Eastern Europe is making its presence known as an outsourcing destination for IT and BPO services. Offshoring activity in Eastern Europe could triple by the end of 2008, McKinsey predicts, with Russia already the engine of the industry in the region

At the Gartner Outsourcing Summit in Dallas in March 2007, it was reconfirmed that IT offshoring is no longer as India-centric as it was before. By 2012, India's dominant position will be significantly diluted by effective alternative destinations, the so-called challengers. Given that cost reduction is no longer the most powerful incentive to go offshore, the market repartition may be explained primarily by the need of customer companies for certain business drivers, specific expertise and niche skills, as well as follow-the-sun delivery.

The challengers' group currently includes the Philippines (9%), Canada (8%), Brazil (8%) and Mexico (4%), whereas India, China and Russia make the leading trinity. Eastern Europe, too, is making its presence known as an outsourcing destination, for both IT and BPO services.

Growth catalysts

The fact that the total value of Russia's IT market has grown 25 times (from $550 million to $13.6 billion) over the last seven years shows that Russia is ready to lead. The country's IT export-oriented outsourcing industry grew nearly the same fold up to $1.3 billion at present, with a $5.8 billion forecast by 2009 and $10 billion by 2010, says IDC.

Russia is respected for its complex software engineering capabilities. A 2006 study by the FCREUE, the Haas School of Business and the University of California concluded, "In terms of education and experience with complex software development tasks, Russian programmers are likely to outrank all others."

Another study by Ernst & Young places Russia on top of several outsourcing locations in terms of skills and training of its IT workforce (See Table).

Despite being almost 80% smaller by population, Russia produces the same 200,000 graduates capable of entering the IT sector as India, according to Microsoft Research, and 20 times more scientists per capita, according to Forrester.

Another key consideration for companies seeking offshore partners is employee attrition rate. Currently, Russian IT outsourcing providers can boast three to four percent attrition rate versus India's over 30%.

Far reaching designs

After his visit to Bangalore in 2004, inspired by the impressive results of the transformed Indian economy, Vladimir Putin instructed the government to enact measures that would create favorable conditions for exporting IT services through entrepreneurship and investment in non-energy related research and development.

As a result, a number of government projects have been planned such as the Federal Agency for IT Exports Development and Investment Fund for Technologies and Innovations. International IT firms participate as co-investors, and some British and American financial institutions representatives who invest in IT and know the Russian market well are ready to make financial contributions.

Importantly, Russian software exports are exempt from VAT payments, whereas Forrester predicts some problems for Indian companies in the near future: The tax-free status of software firms in India comes to an end in 2009, and there is a powerful political coalition that plans to oppose the renewal of such a regime.

Another incentive is the development of industrial techno parks in the areas of the cities with largely unused human resources and scientific potential. As a result, 19,000 jobs are to be created by 2008, and 75,000 by 2011. Such parks shall be set up all over Russia — in Moscow, St. Petersburg, Tyumen, Nizhny Novgorod, Kaluga and in the Novosibirsk and Tatarstan regions.

Credibility witnessed

Recently, a Gartner analyst commented that it could take years for Russia to overcome the perception of being a difficult place to conduct business. A closer look at the situation, however, suggests that it’s not that risky to partner with ex-Soviets.

A recent report by the American Chamber of Commerce in Russia, for instance, states, "2006 proved to be one of the most successful years for Russia over the last 16 years". Ninety two percent of U.S. companies in Russia believe that continued commercial engagement with Russia is positive for American business and 86% believe that Russia’s upcoming membership in the WTO will bring new opportunities for them.

World business leaders like General Motors, Toyota and Ikea seem to understand this well, and Russia is now enjoying a foreign direct investment upsurge, with $17 billion entering the country in 2006. "In 2006, IBM's business in Russia grew by over 20%, and in the most recent quarter (Q4 2006), IBM's growth in Russia exceeded 38% — faster than in China, India or Brazil," says Kirill Korniliev, Country General Manager, IBM East Europe/Asia.

Russian providers deliver high-end, technically complex projects. Moreover, American organizations often perceive Russia as being a closer cultural fit than India, China, and the Philippines. Many customers like Consumer Aware (a company affiliated with Blue Cross Blue Shield of Minnesota) have established stable relationships with local providers such as EPAM Systems. "The EPAM team have been phenomenal at capturing our needs into detailed requirements," says Patricia Ball, VP, Product Development and Management, Consumer Aware. "They helped us think about things we hadn't thought of and the product is so much better as a result," she adds.

On the downside

The quality of English language in the country is cited as a drawback. Another weak point of the Russian high-tech industry is the underdevelopment of its infrastructure — the country lacks PCs per capita, roads are not well developed and broadband is still over-priced. In a recent Gartner study that ranks the level of risks in several popular IT outsourcing destinations, Russia's overall rating is "good" with "poor" infrastructure spoiling the bright picture.

Legislation is viewed as another Achilles' heel of Russia. Intellectual Property (IP) protection is what Russia is criticized for. Yet, in terms of legislation much is being done to improve IP protection. Moreover, leading Russian service providers seek stable relationships with customers and, therefore, pay special attention to security.

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