Enter the Dragon

I spent the last two weeks on holiday in China. Apart from the awesome sense of history (the Great Wall is 3,000 miles long and was completed n 220 BC) it was intriguing to get a sense of one of the world’s two great emerging economies. Shanghai was striking in this regard. In just 20 years since Deng Xiaoping’s reforms Shanghai has been transformed into the most dynamic of ultra-modern cities. There is a striking symbolism in standing on the Bund (one side of the city’s Huangpu river) amongst the fine 1920s and 1930s building built mainly by the British, and looking out across the river at the future. On the opposite bank is Pudong, a sort of Canary Wharf on steroids, a city of gleaming steel and glass. The sheer scale of Pudong is best appreciated from the Grand Hyatt hotel, the tallest hotel in the world at 1,380 feet. From either the 54th floor lobby or the 88th floor (8 is a lucky number in Chinese culture) bar you look out across at the old Shanghai, but also at the forest of skyscrapers that is Pudong. A quarter of the world’s cranes are at work here, to give some sense of scale. The desire to create an image of progress is epitomized by the Maglev train, which whisks you from the town to the international airport at a top speed of 266 mph (431 km/h). It can go at 311 mph (501 km/h), but at its slower cruising speed still does the 30 km journey in well under eight minutes. Symbols are important, and the Maglev stands in striking contrast to the shambolic infrastructure of India’s airports and trains. India does have the key advantage of widely spoken English, but China’s modern infrastructure wins hands down. One danger to Western companies is also apparent in the Maglev. Built on German technology, China now intends to build a far longer Maglev track to Hangzhou, but will build it on Chinese technology: quick learners, or intellectual property theft? Conversations I had when in China suggested that intellectual property rights are an alien notion in China, at least for now; our guide in Beijing ran a web site selling fake Rolex watch mechanisms which can be made up into expensive replica watches. He was simply bewildered at the notion that there could be anything wrong with this.

However, despite this, China is now the world’s largest exporter of hi-tech products. When you are there you can sense the sheer dynamism of the place in the air. As an example, just today Teradata announced that their new R&D centre was to be based in Beijing.

The India syndrome

One of the interesting effects of the rise and rise of India as an offshore location for technology staff is the effect that it is having on the prices that IT consulting firms can charge. We had a situation at Kalido where four well-known systems integration firms bid on a project, and in the end the customer chose none of them, but went in-house with significant input from staff in India. I also encountered a situation last year where a very well known firm was charging just USD 650 a day on a large project for its junior staff, a rate that would have been unthinkably low in 2001, when nearly double that would have been the going rate even for IROCs (idiots right out of college).

If you look at Accenture, perhaps the leading IT consulting firm other than IBM, you will see that its overall business is still growing, but in fact there are two trends: consulting has declined a lot, but outsourcing has risen to take its place. Even Accenture has been unable to protect its premium consulting pricing across the board under the onslaught of lower prices from Indian firms like TCS, Wippro and Infosys. The large consulting firms have responded by setting up large operations in India themselves (“if you can’t beat ’em, join ’em”) but while this has no doubt helped, the daily rates that consultants can charge in the US and Europe is still affected by this downwards pricing pressure. It’s not that the Indian companies are giving it away: Wippro’s profit margins are twice that of IBM.

Of course not every job can be done remotely. Support call centers and programming and testing to specifications are clearly the easiest to do, while projects that require a high degree of iteration e.g. web sites, user interface design, or reporting systems are much less suitable. Still, companies are now moving more complex work overseas e.g. accounting and financial research, so the list of “safe” jobs in IT in the developed world is gradually being eroded away.

Of course this movement has caused wage inflation in India, with 20% pay increases common amongst hot skills, and turnover rates of over 20% in Bangalore being normal (these can hit 50% for call centre jobs). Nonetheless, there is a long way to go. A top programmer with five to ten years C++ experience in the UK or the US might earn well over USD 100k (more in Silicon Valley) but the equivalent in Bangalore is still around USD 15k. It is less in Chennai or Pune. It is going to be a long time before inflation brings Indian wages up to anything like US levels.

This structural price deflation effect still has a long way to play out, with off-shoring growing steadily but still by no means universal, and large companies exploiting the lower prices to push down consulting rates in the US and Europe. It isn’t going to get prettier any time soon. I was in India last week, and the sense of momentum and progress is tangible.

“Near-shoring” continues apace

For European companies considering outsourcing their IT, there is a nearby alternative to India: Eastern Europe. In 2005 This market was worth 149 million Euros in Hungary, 132 million in the Czech Republic and 201 million in Poland, according to a survey by PAC. In Hungary’s case this represents 16% growth, 11% for the Czech Republic and 9% for Poland. Recent high profile examples have been DHL’s move to Prague and Exxon’s setting up shop in Warsaw and Budapest.

There is much logic to this. The eastern European countries had a fine tradition of education e.g. in standardized tests, Hungary’s student maths scores are higher than the US and the UK. Budapest IT salaries are around one third of London, and although they are rising it can be seen that they will take many years to get anywhere near Western European levels. Nonetheless, this is still something of an area for pioneers. In terms of maturity, in my own experience the Czech Republic was comfortably the best established, followed by Hungary, with Poland lagging. In Prague and Budapest it is possible to find several companies who have successful operations, and at least a few recruitment agencies etc geared up to service them. This was much tougher in Poland, let alone the “wild east” of Russia or Romania, or even Belarus or Ukraine.

However it remains to be seen whether these countries will grab much market share from India, which has great advantages of scale, many years of success in this area, and a largely English-speaking workforce. Salaries in India are still a fraction of those in Hungary, even in Bangalore (never mind Chennai, Hyderabad etc) so their economic advantage looks secure for years, while the sheer number of large companies that have trodden the path to Bangalore means that, ironically, India may actually be of lower risk than Eastern Europe, at least in terms of being “proven”. The greater travel time and time-zone differences are the main drawback here, but if India can work for US companies with a 11.5 hour time difference, why not for UK companies with a 5.5 hour time difference? (yes, India’s time zones are measured on half-hours, a relic of the English civil service).

Some companies will worry that the economic benefits for the more advanced/”safer” places like Budapest and Prague may be transitory. Ireland used to be a popular cheap location, but years of EU-fuelled growth at rates of 8% have now brought Dublin close to the UK in terms of IT salaries. This might indicate that, given the setup costs and risks, it is better to go the whole way and go to India, where the wage differences are so vast that it will take decades to get to Western levels, even at the current high salary growth. One interesting recent step was the Indian firm Satyam opening an office in Hungary. The idea is that customers who want to try off-shoring but are nervous can start in Hungary, and then move to India as they grow more confident. Eastern Europe also has one advantage over India – continental language skills, which would be important for markets such as France and Germany.

Certainly the “India effect” is having a structural effect on IT consultancy prices. Even Accenture has been forced to cut daily rates, and indeed Accenture’s consulting revenues are actually in decline, but their overall figures are holding up to a rapid rise in outsourcing deals that is making up for the loss in consulting revenues.

Of course there have been some well-publicized problems, such as Dell’s abortive Indian help-desk, which I can testify from personal experience had big problems, but there seem to have been more successes than failures. After all, it is not as if IT projects in the US or UK all go swimmingly well.

Just as manufacturing has, to a large extent, moved to China, it may be inevitable that more and more IT jobs head off to India, and to a lesser extent Eastern Europe. The economics are compelling, and as more and more companies make it work, it feels less like a pioneering activity for the mainstream, which will fuel further growth.