The new face of offshoring Closer to home?graphics.eiu.com/files/ad_pdfs/eiuOffshoringWP.pdf · A...

A report from the Economist Intelligence Unit

sponsored by Hewlett-Packard

The new face of offshoringCloser to home?

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The new face of offshoring: closer to home?

© The Economist Intelligence Unit �006

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The new face of offshoring: closer to home? is an Economist Intelligence Unit briefing paper, sponsored by Hewlett-Packard.

The aim of this briefing paper is to explore what is driving the trend towards nearshoring in the Europe, Middle East and Africa region. With companies increasingly looking to consolidate business and IT services in lower-cost locations, we look at whether nearshore locations like the Czech Republic and Hungary will be able to remain competitive against global competitors like India and China—and against emerging regional competitors like Romania, Russia and Egypt.

The report is based on in-depth interviews with senior executives, responsible for managing shared-service and outsourcing centres in the EMEA region and beyond. We would like to thank them for sharing their time and insights with us.

The Economist Intelligence Unit bears sole responsibility for the content of this report. The Economist Intelligence Unit’s editorial team conducted the interviews and wrote the report. The findings and views expressed do not necessarily reflect the views of the sponsors.

Delia Meth-Cohn edited the report, with contributions from Aviva Freudmann, Katherine Shields and Paulius Kuncinas. Sigrid Ramberger was responsible for design and layout.

May �006

Preface

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The offshoring business is booming. Whereas a few years ago, only a few US pioneers were setting up shared-service centres and embracing outsourcing, cost pressures are now encouraging companies

across Europe to gain the benefits of pooling services and locating them where skilled labour is cheap.

That growth in demand is matched by a growth in supply of ever more exotic low-cost locations. India has been the biggest beneficiary to date. It has the advantage of a massive supply of ultra-low-cost English-speaking graduates and a good decade of experience. But while India will continue to enjoy strong growth as companies expand offshoring activities, we argue that the future of offshoring will not be a race to the bottom on costs. Locations closer to home—nearshoring operations in Central and Eastern Europe and North Africa—will be a key focus of expansion for companies based in Europe.

Key findings of this report include:

● European companies need shared-service centres that can operate in European languages—not just in English. But India or other rock-bottom locations cannot support operations in anything but English. Most companies also feel more comfortable with the cultural and geographical proximity of European locations. With Central European locations still at least half the cost of the cheapest western European locations, most are willing to pay the small premium needed to get a service centre that addresses business needs.

● New offshoring functions require more interaction As offshoring becomes mainstream, the pioneers are pushing beyond the standard offshoring activities, like finance and IT support, to more complex and customer-facing operations. As more and more transactions can be standardised and performed remotely, these kind of higher-value services need the language and cultural skills that are prevalent in nearshore locations.

● The rise of global service delivery. Global outsourcers supporting business operations prefer not to divide up the world into nearshore and offshore. They see their role as developing a portfolio of cost-effective service centres that can run around the clock, with a wide range of skills and capabilities. With demand now stronger from Europe, global outsourcers are focusing on boosting their capabilities in the EMEA region. Even Indian vendors are now opening new centres in Central Europe to serve the European market.

Benchmarking locations

● With new nearshoring locations emerging all the time, companies need to focus on defining and ranking their needs—costs, proximity, languages, skills, business environment—rather than latching on to the new hotspot.

● Few companies will open large new centres in Europe’s original shared-service locations, like Dublin, Brighton and Amsterdam, but existing operations will slim down and focus on specific high-value functions.

● Central European locations—the Czech Republic, Hungary, Poland and Slovakia— enjoy low costs, strong skills, EU regulations and solid infrastructure. They will remain attractive for higher-value services for the foreseeable future. Wage costs are around half of those in western Europe and wage inflation has slowed since EU membership in �00�—but some cities are already overcrowded.

● Romania, Bulgaria and the Baltic states also offer similar skills with lower wages and are currently attracting a flow of new investment.

● Russia is starting to develop a niche in global IT and R&D offshoring, based on its strong human resources.

● New locations like Egypt, Morocco and South Africa can offer competitive advantages, but companies need to watch availability of skills and overall costs.

Executive summary



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New offshoring locations are springing up like mushrooms. Over the past few years, India has become the undisputed leader in handling global companies’ IT services and back-office

operations, eclipsing early pioneers like Ireland and the UK. But hot in pursuit is China, followed by most of Central Europe, Brazil and Mexico and, increasingly, new destinations like Egypt, South Africa and Vietnam.

Look at the headlines, and you’d guess there is an unstoppable rush to shift all back-office, call-centre and technical activities to ever lower-cost locations, wiping out offshore business in cities where costs are rising as companies move on to new pastures. Following that logic, the current burgeoning of “nearshoring” locations like Prague, Budapest and Bratislava—closer to home than India or China but not as cheap—would just be a brief footnote in the history of offshoring as their costs rise.

But the reality is far more complex. There is clearly an overall shift from high labour-cost markets to lower-cost ones—no-one these days would choose Dublin or Brighton to set up a big new shared-service centre and most companies are trying to make use of India’s very low-cost skills where possible. Nevertheless, the most important development in offshoring is not a race to the bottom, but the emergence of diverse new locations with very different competitive advantages and disadvantages,

supplying the massive growth in demand for offshoring in all shapes and sizes.

The global offshoring market is currently worth around $�0-�0bn, and it is growing by around �0% each year. That means it will double to $100bn by �008. That rapid growth is a result of the increasing pressure on businesses to cut costs while expanding their top-line sales. Reshuffling production activities around the globe has been part of the solution—the other part, which is now booming, is offshoring services.

Pooling services in a shared location cuts direct costs in two ways: through consolidation and wage arbitrage (making use of cheaper pools of skilled labour in lower-cost countries). But by encouraging the streamlining and standardisation of administrative processes, offshoring can also have a longer-term impact on both growth and costs, transforming big, lumbering organisations into leaner and more agile competitors, capable of operating more easily across global markets. As the globalisation of manufacturing has changed the business models of international companies, so the globalisation of services is starting to do the same.

As a result, pooling services and offshoring and/or outsourcing them is no longer seen as an avant-garde option for the pioneering few—it’s become part of mainstream corporate strategy. That shift is not only

Why offshoring is moving closer to home

Offshoring, nearshoring and outsourcing—what’s the difference?Offshoring is the relocation of service activities abroad. Offshoring operations are often divided into farshore, those that are distant from the markets they serve, and nearshore, those that are closer.

Companies can either set up a captive shared-service centre or outsource to a third-party provider—and increasingly

companies are combining both elements. The range of “offshorable” activities is growing all the time, but generally includes IT services, business processes (finance and accounts), research and development, software programming, call centres, help desks, business research and human resource management. In principle, all activities that do not require local knowledge, face-to-face customer contact and complex interactions can be performed remotely.

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pushing the overall growth of the offshoring business, but has produced three distinct drivers for the growing importance of nearshore locations, especially in Europe and the EMEA region:

● strong demand from European companies

● consolidation of new, more complex functions, and

● the shift to a global service model

New demand from Europe

Over the past decade, US-based companies have taken the lead in driving offshoring and outsourcing, with UK companies following on their heels. Now the strongest new demand is coming from continental European companies. These German, French and Nordic companies are looking to gain the cost and efficiency benefits enjoyed by their Anglo-Saxon competitors, but are far less comfortable moving whole swathes of their business to a far-off, English-speaking location like India.

They want to see services in their own languages and tend to demand a higher degree of cultural fit, especially in any customer-facing activities. They also like geographical proximity and similar time zones. “India is not enough if you want to address the growing market in Europe for offshoring,” says Malgorzata Stachowicz, manager of Hewlett-Packard’s business process outsourcing centre in Wroclaw. “To attract the European market you need European languages and cultural understanding.”

Pooling new functions

The second driver of nearshoring growth is the push on the part of those companies that have already enjoyed the benefits of offshoring and outsourcing in areas like finance and accounting or IT services to shift new activities into pooled competence centres. Already, the list of offshoring functions has grown steadily and

now covers research and development, human resource management, procurement and order management and business analysis. But a recent McKinsey study reckons there’s a long way to go yet: even in business processing and IT, it argues, only ��% of potentially “offshorable” activities are already being offshored.

That development guarantees the continued growth of large offshore centres in India and other rock-bottom cost locations. But it also guarantees the continued development of existing and new nearshore locations. For a start, the supply of sufficiently skilled low-cost labour is becoming one of the constraints on the long-term development of offshoring. India and China don’t have enough internationally minded graduates to fulfil this potential growth. What’s more, as the shared-services and outsourcing business starts to embrace more complex and customer-facing services, it requires precisely the kind of advantages that only nearshoring operations can

Ranking of potential offshore locations from the perspective of a German company

Weighting: cost ��%, business environment ��%, risk profile �0%, quality of infrastructure 10%

Score Rank

Czech Republic �.� 1

Hungary �.� �

Poland �.� �

India �.� �

Germany �.6 �

Malaysia �.6 6

China �.8 7

Ireland �.8 8

Russia �.8 9

Source: McKinsey



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offer—languages, cultural understanding, close time-zones and geographical proximity.

It’s easier for global outsourcing providers, with thousands of offshoring employees to exploit the benefits of global mix and match. But companies with advanced shared-service operations are doing the same too. Aluminium producer, Alcoa, for example, has focused on streamlining processes and cutting costs, whittling down its many finance and accounting centres to just five globally—in the US, Australia, Hungary, Brazil and India. It is now focusing on shifting as many processes as possible to India, while building new customer-facing capabilities in its nearshoring operations.

A few years ago, many pioneering shared-service centres saw the future in terms of ever greater automation and Anglicisation, but attitudes have changed. Many have now come to realise that pushing for the lowest possible costs can be bad for business. True, the logic of offshoring is that services don’t need to be performed in the markets where they are consumed, but “some companies saw the dollar signs and went too far,” says Duncan Howard, Director of Customer Operations at Vodafone Egypt. “You can’t expect customers to pay for premium services and not mind being handled by someone whose accent they can’t understand and who has absolutely no knowledge about how things work in their country.”

Alcoa: nearshore perspectives from a pioneerUS aluminium manufacturer Alcoa is a pioneer in financial shared-services. It was one of the first to focus on consolidating its back-office operations, when it set up its first centre in North America in the early 1990s. It brought the shared-services idea to Europe in the late 1990s, setting up centres in Spain, the Netherlands and Italy. It was then one of the first to discover the benefits of locating in Hungary. It set up its first small centre in 1999 after acquiring a plant in Szekesfehervar, 80km outside of Budapest, and then consolidated its other European centres into this location in �00�.

These days, it has only five centres worldwide and reckons it has made total cost savings of �0-�0%. From Hungary it services Europe; from Brazil, located next to another large manufacturing plant, it services Latin America, and from an outsourcing operation in India it services most of the back-office financial activities for the US and Australia. “We locate the shared-service centres in the lowest-cost country where we can find the skills we need,” says Hubert Angleys, Director of Globalisation at Aloca Europe. In the case of Hungary, that is languages, rather than proximity. “The

quality of services depends on language and culture and your ability to hire sufficiently skilled people.”

Alcoa’s approach to shared-services is radical. It has one technology platform, standard processes and is on a constant hunt for lower costs. It won’t centralise everything in India because it needs to spread risk. But Mr Angleys is watching Hungary’s wages carefully. “Today, Hungary’s average wage is still �0% lower than the cheapest West European country,” he says, admitting he was worried for a while as wages spiralled. Now he thinks wage inflation has slowed and Hungary will take longer than initially expected to reach West European levels.

Nevertheless, the profile of the Hungarian centre will change and its overall numbers may well shrink. Alcoa has already shifted global IT support to Bangalore and will look at moving anything that’s not language-dependent to India, its cheapest location. At the same time, Mr Angleys is looking at which other processes he can standardise and absorb, aside from IT, finance and accounting. “Customer service is at the top of my list,” he says. That will no doubt give Hungary’s linguists a longer lease on life.

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HP: outsourcers move nearshore The clearest proof that European nearshoring is more than a passing fad is the activities of the world’s major outsourcers. Their business is to be one step ahead on the shared-services learning curve, offering the right global mix and match of locations and functions to be ready for client demand. Over the past few years, leading outsourcers have focused their attention on getting Europe ready for offshoring.

Take Hewlett-Packard’s operations as an example. HP started its own offshoring operations in the early 1990s, enabling it to reduce operating costs by �0% in three years—and improve service levels and encourage further process improvement through use of technology. Once it had achieved its own transformation, it began to introduce outsourcing services, quickly becoming a leading player in the market.

Its aim is to create a seamless global delivery capacity for business processes and IT support services. The idea is not just to reduce cost, but also to optimise processes and quality and to accommodate client needs such as languages, time zones, specialised skills and scalability. To achieve this, it has huge and growing operations in Bangalore and Chennai, a large presence in China and several centres in the Americas and Asia.

But its current growth focus is in Central Europe, where it is currently building up a force of up to 8,000 people in four new sites: two business process outsourcing sites in Poland and Romania, and two new IT support centres in Slovakia and Bulgaria. “Our centres in Central and Eastern Europe provide services through highly skilled, multi-lingual resources at lower cost than in Western Europe,” says Jan Zadak, HP’s vice president and managing director Central and Eastern Europe, Middle East and Africa.

Growth so far has been rapid. The Polish centre in Wroclaw started operations in April �00� and already has �00 people, with 1,000 expected by next year. It is focusing on finance

and administration, mostly for the EMEA operations of key global clients like Procter & Gamble, which HP used to service from its �0-year old centre in Barcelona. The Spanish centre is now focusing on serving clients in their native languages, charging a premium for that service. Customers for whom mere language fluency is sufficient are served by Wroclaw, where labour costs are half the level than Spain. Services not requiring language skills or proximity can be handled offshore in India.

Languages and interaction skills at a low cost are the key benefits at the newly established Bucharest centre which opened this year and has over �00 people already, with 800 expected by the end of the year. It is focused on procurement and order management, currently developing the services using its own internal service operations as a pilot, before offering them to commercial clients.

“Who would have guessed 10 years ago that we would be doing order management for key customers out of Bucharest,” muses Laurent Poujol, manager of the Bucharest centre. But in five years, he says, Bucharest will need to change again. Some things will be passed on to India, freeing up Bucharest for more interactive services and innovation, like finding synergies between different parts of the outsourcing business. “A centre can last for three years on the basis of wage arbitrage alone,” he says. “But if it doesn’t have a transformational and innovative culture, it will be dead after that.”

HP’s IT support centres in Bratislava and Sofia also fit into a global supply strategy that includes operations in Germany, Spain, the US as well as in India. Both are still expanding their capabilities, but they are also aware of the need to ensure they add nearshoring value. “India is a different business model—it’s big and far away,” says Sasha Bezuhanova, general manager of HP Bulgaria. “We offer multilingual support, ease of communication and knowledge transfer—we can be a real partner.”



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It was these kind of perception issues that led to the outcry against offshoring in developed markets—especially in the US—in �00�. By then, almost 700,000 Indians were already employed in the offshore services business. That process had largely happened behind the scenes, but as newspapers began to report the shifting of thousands of white-collar jobs from the US and UK to India, the issue became politicised. That scared international companies, but they didn’t pull out of India—indeed, �00� saw growth of well over �0% in offshored services in the country, and outsourcers there are booming. Instead, companies took a sober look at business needs and recognised the imperative to be seen to be investing in key markets around the world as well as in low-cost India.

These developments are already having a big impact on more mature shared-services operations. Take the example of technology giant Oracle, which originally consolidated its global back-office activities into three shared-services centres in Ireland, the US and Australia in the late 1990s. Now it has shifted virtually all its finance work to Bangalore and the Indian centre is still expanding. Australia has closed down altogether, while the centres in Ireland and the US have shifted their focus to become control and compliance hubs. Whereas a few years ago, the Irish centre was full of hundreds of young people, now it employs a smaller number of highly qualified accountants with language skills and business knowledge. In addition, Oracle has opened up a major administrative centre in low-cost Romania, along with three specialised competence centres for client sub-sectors in Poland, Hungary and Jordan.

Global models

The third driver of the nearshoring boom is the shift of outsourcing companies and mature shared-service centres in large international companies towards a global service delivery model. That means creating a portfolio of service centres around the world that meet diverse business needs, working around the clock across all time zones,

and taking advantage of a wide range of languages, skills and costs.

These companies are not selecting nearshore over farshore locations per se. As Stephen McGuckin, Managing Director of IT Services at DHL’s Global Business Services Division, puts it: “For us, everywhere is nearshore because we have operations in so many countries around the globe.” They are optimising what international companies like to call their “global footprint”. In other words, they are creating a support structure for international business operations, based on making the most of a global pool of labour.

EIU Offshoring Environment Rankings, 2005

Note: score based on 9 separate measures: proximity, political and security risk, macroeconomic stability, regulatory environment, tax regime, labour regulation, labour costs, labour skills and infrastructure

Score Rank

India 7.76 1

China 7.��

Czech Rep 7.�6 �

Singapore 7.��

Poland 7.��

Canada 7.�� 6

Hong Kong 7.19 7

Hungary 7.17 8

Philippines 7.17 9

Thailand 7.16 10

Malaysia 7.1� 11

Slovakia 7.1� 1�

Bulgaria 7.09 1�

Romania 7.08 1�

Chile 7.08 1�

Source: Economist Intelligence Unit

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For large global outsourcing providers, the recent drive to open up new centres in emerging locations in Europe and nearby is a natural response to the growth in demand for nearshoring locations from new and existing customers. But these are part of a global network of centres, where work is handled globally, according to skills and costs. “We can look at the whole structure and come up with the best options for delivering services,” says Jan Zadak, HP’s vice president and managing director for Central and Eastern Europe, Middle East and Africa. “Clients get a mix of offshore, nearshore and onsite services. Which combination of locations makes sense is dynamic over time. It’s a question of costs, quality and scale.”

DHL: following the sunWhen DHL opted to put its largest global IT support centre in Prague in �00�, it really put Central Europe on the offshoring map. True, DHL’s headquarters are in neighbouring Germany—but the international express and logistics company, owned by German Post, is hardly a novice in globalisation. Before the Prague decision was made, DHL was already outsourcing to India and had a shared IT support centre in Malaysia.

DHL was looking for two things in its shared-services strategy for its ��-hour data centre operations, says Stephen McGuckin, Managing Director of IT services at DHL’s Global Business Services Division. One was to move IT services from expensive places like Hong Kong, London and San Francisco to locations with high-quality labour, lower-cost infrastructure and good access to external outsourcing providers for non-core, commodity-like operations. It also wanted a “follow-the-sun” strategy, with three regional centres, each handing on to the next throughout the day. Malaysia and Prague won out on low-cost, good-quality labour, while the third centre in Arizona had very low communications costs.

“The point was not to go offshore for its own sake—the point was to gain a business benefit from doing so,” says Mr McGuckin. “So we use a combination of in-house resources

in lower-cost locations that are close to business units and external vendors.

In Europe, Prague was competing with the UK, Portugal, Spain, Ireland and other Central European locations. To make the decision, DHL drew up its requirements: IT skills, good infrastructure, a business-friendly government and stable political environment, good air links around the region, along with competitively priced labour, office space and hotels.

It was a close contest, Mr McGuckin says, but DHL is very happy with its choice. With 1,000 people in place, servicing both global and regional business units, the Prague centre will expand to �,000 people by �008. Cost savings have been substantial: consolidation alone boosted productivity by over �0% and the unit cost for an IT person in the Czech Republic is one-third the costs of a person with an equivalent skills set in western Europe, according to Mr McGuckin.

But costs, skills and infrastructure aside, Prague’s proximity is also an argument for DHL. Mr McGuckin, who manages the three regional shared-service centres, has based himself in the Czech capital: “It is geographically closest to the headquarters in Bonn,” he says.

The clearest evidence of this trend away from concentrating large-scale activities in one low-cost location towards taking a broader portfolio approach is the strategy of Indian outsourcers. Tata Consulting Service’s chief executive Subramanian Ramadorai recently told Forbes: “Several years ago we decided the India-centric model had to change. We needed to offer seamless delivery from around the globe.” Tata opened operations in Hungary, Brazil, Chile and China, while its rival Infosys chose Prague and Brno in the Czech Republic, along with Mauritius and Shanghai.



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Look at the latest rankings of offshoring locations and it’s clear that a lot is changing. India always heads the list these days, due to its enormous market of ultra low-cost, English-speaking graduates and strong outsourcing vendors—and despite a less-than-perfect telecoms infrastructure. China is also growing strongly due to market size and cost, but is frequently more a nearshoring market for Asian operations than a global centre, largely due to very limited English skills.

Turn to the EMEA region and old favourites like the UK and Ireland have fallen way down in rankings, due to high costs and limited skill pools. The new EU member states still feature strongly, but there’s an even stronger wave of interest in new locations. AT Kearney’s latest global list, for example, shows the Czech Republic heading the EMEA locations at 7th place globally—but that’s three places down from �00�. It is followed by countries that have never made the ranking before: Egypt, Jordan, Bulgaria and Slovakia.

The proliferation of new locations may seem to add more confusion to location decisions—who knows which places will still be attractive in three years’ time? But companies looking for nearshoring locations should first focus on defining and ranking their own priorities—costs, skills, proximity, attractiveness, business regulations—before looking at the pros and cons of specific locations.

“If you take a “follow-me” strategy and don’t select carefully, you can end up in the wrong location,” says Michiel Weimar, director of Human Resources at Hewlett- Packard EMEA, who worked with the University of Ghent to develop a location analysis tool, known as CoreShore. “The right location depends on your decision criteria and what you want to achieve.”

When companies all pile into the same new locations, the benefits of critical mass and clustering quickly turn into a battle for skills. Before the emergence of new nearshore locations over the past few years, companies operating en masse in places like Dublin and Brighton were starting to despair. Their own centres were growing, but every new entrant into the overcrowded market meant increased

costs and job-hopping, plus the prospect of hiring people whose career choice was between a shared-service centre and a supermarket check-out counter.

Hardly the scenario for low-cost, high-quality services. It was that development which created the momentum for the mainstream push to India, where wages for eager English-speaking graduates were less than a quarter of those for unskilled school-leavers in the UK or Ireland. But with the need for locations that offered European languages within European time- and comfort-zones, it was also the catalyst for searching out new locations

Benchmarking EMEA locationsAT Kearney’s Global Services Location Index 2005 Top 15 locations in Europe, Middle East and Africa

ranked by cost, labour supply and business environment

EMEA rank Global rank

Czech Rep 1 7

Egypt � 1�

Jordan � 1�

Bulgaria � 1�

Slovakia � 16

Poland 6 18

Hungary 7 19

UAE 8 �0

Ghana 9 ��

Romania 10 ��

Russia 11 �7

UK 1� �8

Tunisia 1� �0

Germany 1� �1

South Africa 1� ��

Source: AT Kearney

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in Central Europe—sometimes by companies looking to relocate shared-service operations in crowded hotspots.

Many international companies had already successfully transplanted manufacturing operations to Central Europe. Once they turned to services, they quickly found pools of multilingual graduates and engineers with labour costs half of those in western Europe and a familiar regulatory environment created by EU accession. The only trouble is that once again, companies initially piled into the more obvious places like Prague and Budapest, pushing up costs and attrition rates. Even in Bangalore and Chennai in India, the supply of labour is not sufficient—job-hopping has become more of a problem and labour costs are starting to rise. As a result, the search goes on, with companies discovering new locations all the time.

Russia: falling between two stools?Russia is a very bright blip on every high-tech company’s radar screen. It’s a large, fast-growing market and its engineers are known to be among the best in the world. But many companies have struggled with the decision to set up sizeable global operations there.

French telecommunications equipment company Alcatel is one of the pioneers. It opened a global R&D centre in St Petersburg, where it plans to have �00 engineers by the end of �006—small compared to India, but growing fast. With Intel, Google and Motorola following suit, is Russia now ready for an R&D boom?

Johann Vanderplaetse, Vice President of Alcatel for the CIS, says HQ was impressed by the quality and availability of engineers. “St Petersburg is hotter than it was, but it’s churning out more engineers than in the 1980s and the quality is not dropping,” he says. “Russians are good at developing what we ask them to do, but they are outstanding in proposing new ideas and coming up with new solutions that can be used globally.”

Alcatel has similar R&D centres around the world, from developed markets like France, Germany and the US to emerging ones like China, India and Romania, where it was responsible for creating an international engineering cluster in Timisoara. Despite his praise for Russian engineers, Mr Vanderplaetse is still not convinced that Russia has found a competitive niche. Costs in Russia are not low. Moscow is prohibitively expensive, but even St Petersburg—where costs are �0% less—comes nowhere near India and China. If the government wants to support software development, he says, it needs to move fast on improving the overall environment— especially on tax incentives and intellectual property enforcement.

“Russia needs to watch out,” he says. “There is a risk that it might fall between two stools—between the legal advantages of the enlarged EU and the cost advantages of China and India.”

The growing demand for new offshoring locations has been matched by a boost in supply as governments realise that, with a few policy changes, they can attract foreign direct investment and create high-value jobs for their young graduates. As a result, places like Romania, Egypt and Jordan, that would have seemed completely unrealistic offshoring locations just a few years ago, now boast advantages that can be competitive with those in relatively more mature locations like the Czech Republic and Hungary.



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The Czech Republic tends to come at the top of EMEA location rankings (including the Economist Intelligence Unit’s own offshoring environment index, see table on page 9), largely beating its neighbours due to the help of its proactive investment agency, CzechInvest. Fears that wage inflation after EU accession would put a rapid end to the significant cost advantage in mature markets like the Czech Republic, Hungary and Poland have been turned on their head, with wage growth slowing considerably since �00�. Indeed, companies like Alcoa in Hungary and DHL in the Czech Republic are reporting salary levels this year below initial expectations.

Technical and language skills are very strong, and many global IT companies have set up R&D centres, especially in Poland. Some companies also say they are starting to see a brain gain—the return of skilled local managers from abroad, happy to take up good positions in an international environment. Nevertheless, labour availability is getting tight in capital cities and most new companies looking at these markets should focus more on provincial cities, where entry-level wage costs can be �0% lower and skills availability is still good.

Slovakia is rapidly joining its Central European neighbours into the mature phase, despite the fact it only joined AT Kearney’s list this year. Companies like AT&T, Dell, IBM, and Hewlett-Packard have large centres in Bratislava, attracted by significantly lower costs than in Hungary or the Czech Republic. But there is still strong labour supply in university towns further east.

The three Baltic states—Estonia, Latvia and Lithuania—have also started to become an interesting nearshore location, especially for Nordic companies. Although EU members since �00�, labour costs are still considerably lower than in the mature Central European markets, while the skills profile is similar. But tiny populations and rapidly rising office and wage costs mean that development will be limited, while one operator moans about lack of government help and the absence of an international perspective among employees.

This year has seen a flush of new shared-service operations in Romania and Bulgaria. Both countries have very strong technical and language skills, wage levels considerably lower than in Central Europe, and are on the brink of joining the EU. Romania started the ball rolling a few years ago by giving software developers tax-free status and building up an engineering R&D cluster in the western city of Timisoara. Now outsourcers like GenPact and Hewlett-Packard are rapidly building up business processing centres in Bucharest. Bulgaria is smaller, but has highly qualified technical staff. Until recently, Bulgaria was mostly known for software development, but Hewlett-Packard this year set up a high-level IT support centre for the EMEA region, which aims to employ 1,000 by �007.

Russia is a special case for offshoring. Moscow is too expensive a market to feature on location rankings—and the country is unlikely to play a major role in standard business process outsourcing for the EMEA region. But it is developing a niche for higher-value global IT outsourcing, R&D and software development, especially in lower-cost university cities like St Petersburg, Nizhny Novgorod and Samara. One attraction is that Russia has a huge and growing domestic market, which gives business an added incentive to invest. But it also has some of the world’s strongest human resources.

“Russia is a logical alternative to current players in the offshoring business,” says Owen Christopher Kemp, vice president and managing director for Russia at Hewlett-Packard. “The country has a wealth of academics, engineers and a language-skilled workforce and a cultural compatibility to Europe, the US and even Asia that other players lack.” With 11 time zones, industry-specific knowledge and a number of strong home-grown IT outsourcers, Russia could develop this niche strongly over the coming years.

The latest entrants to the offshoring game are in the Middle East and Africa. Dubai is trying to develop an outsourcing zone, but rising costs and limited labour supply will keep the potential limited. Bigger and poorer countries like Egypt and Morocco have more chance of

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attracting a critical mass of call centres and outsourcers. Morocco has already attracted a number of French and Spanish companies, given its low costs and language skills. Egypt, with its large number of unemployed graduates, is focusing on attracting ICT companies to a special offshoring zone.

In Sub-Saharan Africa, South Africa is seen as a good call centre location, with its English-speaking citizens, European time-zone and good infrastructure—but white-collar labour costs are too high and the supply of skilled labour too limited to be much of a threat to other locations.

For now, companies need to look carefully at the full costs of building the right kind of skills and infrastructure in these less-developed locations, taking into account intangibles like red tape, political instability and corruption. But as the demand for nearshoring grows in the EMEA region over the next few years, it will become as normal for international companies to have service operations in Morocco and Egypt, as it is now in Prague and Budapest. And by then countries like Ghana, Senegal and Kenya will be working their way up the offshoring rankings.

Out of Africa: Vodafone in EgyptThree years ago, nobody would ever have predicted that Egypt could rank 1�th in a global ranking of offshoring locations. It was a country with terrible infrastructure, frightening levels of red tape and corruption, and a government that had an ambivalent attitude towards foreign investment. But when a new technocratic government took over in �00�, headed by the former IT minister, things changed.

The government realised it had some key ingredients for successful offshoring: a big supply of technical graduates eager to work with international companies, strong knowledge of European languages and culture, convenient time-zones and very, very low labour costs. All it needed was a functioning infrastructure and a proactive welcome.

That’s how Smart Village was born, a government-subsidised offshoring zone, a short drive outside Cairo, along with the Information Technology Industry Development Agency (Itida), which aims to transform Egypt’s fledgling call centre and IT services business into a new Bangalore, in part by

incentivising Egyptians to get skills and by subsidising still-high connectivity costs.

Vodafone is one of the international companies testing the waters. It already has a global help-desk centre, choosing Egypt due to low costs and technical know-how. Now it is running a pilot scheme for a call centre providing direct services to Vodafone’s international customers. Duncan Howard, Director of Customer Operations for Vodafone Egypt, is happy with it so far. Egyptians have strong language skills, with accents that are easily understood. Most have travelled or lived abroad, are proud to work for international companies and are not prone to job-hopping.

So can Egypt become Europe’s Bangalore? It faces competition from other African countries including Morocco and South Africa, not to mention Central Europe. But Egypt is bigger and cheaper. Mr Howard is cautiously optimistic, but the biggest obstacle, he says, despite all the improvements and government incentives, is the speed of getting things done.



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