Outsourcing to the Philippines

GLOBAL BUSINESS ENVIROMENT

The United States is home to many of the worlds leading computer software companies, most of which commonly outsource software development to the Philippines. Research and explain why it has become

a base for these computer software companies.

13TH DECEMBER 2013

*IT-Business Process Association of Philippines

Contents Executive Summary ....................................................................................................................................... 2

1. Introduction .......................................................................................................................................... 2

2. Understanding Why Countries Trade ................................................................................................... 2

3. Porters Diamond ................................................................................................................................... 3

3.1. Factor Endowments ............................................................................................................................ 3

3.2. Demand Conditions ............................................................................................................................ 5

3.3. Relating and Supporting Industries ..................................................................................................... 5

3.4. Firm Strategy, Structure and Rivalry ................................................................................................... 5

3.5 Government and Chance .................................................................................................................... 6

4. OLI Location Advantages .................................................................................................................... 7

5. Conclusion ............................................................................................................................................. 7

References .................................................................................................................................................... 8

Appendices .................................................................................................................................................. 10

Appendix A Foreign Direct Investment Policies .................................................................................... 10


Executive Summary This report attempts to set out and investigate why the Philippines has become the base for US software

development. To understand why the Philippines has become the base it is important to understand

why countries trade. By understanding what motivates countries to trade can then provide an insight as

to why they chose a particular country to trade with. Furthermore coupling Porters diamond framework

and OLI Paradigm (location factors) it is possible to explain why the Philippines specifically has been

selected by US firms.

1. Introduction The software and IT services in the US are found to be the most advanced in the world with 55% of

global ICT research and development. Between 2010 and 2011 there was 6% increase in revenue for

this industry, totaling to $606 billion in 2011 (SelectUSA, n.d).

The Philippines software industry in 2011 also saw an increase of 37% with revenues of $993 million,

according to the PSIA (Cacho, 2012). This increased the demand by many multinational firms for Filipino

software programmers and increased the employment of IT professionals up to 50,000 (Vilavicencio,

2012).

2. Understanding Why Countries Trade Trading enables nations to use their resources more effectively and as a result nations trading can

benefit. (Cavusgil et al. 2012). To understand further why nations trade Ricardo investigated that the

comparative advantage principle can be used to explain the benefit of two nations trading. The

foundation of this principle is that importance lays in the efficiency in which the two countries can

produce the goods as opposed to importance being placed on the absolute cost of production (Cavusgil

et al. 2012). Therefore although the US have the resources to develop software it would be more

efficient if they outsourced/imported from another country so that they can use their own resources

efficiently and thus consequently specialize in a different area that is more productive and financially

lucrative. Comparative advantage is not without its limitations. Complex factors that exist in todays

market are unnoticed in addition although US outsourcing can lead to economic gains the fear of

exporting American jobs can contribute to unemployment (Bodor, 2004). P. Samuelson favors this

argument as he suggests that the low cost of software produced is not a great enough gain for the US

economy if jobs are lost as a result of outsourcing. Bartlett and Steele also share this view that

developed nations will have depressed wages (Hill, 2011). Although some critics oppose free trade and

consequently outsourcing, supporters of globalization reinforce the benefit of comparative advantage,

that is nations can specialize in the products/services they produce more efficiently and import those

which they are not efficient, therefore trading benefits can outweigh the costs (Hill, 2011: p26).

Therefore outsourcing software development to the Philippines can lead to a number of benefits that

will be discussed throughout this report. The comparative advantage that the Philippines possess is not

limited to inherited or natural resources. Acquired comparative advantages can attempt to understand


why the Philippines has become the base for software development. Philippines have acquired

advantages in terms of their education, human capital and low labor costs. According to Ivant (2013)

there are almost 37000 IT graduates per year with this number of IT graduates there is a large pool of

educated professionals that are willing to work at a fraction of the cost, thus providing an advantage.

Comparative advantage is limited in its ability to provide a coherent insight into how the Philippines is

more productive and as a result Michael Porter developed the diamond framework to attempt to solve

this problem (Hill, 2011).

3. Porters Diamond Using Porters Diamond framework (fig 1) one can attempt to explain further the Philippines comparative

advantage and also attempt to analyse why the Philippines has become successful in the software

industry. (Wang et al., 2004). Porters diamond framework consists of four attributes.

Fig 1: Porters Diamond Framework (Herguner, 2013)

3.1. Factor Endowments Porter analyses production factors based on the Heckscher-Ohlin theory in terms of basic factors e.g.

climate, location and advanced factors e.g. infrastructure, skilled labor (Hill, 2013).

With a population of 94 million, the Philippines is able to provide a highly skilled low cost labor-force in

the software industry (Schwab, 2013). Skilled labor force has been a result of education priorities where

the government and academics have developed an appropriate academic curriculum. This resulted in

average rate of 400,000 graduates per year with 20% of these in IT and Engineering (Herguner, 2013).

As the IT industry is growing at a rate of 20% annually for the past 6 years, with revenues reaching $16


billion and 960,000 employees (Agence France-Press, 2013), Desiderio (2013) has found that more

companies prefer to outsource to the Philippines.

The Philippines is the third largest English speaking country, with a literacy rate of 94.6% (DTI, 2008).

This provides and advantage for US companies as English is the widely spoken language which enables

effective communication (BBC-News, 2013). A highly skilled labor force and education provides a major

advantage for companies in the US to outsource their software development and set base in the

Philippines.

Infrastructure is a key determinant US companies look at when outsourcing. Schwab (2013) has ranked

the Philippines infrastructure as 96 out of 148 (fig 2). This suggests that although there is adequate

infrastructure in place to enable software development, further development will be needed to

maintain the demand the growing IT industry. This can be seen through the development of submarine

cable systems which offer reliable internet connections. (SubmarineNetworks.com) Internet connections

are offered through cable, DSL and Fiber while Wireless broadband (WiFi) is to be introduced in public

places, thus creating an environment that can better support the expansion of the IT outsourcing

industry. In addition to supporting software development, Arangkada Philippines (2010) found high

broadband connections provides benefits in costs reductions thus allowing the Philippine economy to

become more competitive.

Fig 2: Global Competiteness Index (Schwab, 2013)

Taking a closer look at location advantages, time zone differences between the Philippines and U.S. are

7 to 14 hours which offer the possibility for U.S. companies to offer 24x7 support to their clients.

Location advantages will be discussed later using the OLI framework


3.2. Demand Conditions

Demand conditions analyze how home demand, impacts local firms and can determine them to produce

high quality innovative products. Once companies begin to adapt to local market demand an ecosystem

that boosts and is be able to maintain international trade is created (Hill, 2013).

Due to the Philippines being a former U.S. colony, it plays a key role in persuading the US to outsource

software development. Herguner (2013:pg171) states: Thus, we may argue that keeping and enforcing

cultural similarities act the part of strong local market for the application of Porters diamond.

3.3. Relating and Supporting Industries Porter has found that industries that already have an international competitive advantage can help

related industries attain a competitive position in international trade. This occurs through knowledge

flows between companies, technological investments and optimization of the production process. (Hill,

2013)

The Filipino ITO industry benefits from other multinational companies such as Accenture and RCG that

set base or do business with local firm. In addition ABM Global-Bayan Trade, an e-commerce company

has opened the auction market, facilitating the interaction between local suppliers and possible buyers.

(Herguner, 2013)

PISA (Philippine Software Industry Association) established in 1988 has been playing a pivotal role in

attracting business to the Philippines and has reported in 2012 over 150 members such as GenPact, HP,

IBM Global, Fujitsu and Microsoft and over 400 other companies operating within the country.

(Philippine Software Industry Association, 2010).

Although this has led to innovation enhancement, technological change and determined the nature and

scope of barriers that would hinder further software development paradigms, the Philippines still needs

to create and develop stronger institutions that can further assist the industrys evolution.

3.4. Firm Strategy, Structure and Rivalry This attribute in Porters diamond analyses the different philosophies that each country applies in

regards to management and leadership. Choosing individuals from the right field to lead a company is

extremely important as this will have an immense impact on what that companys main focus will be.

Secondly, rivalry between local firms stimulates growth, the need of improvement and cutting cost

which lead to companies becoming more competitive on an international level (Hill, 2013).

The Philippines has suffered a great deal after the former president Ferdinand Marcos declared Martial

Law in 1972 which led to a weakening of the existing institutions and prevented the succeeding

administration to develop new more stable institutions (Root, 1996). Due to this, late changes in overall

strategy, the Filipino economy grew less than other competitive nations and is now making great efforts

in developing new sites in support of its transition in the BPO industry from call-centers to software

development.


In a more favorable view, the increasing number of local firms such as PointWest Technologies, Orange

& Bronze Software Labs, BlastAsia Inc, Seer Technologies, Exist and CPI continue to diversify the services

provided from iOS, Javascript Server-Side to Cloud and mobile solutions for ISV's and SaaS has had a

crucial and beneficial impact on the pace at which the industry evolves.

3.5 Government and Chance In addition to the four attributes of the Diamond framework, a factor that impacts a countrys national

competitive advantage is the Government and Chance. Porter acknowledges the role that Governments

play in determining an appropriate environment for local companies to enable them to enter the

international market by establishing policies and regulations that will attract and protect companies

world-wide to begin trading with local firms (Herguner, 2013). Furthermore the Government has

implemented foreign direct investment policies that attract foreign companies to invest in the

Philippines (see appendix a).

The Filipino Government has made significant changes to many rules and regulation such as key

legislation acts that institute international standards for data protection and patent rights but still needs

to make additional changes in regards to the time of starting a business of 52 days which is considerably

higher than in other competitive countries. (NEDA, 2011).

As previously identified the Filipino government support the software industry by working closely with

academics and numerous companies in developing appropriate curriculums that will enable graduates

to obtain a skill set that matches industry requirements.

Under the chance factor, Porter analyses external factors that can impact the overall economic situation

of the country. In regards to the Philippines, the 40 years conflict between the government and the

Muslim group that came to an end in 2012 represented a high political risk that could have resulted in

changes of government policies with potential negative impact on international trade (Mogato, 2013).

In addition to wars or political conflicts, natural disasters are also a cause for concern. Maplecroft has

highlighted that the Philippines is most at risk to natural disasters where the country loses $1.6 billion

dollars a year (Chan & Cerojano, 2013). The effects of Typhoon Haiyan have highlighted weak areas in

infrastructure. However, analysts have said that the typhoon will not slow the growth of the economy

because the region affected only plays a small role in the wider economy.

Changes in foreign policies such as Obamas campaign to determine U.S. based companies to bring

offshore jobs back to the country could indeed take its toll on the Filipino economy as U.S. companies

are the major clients for the Filipino software outsourcing industry (Herguner, 2013).

One aspect of economic factors is the inflation rate which can have an effect on international business.

The Philippines economy is steadily growing with inflation increasing from 3.2 to 4.6% (Miel, 2013).

Piracy has been a major issue in the Philippines with many software, music etc. being pirated. This issue

accounted for 71% in 2004. The Government has made laws to combat such issues.


4. OLI Location Advantages When outsourcing to international countries, many multinational firms need to consider the location in

which they are to outsource. Using Dunnings OLI theory we can use the Location factors to understand

why the Philippines has been selected as a base to outsource software development. Location

advantages are those in which a firm deals with when outsourcing to a foreign country.

Based on Dunnings OLI framework, the findings below illustrate the reasons why US outsource to the

Philippines.

- The Philippines culture is identical to the western culture, as it was occupied by the United

States in 1899-1946. The Filipinos can adapt quickly which puts Philippines in lead in offshoring

and and outsourcing industries.

- The political system is also based on the US Congress system

- The country is very low cost compared to other Southeast Asian countries with salaries set at a

minimum wage of $7 a day. It also has low exchange rates and low cost of living which makes it

favourable for US companies to set up base in the Philippines.

- There is a lot of government support in the BPO sector as it is the fastest growing sector with 5%

contribution to GDP

- US based legal system, with better defined labour laws as well as a liberarlised financial system.

- Offers a free-trade environment through ASEAN Free Trade Agreement (AFTA) with main

exports of electronics (above ideas from: PlanBPO, 2012)

Competitive advantage of a firm can increase when the location advantages of a country are improved.

This is because, if a country is able to provide a stable legal system and businesses with communication

and labor resources locational attractions are increased as foreign firms have more experience in

providing goods and services (Dunning, 2001). Dunning (1995) also suggested that whenever locational

advantages were greater in a foreign location, then firms would export goods and services from their

home country.

5. Conclusion To conclude the findings of this report have identified why the Philippines has become the base for

software development. Using the comparative advantage theory it was identified that countries can

benefit from trading with other countries. In addition the comparative advantages of the country can

attempt to understand why specifically the Philippines have been chosen. Using Porters framework, it

has been identified that competitive advantage is brought about through the availability of highly skilled

cheap labor. Other key factors that contribute to the attractiveness of the Philippines include an

adequate infrastructure, similar cultures, support for industry which facilitates software development

activities, government support for education and legislation which has enabled growth in the IT industry.


Using the OLI theory, the findings conclude there are a number of location advantages that contribute to

the attractiveness of the Philippines for software development. Although there is a risk of piracy, the

government has put in place procedures to curb such issues.

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Arangkada Philippines (2010), Infrastructure: Telecommunications and Information Technology, [Online],

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Seven-Big-Winner-Sectors-Infrastructure-Telecommunications1.pdf, [Accessed: 27th November 2013]

Barlow, N. (2013), FDI and Infrastructure Development in the Philippines, [Online], US:Asia Briefing, Available from: http://www.asiabriefing.com/news/2013/07/fdi-and-infrastructure-development-in-the-philippines/ , [Accessed: 23rd November 2013]

BBC-News, (2013), United States Profile, [Online], London: BBC News, Available from:

http://www.bbc.co.uk/news/world-us-canada-16759230, [Accessed: 21st November 2013]

Bodor, J. (2004). American dreams flee; outsourcing sends tech jobs to India, China, Philippines.

Telegram & Gazette. Retrieved from http://search.proquest.com/docview/268897542?accountid=17193,

[Accessed: 25th November 2013]

Cacho, K.O, (2012), PH Software Sector Grew 37% in 2011, [Online], Manila: Sunstar, Available from: http://www.sunstar.com.ph/cebu/business/2012/05/29/ph-software-sector-grew-37-2011-224031 , [Accessed: 24th November 2013].

Cavusgil,S. Knight, G. and Riesenberger, J. (2012). International business: the new realities. 2nd ed.

London: Pearson Education

Desiderio, L.D (2013) Outsourcing revenues seen to reach $16 B [Online], Philippines: Philstar, Available

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[Accessed: 29th November 2013]

Dunning J.H, (2001), The Eclectic (OLI) Paradigm of International Production: Past, Present and Future,

International Journal of Economics of Business, 8(2), pp.173-190.


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http://www.dti.gov.ph/uploads/DownloadableForms/Incentives.pdf, [Accessed: 23rd November 2013]

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7. Appendices

Appendix A Foreign Direct Investment Policies Many policies in developing countries are liberalized in order to attract FDI, where governments will compete in different incentive offerings in order to influence the hosts location decisions. The investment incentives are fiscal incentives such as reduced tax, tax holidays and import/export duty exemptions and non-fiscal incentives such as employing foreign nationals. FI policy in the Philippines has been developed with several laws being passed to attract and promote investment from foreign countries. Philippines have used incentives to attract FDI, where the government has increased the investment on infrastructure which will allow for greater FDI flows into the country (Barlow, 2013)

- Liberalized export incentives where the opening of export processing zones has allowed 100% foreign enterprises to be set up whereas before the Philippines use d the 60/40 rule in which 60% had to be owned by Filipino nationals and 40% foreign nationals.

- Wholly owned call centers and other BPO operations by foreign nationals have been allowed

- Investment improvements in the domestic market thus allowing for competition that will raise efficiency and increase profitability for firms

- Increased investments including frameworks to allow set-up of industry projects - investment incentives - implementation of Public-Private participation projects are

being encouraged by the government - firms based in free trade zones and economic zones also known as Ecozones allow for

imports of products that are free of import duties, custom duties and tax (above ideas have been generated from: Sicat, 2012)


- Projects can be registered with the Board of Investment in order to receive incentives - Fiscal incentives: Income Tax Holiday: 100% exemption from corporate income - Tax up to 8 years, exempt from taxes and duties on imported goods - Non-Fiscal Incentives: Employment of foreign nationals, Simplified customs process, - Philippine Economic Zone Authority (PEZA) PEZA, an attached to the Department of

Trade and Industry, is the Philippine government agency tasked to promote investments, extend assistance, register, grant incentives to and facilitate the business operations of investors in export-oriented manufacturing and service facilities inside selected areas throughout the country proclaimed by the President of the Philippines as PEZA Special Economic Zones

(above ideas have been generated from: DTI, n.d)

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Outsourcing to the Philippines