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Until the early 2000s Israel was the preferred destination for offshore software
R&D, with nearly every major American technology ¬rm having some research pres-
ence in country. The size of these R&D centers is substantial as measured in number of
employees:26 Microsoft, 400; Cisco, 500; Intel, 2000; HP, 2000; and IBM, 500. And all
these centers are performing advanced R&D work, rather than the lower value activities
that are often transferred offshore. For example, the Intel Centrino processor was designed
at Intel-Haifa. In addition, small software ¬rms, with easy access to capital, continue
to emerge and be acquired by foreign giants, such as the 2001 HP acquisition of Indigo
for 900 million USD, or the 2004 acquisition of tiny Actona Technologies by Cisco for
80 million USD.


Ireland
In the 1990s, Ireland attracted investment from 120 foreign technology ¬rms that came
to take advantage of its English-speaking population, low wages, tax holidays, its location
85 The offshore country menu


as an entry point to Europe, and the ease of doing business there. Half of the foreign
technology ¬rms were American, including Microsoft, Oracle, IBM/Lotus, Symantec,
and Sun. Ireland performed some offshoring services, similar to India, for companies
such as EDS, Xerox, and IBM. And, most notably, Ireland developed a healthy sector
of home-grown innovative software product ¬rms that was the source of its pride:
Trintech (e-payments), Iona (middleware), Riverdeep (educational software), and
Baltimore (encryption for digital security). By 2004 Ireland™s software industry had
30,000 workers in more than 800 international and indigenous software companies.
One of the key differences between Israel and Ireland is that while many of the foreign
firms in Israel were conducting advanced software R&D, the foreign technology com-
panies that came to Ireland did not transfer high-end knowledge, and were performing
low-end activities of localization, porting, assembly/packaging, and logistics distribution.
Once Ireland™s wage and cost advantages disappeared, many of these multinationals
departed for lower-cost nations. By 2003 the head of Ireland™s software industry asso-
ciation urged the sector to focus on niche areas of software in order to remain compet-
itive on the global stage. Within the software product sector only the e-learning niche
seemed to represent a strong, viable cluster of ¬rms. Most of the other home-grown
¬rms were not been able to grow to become globally competitive, with only 24 of
700 Irish software ¬rms reaching annual revenues above 2 million euros.


Six lesser knowns
In addition to the more successful software nations, there are many more countries
offering offshore services. They differ considerably: some are very large, and others
are tiny. Some are located nearby, others very far away. What they do have in common
is that they are relatively unknown. Even though their software export sector is often
small in size, these countries should not be ignored. On the contrary, a closer look at
these and at others may prove fruitful because each of them offers a speci¬c set of
advantages to potential users.

Latvia
Latvia, one of the three Baltic states, was one of the ˜Silicon Valley™ clusters within the
former Soviet Union.27 Its software specialists were well regarded. During the Soviet
era, Western software licenses could not be purchased, due to the stringent CoCom
regulations. Instead, software was bought or pirated via third countries and then distrib-
uted throughout the Soviet Union. For example, there were Latvian centers for the
adaptation and distribution of products from the German ¬rms Siemens and Software
AG. This paid off as soon as the Soviet bloc began to splinter. Through contacts with
Latvian emigrants working in Germany, the ¬rst software orders came from German
customers. Clients included Siemens Nixdorf and the German State social insurance
of¬ce, which used Software AG products.
86 The fundamentals


After Latvia regained independence, nearly all state scienti¬c institutes were disposed
of and the big industrial enterprises fell to pieces. The work with German organiza-
tions helped to retain many of the newly unemployed software professionals. Today, the
focus continues to be on Germany, for which Latvia is a nearshore destination (it is only a
2-hour ¬‚ight). Latvia also has an advantage in widespread knowledge of the German
language, resulting from 700 years of German economic in¬‚uence and, from time to
time, German political dominance in the country. The largest offshore provider in Latvia
is DATI, which is also one of the biggest software houses in Eastern Europe. It works
for clients such as Software AG, insurance company AXA, and the largest German
telecommunications ¬rm Deutsche Telekom.
Around 50 Latvian IT companies are actively engaged in offshoring, exports were
20 million USD in 2001. Latvia™s 2004 membership in the European Union (EU) will
make business with customers in Western Europe far easier. Far more liberal work
permits will allow easier mobility.
The Baltic IS Cluster was formed in 2001, in order to expand exports from the three
Baltic states, along with nearby Belarus. The Latvian information technology and
telecommunication association (LITTA) is the coordinator of this regional cluster,
which has 20 members.

Romania
In the 1930s Bucharest was known as the Paris of the Balkans. Although the city has
lost that luster, it is a vibrant hub of many software ¬rms. Within the transition
economies of Eastern Europe, Romania has capitalized on its low wages, comparable
to Indian wages. It is the largest exporter of software in the former Soviet bloc besides
Russia. EITO estimated Romanian exports in 2003 at 130 million USD. The country has
370 ¬rms exporting software, of which most are exclusively exporting.28
The linguistic roots of Romanian as a Latin language means that English “ and espe-
cially French “ are spoken more widely than in other Eastern European nations.
Language has also allowed its ¬rms to move into the IT-enabled services segment. A
case in point is Softwin, one of the larger IT ¬rms, with 400 employees. It has built
practices in four related areas: software services for exports, software services for the
growing domestic market, product software and IT-enabled services, including contact
centers for French ¬rms, and domestic e-publishing.
A number of foreign technology ¬rms built R&D centers in Romania such as
European giants Alcatel and Siemens, each of which has about 400 employees in their
Romanian centers. Alcatel is said to export 10 million USD per year in software from
Romania.
The industry growth, although consistently in double digits, is stunted by an econ-
omy with poor infrastructure, lack of capital (and little venture capital), and a continuing
brain drain of the best graduates of its technical and engineering schools. EU membership
expected sometime before 2010 will likely address some of these issues. However, EU
87 The offshore country menu


membership will also lead to a rapid rise in software wages, which will erase one of
Romania™s main competitive advantages.


Malta
Malta, consisting of a few islands in the centre of the Mediterranean, is with 400,000
inhabitants one of the smallest countries in the EU. Located between Sicily and
Tunisia, it is an important tourist destination. Malta is a typical Mediterranean country
but with a difference: because of its long historical association with Britain, there is a
very good command of the English language. Many Maltese also speak Italian, French,
or German. Although it is in Southern Europe, the business culture and work ethic are
more ˜northern™ and somewhat resemble the British.
Although most Europeans are surprised to hear that Malta is a nearshore IT location,
the country offers some speci¬c advantages. The time zone is the same as Amsterdam,
Rome, or Frankfurt. Malta is pleasant to visit and because of its small size, it is easy to
meet all major offshore providers. A group of Belgian managers, looking for an out-
sourcing partner in 2004, were able to meet all their potential candidates in just 1 day.
Malta joined the EU in 2004 and the political, economic, security, and legal risks are
very low.29 It has a modern infrastructure and programmer wages are much lower than
in Western Europe.
The country now has a few dozen software ¬rms, both local as well as foreign-
owned. Due to historic ties, several British companies offshore to Malta. An example
is Safeway Stores, a large food retailer, which operates more than 500 stores in the UK.
Since 1998, it has outsourced work to Crimsonwing on Malta, which is connected to
Safeway™s mainframe. Over the years, a 30-person team has delivered more than 200
projects in areas of merchandising, supply chain, and corporate systems. Crimsonwing
is one of the largest software houses on Malta and employs 130 IT staff. It has several
British customers, such as Barclays Bank and Securicor.



Vietnam
With a population over 80 million, Vietnam is considered a “young country” as 60% of
the population is younger than 25 years.30 Unlike many other developing countries, the
literacy rate is high, at 94%. Vietnam™s strength is in its inexpensive labor costs, the
average wage rates are one-third to a half of the costs of similar skills in India, and with
lower-turnover rates. There are about 100 organizations, including universities, colleges,
and institutes that are training IT students. These organizations are producing about
3500“4000 IT students every year, which is still a relatively small number. IT training
centers are now being set up in the large cities, including some sponsored by the large
Indian providers TCS, NIIT, and Aptech. TCS has even deployed Vietnamese pro-
grammers at one of its centers in Mumbai.31
88 The fundamentals


Socialist Vietnam is one of the newer entrants in the global software business. The
results of its Doi Moi reform movement of 1986 have yielded economic improvements
in many ¬elds, including informatics. Improvements have been made in the ¬eld of
Internet connectivity, although the prices for bandwidth services are still high. Vietnam
has 10 software parks spread around the country in its major cities: Ho Chi Minh City,
Hanoi, Danang, Haiphong, and Hue. These software parks offer tax holidays and other
incentives to software companies. The most successful one is the Quang Trung
Software Park in Ho Chi Minh City, which houses more than 50 companies employing
more than 1500 software engineers.
The software industry has grown rapidly “ at a 30% rate in 2003. Vietnam has more
than 400 software companies, employing about 10,000 software engineers. However,
almost all of these enterprises are small, and generally still weak in terms of project
experience, business knowledge, management, and English. The Ministry of Post and
Telematics, together with Vinasa (the Vietnam Software Association), have taken steps
to increase quality standards for the industry. There are about 15 companies with ISO-
9000 certi¬cation. And one organization, FPT™s software division, the largest IT enter-
prise in the country, is certi¬ed at the CMM Level 5, the highest level of this
international quality mark. The government plays an important role in other respects as
well: it actively promotes the use and development of Open Source Software.
Foreign clients include Japanese, European, American, and Indian companies,
including Cisco, Nortel, IBM, Sony, and Bayer. The US is the major client; the existence
of the large “Viet Kieu” diaspora has been helpful to bridge the gap between Vietnam and
the US. UK-based Harvey Nash, an IT services provider, is active in Vietnam.
Japanese corporations have been targeted as an important new market, and Vinasa pre-
dicts that the revenue from software exports to Japan will reach 5 million USD in 2004.
A Japanese language center is planned to help programmers work more easily with
their Japanese counterparts.
Vietnam™s software exports were estimated at 30 million USD in 2003.32 The gov-
ernment set an ambitious, and perhaps impossible, goal of increasing the export of
Information and Communications Technology to 300 million USD by 2005. It also
plans to establish a trade promotion organization to help software producers ¬nd foreign
customers.

Bangladesh
With a population of 130 million people, Bangladesh is one of the largest developing
countries in the world. Similar to Vietnam, Bangladesh offers very low wages and a
relatively large labor pool from which to draw. Due to its colonial British heritage,
English is widely spoken among the educated classes. More than 40 public and private
universities, and some institutes and colleges, are offering degree courses in the area of
IT. Every year, 3000 IT graduates are coming out of these institutions. In addition,
there are large numbers of IT training centers with an estimated total output of
89 The offshore country menu


12,000 per year.33 Students from Bangladesh University of Engineering and
Technology (BUET), Dhaka University, and some private universities have scored
high marks in international computer programming contests. Basic technical knowl-
edge is considered to be adequate. Several small foreign clients reported that they
could easily attract quali¬ed programmers, which would have been more dif¬cult for
them in other countries.
There are more than 200 software ¬rms in Bangladesh, although selling hardware
is often a signi¬cant part of their services. Most of these IT companies are small: a
company of 50“100 people is considered large. Several dozen Bangladeshi software
¬rms are doing work for foreign clients, but there are very few subsidiaries of foreign
technology companies. Bangladeshi software exports were estimated at 5 million USD
in 2004.34
Corruption, which is a major problem in Bangladesh, has hardly any impact on the
international projects. We know of a Dutch company that paid a small amount in order
to speed up the process of acquiring telephone lines for its subsidiary. This was quite
reasonable, given the fact that it can take local citizens up to 27 years to get a telephone
connection.
Several Dutch organizations have outsourced software work to Bangladesh. Compared
to The Netherlands, cost savings of more than 50% (including overhead) can be achieved.
These clients mentioned that the quality of documentation and testing is sometimes
inappropriate and quality assurance is weak. This results in software which needs to be
sent back for debugging and reprogramming. There is always a risk that the engineers
leave for a position abroad, but they can be convinced to stay if the project is chal-
lenging (e.g. using new technology) or if better working conditions, additional train-
ing, or other incentives are offered.
Unlike Malta or Costa Rica, Bangladesh is not a tourist destination. Foreigners who
stay in Bangladesh for a longer period of time consider the country, and especially its
capital Dhaka, messy, noisy, and unattractive. When a Dutch company needed a project
leader to head its team in Dhaka, it selected a person who used to travel to such countries.

Costa Rica
Costa Rica is one of the most stable and long-standing democratic countries in the
world. It has been a democracy without interruptions since 1889, which is very unusual
for Latin America. It is one of the few nations without an army, and public education
has been a priority in government spending. With a population of only 4 million inhab-
itants, it has a pool of four public universities and many private universities. It has the
best education system in Central America, along with the highest literacy rate (95%).
Since 1997, investments of Intel Corporation have turned Costa Rica into an impor-
tant exporter of computer chips. In 2002, Intel also opened a software division in the
country. There are around 100 software companies, most of which are small or
medium enterprises. Software exports reached a total of 70 million USD in 2002.35
90 The fundamentals


The majority of these exports (63%) are destined for Central America, where regional
competition is limited. Some ¬rms are conducting nearshore software services for
North American companies.
In order to diversify exports, the government has targeted IT. An alliance of IT-
related organizations started the program, “Costa Rica: Green and Smart ¦” This slo-
gan is derived from the unique natural beauty of the country, which houses 5% of
world™s known biodiversity. The program includes activities to promote the develop-
ment of human capital and to improve the visibility of the country abroad. Two of its
interesting thrusts are exploiting synergies with the large Latino market in North
America, and development of IT-enabled services.
Part II

Managerial competency
5 Offshore strategy
Erran Carmel and Peter Schumacher*




Offshoring has become the management fad of the moment; the innovation du jour; the
accepted reaction to cost pressures; or before 2000, during the technology boom, the
reaction to labor shortages in industrialized nations.
Does any of this constitute a strategy?
In order to begin answering this question, the notion of “offshore strategy” needs to be
quali¬ed for each company. It needs to be seen in a broader context and not in isolation.
First, for medium- and large-sized companies, offshoring is part of a broader globalization
strategy. Second, also for medium- and large-sized companies, offshoring IT is just
one part of the larger scope of knowledge and service activities that companies source
globally, along with IT-enabled services (ITES) and research and development (R&D)
of all kinds. Thus, strategic offshoring is, but, part of an overall sourcing strategy
which deals with the portfolio of strategic options: whether these options be at home,
abroad (in both high-wage and offshore nations), inside the company, outside the com-
pany (outsourcing), and through various collaborations.
Accordingly, an exacting de¬nition of IT offshoring strategy:
The proactive logic, evident to an outsider, in a ¬rm™s portfolio of IT offshoring activities
within the ¬rm™s larger scope of global sourcing.1

Admittedly, few companies take such a holistic view of their offshoring strategy. Most
companies offshore with a more isolated set of goals, and with a shorter time horizon,
in an evolving, or even reactive strategy. US-based GE is an exception in that it did
articulate a broad strategic vision for offshoring. The case of GE is described in detail
at the end of this chapter.
This chapter focuses on corporate strategies that are enhanced by, or that are unique
to, offshoring. This is an important distinction because offshoring is often confused
with outsourcing. Companies can also outsource to a provider at home, in their own
country. To rephrase: this chapter introduces a topic that has not received enough atten-
tion: What is different about an offshoring strategy? Separately, this chapter does not
examine strategy from the perspective of the offshore provider (which provides serv-
ices, such as an Indian provider or a European ¬rm with in-house offshore resources;
more on the providers appear in Chapter 1 and later in Chapter 11).

* Schumacher is at Value Leadership Group Inc., Germany.
94 Managerial competency


The chapter begins by looking at the cost-reduction strategy. We then move beyond
cost-reduction and introduce the notion of strategically leveraging offshore. This is fol-
lowed by an examination of the strategic perils of offshoring. Finally, various strategic
collaboration strategies are introduced.




Cost-reduction strategy

Since offshoring has been driven primarily by cost savings, does this constitute a strategy?
Is offshoring a strategy if the company squeezes a bit more out each euro that is allocated
to IT wages? Strategy theorists will disagree and debate the nuances of such de¬nitions.
Unlike a new product line, or new improved services, offshoring does not constitute a
company™s competitive strategy, since its goal is merely to increase operational ef¬ciency.
IT offshoring has been driven primarily by the executives™ desire to lower operational
costs. Lowering operational costs does not necessarily translate into a company™s strate-
gic advantage, just as saving money on a new of¬ce lease is not a strategic advantage,
but merely the relentless day-to-day effort of any company to reduce its operating costs.
However, in some industries IT offshoring is beginning to be viewed as a strategic
necessity. We have heard this expressed in stronger terms: “offshore or die.” When one
company™s cost ef¬ciencies allow it to lower prices or expand its competitive options, then
other companies must match their competitor™s strategy, or fail. Offshoring is becoming
part of the larger environment of hyper-competition: companies are swept into faster and
faster cycles of competitive responses and reactions in order to remain ¬nancially viable
and cost competitive. Not offshoring may well become a strategic peril. Such was the case
of one of America™s largest television manufacturers, Zenith Electronics, which resisted
offshoring for decades, while slowly shrinking, before it disappeared completely.
The de facto entry point for the offshore strategy is cost reduction. This was intro-
duced in the Offshore Stage Model, in Chapter 1, and shown again here in Figure 5.1.
Most ¬rms that have offshored will likely remain at this stage (stage 3) since their only
strategic goal is cost reduction.
We have heard some executives pursuing a cost-reduction strategy ask “How much
should I offshore?” By this they mean: What is the ultimate ratio of resources that
should be offshore (versus onshore)? In practice, this translates into one of the follow-
ing two measures:
— The ratio of IT headcount (IT staff) that should be offshored.

— The ratio of IT budget that should be offshored.

Among major American companies the trend-setter in this style of numeric goal set-
ting has probably been GE, with its successful offshoring strategy. Jack Welch, the
revered former CEO, is said to have established the 70:70:70 rule; 70% of all GE™s IT
work should be outsourced, of which 70% should go to global preferred vendors, and
95 Offshore strategy



4 Leveraging
offshore


Cost
3
strategy
Strategy focused on
Stage




cost efficiencies

Experimental
2




Offshore
1
bystander
Domestic sourcing only

Time

Figure 5.1 The Offshore Stage Model (repeated from Chapter 1).

of that 70% should be done on the vendor™s premises (which may be offshore). Over the
years, the in¬‚uential 70:70:70 rule was embellished by the offshore industry and it is
usually retold like this: 70% of all IT work should be outsourced, of which 70% is to be
outsourced offshore, and of that 70% should be in India.
Other ¬rms have followed GE™s lead. We learned of similar numeric objectives at
three large organizations. In all three cases the numeric goal was, roughly, to double
offshore staff within just a few years:
— A major American ¬nancial services company expected to reach 18% of

headcount offshore by the end of that year. The goal of 40%, to be reached soon
after that, was suggested by a consulting ¬rm.
— A large American embedded software ¬rm had 9% of headcount offshore, with a

goal of 15“20% offshore within 3 years.
— STM, the large French“Italian chip maker performs applied R&D offshore (though

its main fabs, its manufacturing capacity, remain in Europe and America). In 2002,
it had 24% of its engineers in low-cost Asian locations (mostly India) and 13% in
low-cost European nations, such as Russia. The target for 2006 was to increase the
relative percent in low-cost nations to 40% and 24%, respectively.
Such numeric targets are a rational means for implementing the cost-reduction strategy
because once that strategy has been articulated, it needs to be operationalized by set-
ting goals, de¬ning objectives, and linking them to rewards and performance reviews.
Not all ¬rms have such numeric goals; but without them, organizational resistance
may be more dif¬cult to overcome.
There is no magic number for the “How much should I offshore?” question.
Numeric offshoring goal setting should be less important than the company™s overall
96 Managerial competency

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