Nearshore and offshore activities are nothing new for Europe, according to Dana Stiffer, research director, Services and Outsourcing, AMR Research. But what’s new is “nearshoring is now starting to be internal to the EU with lots of delivery centers in Ireland and Spain, for example.” Of particular note is the accelerated growth of nearshoring in Eastern Europe that has continued for several years for a number of reasons.

For example, according to the Everest Research Institute’s analysis, 10 leading outsourcing suppliers set up about 20 new delivery centers in Eastern Europe over the last three years.

Unique advantages

Lately, according to Stiffer, buyers are interested in outsourcing to geographies outside of India because there are a lot of difficulties in India right now such as high attrition rates and wage inflation; so there’s an economic risk in doing business there.

Services are not as cheap in Eastern Europe as in India, but this region offers other advantages. According to Stiffer, customers can offset some risks in dealing with Asia-Pacific companies by dealing with European Union countries because of benefits of legislation that’s in place, labor laws, taxation, ease of doing business, and ease of movement through the European Union.

For example, Stephen Dunn, managing principal/Europe, Everest Group, says it’s a violation of EU regulations for companies to move specified data outside the EU, so Eastern European countries have become the only low-cost option for this type of work. Eastern Europe is also culturally more compatible and shares languages with the rest of Europe. It happens to be in the same time zone too, so buyers can communicate with suppliers throughout the working day.

Ian Marriott, research director, Outsourcing, Gartner, says the key centers for nearshoring in this region are Prague, Krakow, Warsaw, and Budapest. Prague, though, has encountered imbalances in supply and demand, which has created wage inflation and workers jumping from job to job for more money. Because it remains a relatively expensive nearshore climate, other Eastern European locations like Bulgaria, Romania, and second-tier cities in the Czech Republic, Hungary, and Poland are becoming more price competitive and popular.

German buyers are doing more nearshoring to the Czech Republic, Poland, Slovakia, Hungary, and Romania. Slovakia and Ukraine offer lower prices than Russia and, therefore, get a lot of offshore work from that country.

Large suppliers dominate

Geographic diversification has not resulted in nearshoring by native suppliers. Marriott says the big multinationals like IBM and EDS and large Indian companies like Tata dominate the landscape. Because Eastern European countries have joined the EU, he continues, greater investment in them promotes greater sales opportunities for the big suppliers. They can locate some of their resources in these lower-cost centers and build them into their global delivery approach, particularly when they have customers with pan-European requirements. Local suppliers, says Marriott, are numerous but small and lack the will or scale to compete outside their borders.

Meanwhile, the Indian players have proven to be formidable adversaries. Marriott says “the growth of the top six Indian firms averaged 60 percent in Europe last year.” Indian companies are especially strong in the UK; for many of these suppliers, UK business comprises 80-100 percent of their total business. He adds that they now have their sights set on Germany. It is relatively experienced in nearshoring and has reasonable English language capabilities. The same applies to Sweden, Finland, and the Netherlands.

According to Stiffer, some Indian companies are employing a new strategy for ultimately locating work in India. First, they set up an interim delivery center in Eastern Europe and do application development for a buyer for a period of time until the business relationship matures and both sides understand the rules of engagement and business expectations.

After they are comfortable with one another, the supplier relocates to India and carries on future work from there. Stiffer says “the client has to get used to working with remote resources. Their quality and service might be fine, but the dynamic is different; so it might take a while to learn how to do it properly. The clients are using nearshore locations as training wheels to learn how to do these things.”

Types of nearshore activity

Marriott claims most of the work companies are sending to Eastern Europe is application development and maintenance as well as some management work. He explains that “most of these companies find legacy application maintenance very straightforward and easy to plug in the appropriate skills. When you move into the management side, you’re really moving from project-based work into pure outsourcing activity with the more demanding requirements of taking on the full management of those applications in a multi-year deal.”

Stiffer says there’s a lot of support for back-office horizontal processes like finance and accounting, payment processing, and different HR functions. Indeed, many large companies are standardizing those processes across entire regions like Eastern and Western Europe.

Everest claims the business process outsourcing market has grown dramatically, too, by 50 percent over the last three years and expects that momentum will continue through 2008.

Dunn makes notable mention of remote infrastructure management outsourcing (RIMO) catching on worldwide but especially in Europe. Traditional IT outsourcing transactions gave the supplier ownership of IT assets along with operational responsibility for them. Buyers benefited because this removed the assets off their balance sheets. The cash infusion for the buyer was a big part of the outsourcing benefit. Cost savings from improved operations and the benefits of greater scale also necessitated that the supplier assume control over assets and proximity to them.

Granted, however, both buyers and suppliers found it was difficult to scope the kind of assets that would be needed over a long-term contract because technology changes so quickly.

The advent of the “asset light” model changes the benefits equation. Here, the buyer continues to own and control the assets and the supplier assumes responsibility for operations. The big savings comes not from shifting costs off the balance sheet but from simply shifting labor offshore. Buyers maintain ownership of the assets while suppliers save on the capital expenditure on the assets. Suppliers are also insulated from refreshes needed with quickly evolving technology.

As a result, Dunn predicts the worldwide RIMO market will boom from $1 billion today to about $5.7 billion in four years, which will be a shot in the arm for Western and Eastern European suppliers.

In general, says Stiffer, Eastern Europe will continue to benefit because buyers in North America and Western Europe have to “go to third-party suppliers to get the skills they need, not just because prices are lower. As baby boomers retire and Western Europe and the United States run out of engineers and people willing to do BPO, even more work will move to Eastern Europe.”