Saturday, February 09, 2008

Consolidation in Eastern Europe: Who is Still in the Outsourcing Game?

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For a long time the management of EPAM Systems, Eastern Europe’s largest software development company, was looking to enter the Russian outsourcing market. At the same time the labor market in Belarus, with a population of nearly 10 million and EPAM’s first offshore location, began heating up. So the need for new resources became more urgent.

EPAM management selected Vested Development (VDI), a Russian software development company headquartered in Burlington, Massachusetts. "We looked at a number of companies, but with VDI we knew each other for many years and there was a strong level of comfort" says Arkady Dobkin, CEO of EPAM. VDI, founded in 1993, began life as an offshore software development company. However, since the beginning of 2000, the company has placed a strong focus on the Russian market.

Such is the picture across Russia: many software development companies have seen more success on the local IT market than abroad. The Russian economy, rich in natural resources, finally showed a need for the talented engineers back home. Besides, unlike publicly-listed Western companies looking to squeeze every cent of efficiency out of their outsourcing business case, privately-owned Russian businesses pay well to keep the best suppliers delivering the best results.

The growth of the IT industry in Russia has been remarkable. According to the estimates of Russian information agency RosBalt, in 2007 the IT market in Russia grew by 25 percent compared to the previous year; the market has maintained that growth rate for a number of years in the past. The increasing local market need for IT professionals, exceeding existing supply, resulted in the first signs of the industry consolidation.

Thus in 2007 one of the largest Russian system integrators, IBS Group, completed an acquisition of Borlas, a consultancy and IT services company. At the end of the year the company employed 6,000 people. Also, last year Systematica acquired systems integrator TopS BI. In the meantime Verysell, which employed 750 employees in 2007 and was valued at $300 million by Troika Dialog, raised $50 million to acquire an IT services company in preparation for an IPO.

Across other eastern European countries the fight for IT resources gets tougher. In Poland, the third largest country in the region after Russia and Ukraine, there are only a few large specialized offshore outsourcing service providers. In 2007, the total IT outsourcing market volume was 750 mln PLN (3.5 PLN = 1 Euro). Most of the key players, though, offer software development services to their international customers, accounting for approximately 45 percent of their revenue, although there is no firm statistical data, according to Andrzej Horodeñski, the spokesman of the Polish Chamber of Information Technology and Telecommunications.

"The Polish IT labor pool is close to being exhausted" he says. "The basic reason for that is not labor migration, but mainly the internal IT industry growth" Here IT companies merge to survive fierce competitions from the international giants such as IBM and HP. In 2007 Computerland merged with Emax to form 3000-people-strong Sygnity Group, and at the end of the year Asseco merged with Prokom, creating Poland’s largest IT company.

In Romania, where the country entered the EU on the first of January 2007, its outsourcing industry was simply sold out. U.S.-based Techteam acquired Akela, one of the oldest Romanian outsourcing companies; UK-based Endava acquired AGS; and Adecco bought IP Devel to expand its embedded development team. U.S.-based Computer Generated Solutions bought EasyCall, the largest Romanian call center operator, with 600 employees and Euro 1.8M revenue.

Also, in 2006 Adobe bought the Dreamweaver development experts InterAKT. Now, according to Vasile Baltac, the president of ATIC - Romanian IT association, there are few small outsourcing companies with Romanian capital left. Branches of ICT multinationals or joint ventures where the main shareholder is a foreign company produce 80 to 90 percent of the industry turnover" he says. "All the big names are present in Romania now: Oracle, HP, IBM, Alcatel, and Siemens. Large multinationals number about 3,000 people, and they are very aggressive on the local IT market too"

In Bulgaria the demand for software developers exceeds supply, and the local providers are fighting with Coca Cola, HP, SAP, and Siemens for the talent. VMware solved the problem with resources fairly easily. In 2007 it simply acquired its outsourcing supplier Sciant, a Bulgarian software development company with a lower-cost subsidiary in Vietnam; so Sciant clients had to look elsewhere to set up their operations from scratch.

Acquisitions of outsourcing companies have been happening across Eastern Europe. Exigen, the U.S. outsourcer, has been buying companies in Eastern Europe for a while. In its portfolio, for example, is Dati Gruppa, a Latvian IT company, and Starsoft, a Ukrainian company.

In Ukraine, acquisitions also started to take place although the country has still over a hundred small and medium-size players, with only a handful of them employing over 200 people. For example, Global Logic whose resources are based in India and the U.S., merged with Bonus Technologies, whilst Kharkiv-based Telesens was sold for $2.7 million to NASDAQ-listed TTI Telecom in December 2007. The purpose of the latter deal was to open up markets for both companies, rather than simply secure a resource base.

Tom Scharning, the Vice President of Business Development at EDB, a Scandinavian IT company, has conducted extensive research looking for infrastructure outsourcing capabilities in Eastern Europe. "We looked at both outsourcing and acquisition options. However, we didn’t find sufficient level of expertise in infrastructure management, only some rudimentary skills" he says. So the company decided to acquire a company in the region and train specialists in house.

"We looked at many Eastern European countries such as Russia, Bulgaria, Poland, Belarus, Ukraine, Romania, and Baltic States. We found that only Russia and Ukraine fit the bill. We feared that Belarus, Bulgaria, and Romania will follow the steps of the Baltic countries where the resources became drained quickly and the prices reached those of Finland" Eventually, EDB bought a majority stake in two companies in Ukraine.

"We had a long list of about 40 Ukrainian companies, some of which had high expectations of their valuation" says Sharning. "So finally we made a deal with Infopulse and Miratech, which are now part of the EDB global operation"

In defining its Eastern European strategy, EDB looked not only just at low-cost resources, but it has also followed the steps of its clients. "Scandinavian banks are the key EDB customers. They are moving eastwards towards Russia and Ukraine" adds Scharning, so the company looked for the resource base nearby to continue supporting its clients worldwide.

The consolidation of the offshore outsourcing industry in Eastern Europe has become a reality, which demonstrates both the high demand for the local professionals, located close to the Western European markets, and the bottleneck of the labor supply. As for EPAM Systems, the acquisition was a success; it completed the post-merger integration in 2007. "As a result of the merger we’ve got interesting CIS clients, and now 50 percent of our resources are in Russia and Ukraine" concludes Arkadiy Dobkin.