller suppliers and spark a renewed trend to offshore projects, says Morris.

‘Business process outsourcing contracts are going mainly to places such as the Ukraine and Poland, but there will be quite a lot of smaller scale contracts going to India, Eastern Europe and the Far East,’ he said.

Morris estimates that UK firms will spend between 20 and 25 per cent of their outsourcing budgets on small offshore contracts.

He says the trend for smaller contracts is separate from a perceived trend towards insourcing large contracts, such as the decision by Sainsbury’s to terminate its contract with Accenture and bring its IT services and staff in-house.

Five tips to buying the right tool from provider

Buying logistics software is getting more complicated and there's more at stake. There are a variety of factors to consider in making the choice: the functionality of the tools, the price, delivery model, the reputation of the vendor, the level of users' sophistication and integration with existing systems are all key factors.

To help logistics software buyers and users make a more informed decision, Purchasing recently reached out to a host of software suppliers, consultants and users to get their insight on how to select and implement logistics software. Here's what a few of them said.

Tip #1

Know what problem you want to solve

Mike Regan, CEO of Tranzact Technologies in Elmhurst, Ill. and vice chair of the Institute of Supply Management's logistics group, says logistics software buyers need to have a clear and specific understanding of the problem or process that the desired software is going to address. Sounds simple right? Regan says it's surprising how many logistics organizations skip this step.

“Having worked with hundreds of companies and logistics organizations both as a software provider and through ISM, I can tell you that far too many times they do the equivalent of walking in to the show room and simply saying: 'I am interested in buying a car.' But there's a big difference between a Bentley and an Impala.''

Tip #2

Look to your 3PL for software

Logistics software today can come from a variety of sources: it can be developed in-house, bought from a point solution provider (installed or on-demand), added on from your ERP vendor, or, more often today, as a value-add from a service provider or 3PL.

Roy Cashman, COO of 3PL Transplace in Plano, Texas, says for companies with robust internal resources with the ability to configure software and manage its day-to-day operation effectively, buying logistics software may be the right alternative. However, he warns that day-to-day management will require significant time expenditure from potentially key strategic resources.

“Utilizing software from a technology-advanced 3PL can allow you to tap resources from a provider that is already experienced in manipulating the software as well as its day-to-day use, which can speed implementation and time-to-value,” Cashman says. “This approach also frees internal resources for more strategic projects and allows them to focus on managing at a high level such as monitoring performance.

Achieving economies of scale by using a 3PL's software is another consideration, Cashman says, and a key point to consider is flexibility. “If your requirements change at some point and you no longer need a 3PL but still need logistics software, are you able to leverage a 3PL's software without buying its services?”

Tip #3

Evaluate a software provider for value-added services

It's the flip-side of tip #2, but more logistics software and technology providers today are branching out in the services arena. According to the recent Transportation Management Benchmark Report from Aberdeen Group, “Some enterprises are starting to look to their transportation management solution providers to bolster their internal staff capabilities via managed services. These services can be viewed as a lighter-weight alternative to full business process outsourcing and can come from a software vendor, consulting firm, or logistics service provider.”

The Aberdeen report found that 45% of companies say they are interested in considering managed services for transportation planning, and 44% would consider using them for shipment monitoring and problem resolution. Twenty-nine percent of those polled are interested in using managed services for transportation procurement.

Tip #4

On-demand vs. installed: Depends on the process

The decision between selecting on-demand logistics software and installed may have more to do with the process being automated than with price or ease of use.

According to Johanna Boller, vice president of enterprise software product management at Pitney Bowes, “Due to the more standard nature of on-demand solutions very often there is less flexibility to tailor the application to unique processes. This is often a key factor in determining if an on-demand application can meet the needs of a logistics organization. Potential buyers should closely evaluate the process tradeoffs that may be needed for on-demand solutions versus the flexibility that comes with traditional installed software.”

Boller says traditional installed solutions let users control servers and hardware and network infrastructure. “For a mission critical application such as shipment execution software, you can't afford to have any delays in systems response times at peak shipping periods.”

Tip #5

Consider the level of collaboration required from the software

One of the primary benefits of software in general is the increased collaboration it can provide and logistics software is no different. The ability for logistics carrier, buyer and supplier to collaborate on a shipment's status via the Internet has revolutionized the idea of “on-time delivery.”

Warren Patterson, senior vice president of product strategy and development at SMC3 says logistics software is definitely becoming more collaborative, where information sharing between purchasers and providers of transportation services is key. He's a proponent of hosted/Web-based software that allows information to be shared electronically while access to that information can be systematically controlled.

“Shippers and 3PLs are looking to focus on the results of their processes and not the worry of maintaining all of the functions and links required to work with a large, diverse and constantly evolving carrier community,” Patterson says. “On-demand access via the Web means product updates are instantaneous and seamless to the user. What's more, the product administrator on the user's end can better control who has access to the product as well as levels of access.”

Aberdeen's report says, “Make sure the system used for inbound freight management (which often takes the form of a supplier transportation portal) is architected to be scalable across lots of vendors and is built for high performance and ease of use.”

Advanced evaluation
Six questions to ask your logistics software provider


1. Does the solution have a built-in process for notifying key individuals of important milestones and other events in the process? A technology solution should help users through intelligent prompting wherever possible and it should be a proactive process based on user input. Prompts are not necessarily required in all steps but when designed into the appropriate workflow they can be very beneficial.

2. Is the data that’s exchanged complete and accurate? Any data provided should be complete and programmatically error checked at upload time wherever reasonably possible for inconsistencies and load errors. Efforts should be made from your technology solution to automatically check data for required fields, missing data, and other potential error and data integrity conditions.

3. Are there automated processes for analyzing data? Data analysis should be scenario-driven by allowing the shipper or 3PL to vary certain conditions and elements that form the basis of a result. Dynamic scenarios allow the user to see and work with a broad range of complex criteria that can be more easily managed and compared. Also, the ability to save and recall these settings can be very helpful as a means of comparing results.

4. Are there accurate processes for analyzing specific data? The type of data analyzed by transportation professionals varies widely, from simple carrier service points to complex LTL pricing scenarios. It’s important to understand the type of data you are working with so that you know the solution you’re purchasing is best suited to your specific data analysis needs.

5. Can process results be viewed at a detail level? Too often solutions present only summarized results. The solution should provide the means to make data associations with common data markers or reference points.

6. Does the solution effectively manage complex processes? An effective Web-based technology solution should save time and reduce costs along each step of a process, no matter how complex.

Source: SMC3

Do Services Make Sense For You?

Outsourced Services Can Help You Focus More On What Really Matters, But There Are Risks
To steal a line from the Bard, the question is not “to be or not to be” but “to outsource or not to outsource.” That’s how Shakespeare would have said it if he ran a modern data center, where time is precious, and even the best teams are strained.

Maybe that’s what makes an IT service attractive. It can be cheaper and faster, begun with nothing more than a phone call and a meeting. But it’s not without risk.

When you outsource a key functionfrom network management to disaster recovery to simply cleaning the plenumyou bring unknown people into your office or send your data outside its walls, which is always a concern. And there's the age-old question of quality: Will you get what you pay for? If something breaks, will they fix it? If so, when?

By The Numbers

If you're thinking of using an outside service, you're not alone, not by a long shot. Plunkett Research estimates that global revenue from outsourcing will hit $400 billion by year's end. The National Association of Software and Service Companies estimates that India reaped $16.5 billion in IT service and software exports this year, and consulting firm McKinsey (mckinsey.com) estimates that China earned $6.8 billion in BPO (business process outsourcing) and offshored IT service last year alone.

In a recent report, research firm Computer Economics, which tracks IT services, found growth in all of them. The most popular? Software development, then Web sites/ ecommerce, hosted apps, and disaster recovery. Over half the companies it studied outsourced these functions in whole or in part. Roughly a third outsourced data center operations, but it was the slowest of any service tracked.

Backing Up Data

There are times when farming out an IT function makes sense. Doug Bruhnke of DataPreserve (www.datapreserve.com), which provides offsite backup to small companies, says that outsourced service lets companies focus on what really matters. “From a small and medium-sized business perspective, people are so busy just working on their own businessand that’s what they’re good atthat at this point I don’t think it makes any sense to have insourcing for IT anymore,” he says.

The exception? Companies that have the luxury of throwing dozens or even hundreds of man-hours at every IT problem they face. “The cases where it would make sense,” says Bruhnke, “are when you’ve reached some critical size . . . and you’ve got some technology or information you might want to shield from outside.”

Indeed, sending your data to third parties for backup may worry some, but it’s not without benefits. The first is the cost: A backup service can be far cheaper than building a hardened remote site, ready on demand 24/7/365.

“In addition to being more affordable,” says Bruhnke, “it would be a lot more secure. We’ll run into cases where people are backing up to someone’s garage or an unencrypted situation where data is passing over the Internet unencrypted.”

But dollars and safety aside, the biggest benefit to outsourced backup, says Bruhnke, might be peace of mind. “It’s a don’t-have-to-worry-about-it type solution,” he says.

Running The Network

It’s one thing to outsource your backups, quite another to outsource your network. Yet no small number of companies choose a network management service to run their LANs, WANs, VPNs, Web sites, or back-office apps.

Why? Cost is one factor, of course. Companies such as NIT (www.nitconnect.net), Inforonics (www.inforonics.com), and External iT (www.externalit.com) claim to save big bucks. Hosting servers in a third party’s data center can mean a windfall of savings on racks, ingress and egress controls, fire suppression, and more.

But as always, trust issues prevail, made worse by the penalties that HIPAA, Sarbox, and Gramm-Leach-Bliley impose for a data control or privacy breach. Out-sourcing a portion of your precious network means trusting a vendor completely, not only with service levels but with the measures it takes to prevent everything from malware to malicious inside abuse. Thus some companies choose a blended approach, with a vendor controlling a portion of daily operations (say, ecommerce or Oracle apps) under the watchful eye of in-house staff.

Cleaning Up

One field where a service is easy to swallow is data center cleaning. After all, how many IT managers like to do windowsor plenums, or a little rack scrubbing?

Experts in data center cleaning, such as Premier Solutions Company (www.premiersolutionsco.com), DataClean (www.dataclean.com), and Sterile Environment Technologies (www.set3.com), can manage advanced problems too, including zinc remediation, toxins, or dust in delicate servers. And they can do it far better than in-house staff, with special equipment that few SMEs have.

The bottom line? Backups, Web hosting, network management, cleaning, software design, help desksyou can outsource every part of your data center, floor to ceiling. You can turn over every task, using the power of your wallet and not just your in-house labor to keep things in order.

But how you do it, not to mention the cocktail of vendors and options you choose, is unique to each data center.

by David Garrett


Sample Vendors

Vendors that offer outsourced IT service come in numerous flavors, from Web hosting to back-office apps to backups. Here are just a few:

Aelera
Offers a range of managed service and software, with a focus on economic regions and community development
www.aelera.com

DataPreserve
Offers hardened remote backup and disaster recovery for small to midsized enterprises
www.datapreserve.com

Premier Solutions
Offers a data center cleaning service to keep dust and irritants away from vital servers
www.premiersolutionsco.com

External iT
Offers device management, application management, and a 24/7 help desk
www.externalit.com



To Outsource Or Not To Outsource?

Analyst Carmi Levy of the Info-Tech Resource Group believes there are right and wrong ways to outsource an IT service. “Just because a service can be outsourced does not necessarily mean that it should be outsourced,” he says. (Disclaimer: Info-Tech analysts write a regular column for Processor.)

When should you retain a service? According to Levy, a vendor can be an attractive option if you don’t have the right in-house staff, can’t train the ones you have, or can’t find what you need within the local or regional job market, providing you have a recruitment budget.

In contrast, if vendors "are unable or unwilling to customize their offerings to the particular needs of an enterprise," says Levy, look elsewhere or keep things in the family. You should also consider how much work it takes to manage a vendor. "Generally, highly complex, customized environments demand significantly greater degrees of relationship management, which can quickly negate much of the cost advantages of outsourcing.”



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