Software Organizations looking for software services realize that India has a massive number of technically talented skilled professionals available at a very lower cost. These organizations wish to use this talented workforce in order to undergo their software projects at a lower cost. Foreign companies gain by the lower prices while technically talented people reallocate back into the sectors which suit their talents. This occurs because they receive comparatively higher wages due to the increase in demand for their technical services.
Potential clients, however, are not much clear on the capabilities of the Indian talent to do credible, quality projects within a well-defined time frame. In simple words, information asymmetry exists in between the providers of the software development services in India and the potential customers in foreign countries. They exactly do not know whether the talent in India has the ability to deliver the kinds of services or products in the manner and specifications that they required. This becomes especially crucial in large-scale software projects where the client's organization and profitability depends on the proper implementation and management of systems. At the early growth of the industry, a viable domestic and local market did not even exist which further raised the concern of potential foreign clients. In light of these concerns, how do the overseas companies gain the information on firms in India and find one that may closely satisfy their requirements and concerns?
They have to search for them. Although foreign companies know of the cheaper technical talent available to them overseas, they incur an additional search cost in looking for the companies that have the abilities to satisfy their specific requirements. If this search cost is too much high, clients may not find using the Indian talent feasible and a mutually beneficial transaction will fail to occur. The transaction becomes profitable only if the advantage of using the Indian talent outweighs the cost of searching.
Now let's try to model how the overseas firms behave when trying to choose an Indian company. This model will include approaches of traditional comparative advantage models with the new concept of transaction costs involved in searching for the suitable Indian firm. Consider a overseas firm searching for an Indian partner to complete a software development project. Subtracting the cost of using an Indian company from the benefit gives the gain that the western firms obtain from using an Indian company.
Now, what is the advantage of using an Indian company? Using classical comparative advantage models, overseas firms use Indian software companies if the cost of a software project is cheaper in India then in their local domestic country.
The cost of doing a project in India is a function of the search effort since the client searches for the lowest cost company and the more effort the client spends the lower project cost company he or she is likely to find.