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In the wake of Y2K, U.S. companies are outsourcing even more technology tasks overseas.
Tim Reason, CFO Magazine
April 1, 2001
The Year 2000 problem didn't bring the world to an end, but it did make it smaller. Many U.S. companies established offshore computer-support operations in the mid-1990s, when the Millennium Bug created an urgent need for software talent. The most popular locations, such as Ireland and India, offered well-educated, English-speaking programmers and convenient time differences for round-the-clock remediation.
As the Y2K threat subsided, so did the demand for Cobol coders. But other offshore support functions have blossomed, as U.S. multinationals have grown comfortable with the cost-saving notion of sending IT chores overseas. Today, for example, shared services centers that handle not only transaction processing but also sophisticated finance functions abound in Ireland's capital city, Dublin. So do customer service centers, which are also popping up in such countries as India and the Philippines. With U.S. companies suffering from a chronic and substantial deficit of domestic IT talent, the vogue for offshore operations is bound to grow.
The original attraction of low cost is fading in such countries as Ireland, where an economic boom has caused wages to rise. But that loss is being offset by greater sophistication in the workforce and in the technology infrastructure. Meanwhile, other countries are stepping in to provide low-cost IT services.
Erin Go Boom
For the past five years, the Irish economy has grown 9 percent annually, notes Enda Connolly, director of IDA North America, the New York-based arm of Ireland's Industrial Development Agency. And the shared services centers of multinational companies have been a major factor in that phenomenal growth. "There are now about 50 shared services centers in Dublin," says Glen Walker, former CFO of Comerio, Italy-based Whirlpool Europe, the first large U.S.-owned multinational to choose Dublin as a shared services site.
Dublin was first proposed to Walker in 1995 by the managing director of the company's Irish sales organization. Intrigued, Walker visited the Dublin operations of Gateway and Microsoft, and also met with finance minister Bertie Ahearn, now the country's prime minister. A cost comparison showed that Dublin was at least 10 percent cheaper than the Heathrow corridor, just outside London.
With no shared services centers to emulate, Walker's staff devised their own criteria. Beyond low costs, says Walker, "we wanted a green-field site, with a good telecom system and a young, readily accessible, highly educated workforce." Language was also an important consideration, but Walker claims it was polyglots, not mere English speakers, that he sought. "We wanted to talk to vendors throughout Europe in their local language," he explains.
Dublin was a different place six years ago, recalls Walker. "No one had done this in 1995, and the unemployment rate was 17 percent," he says. "The Irish were living all over the world — there were no jobs for them at home. We were able to attract college graduates to fill both high-level jobs and clerical jobs."
Victims of Popularity?
Obviously, one factor that first-mover Whirlpool did not consider was the number of other shared services centers nearby, but that has since become both a plus and a minus for companies locating in Ireland.
It was certainly a plus for Accenture (formerly Andersen Consulting) when company officials decided in early 1998 to centralize European finance department services in Dublin. "We looked at the trend toward shared services, and decided we should practice what we preach," says Marian Corcoran, a partner at Accenture's Dublin practice.
With plenty of experience setting up such organizations for its clients in Dublin, the practice set up the firm's own European accounting services center, too. Implemented in the summer of 1999, the center now provides accounts payable, billing, Pan-European cash management, and other accounting services to Accenture practices in 16 European countries. Its IT help desk supports professionals in 18 countries. Among the unexpected benefits of the burgeoning shared services market, says Corcoran, "was how easy it is to start up. Vendors here are used to doing things quickly."
Yet for Whirlpool, Dublin's success came at a price. Speaking at a conference in Boston in November 2000, Steve Freeman, director of Whirlpool Europe's shared services center, noted that the annualized rate of turnover among IT personnel was 62 percent in 1999. "Dublin has begun to price itself out of the market," said Freeman. Walker takes a more benevolent view, pointing out that IT is only a small part of the Whirlpool operation. "With Dublin booming as it has, we are experiencing a fairly high degree of turnover," he admits, "but our general turnover is much less than [IT turnover]." Even IT turnover has since decreased, to 45 percent in 2000.
"Attrition is high [in Dublin]," admits Accenture's Corcoran. But she credits the firm's retention policies and the Irish government's recent efforts to spread development beyond Dublin with capping Accenture's attrition rate at about 15 percent, a relatively low rate for Dublin-based shared services centers.
IDA's Connolly makes no apologies for Ireland's success. "At one time, Ireland was relatively cheap, and still is relative to Europe," he says. "But we don't position Ireland as a low-cost environment." Although he is quick to note that the 12.5 percent corporate tax rate now being phased in still makes the country a bargain, Connolly says companies come to Ireland "to get quality people with high skills and high productivity."
U.S. companies seem to agree. Of a record 23,300 new jobs created in Ireland last year, 13,407 were with U.S. companies. American Home Products, for one, recently announced that it would spend $520 million to expand its Dublin operations, adding 1,300 jobs. Meanwhile, Microsoft celebrated its 15th anniversary in Ireland last year with the announcement that it was establishing an Internet data center to handle all of the company's Web business transactions across Europe, the Middle East, and Africa.
Passage to India
India, long renowned for its huge pool of software engineers, is also a favorite location for offshore technology services. According to India's National Association of Software and Services Companies (Nasscom), 185 Fortune 500 companies outsourced their software requirements to India during the last two years, and the industry grew by 53 percent during 1999.
In the wake of Y2K, India is attracting attention for services that include E-commerce, euro solutions, customer relationship management, application service providers (ASPs), and IT-enabled services, according to a recent Nasscom report. A Nasscom-McKinsey study notes that IT-enabled services (covering a wide gamut of services, including call centers, data processing, back-office operations, Web content development, and so on) could generate annual revenues of $17 billion in India by 2008, creating as many as 1 million new jobs.
Hewlett-Packard decided in July 2000 to open a finance shared services center in Bangalore to support its European operations. Although still in pilot phase, with 90 people on site, it is expected to grow by 50 people per quarter over the next two years and will become "our global center," says Robert Shultz, HP's director of worldwide finance operations. "Ultimately, it will serve more than Europe for certain corporate transactions."
Although he describes the new center as "pretty much a green-field operation from the financial services side," Shultz notes that HP's existing infrastructure in Bangalore played a major role in the location decision. "We thought about both Manila and Ireland," he says, "but we had a fairly large software operation in Bangalore already."
Shultz says Bangalore's other draw is that "the city has a large number of universities that offer both commercial [business administration] and engineering degrees." To date, he says, the skills of the center's employees have exceeded his expectations. Data communications, another critical concern, has also worked well. "The Internet is the key to this," says Shultz. "Our goal is for an employee to sign on to the Web for finance activities and not know where the back office is. In our case, a lot of finance functions will be done in India."
The Need for Speed
Shultz says HP is moving "fairly conservatively" in India, but other companies are moving faster.
"We got our Indian operations up within a month," says John Hunt, CEO of Redwood City, California-based Obongo. An ASP, Obongo provides bank Web sites with E-commerce applications used by the banks' customers. Thanks to a contract with Citibank that required round-the-clock Web-based customer service, expansion of Obongo's Silicon Valley customer service center became a top priority. India was a natural choice for Obongo because so many Indians work at the company. "We're an Irish-Indian company, but we didn't even consider Ireland," says Dublin-born Hunt.
Just 30 days after the company's co-founder, Samir Palnitkar, flew to India to explore the options last summer, says Hunt, the company's customer service operation was up and running in Mumbai, outside Bombay. A dozen customer service reps provided by Quarktek, an Indian outsourcing firm chosen by Palnitkar, were quickly trained on the company's Kana system, which E-mails responses to customer questions or complaints.
"The vast majority of customer service inquiries are handled with canned responses," says Hunt. "However, these are very well-educated, literate people."
They're also cheap. Although Hunt insists that speed was the primary advantage of using Quarktek, Obongo's vice president of finance, Adam Gold, estimates that the full cost of handling each customer service inquiry in India is half of what it costs in California.
While Web-based customer support can theoretically be done anywhere, it might seem that telephone-based support must be done in-country. Indeed, the local accent of call center reps is a major consideration when locating call centers. But while a strong Irish brogue or Indian accent might be a bit too much globalization for the average U.S. consumer, Los Angeles-based PeopleSupport Inc. found that the long association between the United States and the Philippines provided a low-cost source of "American-English speakers."
"We looked at a number of offshore locations, including Ireland and India, for a talented and educated labor pool," says PeopleSupport CEO Lance Rosenzweig. But Ireland was expensive, he says, and both Ireland and India use British English. Accent wasn't the only advantage of the Philippines, he adds. "We have 100 percent college-educated employees," says Rosenzweig. "That's important, because the call center industry is changing from pure telephone support to a multitouch support that traditional call-center employees couldn't handle."
About 100 companies rely on PeopleSupport's two 24-hour call centers, one in St. Louis and one in Manila. "We call it St. Manila," says Rosenzweig. "All the clocks are on St. Louis time, and we have videoconferencing links between the two so clients that want to train their teams can come to St. Louis." Although run as one virtual call center, there is a significant difference between the centers: the approximately 150 customer service representatives in Manila cost a quarter of what PeopleSupport must pay the same number of reps in St. Louis.
With the economy in a downturn, Rosenzweig is betting that the popularity of offshore customer support will soar. To meet the demand, PeopleSupport plans to form an incubator service to help companies set up their own Manila-based call centers. "It is hard to justify a U.S.-only customer service location," says Rosenzweig, "because the cost savings [offshore] are tremendous, and the quality and retention levels are better."
Tim Reason is a staff writer at CFO.
In February, the European Union issued an unprecedented formal reprimand to Ireland's government, which was planning to boost its already skyrocketing economy through additional public spending. This isn't the first time the Emerald Isle has run afoul of its continental counterparts; the EU previously challenged targeted tax breaks to certain industries as unfair state aid.
Ireland's response? A plan that moves all industries to a standard corporate tax of 12.5 percent by 2003, eliminating the "state aid" objection. "Taxes are a sovereign issue for nations within Europe," explains Enda Connolly, director of IDA North America. "Europe cannot dictate the corporate tax rate."
"Ireland will offer one of the lower rates in EU countries," says Stephen Bates, a senior manager with KPMG's E-tax solutions group. That should keep the country a good bargain despite rising labor and real estate costs. But Bates and other tax experts warn that other tax issues also should be considered when shopping for an offshore location:
"Controlled Foreign Corporation" status. Offshore operations that are majority owned by U.S. corporations must be carefully structured to minimize the impact of CFC (also known as Subpart F) regulations that could make some of the entity's income taxable directly to its shareholders.
Value-added tax. "VAT rates can be in the double digits, and are always an extremely important consideration in Europe and around the world," notes Bates. For shared services centers and many other corporate support operations, "the entity can be structured so that VAT is avoidable or the cost can be mitigated," he says.
Withholding taxes. These are "a trap for the unwary," says Bates. Withholding taxes don't directly affect a decision about where to locate offshore operations, but they do determine which countries they can serve. For example, India might require a company subsidiary to withhold taxes from the fees it pays to a service center located in Ireland. "That could be a deal killer," adds Bates. "A lot of developing countries require withholding taxes for technology services."
Permanent establishment. PE is the international equivalent of nexus. That is, serving a customer subsidiary could establish presence, making the offshore entity liable for taxes in the customer's country.
Treaty networks. "Withholding rates are often reduced significantly by treaties" between countries, notes Bates, so companies should check both the quality and quantity of tax regimes. Treaties can also prevent tax on business income if there is no PE. —T.R.