Deloitte dives into India's growth with equity deal

iPhone-toting millennials flock to work in four daily shifts. They ignore the construction worker urinating in a vacant lot. It's 41 degrees outside. The locals are crabby, waiting for the beloved rainy season.

"I am very thankful to you for choosing my city," my driver, Ameer says, referring to the influx of Western service companies who have altered the face of his hometown over the last 25 years. "There are many more jobs," he says.

Ameer's 15-year-old son, a gadget nut, ‎is likely to be snapped up by a Western tech company when he graduates. Ameer tells me that native-born Hyderabadis account for about half of the 8 million people who now call Hyderabad home. "The rest are from somewhere else, they come for the work," he says.

Branded internally as "Deloitte US India", the 27,000 employee operation refers to six subsidiaries of Deloitte's US firm. Its heavy-duty users are its US parent, plus Deloitte sister firms in Australia, Britain, Canada, and the Netherlands, although over time it has grown to support 43 different Deloitte firms around the world for audit, tax, consulting and risk advisory functions, as well as back office tasks such as marketing, human resources and information technology. It is a separate entity to the Indian Deloitte firm, which has roughly 6000 employees and serves domestic clients.

Administrative work on Australian company audits is all done out of Hyderabad, along with research for merger and acquisitions, conflict of interest checks on new engagements, and collections for the entire $1.3 billion revenue generated by the Australian office.

But it has rapidly evolved into a value-added innovation hub, designing data analytics, cyber security and other service offerings of its own accord and exporting them back to US and Australian headquarters to on-sell to clients.

Mind-boggling growth

Visits by multinational clients are averaging five or six a week to Deloitte's US India facilities, as companies seek to preserve profit margins while investing in new products and services.

The conversion rate from these visits is almost 100 per cent, according to Bruce Stewart, a Dallas-based partner responsible for Deloitte US India. It is primarily project-based consulting work, ranging from six months to three years.

A decade ago, Deloitte US India employed about 3500 people. That's now close to 27,000 and the company expects to recruit 12,000 new professionals this year alone – the equivalent of Deloitte's entire British office, and double its Australian firm headcount.

By 2020, Deloitte US India is projected to employ 48,000. Even allowing for staff attrition of 16 to 19 per cent, the net gain is big. "We always overshoot these projections," Mr Stewart says. He believes the 2020 headcount will be closer to 60,000.

Hugh Mosley, a Melbourne-based risk advisory partner who oversees Deloitte Australia's Indian offshore operation, is acutely aware of the role Deloitte is playing in India's emerging economy.

Salaries are jumping 12 to 15 per cent a year at Deloitte US India, while inflation averaged 7.85 per cent over the past four years. Disposable incomes have surged in the span of a single generation.

"[Indian millennials'] salaries are higher but also their buying power is stronger," says Abhay Garg, who leads Deloitte Australia's operations in Hyderabad.

"The disposable income from one generation to the next has increased enormously," my tour guide Jonty said.

An educated "corporate dropout" with an MBA, who worked for the Bill Gates Foundation before starting her own tour company, Jonty regales me with a story of her housekeeper in Bangalore who earned about 600-700 rupees ($12) a month but quit work when her son got a job with a Western business process outsourcing outfit earning 10,000 rupees ($200) a month.

Appetite for Western brands

Mr Garg said Indian millennials are buying cars and houses earlier, travelling more, and have an appetite for edgy Western brands. Swedish furniture giant Ikea plans to open its first retail store in India in Hyderabad next year, an investment of 20 billion rupees.

Australian franchise chain, Howards Storage World, is also due to open a store in Hyderabad's newest and biggest mall, Sharath City Square, in Hitech City. It already has stores in Chennai and Bangalore, and opened its new concept Kochi store in February.

The Modi government through its "Make in India" policy has continued to roll out incentives to attract foreign investment to generate jobs for the 1 million people who join the workforce each month. However, a trade agreement aimed at increasing Australia's two-way trade between India – which last financial year was $18 billion or three per cent of total trade - has been hindered by protectionism.

"The range we get here of brands like Nike and adidas is so limited," Jonty complains. She recently purchased ‎some Slazenger gear from Britain online and had it shipped to India. The customs tax was exorbitant, ranging from 50 to 70 per cent of the value of her purchases.

Hefty custom tariffs and the time it takes for imports to clear customs is a major impediment for Western retailers seeking to expand in India. Balachandra Yadalam, master franchisor for Howards Storage‎ in India said stock takes two weeks to clear customs and is subject to 29 per cent import tax.

In the Westin Hotel Hyderabad bar, the wine list sports nine varieties of reds from France, Spain, Argentina, Italy and Australia. It's just for show, and to aggravate guests as they work their way through the menu and are denied everything except Indian wines, or the 2013 Jacob's Creek from Australia at the inflated price of $26 a glass ($124 a bottle).

"It's the taxes" my host explains apologetically. India's wine industry is very young. It shows in their vintage. I become unusually sober during my stay.

Tax is also a point of contention for Deloitte, one of several multinational corporations engaged in a battle with Indian tax authorities over transfer pricing rates. The government wants to increase rates to the mid-20 per cent mark to repair the national budget, while multinationals seek to keep it in the mid-teens.

The ongoing uncertainty with Indian tax authorities makes it hard to price proposals accurately, says Mosley. He said industrial relations laws that make Australia a high-cost place to do business are just starting to show their face in India. For example, the Indian government recently increased the maternity leave provision to 26 weeks, up from 12.

Rising costs is something Deloitte is keeping a close eye on in India. At its current trajectory, the labour arbitrage which originally attracted the Western firm to India could evaporate within 11 to 15 years, Deloitte's internal simulations show.

Mr Mosley believes there will be a correction that prolongs this window.

Cheap labour

Right now, the labor arbitrage is still attractive. The fully loaded cost of an experienced technology consultant in Hyderabad is about $25 an hour, the equivalent of a babysitter in Sydney. Fully loaded means it includes not just annual salary, but all the overheads associated with employing that person - rent, technology, training and taxes.

An MBA qualified commerce or IT graduate with proficient English costs $US25,000 a year (fully loaded cost) in Hyderabad, compared to a base salary of $50,000 to $60,000 in Sydney or Melbourne.

While talent retention is the major reason Mr Stewart is "banging the table" about admitting an Indian homegrown partner to the US equity pool, the evaporating arbitrage is a secondary concern.

Prime Minister Malcolm Turnbull cited Treasury projections putting the Indian economy on equal footing with the United States by 2050, and still growing fast, at a Lowy Institute lecture in March.

"While China's working-age cohort is likely to shrink by 20 per cent by the middle of this century – at which point its demographic descent could be steeper than contemporary Japan – India's workforce will keep growing well into the second half of this century," Mr Turnbull said during his lecture.

Deloitte has read the tea leaves. Already a dominant tenant in Hyderabad's Hitech City, Deloitte is building a new campus in collaboration with Indian construction company Meenakshi which will cover an entire city block. The first phase is due for completion next year.

US tech giant Amazon is also ramping up its presence, investing in new offices and a larger workforce. While it is gearing up, Amazon is not exactly an Indian success story. It has been overtaken by the local competitor Flipkart, and become a warning to Western brands, highlighting the need to let locals share in the international business more.

Graft

It is in the course of a discussion about commercial real estate, with a Hyberabad property developer backed by Australian foreign investment, that I get my first insight into how the much talked about corruption in India operates.

"We pay 70 per cent of our rent in 'white money' and 30 per cent in 'black money'," the developer tells me. The "white money" goes through official channels and is subject to tax. The "black money" is a thriving cash economy.

The Australian developer first saw the potential in Hyderabad in 2011 but waited until the change of government in 2014 before buying a $1.2 million plot alongside the freeway leading into Hitech City. "It was too risky before that, too much corruption," the developer tells me.

It is widely acknowledged that a lot of corruption has ‎been stamped out over the last year. But it is a deeply embedded practice. .

The developer plans to apply for a government grant, through an initiative announced in April to begin construction on a $10 million commercial office tower. He said the amount of "white money" invested will depend on the extent of bribes he needs to pay to bureaucrats. The difference between striking a sweet deal or not is an immediate profit of 30 per cent compared with waiting four years to recover his costs, he says.

Tim Eddy, who has overseen EY's offshoring facilities in India for since 2009, says he has never been asked for a bribe. "I wondered if we might be. That would make us deeply uncomfortable," Eddy says.

EY has 16,000 staff in India supporting its global offices around the world, excluding its domestic Indian firm. It will comfortably employ more than 40,000 by 2020, Eddy says.

Killing jobs, or creating them?

Buried within the 27,000 employed by Deloitte US India are 800 full time equivalents assigned to Deloitte Australia. As a group, they represent 15 per cent of Deloitte Australia's total headcount.

For big client engagements - typically digital assignments or software installations - they come to Australia for two- to three-month-long stints, sometimes in groups as large as 50.

The expansion of its Indian operations is not replacing local jobs, according to Mr Mosley. The growth in the two offices is symbiotic, he says.

Since ramping up in India, Deloitte Australia's annual income has risen from $854 million in 2008-09 to $1.3 billion in 2014-15. Its annual intake of Australian graduates has increased year-on-year to about 460 in 2014-15, compared with 25 in its Indian operations. And during the time the India-Australian operations have grown from zero to 800, Deloitte's local headcount has risen by 1546.

Deloitte chief operating officer, David Hill says the offshore operation has allowed Deloitte Australia to keep a lid on costs while giving the firm unprecedented elasticity in its workforce.

"The consulting business doesn't use our Indian colleagues based on cost. It's hard to quickly scale up a team for a $200 million [software] system implementation job in Australia," he said.

However, critics of offshoring argue that short-termism is blinding Western countries to its detrimental impact. Outsourcing America, published by the American Management Association, says one in three workers displaced by offshoring remain unemployed, according to US Labor market statistics, while many of those who find a job take a major pay cut, leaving them with less disposable income.

The economic impact when consuming classes no longer have the income to consume had many finance leaders worried at the Davos World Economic Forum in January.

In addition, offshoring critics argue that blue collar workers who retrained in science, technology, engineering and maths – often touted as future-proof sectors – face the prospect of having their second career disappear overseas. "That's the reality of the world we live in. All parts of the world are subject to disruption, no employee can stand still," Hill says.

After a full-day tour of EY's offshore facility in Trivandrum I can't get the Irving Berlin song Anything You Can Do out of my head. With professional services firms pushing the message that India can execute tasks better and cheaper, what are the "safe" jobs in mature economies?

Eddy says roles require client's trust and deep industry knowledge can't be offshored. Then he shows me a video on robotics, likening humans to a contemporary version of the horse when it was superseded by the car.