A top performer: Building market share and improving competitiveness

In 2003 the Philippines’ potential as a business process outsourcing (BPO) centre was fully realised after a five-year trial phase. The industry had a compound annual growth rate (CAGR) of 30% from 2006-10, surpassing the 15% global average, according to the Business Processing Association of the Philippines (BPAP).

A KEY EARNER: As companies capitalised on the abundant, qualified, English-speaking labour pool, the Philippine BPO industry employed some 640,000 workers and generated some $10.9bn in 2011, displaying over 22% growth over 2010, the year in which the country overtook India as the world leader in the stand-alone voice business. The 2011 employment figures represent at a 24% increase over the previous year.

With the second-highest potential for job creation and its position as the third-largest contributor of foreign exchange receipts, the country’s BPO industry is a centrepiece of the Philippine Development Plan 2011-16. Ranked second among the BPO industry’s global players, there are initiatives to strengthen its lead and aggressively build its market share in the high-yield, non-voice knowledge process outsourcing (KPO) sector.

However, the honeymoon period for the sector is fading. Designs for expansion face several critical challenges across societal, economic and legislative platforms, all of which the government is working to address via the Philippine IT-BPO Road Map 2016, launched in 2010.

TARGET MARKETS: The country’s planned expansion into KPO covers a broad array of back-office services combined with technical and industry-specific disciplines. Already proficient at accounting, business-to-business IT support and human resources, new target markets include, engineering, software, animation and game development, health care information management (HIM) and legal transcription, which have all benefitted from a global trend that embraces outsourcing.

HIM and legal process outsourcing (LPO) are set to be key areas of growth, with the country counting on its superior English proficiency levels compared to India. This advantage has given the Philippines 20-30% of US, UK and EU voice BPO markets. Engineering services outsourcing (ESO), another key target sector, is projected to increase globally to more than $1trn by 2020.

Whereas LPO provides substantial cost-saving advantages, the HIM sector has a likely growth vector. The US has mandated that all Americans must have an electronic health record by 2014, a move now being echoed in the UK, EU, Canada, Hong Kong, Australia and New Zealand. It is a market that global outsourcing advisory firm Tholons estimates will be worth $18bn by 2015.

“The HIM industry continues to be a great opportunity for the Philippines in terms of outsourcing, given the current global financial situation and the surplus of nurses in the country,” James Donovan, the group CEO of sector player ADEC Solutions, told OBG.

According to BPAP projections, the Philippines could secure 10% of the KPO market, and its client demographic has slowly evolved to take advantage of these opportunities. Its US share was reduced from 81% in 2006 to 74% in 2010, allowing UK, EU, Asia Pacific and even domestic markets to register small gains.

PROJECTIONS: Based on 20% CAGR from 2010, the 2016 development plan has a revenue target of $25bn, which could see incremental export revenues touch $33bn over the same period. Tax revenues would benefit from an additional $7.5bn, and 4.5m direct and indirect jobs could be created. While this marks the upper tier of the government’s estimates, a CAGR of just 9% could bring export revenues of $15bn, 2.38m jobs and $4.5bn in tax revenues, according to projections from BPAP, Everest, the World Bank and the IMF.

Globally, the industry anticipates 10-15% CAGR to 2016, according to the BPAP. This will take the non-voice sector’s value to $70bn-73bn on 20-25% CAGR. By comparison, the IT and ESO sector, with 11-16% CAGR, will build on its strong foundation of $65bn-80bn and reach $136bn-144bn in the same period. The country’s prospects are optimistic, having enjoyed a strong global reputation that has attracted foreign investment to a sector with minimal regulation and no monopoly.

MARKET STRUCTURE: Of the 750 BPO firms in the country, the top employers account for only a 4% market share. More than 53% of companies employ fewer than 50 persons and some 43% have from 50-2500 workers, meaning the diversified structure of the market and evolving skills demand has enabled a relatively self-regulating and competitive market to evolve.

This has not been without problems. A series of media reports and a July 2010 paper from the International Labour Organisation alleged poor conditions within the BPO industry, while the Ecumenical Institute for Labour Education and Research, a trade unionist advocacy group, argued that almost two-thirds of the sector’s workers are irregular hires denied representation in unions and the benefits of formal employment.

But with a legacy derived from President Ferdinand Marcos’s imposition of martial law and the revocation of workers’ rights four decades ago, labour disputes are not uncommon in the Philippines. There may be grounds for some of the concerns raised, but most are seen as symptomatic of broader issues within current legislation. Faced with staff attrition rates as high as 60% in some sectors, as well as a shrinking pool of qualified labour, companies have increasingly been at pains to accommodate their workers’ needs.

Similarly, BPAP argues that while the sector has been intimately involved in efforts to bolster the industry’s image both at home and abroad, it has simultaneously been unfairly vilified by the media.

A key step forward was the November 2011 signing of the Davao Code, a voluntary index of best practices for BPOs in line with the 22-point labour and employment reform agenda of the Aquino administration.

The move toward self-regulation is seen as a means of bypassing the convoluted mechanisms of legislative reform, a process that has delayed the BPO Workers Welfare Act, which was submitted to congress in 2010.

REGULATORY REFORM: Elsewhere, regulatory reform has seen progress in the introduction of the Data Privacy Act 2011. The act is one of three information and communications technology (ICT) measures demanded by the industry to bring the Philippines in line with legislation already enacted among its competitors regarding international standards for data protection. A cyber-crime prevention act was also passed in June 2011, but the sector’s last demand, the formal creation of an ICT department, with many industry leaders lobbying in support of its development.

These reforms will help maximise the investment and employment potential of foreign companies already in the country which have plans for expansion that require Philippine legislation to be consistent with their home country’s standards, particularly among the non-voice sector. HIM, a key target of growth, is notable among these, requiring compliance with the US’s Health Insurance Portability and Accountability Act of 1996.

Enforcement remains a common issue among Asian economies and the government acknowledges that law enforcement officials require support. The country has courted further international approval with the establishment of intellectual property (IP) rights courts and provided specialised training for judges, enacting unique rules for the issuance of ex-parte search and seizure orders in civil cases for IP rights holders. Given that the Aquino administration pledged to rule with integrity, progress here may yet be consolidated, allowing the Philippines to achieve the 20% or more share of the global non-voice market that it desires.

COMPETITIVENESS: The country has earned a top-tier reputation, winning “offshoring destination of the year” from the UK’s National Outsourcing Association in 2007, 2008 and 2010, in addition to strong praise from the likes of KPMG and IBM in recent years.

The country also hosts more than 60 Fortune 1000 companies, including HSBC, JP Morgan Chase and Siemens. However, it faces strong competition in penetrating new markets beyond its current US and EU client demographics, particularly within ASEAN.

“I think we have the potential to be a world leader in the non-voice, back-office sector, but we will never surpass India in IT, they are just too big,” said Gigi Virata, BPAP’s senior executive director.

With a labour pool of over 3m, India’s lead is unrivalled, but its spiking operational costs and volatile inflationary surges (posting aggregate rates of 20% for the past two years), have unnerved investors seeking to spread their operations and risks across the region.

The Philippines, presenting stable inflation rates of 4-5% since January 2010, remains a predictable market environment for investors outside India and China.

Companies including leading IT-KPO firms Hinduja TMT (Indian) and SPi Global Solutions (Philippine), which are among the country’s top 20 BPO employers, have split their assets and operations between India and the Philippines, the region’s two great BPO tigers. The mutual complementarities have provided effective redundancy and business continuity capacities that were brought to bear most recently during Typhoon Nalgae.

This relationship has been reciprocal, as both India and the Philippines continue to face infrastructure and institutional challenges, including corruption, an inefficient labour market and low quality primary education, all of which undermine business competitiveness. Yet 2011 saw the Philippines as the top performer in terms of improvements in the World Economic Forum’s “Global Competitiveness Report”, up 10 places to 75. This may reassure current BPO investors but is unlikely to cause a sea change in investor confidence. In a BPAP-sponsored survey of why BPOs choose the Philippines, “favourable business environment” ranked third behind available talent and reliable BPO infrastructure.

TELECOMS: Concerning telecommunications, the cost of bandwidth has dropped by some 85% in the past five years. The telecommunications network is now capable of handling volumes of data transmitted through international broadband cable at 250 GB per second via four cable landing stations (two more are in the works). Also, the Board of Investments (BOI) reported in November 2011 that power rates are expected to drop by 25% in the next three years as the effects of Electric Power Industry Reform Act 2001 strengthen.

INCENTIVES: The Philippines falls just short of India’s price competitiveness, but strong and flexible incentives provided by the Philippine Economic Zone Authority (PEZA) and the BOI, along with certain cultural advantages, have endeared the country to firms with Western-centric customer bases.

“Philippine culture offers some distinct benefits for services like those provided by the BPO industry,” Kristina Beckendorf, the managing director at Maersk Global Services Centres (Philippines), told OBG. “Filipinos are known for their service mindedness, their focus on customer experience and a high level of empathy. This makes the country an excellent location for contact centres, but also for general support services. In addition, there is a skilled talent pool available for increasingly advanced creative and analytical services, which is an exciting development for the Philippines.”

This has applied by extension to employers as well, with many companies citing a high level of engagement and loyalty among their staff as a positive reinforcement with regards to the value of their investments. “Western clients and their customers are gradually becoming more sophisticated in their demands for customer service and quality within the BPO sector,” Neil Elias, the country manager of business consulting and outsourcing firm Logica, told OBG. “Given that the Philippines is a service-oriented society with deeper historical ties with the West, the BPO sector here is in a good position to capture this maturing market.”

LABOUR SHORTFALLS: Despite a scalability second only to India, BPAP estimates a 260,000 shortfall in labour by 2016 if the traditional workforce supply to the sector does not increase greatly. With this looming gap (plus the 60% of “captive” firms eyeing growth beyond current operations), addressing the deficiencies within the education system is now an urgent issue. “Our rate of growth right now largely depends on how many qualified people we can hire, which involves a lot of training and education reform,” Virata told OBG.

Direct hires by companies makes up less than 8% of applicants due to insufficient language or critical analysis skills, although this can be boosted to 20-30% by additional training. Enhancing skill levels remains a core focus of BPAP and government support to the industry, with training courses established nationwide through a revolving fund under the Technical Education and Skills Development Authority, to which the government promised an additional P500m ($11.4m) in 2011.

While this has helped the industry tap the more than 450,000 college graduates produced each year, non-graduates have typically been excluded from the labour pool. This is due to a shortfall in the education system, which is based on just 10 years of mandatory schooling. Reform centred on the addition of two academic years is scheduled for 2012 but has faced opposition. Even if it is passed, a labour shortage is likely to remain an issue until the next tranche of graduates and non-graduates enter the job market.

Staffing gaps have also appeared within management, but this has principally been due to the relatively young age of the industry, meaning workers have not yet had the chance to build portfolios with much managerial experience. “Part of the perceived gap in management is due to the companies’ preference to find managers from within,” Virata told OBG. “Since it’s a relatively new industry and there is a relatively high attrition rate, you don’t get many employees staying on after three to five years, and that’s where you get your management candidates. It’s going to take time to expand this pool.”

American and Indian managers have been brought in to complement local capacity, but staff retention and the building of a local management pool is a key strategy. Average attrition rates are 24-25%, while at call centres it can be as high as 60%. However, many of these firms are less reliant on a skilled workforce and employ students or part-timers, staffing arrangements that can amplify the perception of a trend. BPAP reports that average tenures have increased, but as the industry becomes more knowledge-based and experience-orientated, managerial shortfalls are still expected.

Effective recruitment profiling, training programmes, career development courses, job shadowing and international secondment are reported to have had more success in reducing attrition rates than cash incentives in an industry that pays on average twice the minimum wage already. Though pricey, foreign exchange programmes have been lauded for their role in maturing students and inspiring them to overcome deference to seniors during decision-making processes.

NEW DEVELOPMENTS: The workforce issue has accelerated the development of 25 Next Wave Cities and reduced BPO concentration in the National Capital Region (NCR) from 83% to 75% from 2006-10. BPAP’s figures show these second- and third-tier cities are established urban centres with tertiary education facilities that in 2009 provided 75% of the BPO-qualified labour pool. The government’s identification and subsequent development of the real estate, telecoms and social ecosystem infrastructure has attracted BPO investments with BOI and PEZA incentives and has also helped reduce migration to Manila. More than 125,000 BPO workers are now employed outside the NCR.

Metro Cebu and Clark were together home to 49,000 workers in 2010, and other cities, including the former summer capital Baguio City and Manila’s outlying Santa Rosa City, have also become host to smaller operations, demonstrating the capacities of even small urban centres to accommodate the industry’s needs.

Davao, which currently supports a BPO workforce of 7000, could manage up to 20,000, according to BPAP. However, its potential has been undermined by concerns regarding the separatist Islamic insurgency on the island, despite the fact that the city remains untouched by the violence and enjoys large investments as a new international gateway to the country, as evidenced by the province’s strong economic growth. In November 2011 US-headquartered VXI Global Solutions opened offices in Davao and is expected to hire 1500 staff in 2012. Convergys is also said to be eyeing the city, particularly the 18,000 university graduates it produces each year. Thus, even if peace talks with separatists are not concluded, Davao and its neighbour Cagayan de Oro should continue to see strong inward investments.

OUTLOOK: With further soft and hard infrastructure investments, Next Wave Cities could relieve much of the pressure on the industry, but only in concert with national education reform and the creation of links with domestic industry, which the government plans to exploit in the form of regional, specialised talent. The 4% increase in domestic utilisation of BPO capacities since 2006 demonstrates that it is on the right path.

Challenges remain, but with demonstrated private and public sector coordination, the Philippines is looking to maximise its potential by maintaining its overall cost competitiveness, consolidating existing market share, enhancing non-voice market segments and nurturing its future talent pool to reach its 2016 targets.