Eastern Europe an Emerging Outsourcing Leader - a deep look!

Hot on the heels of the release of major information report for IT Outsourcing industry in Central and Eastern Europe, “CEE IT Outsouircing Overview 2010”, we start observing an increasing number of publications trumpeting “the emergence of new IT outsourcing leader”.


Eastern Europe is more often named by many as an emerging outsourcing hotspot which is going to challenge world’s premier outsourcing destinations, especially for knowledge-intensive and innovative R&D and software engineering work!

Is it really going to happen? and if yes, what preconditions for this?

In our new series “Eastern Europe an emerging IT outsourcing leader”, we’ll try to answer some of these and other not less important questions.

But let’s get some things clear at first!

---

Post #1 - Two Meanings of The One Name

I picked up this example as there is some confusion in differentiation between outsourcing destinations in general and IT outsourcing destinations in particular.

To clarify this I’d like to take example with “car” - as this word may have some imaginative similarities in this respect. The word car can be used to describe both a sedan and a big truck, when speaking of the car we can mean them both, right?

Well, in this case the question to these car owners - “can you help me to move my belongings to new flat?” will be differently considered. Same story with IT outsourcing, as in metaphorical comparison such outsourcing trucks as “India” and “China” can completely move company’s belongings while such sedans as East European countries can move some compact or fragile parts at a time.

Let’s expand this thought a bit more, let’s see the moving process in this way - the India truck can move everything, but in a bulky way making you feel a bit concerned over the road, while Eastern sedan taking just some parts gives you control. See it is more about specialization :)

That said, indeed, Central and Eastern Europe is an emerging destination for IT outsourcing, and have been considered so for the last decade. But the competition with BRIC countries is rather illusive and might be considered seriously only in selective yet very crucial areas of IT outsourcing umbrella.

What does it mean?

Eastern European has always been considered as destination of choice for complex, knowledge-intensive software engineering and R&D projects, requiring in-depth expertise and innovation.

With solid scientific legacy and strong technologically-oriented education system (with only 1% of world’s population Ukraine has 6% of the world’s scientists) Eastern Europe appeared as a perfect choice for desperately seeking technological brain Western hi-tech innovators.

Apart from one-stop-shop outsourcing destinations such as India and Philippines featuring high-level of English penetration and abundant talent pool of various types of trades Eastern Europe since the first day was associated with the word “technology and engineering”.

Thereby, the lion share of the portfolio of IT outsourcing services provided by companies from Eastern Europe mainly composed of services related to software engineering and product development, while India, Philippines and China’ IT offerings largely mixed with data processing & support related offerings such as data management, IT support, system administration and others.

Where it came from?

Having well-developed scientific research and space industries the Soviet Union needed an efficient and productive education system able to cope with the growing demand for engineering brain.

The popularity of engineering and scientific professions has been spread throughout then-occupied and allied Eastern countries, thousands of universities and faculties have been opened setting a mark for high-quality technical education.

Andre Geim 2010 Nobel Physics Prize winner about Soviet Union education - You cannot obtain such an education, not in Harvard nor in Cambridge, nowhere!

Subsequently, all that brought an incredible progress in electronics and technology science making Eastern Europe a viable resource for immigration resources of Western countries. Providing some statistics, there were millions of engineers, scientists and mathematicians migrating to the US and Europe, during and after the collapse of Soviet Union. Then Polish immigrants, made a huge contribution to the UK labor market after joining to EU.

Thanks to cultural, historical and religious affinities, scientific and education potential immigrants from Eastern Europe saw a warm acceptance in their new whereabouts leading the innovation and technological advancement in United States and Europe. Several examples of this fact: Google with its founder Sergey Brin, two Nobel Prize Winners, physicists Andre Geim and Konstantin Novoselov and many others.

This fact not only spread the reputation of Eastern Europe as a mine of technological and scientific talent, but predetermined the whole course of the future industry. Eastern Europe’s colossal pool of engineers, scientists, mathematicians proved to be a magnet for foreign companies seeking technological brains.

After the collapse of Soviet Union in many member states rocket building facilities and scientific bases were re-qualified for providing commercial hi-tech services and products. Since early 1990s various organizations have been formed on the facilities of technical universities and scientific laboratories to provide assistance in complex R&D areas.

Back to 1991, the Swiss software innovators came to Ukraine for technological competence and signed what is known as the first outsourcing contract signed in Eastern Europe.

It was exactly the group of scientists from the Kiev Institute of Cybernetics, nowadays known as Levi9 Ukraine, which provided technological supervision for the development of large-scale object-oriented system which subsequently earned its owners TOP100 Manufacturing Software Firms Award.

What does it mean? - Part II. Innovation Outsourcing

Well, basically it means that although Eastern Europe is considered as a competitor to world’s top outsourcing clusters such as BRIC for the provision of whole range of IT outsourcing services this general competition term is rather illusive and argumentative.

There is a huge gap in terms of market revenue and labor pool between India, China and Eastern Europe, and even considering the stunning 23 percent growth rate for IT export in Eastern Europe its still far behind the so-called competitors’ indicators.

Another trend, however might be observed in the niche of software engineering and R&D areas as previously indicated 23 percent of growth mainly distributed between these to backbones of Eastern European IT export market, with countries such as Ukraine and Romania doubled their export of software development services.

Innovation outsourcing to Eastern Europe is booming and big internationals such as Siemens and Deutsche Telekom already gave a preference to Eastern European providers to source their innovation and knowledge-intensive activities.

---

In the next part we will discuss:

1. Factors that might influence alignment of forces in IT outsourcing:

The EU - US outsourcing race

Last year European Union outspent US for IT Outsourcing contracts for the first time benefiting Eastern Europe as a regional cluster for Western Europe.

Beginning of 2011 was marked by the quick start of US economy, while EU faced currency crisis and economic recession in its second-tier member countries. This may have a bearing on the spending figures.

Nearshoring Trend

Nearshoring is a main trend in today’s outsourcing arena. Similar time-zones, physical proximity and cultural affinity proved to be as important outsourcing drivers as cost-savings and technological competence.

Increased focus on vulnerability management as well as shift in outsourcing delivery preferences to nearshore and sameshore can help nearshoring destinations such as Eastern Europe to profit from nearshoring advantages in their specific clusters.

Egypt Crisis - will it change outsourcing landscape in the region?

A weeks-long unrest in Egypt has became a real crisis, which already been named by some as “the worst disaster since Iran’s revolution”. One of the country’s main industries - tourism has already felt consequences of this crisis as tourists planned their holidays in Egypt from around the world have been advised not to enter the country because of unrest and tense situation.


Direct competitors of Egypt's Red Sea coastline such as Turkey, Spain and others are getting benefits of busy beaches and flows of tourists as last have turned their back after several weeks of anti-government protests that forced president Hosni Mubarak to flee the country.

What about Outsourcing?

Some acclaimed experts already expressed their cautions with regards to perspectives of Egyptian outsourcing industry unless the situation stabilize soon. For the last several years Egypt’s outsourcing services industry demonstrated dynamic growth getting fame as a hotspot for global outsourcing.

In 2009, Egypt for the first time has joined joined Gartner's alphabetically-ranked annual list spelling out the world's top 30 leading locations for outsourcing services. One of the main treats of such a progress has been named Egypt’s government extensive support and liberalization of tax regime for ICT. Egypt received enormous support from the government, particularly in the ICT industry with a reported $2 billion investment in its telecommunications infrastructure.

This crisis might be a heavy blow to Egypt perception at the international outsourcing arena as despite its robust progress and high rankings, the country has a number of weaknesses among which most notorious - negative business perception.

An LSE Outsourcing Unit in its study “Beyond BRIC” noted that Egypt still suffers from a negative perception and a belief that it is a country regularly targeted by terrorists and government disputes.

From the history one might notice what role perception plays in such industry as IT outsourcing. As a perfect example India’s terrorist events and corruption scandals in 2008 which have irreversibly changed risk/rewards calculations in the whole outsourcing industry pushing India in its own outsourcing crisis.

Alignment of forces in the EMEA region

Egypt has been considered for years as a bridge between Europe, Middle East and Africa. The country has been competing with Morocco and East Europe for European clients, mainly from UK, France and Spain and was looking to expand its reach to Benelux market (Netherlands, Belgium and Luxembourg). The country has been positioning itself as a nearshore destination to Europe, following the growing nearshoring trend in the region and jumping on the bandwagon of Central and Eastern European cluster.

In its report “2009: The Year of Outsourcing Dangerously” the Black Book of Outsourcing included Egypt in the list of safe locations for operating with low downstream risk leaded by Central and Eastern Europe and Latin America, while the entire Africa region was recommended to be avoided.

However, the current crisis and its possible developments can have a detrimental effect on country’s outsourcing gains of past years. As in response to precarious conditions conservative and consensus-driven Europeans might not include Egypt in the list of preferable outsourcing destinations keeping short-sighted nearshore precedency.

Moreover, other emerging outsourcing hotspots such as Serbia, Romania, Ukraine and Belarus are on the track to grow their positions as leading locations for offshore/nearshore services placing a significant emphasis on IT and business process services providing a vehicle to their economic growth.

For Egypt there is everything still to play for and - we hope - its government will not forget lessons learned previously reacting in good faith and on reasonable grounds so to prevent disaster that will be remembered by next generations.

Austrian IT companies chose nearshore for outsourcing their software development

As a part of its Pan-European IT outsourcing research 2010, IT Sourcing Europe, a UK-located ITO research and advisory agency presented its findings of Austrian IT Outsourcing Software Development survey.

The survey aimed to explore the key trends and challenges among software development firms that outsource their software development areas to the 3rd party outsourcing providers.

In the period between September and October 2010 approximately 160 small, mid-sized and large companies across verticals in Austria were surveyed.

The survey results indicated that the number of nearshore software development outsourcers is double the number of offshore outsourcers (32% vs. 16%). For the time frames the study differentiate as offshore at least 2 time zones away from the home country, while nearshore maximum 2 time zones away or within Austria.

These figures supported by the top outsourcing drivers of the choice of the outsourcing destination in Austria which are: geographical and cultural proximity (25%), available IT resource pool (19%) and low costs (18%);

Among the main outsourcing goals polled companies indicated the following: to reduce operating costs (30% of respondents); to get access to more qualified resources and skills which are hard to find within Austria (24% of companies polled) and to respond to pressures from investors and/or executive management to cut down software development budgets (22% of participants);

The majority of the Austrian companies surveyed (28%) outsource 40% to 59% of their entire software development function, while only 2% of companies outsource less than 10% and 19% of companies outsource 90% to 100% of their software development volume.

The most outsourced area of expertise in Austria is Web 2.0 (Microsoft ASP.NET, Java, EpiServer, open source etc) – 42% of companies polled, followed by mobile development (34%). The least outsourced area of expertise is embedded development (only 3% of companies surveyed).

Steady growth for IT outsourcing over last years

According to a California-based IT industry research firm Computer Economics spending on outsourcing within IT industry increased from 3.8 percent in 2008 to 6.1 percent in 2009, and set to show even greater rise in 2010.

Technology and business companies are moving more of their IT spending to outsourcing, according to a new study, which may interest international contractors.

John Longwell, vice president of research for Computer Economics, a California-based IT research and advisory firm, said the recession has been one of the key reasons why firms are increasingly opting to outsource their IT functions.

However, new currents in IT industry such as Cloud computing contributed to the growth of subcontracting within the industry. "Cloud computing is a development that will result in more money being spent with outside service providers, regardless of the macroeconomic climate."

The report from another researcher REC Technology revealed that demand for people who work as an IT contractor is on the rise as well.

Why Near shore - the mitigation of business risks

During last years we have seen in practice that the nearshore outsourcing model provided a viable alternative between the desire to optimize application development and maintenance costs from one side and to reduce uncertainties and downstream risks of sending those activities to offshore providers from another. Geographical and cultural proximity, no time-zone difference, linguistic and scholar affinity and availability of strong IT skills inherent to nearshore locations allowed to develop intimate business relationships that translated into better communication and project management. While proximity and no visa hassles made it easier for project management to be more present in the project. As a result companies engaged in nearshore outsourcing model in many cases saw increased project management efficiency, better quality of output and less extra work.

From other side escalating uncertainties in traditional offshore locations, increasing costs and attrition levels combined with increased focus on vulnerability management and safety of corporate data have irreversibly changed customer delivery preferences to nearshore and sameshore options allowing those geographically closed destinations to profit from nearshoring advantages in their specific clusters based around clients in North America, Europe and Asia. According to recent surveys of global corporate executives, the top locations to operate with lowest downstream risks in 2009 were Central and Eastern Europe as well as Latin America, which are significant nearshoring destinations for US and West European customers respectively.

According to Black Box Research report uncertainties in offshore locations continue to escalate thereby strengthening focus on vulnerability management. Having service centers Nearshore and Sameshore will be a major client priority in outsourcing for next several years as clients will prefer to keep their data, process resources and account closer to where the business actually is.

IT Outsourcing in Central and Eastern Europe 2009

The alignment of forces in Global Outsourcing Industry will change, there is no doubt about it. There is some dominant reasons further to big changes:

- Current economic crisis swept the global markets and already hit the IT industries around the world. In this tough environment organizations have to carefully weigh all benefits and risks of sending work to outsourcing providers as well as once again reexamine what might be outsourced and what should stay in-house.

- Recent scandals in Indian IT outsourcing markets where service providers are losing their advantage against global competitors for providing IT outsourcing services as customer satisfaction levels fall (satisfaction with Satyam declined 15%, TCS dropped 8% and Wipro fell 4%)

- Europe has a record number of contracts were signed during last year and finally outruns US for outsourcing deals in 2008, despite a 50 per cent fall in the value of deals in the second half of the year

- Recent Gartner's report of TOP30 outsourcing destinations claims that BRIC (Brazil, Russia, India and China) dominated as offshore leaders in 2008, but it has also marked the rise of new outsourcing destinations as well as well scoring of CEE countries. Because of India's higher IT staff turnover and recent horror stories companies are choosing offshore providers in Eastern Europe where language skills are better and outsourcing providers appear to have a more in-depth understanding of their clients than competitors farther east.


Partially or entirely, all those facts strengthened positions of Central and Eastern Europe region as a major player in the global IT outsourcing market in terms of market volume, the number of IT professionals and IT companies offering outsourcing services. Increasing demand of Nearshoring services is also caused by a general interest of EU companies in entering to the CEE market with a desire to cut costs by using local outsourcing resources during an entrance.

Indeed, CEE countries are still more expensive compared to their Asian competitors such as India or China. However, Gartner's outsourcing report claims that recent EU entrants Slovakia and Romania, together with Russia and Ukraine were scored well on cost grounds and the CEE region whilst far from homogenous, enjoys close geographical and cultural links, particularly with the Western European markets.

Although the country (Eastern Europe) currently taking third place after India and China, it promises to rise up in near future with such attractive offshore work centers as Russia, Ukraine, Czech Republic, Poland, Romania, Belarus and the Baltic. These destinations not only offer low cost skilled labor force, but also an attractive regulatory environment with a close proximity and cultural ties to Western Europe and US. The other advantages of moving to Eastern Europe offshore markets are connected to its political stability, while India has an ongoing conflict with Pakistan and Sri Lanka.

Eastern Europe has highly efficient school system that adds thousands of skilled labor every year to its professionals, for example The Soviet Union's solid legacy in the fundamental sciences provides students with a strong education in numerous technical disciplines. According to the GoalEurope, there are 30,000 IT graduates only in Ukraine every year. With government commitment to the industry there is highly skilled labor force with minimal socio-cultural differences found in CEE countries.

As quality becomes more important during this recessionary times and outsourcing is not Just a Way to Cut Costs Anymore, customer wants to get better business processes from outsourcing providers in order to increase customer satisfaction and save more money. It requires from outsourcing providers more in-depth understanding of their clients along with ability to go beyond the traditional outsourcing services.