Given the current global financial crisis, we are already seeing companies cut down on IT spending. Most industry observers believe we will see another round of IT cost-cutting in the first quarter of 2009. However, Alexei Miller, executive vice president overseeing customer relations and project management at DataArt, a global provider of high-end software outsourcing services, says it won't be "doom and gloom" for corporate IT spending over the next two years. In fact, he predicts that as the dust settles, Eastern Europe's outsourcing service providers will emerge relatively unscathed.
Miller points out the Eastern European outsourcing software industry has features that may help insulate it from fallout. "First, it depends on global financial institutions to a much smaller degree than India. Second, its service book has a much lower share of lower-value BPO, operations, and maintenance work. For many providers, the percentage of application development and R&D work in their portfolio is north of 90 percent." He believes that a company would cut its BPO work -- especially if the company is involved in a merger or acquisition -- before it would cut mission-critical application development.
For Miller, the interesting part of making predictions is trying to identify where IT budgets will grow in a tough economic environment. He predicts one such area will be boutique investment firms and hedge funds established as large banks vanish. "Not only will they look to build new technology quickly, but few of them will have the traditional corporate guidelines prescribing India for all conditions."
The biggest growth area, he predicts, will be in high-value services. "The economic crisis will accelerate the trend towards specialization, and Eastern European providers can claim an upper hand there," states Miller. Headquartered in New York city, DataArt has two R&D centers in Russia, two in Ukraine, and offices in London.
Focus on costs has misled some service providers away from specialization
Although outsourced software services grew "in the good times, when there was plenty of easy business from clients looking for plain vanilla cost savings," Miller believes that focus on costs misled some Eastern European providers. "It made them think that a resource-oriented outsourcing model will work for them long term."
Today, as Eastern Europe's local economies grow (especially in Poland, Czech Republic, the Baltic states, and Russia, "which is flush with oil revenue"), many providers no longer offer a low-cost structure.
Miller believes outsourcing software service providers that are "stuck" with only a low-cost model and have not invested in a specialized skills angle with industry-focused expertise will not flourish.
Most pricing of outsourcing services comes down to a simple case of monthly labor cost or a provider stating "here's what we can do to optimize your process, and it will cost you this much per month." But he's a believer in the fact that "you cannot adequately show that you are doing things quicker or better than your competition, or with better applicability to the client's business situation, without specialization and really understanding the dynamics of the client's industry."
In fact, he goes so far as to say that providers often ill-serve the client community by placing too much focus on labor costs and failing to realize the value that they can bring through industry-specific expertise and niche solutions.
He adds that "by and large, most outsourcing providers are followers; very few are leaders. You can't really provide leadership without domain knowledge of the buyer's industry and also expertise in specialized processes unique to that industry."
As an example, software development for the trade process aspects in financial institutions' business requires more than software development expertise. The provider needs market data relevant to compliance with requirements, competition, and knowledge of how quickly products evolve over time. In another example, the pharmaceutical industry has very sophisticated compensation models with a large sales force, and systems must be able to keep track of everyone's contribution, their incentives, and compensation. Until recently, there was no packaged software product in this space, and pharmaceutical companies had to build products on their own and explain industry nuances to software consultants hired to do the modifications.
Miller says DataArt's strategy is to import domain knowledge to its software engineers rather than adding a shop of consultants. In the financial institutions arena, for example, he says his company thinks "it works great when you have engineers who actually understand what a convertible bond is and understand the accounting peculiarities of mortgage-backed securities. But it takes years of training to build teams like that. We started it in 2003, and it's only since 2007 that it's really been paying off. Building that knowledge into a software team is a very long-term road, but it is a key to our success."
Selecting an Eastern European software provider
Miller comments that most analyst firms' predictions for Eastern European providers slice the region down to individual countries. In that view, Ukraine generates a lot of interest as a large country with a large talent pool. "Its economy has not been as robust as Russia's (because of the oil revenues factor), so the cost factor remains very favorable among outsourcing providers in Ukraine," he says. Politically, analysts also view it as more oriented toward the West. Miller says the analyst community believes Ukraine is poised for a higher rate of growth than Eastern Europe in general.
Regarding Russia, he says there is a lot of talk about whether its growing economy will impact the basic fundamentals of outsourcing in the next five to 10 years, or even sooner, as happened in India. He believes Russia's rapid growth will be a factor in the position Russia plays in outsourcing in the future.
"Analysts are saying the Russian position will remain that of an R&D destination, not a BPO one, and won't be much affected by rising costs. However, they're not conclusive on this and are really asking more questions rather than giving answers to predictions on Russian economy's growth and its effect on the rising costs," explains Miller.
One of the questions is how quickly the Eastern European outsourcing firms will consolidate. Currently, the largest among them have 4,000-5,000 people, which makes it difficult to position themselves as competitors of Indian firms with hundreds of thousands of people. Another question: will the big Indian firms engage in mergers and acquisitions and swallow the Eastern European firms?
Miller's opinion is that the Eastern European software services market is at a crossroads and will split into two distinct categories: (a) the specialist firms such as DataArt, which could each have 100 to several thousand people but will remain small, niche players on a global scale and (b) the firms focusing on a commodity, labor-arbitrage play.
He says he does not believe "the fundamentals are there for the commodity players to be the predator rather than the prey for stronger players in other countries." However, he sees a bright future for the niche specialist firms in Eastern Europe, along with buyers' growing appetite for specialized R&D services.
Case Study: Transforming the business of selling art requires software specialization
One area of software services specialization for DataArt is development of complex online trade marketplaces. A client for these services is artnet Worldwide, an innovator in the art business and the leading Internet portal for the art market. DataArt built for artnet an online auction platform that offers continuous online auctions of modern and contemporary fine art, prints, and photography. Jacob Pabst, vice president of technology and product development at artnet, says his firm did extensive research for half a year and reviewed providers' proposals.
"We were very convinced by DataArt's abilities," recalls Pabst. "We met with their developers, their leadership and people here in New York, their references, and tried them out on some initial tasks. Everything we saw was only good, especially the quality of their technicians. We were convinced that DataArt could provide the kind of quality that we already have on our team." He adds that it's difficult to find enough resources with the necessary skills at reasonable costs in the United States, even though the company has a job search running all the time.
"We actually launched an online auction site back in 1999 after artnet's IPO on the German stock exchange; so did some of the big auction houses," Pabst recalls. "We were there too early for the market. But we never gave up the idea."
From there, the company considered shifting to software solutions already on the market that it could modify to fit the art business. But artnet realized there would have been too many change requests, and the changes would have been too big. When artnet shifted to an offshore strategy, it found DataArt, which delivered a proposal on how it would develop the online art auction and deliver it on time and for the right price. "And they did what they promised," says Pabst.
Miller says a primary success factor was DataArt's flexibility and understanding that "changes are a way of life for artnet. We needed to be quick on the turns, anticipate and manage change requests proactively, and find ways to incorporate them into the project without compromising schedule and quality - rather than thinking in a traditional software development mode, which often pushes new change requirements into separate project iterations."
He points out another success factor: the chemistry of the two groups working on the project. It goes beyond a corporate cultural fit and gets right down to the particular people on a team, he says, and DataArt's ability to put together a team of five to 25 people who were the best fit for artnet's team really mattered.
Pabst, too, cites a driver for success: artnet's philosophy is that it's necessary to effectively manage offsite projects. artnet has a U.S. project manager closely overseeing the project and U.S. technical people overseeing all the technical aspects.
The DataArt team had expertise in software development as well as expertise in auction processes including different methods of billing and the time constraints of the business. But the art business requires even more specialized knowledge.
Miller explains, for instance, that the normal software development process of doing a limited release (open beta testing) to make sure the software is operating correctly will not work for the art business. "If you put a piece of art on sale in an auction that's open to only a small audience, the art either won't sell or will sell for too low a price." In cases like this, where a gradual release is not possible, it puts additional stress and responsibility on the developer for perfection -- getting it right the first time. "It's an interesting aspect to deal with," he adds.
artnet's overall strategy and the main advantages of its online auction platform include lowering costs (thus also the price of art) and accelerating the time to complete a sale. Pabst says selling works online costs about half as much as at traditional auctions because there are no catalogs to print or salesrooms to maintain.
Another advantage is transparency -- something quite foreign to the art business, a closed market dominated by large auction houses and dealers such as Christie's and Sotheby's. As Pabst explains, "Dealers don't make public the price they sell the paintings for and how much they would pay for a painting. If you're not an expert, and you go to a gallery in New York and are interested in a painting the owner will sell for $10,000, you don't know if that's the right price. For young collectors or even people who just want to have a painting, it's complicated to get a better understanding of the art market because there is not enough information."
artnet's first project, now accessible on its auction site, was a price database that reveals the actual sales price results from dealers' auctions. "Normally the only way people would know this information is in the catalogs that dealers send to their clients after a big sale," explains Pabst. "But there are hundreds of auctions houses, and you would need hundreds of catalogs for an accurate understanding. All the information buyers and sellers need to make informed decisions is at their fingertips online, bringing transparency to this market along with reduced transactions costs and faster turnaround. Each benefit is geared to increase trust in a growing art market and provide liquidity to the market."
Pabst reports the site was launched in January 2008 with very little publicity in the United States and Germany and revenue has already exceeded internal projections. He says DataArt's software developers continue working on site enhancements and new features as well as maintaining the site.
Advising companies seeking specialized application development and R&D services, Miller says, "When the critical moment comes and you have identified a few candidates that look good on paper, make the potential providers work before you make any commitment to them. Get pilot projects together, possibly with more than one provider at the same time. But don't throw easy work at them. Make sure you give them difficult work up front because anyone can do easy work, and that won't tell you anything about their true capabilities."
Lessons from the Outsourcing Journal:
- The Eastern European software services market is at a crossroads and will split into two distinct categories: (a) specialist firms/niche players and (b) firms focusing on a commodity, labor-arbitrage play.
- Ukraine may be poised for higher growth in outsourced software services than Eastern Europe in general because of its favorable cost factors and its political orientation toward the West.
- When narrowing down choices in service providers for software services, a good strategy is to implement a pilot project (especially with more than one provider at the same time). However, the pilot should be a difficult project; easy projects won't reveal true capabilities.
- For buyers whose business requires frequent changes in software projects, select a provider that is flexible, understands that change is a way of life, is quick on turns from a course, anticipates and manages change requests proactively, and finds ways to incorporate them into the project without compromising schedule and quality.