Global Workforce Report Emerging Markets—Looking Beyond Wages

By Fay Hansen

Nov. 20, 2008

Wages are rising at double-digit rates across much of Central and Eastern Europe, but Cisco Systems is sitting tight, with 16 offices spanning the region.

    “High wage inflation is there, with some pockets in the area more affected than others,” says Agnieszka Halas, Cisco’s human resources manager for Central and Eastern Europe. “But the econo­mies are showing healthy growth, and from a long-term perspective wage inflation does not affect our strategy. It’s not a showstopper.”

    Based in San Jose, California, Cisco generates $40 billion in annual revenue and employs 66,130 workers worldwide, with 28,700 employed outside the U.S. The company moved into Central and Eastern Europe in 1995, when unemployment in the region was high, wages were low and foreign investment was still nascent. Those conditions shifted rapidly in the next de­cade, but Cisco remains committed to being a major presence in the region. This year, it will train 51,000 students in Central and Eastern Europe in information and communications networking skills.

    “Years ago, some companies invested in the Central and Eastern European region for the sole reason of labor-market price advantage, but those days are over,” says Scott Marlowe, general manager for Hay Group, Czech Republic. “Now companies are looking at the price of talent as the third or fourth factor in the investment decision. Instead, they are looking at the markets themselves, the proximity to other markets and the available talent.”

    Higher labor costs are a predictable development as many of the Central and Eastern European economies mature well beyond their original emerging-market status. But strong economic growth and significant talent pools continue to attract companies that are not tied to labor arbitrage.

    Uncertainties touched off by the global financial crisis and high currency valuations and wage inflation may darken the macroeconomic landscape, but savvy multinationals are increasingly taking a broader look at Central and Eastern Europe’s advantages. Improvements in the labor supply, combined with the European Union’s push for true labor mobility, should capture the attention of any human resources executive looking for fresh talent.

Relative advantages
    Despite market maturation, Central and Eastern Europe remains one of the fastest-growing regions in the world, with annual GDP growth averaging 6 percent in 2007 and forecasts calling for 5 percent growth in 2008. Across Central and Eastern Europe, rising employment and skills shortages have been driving up wages since 2004, when 10 nations joined the European Union, which at the time had 15 member countries. “Wage inflation is a challenge for all multinationals in the region,” Halas says.

    In the context of global investment, however, Central and Eastern European wage inflation is still below the rates reported for other markets with attractive labor pools. For the past five years, annual wage inflation has averaged 19 percent in China and 21 percent in Brazil, compared with 5 percent in Mexico and 3 percent in the U.S., according to McKinsey & Co.

    In the service and IT industries, wage growth in Central and Eastern Europe is comparable to or lower than wage increases in alternative emerging markets. Turnover is high, but significantly lower than in comparable markets in China or India.

    The Cisco business profile in Central and Eastern Europe requires two broad skill sets—marketing, sales and business management; and engineering and tech- nical skills. “The company represents a vibrant environment in all areas of business expertise and technology,” Halas says. “If you paint a picture from the talent perspective, Central and Eastern Europe is a young region with a huge inflow of foreign investment,” especially since the EU expansions.

    For managerial and technical talent, demand continues to outstrip supply. Cisco has responded with aggressive training programs aimed at both skill sets. “On the technical side, Cisco is well positioned to get the best people and also has a good track record of building talent in general,” Halas says.

“Like other emerging markets,
Central and Eastern Europe is now experiencing continued labor outflows and some relatively recent inflows from reverse migration.
It’s important to look at demographics of the trend and the skill sets
captured in the outflow.”
—Agnieszka Halas, human resources manager for Central and Eastern Europe, Cisco

    In addition to its Networking Academy, which pulls in potential technical candidates, Cisco is now building entrepreneurial and management training institutes across the region. Cisco also partners with 800 universities across Central and Eastern Europe to build talent and boost growth.

    Throughout Central and Eastern Europe, Cisco operates with local teams. “As you cross borders into different countries or areas, there is a wealth of languages, so we need a local footprint,” Halas says. Regional leaders work from their home countries and communicate through the technology network.

    Cisco is organized into two regions within Central and Eastern Europe. One region encompasses the nations that entered the European Union in 2004, plus Romania and Bulgaria, which joined in 2007, while the second region, which Cisco calls “Europe East,” encompasses the non-EU nations, including Croatia and Turkey. This split reflects business realities within Central and Eastern Europe, where EU membership ensures a level of political and economic stability and market maturation not yet achieved by nonmembers.

    For EU members, accession generated vast changes in state administration and infrastructure and set off a series of privatizations that continue to offer attractive business opportunities. Outside the EU nations, the drive to meet membership requirements has fostered a push for innovation and productivity. Croatia and Turkey, which entered EU accession talks in 2005, have already seen huge jumps in foreign investment.

    Vast amounts of foreign investment within the Central and Eastern European EU member states have deformed their labor markets, Marlowe reports.

    “The multinationals hire large groups of employees in a single job category. This is not normal, organic growth, but abnormal growth,” Marlowe says. “In Prague, for example, a city of 1 million people, a company recently hired on 850 IT professionals. This puts a strain on hiring and distorts salary growth. Multinationals are still implementing here strategies that were thought up somewhere else.

Easing pressures
The strain on the labor supply and wages may ease as true labor mobility rises.

    “Like other emerging markets, Central and Eastern Europe is now experiencing continued labor outflows and some relatively recent inflows from reverse migration,” Halas says. “It’s important to look at demographics of the trend and the skill sets captured in the outflow. For example, in Poland, most of the emigrants were young and relatively lower-skilled workers who moved to the U.K. and Ireland for work in manufacturing and retail, and this created a challenge in Poland. But it did not create a challenge for Cisco.”

    The outflows that sharpened Central and Eastern European labor shortages are now easing as the global economic slowdown hits Western Europe. The U.K. Home Office reported in August that the number of work-permit applications from Central and Eastern European EU member states had fallen to its lowest level since the 2004 enlargement. The number of applicants from Bulgaria and Romania, the 2007 accession states, also dropped.

    In addition, the European Commission has renewed its commitment to labor mobility with a concerted drive to remove barriers to cross-border flows, which should increase inflows and outflows aligned with actual labor market demands in all member states.

    “At Cisco, we see the ease of mobility as a positive development,” Halas says. “The high-tech sector that Cisco operates in has benefited from increased mobility because we can bring needed skill sets into the region.”

    Apart from the impact of lower outflows and higher inflows set off by the downturn, labor shortages and wage inflation will also ease as export-dependent industries in Central and Eastern Europe trim production.

    “With the financial crisis now, there is a lot of uncertainty, which is moving down into the labor markets,” Marlowe says. “Today, employers are more able to resist pressure from their line managers to constantly hire on more employees, and the line managers are in more of a dialogue with HR about labor supply and demand. Before, HR was simply a recruiting machine even though companies were maturing.”

    Because of the skills shortages, multinationals in the region have struggled to meet employee expectations for advancement. “Employees were used to rapid development and salary growth,” Marlowe says. “The pressure on pay has been tremendous, and the issue was what else the company could offer. Over the past two to three months, the pressure has eased as employees and line managers see the financial uncertainty. It is important to note that these economies have never seen recession.”

    Labor mobility varies highly from culture to culture. In Poland, for example, there is a high level of willingness to relocate abroad, while this willingness is much lower in the Czech Republic.

    “We have seen some inflow from returning immigrants in Central and Eastern Europe, and a higher level of the free movement of labor and mobility within the region,” Marlowe says.

    “It is important to note that in Central and Eastern Europe, especially Central Europe, companies are capital-centric in a geographic sense,” Marlowe says. “Language capabilities, mobility and attitudes toward work are very different in the capital cities. If you are investing outside the capital cities, you will encounter very different cultural realities. If you’ve been to Prague, you haven’t been to the Czech Republic. It’s a different reality.”

Evaluating the markets
    Multinationals operating in Central and Eastern Europe should be prepared for some renewed pressure on wages and prices as the 2004 EU entrants move into the eurozone—that is, the union of EU countries that have adopted the euro as their official currency. Until then, HR executives will have to monitor currency fluctuations across the region, and especially in countries such as the Czech Republic where valuations have been especially high.

    “The koruna is not expected to appreciate much more, but HR executives must conduct their labor-cost due diligence and must look at currency fluctuations, particularly in Poland and Czech Republic,” Marlowe advises. “When these countries move into the eurozone, life will be much easier, but most Central and Eastern European countries will see price increases and some wage inflation with the introduction of the euro.”

    Some wage inflation may occur as comparability occurs with the eurozone, but Marlowe believes that there is a tendency to overestimate the impact of comparability.

    “Within the current EU, there are salary differences and employees understand the differences in purchasing power,” Marlowe says. “Purchasing-power knowledge has also brought managers back into Central and Eastern Europe because they see the advantages. Also, managers have more freedom to develop here. In Western Europe, you make one mistake and you are dead. Here, managers have more freedom to experiment.”

    HR executives who are evaluating Central and Eastern European locations should also be aware of sharp political and economic variations within the region, according to Hylke Sprangers, NorthgateArinso’s vice president of operations for Europe, the Middle East and Africa. NorthgateArinso, headquartered in Hemel Hempstead, England, is a major HR software and services provider with 4,500 employees in 32 countries. In 2005, it opened a regional delivery center for Europe, the Middle East and Africa in Katowice, Poland.

    “For us, the importance of Eastern Europe is twofold,” Sprangers reports. “First, it is a big economic market for our clients that have operations there, and second, we want to benefit from the low-cost talent pool. A lot of our clients are moving into the EU [member countries] of Central and Eastern Europe. For example, Cadbury Schweppes opened a new factory in Poland in 2006 and it already employs a much larger workforce than was originally planned.”

    Sprangers advises HR executives who are evaluating the region to first determine whether the company is considering an EU or non-EU location. “For the countries that belong to the EU, there are data privacy issues, unless the company will only be servicing operations of clients in the United States,” he says. “In addition, there is less economic and political stability in the non-EU nations, especially since the invasion of Georgia.”

    NorthgateArinso has not experienced skill shortages in Poland, but Sprangers notes that Polish workers are very mobile and willing to relocate to other countries for work and international experience. “We now see attrition of 10 percent and rising in our Polish center,” he says. “There is some inflow of returning immigrants, but the outflow is also continuing. This is normal within emerging markets.”

    High wage increases are also entirely normal, Sprangers notes.

    “Central and East­ern Europe is a contender for Asia, especially India, where the shortage of technical talent is acute. In India, wage inflation has been running 15 percent a year for five years and attrition can hit 50 percent. Companies investing in Central and Eastern Europe must make a business plan for five to 10 years.”

Workforce Management, November 17, 2008, p. 29-35Subscribe Now!

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