Annex Newsflash 2005-29                             September 30, 2005



Updated 12/07/05, 7:30 AM MST (adds R&D Gold Mine)

Analysis of Global and European Investment Opportunities

New "Drang Nach Osten"

Russia and Its Environs Offer Best Growth Potential;

Also, Offshoring Backfires at Dell

PHOENIX, Sep 30 – Over a century ago, brave and entrepreneurial Americans bent on opening up new frontiers answered the call "go West young man."  Nowadays, the brave and the entrepreneurial among the global multinational companies operating in Europe should be going in the opposite direction with a new "Drang Nach Osten" ("Push toward the East")[1] strategy.  The best investment opportunities lie in Russia and in its former dominions in Eastern Europe.

No surprise there for our regular readers.  That's the gist of our high-level analysis of the European market, as outlined in our last year's global investment report "To Russia with Love and $$$" (Oct 2004).  What's new is that our conclusion has traction on the ground, too.  That is the bottom line of this writer's just-concluded market research trek through Europe that took up most of September.

Our reasoning was pretty simple.  Russia and Eastern Europe have the world's best educated work force at the lowest cost relative to other countries, both in Western Europe and elsewhere around the world.  Which means that they offer investors the best bang for the buck, especially for research and development activities.

As you can see from the above chart, derived from the raw UNCTAD 2004 data (a United Nations global investments report), Russia and other Eastern European countries stack the Top 10 list of the most attractive nations from for an investor based on the relative cost of university-educated labor.  Only India and China in Asia, and Argentina and Brazil in Latin America, come close.  Developed European countries, as well as the U.S. and Japan, hold up the rear of the list of select 30 nations.

That is not, however, how the world's largest multinational have been investing their money since the end of the Cold War.  Despite Russia's investment appeal based on common sense and reason, the world's largest country has been largely spurned, while tiny nations, such as Hungary and Israel, for example, have been favored (see above chart). 

One reason may be that the multinationals followed the advice of international economic research firms, such as the Geneva-based World Economic Forum (WEF).  The WEF has been measuring national competitiveness and producing Competitiveness Reports for over two decades.  In formulating the range of factors that go into it, the WEF identifies “three pillars” of its analysis: the quality of the macroeconomic environment, the state of the country’s public institutions, and, the level of its technological readiness. 

The WEF says it uses a combination of hard data—e.g., university enrollment rates, inflation performance, the state of the public finances, the level of penetration of new technologies, such as mobile telephones and the Internet—and data drawn from the WEF’s Executive Opinion Survey before formulating its conclusions.

Well, the chart you see above is a result of such composite WEF analysis.  Finland, the U.S. and Sweden are seen as the world's most attractive countries for investments from the WEF point of view.  Russia and its environs are the least appealing among the select 30 nations.

In other words, the WEF's chart is almost the exact opposite from the one we had created last year, based on the U.N. data, and on our interpretation of entrepreneurial, if not institutional, investment appeal.

Yet WEF Also Touts Russia's Appeal

What's interesting, however, about the latest WEF report, released just two days ago (Sep 28), is that its narrative does not seem to match its data.  The WEF, just like ourselves, is actually lauding the attractiveness of Russia and other Eastern European countries, its quantitative analysis notwithstanding (which makes one wonder about its value, doesn't it?).

"Swift reductions in the costs of transport and communications have made it easier for global corporations to shift production to places in the world which are capable of bringing together the right combination of skills and low labor costs with political and social stability," writes Augusto Lopez-Claros, WEF's chief economist and editor-in-chief of its annual report on global investments. "This has become evident during the past decade in Central and Eastern Europe, whose economies have been growing at twice the average of the rest of Europe."

Lopez-Claros further argues that there is "no intrinsic reason why the Russian economy could not enter a period of high, sustained growth in coming years."  He points to a number of structural features which create the conditions for rapid growth, such as "gains in efficiency from the continued elimination of distortions, the country’s impressive natural resource endowment (likely to spur the continued interest of foreign investors), and its human capital stock, which—weaknesses in the public sector notwithstanding—can be considered a competitive advantage."

Estonia, for example, about which the WEF says is "by a significant margin the most competitive economy among the 10 countries that joined the EU last year," is ranked 20th, while Poland moved up nine places to 51st place among the 117 countries the WEF report analyzed.

In short, the WEF is pretty much saying the same thing as we did last year: "Drang Nach Osten" is the way to go for companies looking an opportunity to grow their businesses more rapidly.  Sure, the risks are greater than in good old staid Western European economies, but so are the rewards.

Besides, "in an increasingly integrated world, the dividing line between 'local' and 'global' is becoming increasingly blurred," argues Klaus Schwab, executive chairman of the WEF in the preface to the report.  "The most effective way to tackle poverty in the developing world is to open the markets of the rich countries, particularly for agricultural exports from the low-income countries."  But a "rising protectionist sentiment in the rich industrial countries has already raised its ugly head," he warns ominously.

Major European Countries Losing Their Appeal

Speaking of those "rich countries," the news is bleak, according to the WEF report.  Many of the major European countries have slipped down the rankings.  Neither of the U.K. nor Germany, for example, the EU's two biggest economies, feature in the top 10.  The U.K. is ranked at number 13, and Germany moved down two places since a year ago to number 15.

France, meanwhile, dropped from 27th place down to 30th place, while Spain and Belgium slipped down six places, to 29th and 31st ranking respectively.

Among the worst performing EU countries, however, are Italy and Greece, the lowest ranking EU countries except for Poland.  Italy is ranked at 47th place, while Greece slipped down nine places to 46th place.

Those among our clients with longer memories may recall that IBM blamed its first quarter fiasco on the sluggishness of the very European countries that the WEF report is now also panning (see "IBM: Slammed and Dunked," Apr 2005).  What followed was swift IBM action to downsize its work force in big European countries, and to rebalance it elsewhere around the world (see "IBM Restructuring," May 2005).

Well, Big Blue may find a little solace in the WEF report that suggests its problems in Europe may be more endemic and less Blue.

China and India: Well Down the List

As for China and India, the main "offshoring" destinations that have attracted hundreds of billions of dollars of foreign investments in the last 15 years, they are ranked only 49th and 50th respectively by the WEF (which once again raises questions about usefulness of such data).

"While China dropped three ranks, India moved up five places," the WEF notes. "The Chinese authorities have been trying to reign in the growth of credit, and the strength of demand has resulted in an acceleration of inflation in 2004."

India’s improved rank, on the other hand, "mirrors the country’s somewhat higher position in the technology index," the WEF says.  "The increasing inflows of foreign investments to skill and technology-intensive sectors observed over the past few years have certainly succeeded in boosting the mood of the business community."

But the remaining worries in India, "stem from the slight progress made in fiscal adjustment, the low penetration rates of new technologies, and low enrollment rates for higher education," concludes the WEF.

Offshoring Backfires at Dell

PHOENIX, Oct 1 - As popular as "offshoring" has become in the IT industry, it was just a matter of time before it started backfiring.  And it is ironic that the "king of PC," Dell, has become one of the first publicly visible victims of a strategy that compromises service quality and ultimately future sales in quest of supply-chain savings.  

A case of saving a dime while losing a dollar?  Judge for yourself...

"It didn't seem as if he was asking for much," writes Business Week in its Oct 10 edition, released online on Sep 30. "When the CD drive on Peter Ulyatt's Dell desktop computer failed this summer, he called the support crew at Dell, where he'd bought the $1,600 machine nine months prior. Armed with an extended warranty that cost him an extra $300, the Pasadena (Calif.) retiree got on the phone and waited. After sitting on hold for 45 minutes, a technician whom Ulyatt could barely understand came on the line and diagnosed a 'software problem.' Ulyatt's call, transferred to the software technician, was dropped. Calling back, Ulyatt waited on hold another 45 minutes, asked for the software desk, and waited a half-hour more before hanging up. "At the moment, I'm not high on Dell's service," says Ulyatt, who plans to buy two new PCs in a year or so. "When I buy again, I will look at others beyond Dell."

As Business Week also notes, Ulyatt's ordeal is not an isolated case.  "All tech companies have some unhappy customers, of course, but recent surveys suggest the ranks of frustrated Dell Inc. owners are growing," says Business Week.  "Complaints to the Better Business Bureau rose 23% in 2004 from the year before, and they're up another 5% this year. And Dell's customer-satisfaction rating fell 6.3%, to a score of 74, in a survey by the University of Michigan."

This writer has had similarly unsatisfactory offshore service quality experiences, with Dell's and Microsoft's India-based tech support reps, though not as egregious as the case of the poor Mr. Ulyatt.  Ultimately, the vendors who are prepared to trade off support quality for cost savings will face the inevitable outcome: loss of future sales. 

Too bad John Kerry isn't running for president - this year! J

Happy bargain hunting!

Bob Djurdjevic

[1]  Drang nach Osten ("Push toward the East") is a term used in Germany's history that means the expansion of Germany, German states and German settlement, that led to the conquest of former Slavic and Baltic areas by Germany commencing during the Middle Ages, until the end of World War II in 1945, when the Nazis were defeated by the Red Army of the Soviet Union.

Eastern Europe: "An R&D Gold Mine"

But Microsoft Also Investing Heavily in India

SCOTTSDALE, Dec 7 - "The former East Bloc is an R&D gold mine for Microsoft, Nokia, and others," said Business Week in a headline of its Dec 12 international cover story.  

"University graduates from Warsaw to Bucharest are suddenly the region's hottest commodity," the article noted. "International giants from Oracle (ORCL ) to Delphi (DPHIQ) to Samsung Group are snapping up highly skilled youth with degrees in engineering and computer science, and setting them to work on the next wave of innovative products."

Now, if that sounds familiar, it is no wonder.  

"The best investment opportunities lie in Russia and in its former dominions in Eastern Europe," we noted in our "Drang Nach Osten"-piece, published in late September after this author's tour of Europe that confirmed what we first said over a year ago in our 2004 global investment report "To Russia with Love and $$$" (Oct 2004).

"R&D spoken here... in English, Cyrillic," read the headline of our workshop slide produced at about the same time.  Its message hailed Russia and Serbia in particular as "world's new creative brain hubs."   We also noted that Microsoft was setting up an R&D center in Belgrade, Serbia, with the principal mission of developing handwriting recognition software in both Latin and Cyrillic alphabets.

Well, Microsoft, for one, certainly isn't putting all its eggs in one basket.

Microsoft Also Investing Heavily in India

The world's largest software company plans to invest $1.7 billion in India over four years to deepen its presence in that market, Chairman Bill Gates said today (Dec 7) at a New Delhi news conference, according to a Reuters report.  

About half Microsoft's investment will be spent on beefing up its existing research and development center, its global software delivery unit and expanding to 33 cities with 700 retail outlets.

"We have about 4,000 people (in India); we would be growing that by 3,000 over the next several years," Gates told reporters at a news conference.  "The human resources here are really fantastic. Our employment growth here would be far more rapid than in the U.S."

India's fast-growing $17-billion export-oriented software services industry has been a magnet for multinationals lured by wages in India that are often a fifth of Western counterparts, Reuters noted.  Here are just some recent examples of it:

  • Intel said on Monday it would pour $1.1 billion into its Indian operations in the medium term, including setting up a venture fund to take stakes in start-ups.

  • In October, Cisco said it planned to invest $1.1 billion over the next three years and triple its staff numbers in India.

The big IT users are also jumping on the bandwagon.  J.P. Morgan Chase & Co. said this week it hoped to hire 4,500 graduates in India over the next two years.

The preceding suggests that two major global trends are under way - outsourcing of predominantly services jobs to India, and of R&D to Russia and Eastern Europe.  Both will produce measurable benefits to the multinational companies that lead the way and get the pick of the litter in terms of new hires.  But they also spell pain back home.

U.S. Layoffs Soar, But So Does Productivity

In another story that broke this morning, planned job cuts by major U.S. corporations increased 22% in November to 99,279, according to a monthly tally released Wednesday (Dec 7) by outplacement firm Challenger, Gray & Christmas. Planned layoffs have increased three months in a row now.

So far in 2005, major U.S. corporations have announced 964,232 job cuts, up 3.6% from the year-to-date total a year ago. More than 10% of the job reductions this year have come from the struggling automotive sector, which has announced 105,886 cuts this year, including 16,870 in November.  

As if adding insult to injury, Ford also announced this morning that it would cut up to 30,000 American jobs and close at least 10 plants in North America over the next five years.  Obviously, the Ford layoffs were not part of the already bad November job statistics.  Which means things will only get worse in the future.

Of course, the American automotive industry woes and the outsourcing of services jobs to India are two unrelated trends.  But try explaining that to the average Joe, especially considering all the hype about "offshoring" by the Democrats.  So stand by for more political fallout from a trend that has actually raised the productivity of the U.S. non-farm business sector by 4.7% annual rate in the third quarter, the fastest rate in two years, according to the U.S. Labor Department release, issued yesterday (Tuesday, Dec 6).

For additional Annex Research reports, check out... 

2005 IT: Global Investments: New "Drang Nach Osten" (Sep 2005); HP: Sweet Turnaround (Aug 2005);  Dell Spooks Street (Aug 2005);  EDS Ups Its Forecast (Aug 2005);  Capgemini Beats Forecast (July 2005);  Fujitsu: Losses Reversed; Forecast Upgraded (July 2005);  IBM: Polaris Eclipses T-Rex (July 2005);   IBM Bounces Back (July 2005); Accenture: Smashing Records (July 2005); Merrill's New Bull (EDS) (May 2005);  IBM Trumps Trump (May 2005);  Tweaking Big Blue (May 2005); Hurd's First RBI (May 2005); Dell Rings the Bell (May 2005); Stock Buybacks: The Phantom Is Back (May 2005); EDS Misfiring on All Cylinders (May 2005);  HP Surges, Dell Slumps; Lenovo Completes IBM Deal (May 2005);  Fujitsu Revenues Flat, Lower Net (Apr 2005); Capgemini Jettisons Healthcare in N.A. (Apr 2005); HP: From India to Poland (Apr 2005); IBM: Slammed and Dunked (Apr 2005); Hurd Advice: Up Mount Market Cap (Apr 2005); Accenture: Roaring Ahead (Apr 2005);  Fujitsu Unveils New Servers (Mar 2005);  EDS Executive Suite; HP's New CEO (Mar 2005);  An iSeries Revival (Mar 2005); EDS Booster Club Fees Rise (Mar 2005);  An Upside-Down View (Mar 2005);   The Worst of Both Worlds (Mar 2005);  Octathlon 2005: Accenture Wins (Mar 2005);  IBM Global Services: Smaller, Shorter - Better? (Mar 2005);  IBM 5-yr Forecast: Quality over Quantity (Mar 2005); Rumor Lifts EDS', Fujitsu's Shares (Mar 2005); Capgemini: Turning the Corner (Feb 2005);  IBM Servers to Grow Again (Feb 2005);  Carly's Fickle Fans (Feb 2005);  CSC: Gearing Down on Purpose (Feb 2005);  EDS: Grossly Overpriced Stock (Feb 2005);  IBM Historical Update: 2004 Shot in the Arm (Feb 2005); New HeadTurners Series #1 (Feb 2005); IBM: A Crescendo Finale! (Jan 2005); Accenture: Strong Finish, Better Start (Jan 2005); Annex Coverage 2004: IT Services Dominate (Jan 2005)

2004 IT: EDS: The Titanium Stock (and other Wall Street tales) (Dec 2004); IBM PC: Good Riddance (Dec 2004); Fujitsu: Recovery Continues (Nov 2004);  IBM Server Renaissance (Nov 2004);  HP Hits Home Run (Nov 2004); Capgemini: Revenue, Stock Soars (Nov 2004); EDS: Jordan's Swan Song? (Nov 2004);  To Russia with Love and $ (Oct 2004); IBM: Slow Quarter No Longer (Oct 2004); Accenture: Revenues, Profits Up, Stock Down (Oct 2004); Capgemini: A Takeover Target? (Oct 2004); Sellout of America (Oct 2004); Spy Wars (Sep 2004); Outsourcing Boomerang (Sep 2004); EDS to Cut Up to 20,000 More Jobs (Sep 2004); Capgemini Stock Plummets on Unexpected Loss (Sep 2004); HP Savaged by Wall Street (Aug 2004); Moody's Lowers the Boon on EDS (July 2004); HP: Delivering Value Horizontally (June 2004); Accenture: Revving Up a Notch (June 2004); Beware Your CFO! (May 2004)IBM: Changing of the Guard (May 2004); Capgemini: Texas-size Home Run (May 2004); Following the Money (May 2004);  EDS: On a Wink and a Prayer (Apr 2004); HPS Wins by a Nose! (Octathlon 2004); Accenture: Burning the Track (Mar 2004);  IGS: "Crown Jewel" Restored? (Mar 2004); HP: Still No Cigar (Feb 2004); Cap Gemini: Another, Smaller Loss (Feb 2004); CSC: Good Quarter Gets Boos (Feb 2004); EDS: "Hot Air Jordan" Flaunts Flop as Feat (Feb 2004); IT Industry: Whither Goeth It? (Jan 2004); Cronyism Is Alive and Well at EDS" (Jan 2004)

Or just click on and use "financial engineering" or similar  keywords.

Volume XXI, Annex Newsflash 2005-29
September 30, 2005

Bob Djurdjevic, Editor
(c) Copyright 2005 by Annex Research, Inc. All rights reserved.

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