How does inflation and currency fluctuation impact on your offshoring deal?

The last 12 months have been turbulent times for economies throughout the world. It is ever clear that financial markets are increasingly intertwined, dependent and impacted by one another. Companies with offshored operations will, or should, be aware of this. 

At the current time and given the volatility of the markets, organisations with offshored centres should review the sustainability of their business case. Companies need to review their business case in light of inflation and currency fluctuation across the globe. Economical turnover, market tendencies and other factors have impacted, in different ways, both inflation and the behaviour of different currencies against the pound. This has drastically impacted on certain locations and has made some locations more expensive than previously and others cheaper compared to 2008.

So how has the volatility affected the location where your offshore operations may be located? Each of the key markets are reviewed below:

• India: Is the most popular location for UK companies to offshore their back office operations. Most industries have a presence in India with companies from the likes of British Airways, Aviva, HSBC, Nokia etc. In 2008 India saw a wage inflation rate of 13%. Adding the 7% revaluation, the Rupee has gained today against the Pound, we can say that in terms of wages, India has become around 21% more expensive for clients who have offshoring there. Other costs such as infrastructure, rent, facilities, etc. have also increased around 16%, considering 7% currency increase and a general inflation of 8%. However, projections for 2009 predicts a wage inflation rate of 8%, which will be the lowest compared to previous years, but the highest compared to all locations in Asia. 
• China: Although cited as a popular offshore location, there are significantly fewer examples of UK companies with operations located here. Many outsourcing providers have expanded in to this market and US companies, such as Avaya, have transitioned operations here. China sees the largest overall cost rise in 2008. 51% increase as a result of revaluation of the Yuan against the Pound and a 13% in wage inflation, China has increase around 70% in terms of wages as an offshoring location in 2008. For other costs, there is an increase of around 60% considering 6% inflation and 51% currency revaluation. Wage inflation is projected to increase by 8% in 2009. However, this projection can vary due to the fact that China still lags behind the likes of India for producing skilled labour with the right language capabilities, so this shortage could lead to even higher wage inflation for the next year.
• Philippines: Another popular location with US companies, more so than UK companies due to the time zone difference and history in the region. The Philippines is the location with the second highest cost increase in 2008. With a 19% revaluation of the Philippine Peso against the Pound and 10% wage inflation, there is an increase of around 31% in terms of wages. For other costs, considering inflation of 9% and revaluation of 19%, there is an increase of around 30%. Never the less, projection predicts that in 2009 it will have the lowest wage inflation in Asia, being 7% due to the global crisis and financial squeeze that has affected companies in the Philippines.
• Ukraine: A new emerging market the Ukraine offers a range of skills from the expected low-end processing through to higher end services such as knowledge process outsourcing (KPO), which is not so typical of this type of location. Ukraine saw the biggest increase in wage inflation of 23%. However, the depreciation against the Pound is also the highest. Hryvnia's devaluation is 15%, which gives an overall estimated increase cost of 4% in both wages and other costs. Even though the wages were lowered in November 2008 by 4%, the projected wage inflation for 2009 is 17%, the highest compared to other locations.
• Poland: A popular nearshore location for some time with the likes of several companies, such as UBS and Shell, having operations here. This location has had the lowest cost exposure in 2008. The devaluation of the Zloty, by 10% against the Pound, covers the wage inflation of 9%. Poland is around 1% cheaper in terms of wages. For other costs, considering an inflation of 4% and a devaluation of the Zloty of 10%, Poland is now cheaper by around 7%. However, even though the inflation forecast is around 3% for 2009, Poland has the risk of getting a big wage increase in 2009 due to the high number SSCs operating today and to the fact that, as being part of the EU, skilled resources are shifting to other European countries seeking better job wages.
• Romania: A nearshore location with high quality skilled and multilingual labour pool, low property costs and growing infrastructure has led companies such as Betfair, to have their operations here. Romania had a medium cost increase compared with other locations. With devaluation against the Pound of 2%, and a wage inflation of 21%, there is an overall increase of around 19% only in terms of wages. For other costs, between Inflation and revaluation of the Neu Leu, there is an increase of around 9%. However, the forecast for wage inflation for this year is between 5-7% due to economic recession and redundancies in 2009 to reduce costs, being much lower compared to 2008.
• Hungary: Like Romania, Hungary is also known for its high quality skilled labour and low costs with the likes of companies, such as Diageo and Siemens, running operations here. Hungary is a location with a low cost increase in 2008. With a 1% of revaluation of the Forint against the Pound, the difference lies mainly in the 8% of wage inflation resulting in Hungary becoming around 9% more expensive in terms of wages. For other costs, considering Inflation and currency devaluation, Hungary has an estimated increase of 6%. For 2009, we expected similar or even lower wage inflation due to high unemployment rate it suffers today.
• Czech Republic: A Location with high quality skilled labour and a focus on improving infrastructure and business environment with the companies like DSG International, running operations here. Czech Republic is the location with the third highest wages cost increase after Philippines. Between 13% of the revaluation of the Koruna and the 8% of the wage inflation, there is an estimate cost increase of 22% in terms of wages. Other costs, considering inflation and currency variance, there is an increase of around 20%.

The table below summarises the inflation + currency variance impact for countries reviewed in 2008.

Source: Alsbridge research.

Organisations that outsource to India, China, or any offshore location for that matter, should be aware that inflation is higher than the UK and should have made allowances for currency fluctuation. This extreme variance in 2008 is likely to be ‘painful' for any client who is baring the full cost

Despite the increases in wages highlighted above, most which are greater than seen in the UK, offshoring still can and does provides cost benefits to UK companies. This is because these increases are on a cost base significantly lower than the UK.

The actual cost in several locations, even though the had higher percentage increase In 2008, are still cheaper, e.g. China experienced cost increase more than twice that of Philippines, yet they are still cheaper.

It goes without saying that these factors must be considered and incorporated into the contract with an offshoring supplier otherwise benefits could be overstated. In modern contracts there are effective risk sharing mechanisms that can be put in place so risk can be dealt with in several ways, e.g. risk can be shared and/or capped to protect the client. Ultimately there are still large savings to be made from offshoring as these offshoring locations are still along way behind the labour costs of the UK.