The Coming of the New Wave
During the last five years, the number of business process outsourcing (BPO) and new shared service center (SSC) deals in the Central & Eastern European (CEE) area has increased dramatically . Even accounting for the dramatic impact the "Global Credit Crunch" has had on the region, it is now an area that has to be considered in every shared services leader’s strategy. This report looks at the current trends in the region and the impact recent credit market events have had on their prospects as offshore locations.
These new players in the offshoring market are utilizing the competitive advantage they have over on-shore and Asian destinations, including:
- Attractive environments for foreign investments
- High availability of technical and language skills (especially in European languages)
- Strong cultural similarities to other European countries
- Geographical position and time zone (close to Western European markets)
- Increasing availability of low-cost office spaces
- Increasingly robust infrastructure
It still remains a region that is subject to dynamic forces that influence SSC strategies in the region. Established locations such as Poland are reaching maturity and saturation, new countries such as Romania are becoming credible alternatives, and the socio-economic environment continues to change dramatically.
The environment for investment in the CEE region and future trends
This history and atmosphere have very real implications for investment decisions in this region. In this section we look at the prospects for the region and the overarching trends that impact SSC operations.
Despite recent credit market events, the economic outlook continues to remain positive for the region, providing a positive background into which to develop SSC operations. The massive investments in Central and Eastern Europe, together with the birth of a strong new private sector had a positive impact on the growth of GDP, putting East European countries in the top countries in the world in terms of economic growth.
The current disruptions in international credit markets are less likely to have a significant long-term effect on the Central and Eastern European economies. The European Bank for Reconstruction and Development (EBRD) has noted that the impact of the international credit crisis will be limited as "banks in the region had little if any exposure to structured assets linked to US mortgage markets." The problems faced by a few countries, including Hungary, in financing its foreign currency debts, causing them to resort to the International Monetary Fund, look to be a short-term exception to this.
Whilst the region will not escape any global slowdown in the global economy, growth trends are likely to remain in place. According to the latest estimations from EBRD , the CEE region is actually expecting a growth of 4.3% in 2008, and 2.2% in 2009, thus a painful slowdown from recent year’s trends, but no signs of recession.
Key Demographic Trends
Recent studies have suggested that the services labour market is tightening in CEE countries like Poland , however the latest statistics show that the trend is now reversing and that labour supply is improving. In May 2008, the UK Border Agency announced that "the number of Eastern Europeans applying to work in the UK has dropped to its lowest since 2005", while many Eastern Europeans who work in Spain and Italy are also returning to their home countries.
These fluctuations in migration trends can have multiple causes; the international credit crisis, the improvement of living conditions in CEE countries, changes in workforce supply and demand. It also remains to be seen whether these outflows back to CEE countries will be permanent. None the less this pattern provides a healthy boost to the CEE labour markets and reverses the trend of a tightening labour pool.
Infrastructure development in CEE
The CEE region is experiencing an unprecedented growth in transport infrastructure development projects, which are aimed at bringing the infrastructures of these countries to European standards. However they generally also have access to world class technology and communication infrastructures. This area has been a positive legacy of their past and a priority for the current round of investment.
The scores shown in the chart above are good indicators of the level of technological development in the region. This index takes into account elements such as technology infrastructure, IT skills and data protection legislation. All these countries, with the exception of Bulgaria, are now in a position where their IT infrastructure can support SSC operations in multiple locations. CEE countries have a clear advantage over India, China and emerging parts of Africa with regards to technology infrastructure.
Whilst there has been a trend in recent years to keep voice services on-shore, this region offers genuine opportunities to provide voice services in the customers’ own language. Even if voice services are retained on-shore, there still needs to exist the language capability to communicate with the customer countries’ local teams. As a result language skills still remain an attractive feature of this region.
The total number of English speakers in Central and Eastern European countries is estimated to be over 30 million speakers, while the number of German speakers over 16 million.
In terms of foreign language skills (other than English) the countries of CEE can be divided in three main groups:
- German language: Poland, Czech Republic, Slovenia, Hungary, Romania;
- Russian language: Latvia, Lithuania, Poland, Bulgaria, Czech Republic, Slovakia;
- Latin languages (French, Spanish, Italian): Romania.
However this strength does have a downside. The region is a poor one for developing operations that serve countries in Asia.
Office availability and costs
Even though real estate costs have been growing constantly during the past years in all CEE countries, these locations are still attractive compared to others in Asia or Western Europe.
As seen in the chart above, new EU entrants tend to have the lowest office occupancy costs amongst the Central and Eastern European countries.
If a decade ago finding quality business spaces in most Eastern European countries was a challenge, especially outside the capitals, today the situation is changed as large scale real estate developments have been completed such as business and technology parks as well as numerous office buildings. Office spaces are now available at reasonable costs in capitals, and smaller towns in all CEE countries.
Many shared services centers choose locations at the outskirts of capitals or even in smaller cities where the costs are substantially lower.
Office space availability is forecast to continue growing at a significant pace throughout the region. It is important to note that whilst growth is rapid in the smaller cities of Romania, Slovakia and Bulgaria, that rapid rate of growth comes from a very small base, thus demand continues to outpace availability. This means under only 25,000-100,000 sqm of modern office space every two years is coming on line in these locations. As a result planning office space acquisition is a key task for every entrant to these markets.
Education and professional skills available
The communist era left a legacy in the CEE countries of a skilled workforce that had free access to high level professional and language education. This represents an ongoing strength in the region for those looking to develop SSC operations.
New EU member states produce a higher number of tertiary education graduates (8.59 per 1000 inhabitants) than the E15 average (7.47 per 1000 inhabitants). Public spending (as percentage of GDP) is similar amongst the new EU countries, EU15 and US being around 5.3%. (Source: Orion partners / Eurostat).
In recent years the general availability of these skills has been restricted because of two inter-correlated reasons: the fall in unemployment and emigration. As immigration trends reverse the fall in unemployment remains a problem, and one that is exacerbated by the returnees.
After the enlargement of the European Union, the migration of workforce from the new to the older members, combined with increased foreign investments in the new entrants resulted in a drop in unemployment levels in the CEE countries. In Poland for example, unemployment dropped from 20% at the time the country joined the EU to 11.5% in 2008.
Whilst this could begin to present wage and employment difficulties for SSCs in the region, the current return of émigrés should have a positive impact on this. Their return will put increasing pressure on the local job markets and damp wage inflation.
Added to the availability of skilled employees, professional skills are also in short supply, though this is improving. As companies look to move more than basic transaction processing to the region the availability of skilled employees becomes increasingly important. A number of organisations are also finding that to improve service levels, they need deeper functional skills in their SSC workforces (source: Orion Partners interviews with SSC leaders 2007 and 2008).
Where advice and guidance services are provided, for example HR and pay advice to staff and managers, a much richer and robust service can be provided where staff have some professional knowledge of the functional area they are working in. This is achieved through undertaking western European professional qualifications in; HR, Finance, IT and Procurement.
An important trend in Central and Eastern Europe, that became clear especially after these countries joined the European Union, is the rapid increase in wages.
However even if the wage inflation can reach up to 5 to 6 percent per year, at these rates it would take 16 years for the salaries to double, but they would still be lower than today’s salaries in countries such as Germany or the UK.
As seen in the chart above, pay increases above inflation in India are projected to rise well above the increases in European countries. In Europe, countries with more mature BPO markets such as Czech Republic will have lower pay inflation than emerging markets such as Bulgaria or Romania.
However the total labour costs (including non-wage components) registered much higher changes over the Q4 2006 to Q4 2007 period with CEE countries leading the list.
Make the most of regional competitive advantage in selecting a location
Based on our detailed analysis of the BPO market in the CEE region, we have identified that countries compete from different positions. Each offers a different set of advantages to the organisation looking to open or relocate shared services centres.
In choosing the SSC location, besides looking at the general factors that influence the day to day, tactical delivery or services, organisations need to make sure that the decision is in line with their strategic objectives.
In the figure to the right we can see which countries top the list on strategic positioning in the market, for three of the main competitive advantages.
The maturing of countries like Poland still offers real opportunities for organisations that really need to access a sophisticated skills base. However it is interesting to note that Romania is emerging as a real alternative that also provides increasingly high level skills, at a lower cost.
What does the future hold?
The current political, economic and social developments that are taking place in Central and Eastern Europe are likely to continue for the years to come as the increased stability, ongoing support from the EU, and unique set of advantages make these countries appealing to foreign investments.
As the international financial crisis continues, the increased volatility and uncertainty that affected the world has spread quickly through the countries of the CEE region. The challenges posed by global financial meltdown are more and more visible. These challenges originate from three key sources; the increasing cost of foreign financing, heightened volatility of foreign exchange rates and foreign trade balances which are heavily dependant on exports to countries directly hit by the crisis.
This limited impact (compared to other countries) is due to the internal domestic characteristics of the economies in the region. If we take the case of Romania, Mugur Isarescu, Governor of the National Bank of Romania, summarised the characteristics that have softened the impact of the financial crisis and contributed to maintaining financial stability:
- "Credit institutions in Romania don’t have exposures to sub-prime instruments which lie at the root of the turmoil"
- "The overwhelming majority of banks [...] abide by the Basel II capital adequacy standards"
- "Some of the regulations issued by the National Bank of Romania have often proved more restrictive than Basel II standards"
In addition, the mortgage market in these countries (~2% of the GDP) is minuscule comparable to more developed countries. As a result the impact is largely externally driven and significantly minimised.
For shared services, a slowdown in these areas can however increase the opportunity, by yielding secondary effects such as increased workforce availability and strengthening a cost advantage that the area has for the following years.
The rise of the new wave
Throughout our analysis we have found that a new player in the region is beginning to take its place alongside more establish countries. Romania’s position in a range of areas is becoming increasingly strong. The workforce is highly educated, the office facilities and infrastructure are improving rapidly, and the cost advantage over other parts of the region is still significant. We see a bright future for this country as the mature locations begin to lose their competitive advantage.
Competition amongst the offshore locations is strengthening and an increasingly wider range of possible locations have become available to organisations. This increased number of choices available affects the opportunity cost of relocation, making the decision more complex than it was just one decade ago. However given this range of choices, it is now possible to choose a feasible location in line with your organisation’s strategic agenda with minimal or no compromise. This represents a strong incentive for SSC leaders to pursue the opportunities on offer with more vigour than ever.
About the Authors
Simon Constance is Shared Service Practice Lead for Orion Partners in London; Mircea Albeanu is a Consultant for Orion Partners in London and Bucharest. Orion Partners are independent business advisors specialising in HR transformation, including HR shared services, business partnering for HR, HR outsourcing and HR technology.