This past summer the broad avenues and squares of Kiev were bustling with color and life; young people clambered over the Soviet-era hilltop park overlooking the Dnieper plain and thronged the cafes and nightclubs below.
By December the ride was over. The ATMs either didn't work or limited how much one could withdraw. The country's largest bank was on the brink of collapse. The Ukrainian government called out to the International Monetary Fund for help, and was answered by a $16 billion loan. The local currency, the hryvnia, was worth half what it was at the start of 2008.
Is this the kind of environment in which you want to outsource your back office, your accounting processes? To code your banking and ancillary solutions? Are there stable partners here?
Many American banks will be preoccupied this year with keeping their own doors open and staying ahead of the global economic crisis; but the issue of outsourcing abroad, how much and to where, is a vital strategic question that must be addressed. Companies continue to operate under extreme cost pressure, and outsourcing is a natural solution; in some cases, even legal departments are being shipped out to India.
On the other hand, from hedge-fund haven Dublin to Vilnius to Mumbai and Singapore, local economies are being stressed severely, even to the point that stability seems threatened and business dealings might be unwise. They have their own liquidity crises, infrastructures are shaky, and populations are under mounting financial pressure. Outside experts, economists and executives of third-party partners are nervous and pessimistic.
The answer, as always, boils down to calculating risk. With a dollar on the rise and locations for outsourcing sliding into recession, there will be bargains. Captive operations and subsidiaries could be had for cheap; existing cost structures can be lowered.
By far the largest business processing, call center and IT outsourcing destination is the massive subcontinent of India, where this year alone foreign direct investment is about double last year's, at $6.5 billion, and industry association figures suggest eight million jobs will be added in outsourcing sectors in India in the next decade.
Impressive as that may sound, however, a columnist for India Today, a large-circulation newsmagazine, argues that the local outsourcing industry is reaching the limit of its immediate talent pool, and that quality-control issues - think Dell's outsourced-then-insourced customer service - means the nation's most visible Western-oriented industry is on shaky footing. Political instability is also an ongoing, grinding concern on the subcontinent. The horrible Mumbai attacks drew a lot of attention because of its Western casualties, but it's only the latest of several episodes of violence.
And the economic turmoil is being felt in India. As the year came to a close, it became clear that India's outsourcing firms were freezing salaries, cutting back on investments and laying off programmers. Wipro, one of India's big outsourcing names, cut its workforce by 2.5 percent. On the other hand, Infosys is sitting on $2 billion in cash and hiring.
In Eastern Europe the outlook for outsourcing is also uncertain. In these locales outsourcing was meant to follow the example of Dublin, pushing beyond call centers and IT help desks into more administrative functions and into the creation of locally owned "code farms" or "software factories," churning out made-to-order software solutions for the financial industry and tapping into an emerging "knowledge economy."
But the financial crisis is starting to bite hard in the former Soviet satellites. Frank-Jürgen Richter, CEO of Horasis, the Swiss-based globalization and systemic risk analysis firm, worries the Ukraine is in real danger of losing its footing in the markets. "I'd heard the ATM machines were not working any more. You have to bring lots of cash," he says. "This country is now very much hit by the financial crisis." Actually, the ATMs were not completely off during his trip. But they were on intermittent shut-down or withdrawal-limited mode while local banks endured a $1.3 billion run on the hryvnia for euros or dollars; after the IMF stepped in with the first tranche of its rescue package, things stabilized a bit.
Kiev is home to dozens of young small-to-medium sized software developers and administrators that specialize in the financial sector. There's no shortage of worry on the ground - over inflation, over currency stability, the banks, debt. They also sense there's opportunity, says Anna Vlasyuk, marketing director at one of the larger ones, Infopulse, which codes financial management software for suppliers to American banks and one UK bank.
"We hope that inflation will not rise too quickly. The national bank is doing its best to keep the currency stable. In this case, the contracts for next year will be beneficial," Vlasyuk says. There are two options: clients may cut costs and kill projects, in which case Infopulse gets less work, or clients may cut costs and outsource projects, in which case there's more work. "It'll be complicated for small firms to survive this period. We are diversified, but if you have two or three customers, and one of those customers has trouble, it's a risk. Then these companies either disappear or merge."
Even so, Richter is optimistic about outsourcing long-term. "The tendencies are clear: outsourcing is here to stay, especially during the crisis. We see more and more countries, even in Africa and the Middle East, moving in this direction toward outsourcing and offshoring," he says. "I strongly believe in the future of these Eastern European markets in terms of third-party contracting business in all areas relating to IT outsourcing, especially in banking."
Mark Minevich, a Moscow native and New York City-based globalization analyst, says the difference in Ukraine from start to finish of 2008 is startling. Here, as in other locations, he believes captive operations - wholly owned subsidiaries or sub-units - offer U.S. banks the most control and least exposure to local conditions. The problem is this option doesn't offer the best cost savings, it doesn't build local partnerships with whom to grow and it doesn't completely insulate a bank from a country's infrastructure weaknesses.
For all these reasons, banks from the West will continue to pursue a variety of outsourcing options, both captive and noncaptive operations, Minevich says. "Stability is the name of the game. But cost pressures ensure more outsourcing from multinationals now than ever." Captives are the most likely to grow, he says. "Still, there is room for the best third-parties and locally-owned partners. The best ones."
In Riga, 650 miles northwest of Kiev, Valdis Lokenbahs, chairman for Lattelecom Technologies, part of the regional Baltic state-owned telecom operation, mulls the future of outsourcing. He is a Soviet-trained computer engineer, rocket systems analyst, and a pioneering Latvian entrepreneur. In 1995 he founded Dati, a Riga-based software firm now owned by San Francisco's Exigen; it codes many custom software solutions for financial institutions and draws on resources far into Russia and other Eastern European countries.
Lokenbahs has long held dear the idea of starting software factories, but he worries about the future. "We are part of the world situation, which is extremely bad," he says. "Latvia is starting to feel the recession, and soon we'll feel it full-size. It is surprising people, because in 2000 we heard about recession more than felt it. Next year the forecast in Latvia is for the economy to shrink by five percent, and I think that's optimistic."
Even so, he thinks the software farm idea is still viable. With Lattelecom Technologies, there is a twist - as a public-private partnership, Lattelecom is even now cash-rich. It also has deep inroads into Baltic IT and dominant market share. It is a large regional ISP. This kind of expertise, and specialist connections that reach well beyond Riga, is what helped LT land work this summer to upgrade ERP modules for German data giant SAP.
Juris KaÏa, a longtime Riga-based tech journalist and blogger, says it's a signature move. "You bring together different actors: the academics do this, the student programmers do that. LT does quality control and delivers the final product," KaÏa says. "Lokenbahs' idea has always been to make the software factory but without having everything done in Latvia."
But it's hardly been smooth sailing; SAP put the project on hold for the summer to review its cost structures. Only in early December did the gears again start moving on the project. Hungarian industrial economist Magdolna Sass says this is why third-party outsourcing partners have such a hard time of it. Few players are cash-rich, like LT. If a big project is held up, things get ugly fast. "It is for sure now that Hungarian banks are very short of resources. They are increasing deposit interest and still curbing credit," Sass says. Hungary recently took a $15.7 billion IMF bailout, and economists expect a seven percent drop in GDP next year. "That's too drastic, but it shows you how pessimistic people are here," she says.
Sass believes local economic stress and currency fluctuations are already impacting outsourcing providers, their capabilities, their infrastructure, their employees. But she thinks recession will affect potential outsourcers more - and drive them to places like Budapest, a BPO center. "Cost pressures become even more important. Because of that, they are expanding here: in accounting, finance, and legal capacities."
Horasis's Richter agrees with Sass. In the near term, Indian BPO players like Infosys and Wipro may suffer because projects will scale back. "But in the long term companies have to do even more outsourcing," he says. He even expects changes closer to home in the U.S. "I see more and more of these American Midwest regions developing into nearshore locations," he says. "The [cost] is not at Indian or Chinese levels. But it's quite low compared to the East or West coasts.