Topic 6: Outsourcing a UK based IT company

Ajith Jayathilakan 13MBA0103/F2 Slot

5/4/2014




Abstract: This report focus on outsourcing a UK based software company that aims to
outsource some of its software development to a foreign supplier. The three countries
considered for outsourcing is Russia, Hungary and Mexico. All these countries have well-
developed IT industries that have the capability to provide good quality software. As such
this paper looks into the other factors that will help to find the best country that satisfies all
the needs of our company. Various factors like the economic stability, cost competitiveness
and existing IT environment of these three countries will be looked into to choose the most
suited country for this companys purpose.
INTRODUCTION
Offshore IT outsourcing has been an area of significant interest for many years, and is
continuing to play an important role in the economic development strategies of transition
economies. Labour costs in transition economies are significantly lower than in developed
countries such as the UK, and the skills and resources required to deliver IT-based solutions
are increasingly found in nations outside of the more developed economies. The availability
and low costs associated with these skilled resources have been a prime motivation to move
the software development and support work offshore. Industry analysts, academics and
practitioners continue to predict steady growth in the demand for offshore IT development
and support services. Countries such as India and Ireland have already established themselves
as market leaders with recognized IT outsourcing industries. India currently dominates the
global outsourcing market, and various estimates suggest it accounts for approximately 80-95
percent of the total global software export value. India has the advantage of low prices and a
huge skilled workforce. Ireland is also a recognised outsourcing leader and although its cost
base is higher, it can compete on the basis of country stability, service quality and its native
English-speaking workforce. These are hence the criteria that determine which of the above
mentioned countries will suit this UK-based firm.
METHODOLOGY
To find out which among these highly resourceful countries provide the most apt country for
outsourcing the software, a comparison would be made between these countries in terms of
their political and economic stability, cost competitiveness, and IT environment they have.
RUSSIA
Russia is one of the fastest growing destinations for quality offshore outsourcing with
business environment that has matured to the point where it has come to be considered a
credible location for software services and IT outsourcing. Russia is seen as a good place to
solve complex technical problems because of its highly skilled talent pool. The main reason
that has been found to make Russia attractive is the relatively cheap labour compared to that
of Western Europe along with the political and economic stability.
The cost of a nation's resources is one factor that determines its cost competitiveness in the IT
sector. The average cost of a Software Engineer in Moscow is around USD $27,910
1
. Russia
also falls below average in cost competitiveness for its senior IT workers, with Software
Engineers with ten to twenty years of experience averaging a salary of USD $32,650
1
or 39
percent of their US counterparts. Also the taxes in Russia are moderate at 20 percent
compared. Russia also maintains an indirect tax rate of 18 percent
2
. Russia has a tariff rate of
5.2%
3
.
Russia has nearly 1 million technically trained employees and has the third-largest pool of
engineers per capita.
Russias economic freedom has been stagnant for the past 20 years. According to 2014 Index
of Economic Freedom the business freedom index in Russia is 70.0
3
. It describes that there
would be considerable inconsistency in the entrepreneurial decision making due to the
bureaucratic obstacles and inconsistent enforcement of regulations.
Russia outsourcing focuses on development of tailor-made software. These types of projects
are designed to address a clients specific needs and can accommodate that customers
particular preferences and expectations. Apart from this Russian programmers are seen as
better able to develop innovative and complex projects because of their willingness to think
outside the box. Daniel Marovitz, Deutsche Banks COO of technology for global banking
told Software Russia, Most Indian firms are very process-focused and, if something can be
template-ized, then thats very good. Things like Six Sigma and ISO are part of their DNA,
but that doesnt lend itself to innovation. For innovation, testing new ground with new
software, Russia is a good place. According to RUSSOFT, the Russian software outsourcing
industry was worth $2 billion in 2012. Export of software development outsourcing services
increased by 10 percent to $2.1 billion, which is in the middle of the range of $1.6 billion to
$3 billion that various sources had predicted by 2011. Russoft has also seen industry-wide
growth of 27 percent
4
.


1
Pay scale for various job titles in Russia available at
http://www.payscale.com/research/RU/Country=Russia/Salary
2
Taxes in Russia http://www.sourcingline.com/outsourcing-location/russia
3
Tariff Rates of Russia http://www.heritage.org/index/country/russia
4
RUSSOFT Association, 2013 Russian Software Developing Industry and Software Experts available at
http://www.russoft.org/downloads/RUSSOFT_Survey_10_en.pdf
HUNGARY
Hungary has the highest share of outsourcing in IT Services from the Eastern European
region. The economic activity and population is strongly concentrated in Hungarys central
region. Almost half of the GDP is produced in that area, using about one third of the
employed workforce (where production is led by the services area); moreover, this region has
attracted two thirds of foreign direct investments in the last decade.
Software Engineers Developers with one to four years experience have salaries that are USD
$19576. Senior Software Engineers with ten to twenty years of experience are also expensive
in Hungary, commanding around USD $30,000 to USD $37500, depending on the workers
level of experience, averaging 38% of US salaries. The cost of office space in Hungary
(Budapest) is average, with an annual cost of around USD $40.86 per square foot annually,
according to the study by CB Richard Ellis. The corporate tax rates are 19%, indirect tax rates
are 25%, SMB effective rates is 53.3% and but since as a part of EU the tariff rate is as low
as 1.1 percent
5
.
The education system provided in Hungary provides talented professionals with
comprehensive knowledge. The achievements Hungary has made in the field of IT
development and innovations are outstanding not only compare to neighbours but even
globally.
In Hungary, launching a business takes about a week and the overall labour code lacks
flexibility. According to 2014 Index of Economic Freedom the business freedom of the
country has been rated as 79.3
5
.
Considering the political stability Hungary under the Victor Orbn has created a highly stable
country in Europe. With the liberalization of the trade regime the FDI inflow into the country
has increased.
Hungary has a strong well-built IT environment with a lot of very well know IT companies
like the Graphisoft AutoCAD systems, iGO mapping and navigation software, Prezi
cloud-based presentation services, Kurt Ltd. data saving. Also Budapest is ranked in the top
three of all the major outsourcing ranking lists (IDC, THOLONS, Fortune 500, Business
Week, and Computerweekly).As per Pierre Audoin Consultants (PAC) analysis it was found

5
Tariff Rate of Hungary in EU available at http://www.heritage.org/index/country /hungary
that the concentration of the Hungarian IT services market is high, as the first 20 players got
more than 60% of it. This can be explained by the high use of sub-contracting and by the fact
that most large contracts are gained by a few large players. On a market affected by the
increasing shortage of IT skills, younger workers are more and more embracing the
freelancing mode of working.
MEXICO
According to A.T. Kearney, Mexico is a leader in the IT and BPO industry, ranked the sixth
most attractive destination to locate information technology (IT). Mexico has recorded high
growth rates in recent years in the IT services, BPO and software market (8.9% annual
average increase during the 2006-2012 period). Business Monitor International estimated the
value of the IT services and BPO market at 10.5 billion dollars in 2012. According to reports
from the Ministry of Economy (SE), Mexico has become the third largest exporter of IT
services globally. This is because of the good political stability and well groomed IT
graduates.
Mexico has a workforce population of around 47 million. The sourcing workforce proves to
be strong in software development. With the prevalence of English language barriers, Mexico
produces software that has been precise to what the company has specified. Mexico is taking
steps to improve its information technology talent resource, collaborating with the World
Bank and Ministry of Economy of Mexico in creating Mexico FIRST which will set aside
USD $40 million to subsidize the training and career certification programs of its IT students.
Through this program they will be able to access better networking certification programs.
This would help to produce more number of IT specialists in Mexico.
When considering the compensation of the employees in the information technology sector,
Software Engineers in Mexico earn salaries averaging USD $19,370, and senior resources are
comparable at 36 percent. IT Project Managers average salaries of $36,100
6
or 35 percent of
US counterparts. The average lease rates of Mexico city is stable averaging to USD $32 per
square feet for a Class-A office. The corporate tax rate is 30.0%, Indirect Tax rates 16% and
SMB effective tax rate is 50.5%
7
. Mexico has a tariff rate of 2.2%
8
.

6
Pay scale of various job titles available at http://www.payscale.com/research/MX/Country=Mexico/Salary
7
Tax Rates of Mexico available at http://www.sourcingline.com/outsourcing-location/mexico
8
Tariff Rate of Mexico available at http://www.heritage.org/index/country/mexico
Launching a business in Mexico takes up to six days on an average, with no minimum
capital, but the licensing takes over two months. Mexico has recently watered down a labour
reform bill to protect the labour unions. Mexicos business freedom has been rated as 76.8 as
per the 2014 index of economic freedom.
Mexico IT industry is in an emerging with more than 2000 IT companies with more than
600.00 already working and 65,000 graduating each year. Tech companies range from start-
ups like Guadalajaras Centro Del Software to veteran industry like IBM and Intel. Local
entrepreneurs agree. During a recent visit to the Centro Del Software, Jesus Michel, an
executive at IBM de Mexico, told that due to a triple play of collaboration between the
government, private businesses and universities Guadalajara is becoming the Silicon Valley
of Mexico.
9
With the presence of this Silicon Valley the growth of the company would be
high in Mexico.
RESULTS
When a comparison is made with these three countries we can see that Russia has good
highly skilled labour who can supply good quality software. But in Russia the economic
stability is less and has a high labour cost and tax/tariff rates. This makes Russia an expensive
country to outsource this software development. When considering Mexico the economic
conditions are stable and there are skilled labours at a low cost. The indirect taxes and tariff
rates are also less in Mexico compared to other two. But since UK is a part of the EU so is
Hungary we have got low trade tariffs. This gives us a better advantage to invest in Hungary
rather than Russia and Mexico. The low employment rates or the low tariffs are not the only
factor; we can also find that Hungary has a large number of IT industries that are renowned
for the quality products they produce. As such for a good quality software development
Hungary stands out as the best country to outsource.


9
Nathaneil Parish Flannery, Mexicos Silicon Valley available at http://www.americasquarterly.org/mexicos-
silicon-valley
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