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West Meets East

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Global Services

For Western Europe and the U.S., Central and Eastern European countries are emerging as highly attractive outsourcing destinations.

Over the past decade, with the support of modern communication networks and high standards of education, many countries have climbed to the top of the offshoring tree. Among these are countries in Central and Eastern Europe (CEE). Though CEE does not provide cost savings to the same extent as other offshore locations, its cultural and geographical similarities to Western Europe and language capabilities make it a serious contender for outsourcing operations.

Favored outsourcing destination

In 2007, there was a dramatic increase in the demand for outsourcing in Europe. Of about $12 billion in mega deals awarded globally in 2007, over two third (68 percent) have been in Europe. The demand for offshoring among Western European countries rose by 50 percent from 2004 to 2006, with Eastern Europe emerging as a favorite destination. McKinsey estimates that offshoring operations in Eastern Europe could triple, to more than 130,000 jobs, from 2005 to the end of 2008. Dell, IBM and Morgan Stanley in recent times have outsourced their operations to Eastern Europe. At present, Eastern Europe’s outsourcing business is approximately $2 billion, which is a small fraction of about $386 billion global market. However, according to Gartner Dataquest, the growth in Eastern Europe would exceed growth in the rest of the market over the next four years; the outsourcing business is expected to expand by nearly 30 percent in Eastern Europe by 2010, as compared to 25 percent for the global market. Eastern Europe’s software industry grew by 12.53 percent in 2006, and is expected to grow at a Compounded Annual Growth Rate (CAGR) of 10.87 percent until 2008.

The appreciation of the Indian rupee, the political conditions of the country, high talent attrition rates and infrastructure strains have compelled clients to look for an alternative outsourcing destination, according to neoIT. Many CEE countries have come up as alternatives to such traditional offshore destinations. While Poland, Hungary and the Czech Republic have already shown bright prospects in the outsourcing market, newer destinations in CEE, including Romania and Bulgaria, are upcoming too. Also, labor shortages and higher wages in Western Europe make outsourcing to Eastern Europe an attractive strategy. CEE also has several cities with universities, which can offer a highly educated and multilingual talent pool.

Thus, 2008 will be the biggest year for the expansion of IT-service delivery and outsourcing capabilities beyond India. And this has helped to open new markets in regions like CEE, which can offer long-term benefits to its clients. According to A.T. Kearney’s Global Services Location Index study, CEE countries continue to be popular among European companies that are seeking alternative locations for their IT and business-process outsourcing services.

The CEE advantages

Although labor cost savings of outsourcing to India would be much higher, CEE offers certain advantages for Western European outsourcers that are not available in offshore destinations such as India or China. Multilingual capabilities and cultural similarities ensure that communication between outsourcers in Western Europe and their captive centers in CEE is effective and unambiguous. Therefore, projects or operations that depend on communication and complex business processes work best when outsourced to CEE. A highly skilled and talented workforce, shorter journey times and smaller time zone differences also make CEE an attractive destination for business outsourcing.

Quality work: Countries in CEE have proved their ability to deliver quality work in short timeframes and at lower costs. Companies in Western Europe, which have worked with Eastern Europe, are impressed with their professionalism and timeliness. According to Gartner 7th Annual Outsourcing and IT Services Summit, European organizations are steadily increasing their utilization of outsourcing and external services to enhance their performance and improve their competitiveness.

Favorable political environment: Unlike other low cost outsourcing locations, CEE has a stable political and economic environment. With simplified tax structures and subsidies for office construction, the governments of these countries are making the region attractive for the outsourcing business.

Strategic location: Apart from geographical proximity, many CEE countries also enjoy the benefits of being part of the European Union (EU). Companies in this region benefit from similar time zones, ease of communication, and convenient and fast travel options between cities.

Cost savings: The Czech Republic is part of the EU and North Atlantic Treaty Organization (NATO). At the same time, the members of the EU — particularly the Czech Republic, Hungary, Poland and Slovakia — can offer average labor cost savings of 40 to 60 percent over costs in Western Europe. The cities in non-EU countries can offer cost advantages of 60 to 80 percent. EU accession is one of the factors attracting international companies to invest in the Eastern European software industry. The statistical agency, Eurostat, estimates that employees in Hungary and the Czech Republic earn one-fourth of the employees in Western Europe and Slovakia’s employees only earn one fifth of the wage levels in Western Europe.

Well-developed language skills: In countries such as India and Philippines, English is the sole operating language in the outsourcing business. However, Eastern and Central Europeans speak a variety of languages such as English, Russian, French and German, as well as their local languages. Companies from outside English speaking countries appreciate these multilingual skills in CEE. Thus, countries like the Czech Republic, Hungary and Poland, with a large number of German, Italian and French speakers, have an advantage over their competitors. Moreover, the cultural proximity of CEE with its U.S. and European clients is an important consideration, especially for complex business processes.

Large talent pool: Eastern Europe has 40 to 50 provincial cities with universities large enough to supply a highly skilled labor force. There is also a strong focus on research in the fields of science, technology and mathematics in the education systems. As compared to other countries such as India and the U.S., many companies have found graduates from Eastern Europe more employable. According to a study, MNCs consider employing 50 percent of engineering students from the Czech, Polish or Hungarian universities, as compared to only 25 percent from India or 10 percent from Russia and China. CEE also has a highly efficient school system that adds thousands of skilled, talented labor every year to its professionals. All CEE countries are typically strong in mathematical and programming skills. However, technology skills are more developed in India and Russia.

Attractive outsourcing destinations

Russia: Russia is consistently ranked as the premiere destination to outsource. It is the third favorite destination in the outsourcing business after India and China. IDC has predicted a 40 percent growth in the software developer population alone between 2005 and 2008 in Russia. The attrition rate is just 8 percent in the Russian market. The education system is also very strong and 50 percent of the student population is studying technology, science or engineering, which is far more than in China, India, Japan and the U.S. A stable economy that results in slow inflation and steady rates for cost of living is an important consideration in outsourcing.

Romania: Romania has expertise in application software development, HR development and business solutions in ERM, CRM and e-commerce. It also provides R&D facilities to some of its clients. Romanians stand out with their language skills, a well-developed IT industry and the availability of a vast IT labor pool. The government has granted 100 percent income tax exemption for the IT workers to aid the progress. The Romanian IT outsourcing industry is growing much faster than in the rest of CEE.

The Czech Republic: Companies in the Czech Republic supply software localization services, product testing, custom application development and IT translation services in a wide range of languages for Europe, Asia and the U.S. The Czech Republic was ranked sixth on the 2005 Global Services Location Index and scored the best in the region.

Slovakia
: Slovakia was ranked 16th on the 2005 Global Services Location Index, which is the second-best position among CEE countries. It has strong technical support call centers, a favorable business environment, political stability, and a strategic geographical location. Other factors working in its favor are the macro-economic conditions, infrastructure, high level of education, accessible technical expertise, extended knowledge of foreign languages and an effective price ratio.

Poland: Poland has been reasonably successful in attracting outsourcing providers from the U.S. and European countries. It has low-wage inflation, low infrastructure costs and increased harmonization of laws with the EU through the implementation of directives into Polish law and the direct application of regulations. It has a civil law jurisdiction based on the French and German legal traditions and a skilled labor force. The state and the local authorities have a positive attitude toward the development of outsourcing opportunities in Poland.

Conclusion

CEE countries are emerging as prime outsourcing destinations for both Western Europe and the U.S. This region offers an educated, multilingual labor force, talented professionals who are trained in key technologies, reliable IT infrastructure, moderate to low cost of labor and access to the greater EU. Its secondary educational system and technology-oriented higher education has made it a strong contender for software development, R&D and engineering services. According to the United Nations Conference on Trade and Development, in recent years, the CEE region has captured more than 20 percent of the global market in IT outsourcing. Poland, Hungary and the Czech Republic house several captive centers of major global firms. Moreover, they offer labor-cost advantages of 20 to 30 percent over Western Europe and the U.S. With the wind of outsourcing blowing from the traditional outsourcing destinations to the more attractive ones, the CEE countries are bound to emerge as hot spots for outsourcing in the near future.