Prospects for Out-Sourcing to Central and Eastern Europe?

I have been interested for some time in the opportunity which Central & Eastern Europe has to establish itself as a centre for outsourcing. Over the past year or so there has been increasing comment on the problems facing India’s IT and outsourcing industries.  Mostly, these have centred on two inter-related factors compounded by double-digit wage inflation.  That wage inflation should be an issue should hardly be a surprise; the law of Supply and Demand dictates – fairly obviously – that locating in a low-cost location will cause costs to rise as sure as getting into a full bath causes the floor to get wet. A recent report by Forbes (quoted here in a white paper on CEE outsourcing) quotes Indian wages as rising by 14.4% in 2006, 15.1% in 2007 with an expectation of a 15.2% rise in 2008. Any advantage of pure cost is quickly being eroded.

However, the other factors are more interesting.  Firstly, there is a sense that India made a strategic error in allowing itself to become purely an execution arm with the original thinking and creativity remaining in the client country; India hasn’t developed its own creativity, is not generating its own Intellectual Property.  Tied to that, there is a suggestion that the Indian education system, by being rooted in rote learning, does not lend itself to the encouragement of critical thinking and originality.  It is interesting to try and square this with the huge volumes of PhD’s which the country produces.

This piece also caught my eye recently.  It’s an article on TMCnet.com highlighting Argentina as a rising outsourcing location for Creative work.  Alongside the (short-lived?) cost advantage, the key to Argentina’s success is a population grounded in Western culture and traditions; simply, they have a "natural flair for westernized designs and concepts".

Back to CEE.  Countries in the region have several advantages.  Certainly, they share the current but temporary advantage of lower costs (although already wage inflation is high in technology hot-spots like St Petersburg).  However, they also enjoy a (Soviet) legacy of very strong education, particularly in maths, science and engineering.  In addition, for Western Europe, they have the geographical advantage of proximity.  Further, several of those countries are already within the EU with all of the structure and access to development funds which that brings.

Where does the current economic maelstrom leave CEE though?  Looking at the long term, many of their advantages remain.  Not only that, but weaker currencies and an increased focus from Western firms upon value and costs will make sourcing from CEE even more attractive.  However, demand will decrease during a global recession.  CEE countries are also going to face a number of further challenges.  The financial meltdown means that the availability of (Western-backed) credit in those countries will shrink away; it will be difficult to raise funds to get established or to expand.  In addition, taxes will rise as hard-pressed governments try to re-balance the books.  At the same time, much needed public spending on vital infrastructure will be curtailed. 

I guess, in summary, it is a good time for western firms to connect with well-established, solvent partners in CEE countries.  There, they stand the best chance of benefiting from the value and low costs on offer whilst avoiding the worst of the economic risks.