60021 Developing an African Africa Trade Policy Notes Offshoring Industry--The Case of Nigeria Note #3 Ismail Radwan and Nicholas Strychacz May, 2010 Introduction and what government policies are required to ensure that Nigeria play a role in the growing Nigeria's economic potential is vast. The ICT offshoring sector. This note will also country's considerable resource endowment, provide policy prescriptions and practical advice strategic coastal location and large internal for policy makers, enterprises, and other market should allow it to become an economic stakeholders for developing a successful powerhouse for Africa. Yet Nigeria has not yet offshoring sector in Nigeria. In addition, this realized this potential. Like most African policy note should be of interest to policy countries, in order to begin on a path of rapid makers and stakeholders throughout the region, and sustainable development, Nigeria will have as many challenges and policy prescriptions to support private sector growth and look for examined here are relevant to countries opportunities to diversify the economy away throughout Africa. from the oil sector. One attractive way to do this could be to develop the nascent offshoring What is Offshoring? information communications technology (ICT) sector. Countries around the world that are Outsourcing occurs when one company investing in high value added sectors such as delegates responsibility for performing a ICT, in particular countries such as India, South function or series of tasks to another company. Korea, and the Philippines, are reaping the When the second company is based in another benefits of adapting their economies to be more country, outsourcing becomes offshoring. competitive in global services trade. Recent improvements in information technology and lower costs of data transmission have This note aims to raise awareness for Nigeria's extended the concept of offshoring to tradable potential as an offshoring hub in Africa, and is services. Services offshoring has become a aimed primarily towards policy makers and popular strategy for firms looking to streamline potential private sector investors.1 It addresses costs, improve customer service, and enhance the questions of what Nigeria can do to take their core competencies. Services offshoring advantage of the benefits of global trade in encompasses a wide variety of export-oriented services, how the country can brand itself as an services that span the entire value chain. In offshoring destination for international investors, 2010, the global offshoring market was jobs are relatively well paid, it is estimated by estimated to be around $90 billion,2 and is likely UNCTAD that each new position generates a to grow rapidly as technology and countries' further three jobs in the rest of the economy.5 capabilities improve. Beyond job creation, offshoring creates positive How Can Services Offshoring Reduce spillover effects that can further benefit the Poverty? economy as a whole. Among these benefits are: Figure 1: High income countries have large service sectors Incentives are created for education. Sectoral Contribution to Country GDP, 2006 While manufacturing outsourcing relies 80% 70% on a cheap, low-skilled workforce, 60% services outsourcing relies on a well- 50% educated and skilled workforce. The 40% employment of a relatively skilled labor 30% force in services trade increases the 20% returns to education, and in this way 10% creates incentives to acquire skills that 0% are marketable in the global economy. Low Income Middle Income High Income Technology and knowledge are Countries Countries Countries *2004 transferred. Repeated and frequent Agriculture Industry Services interactions with foreign firms increase Source: World Bank: World development Indicators, 2006 knowledge transfers. This is not limited just to technical knowledge, but also Services trade can be an engine for growth and includes the business standards and can catalyze poverty reduction. In countries that managerial know-how that feature have grown quickly and that have been able to prominently in the long-run growth sustain high growth over long periods, the trend for any developing country. service sectors have been responsible for much Human capital is improved. Export- of that growth, generally growing much faster oriented zones have been shown to than other sectors of the economy, as can be improve the quality of human capital seen in Figure 1. Indeed, engaging in services and the productivity of the local trade enables countries potentially to bypass the workforce in domestic economies as industrial development stage and engage directly long as foreign investors help to train in high value added sectors.3 An example of this the local workforce and encourage is found in Nigeria where mobile phone further learning.6 This can take place at subscribers greatly outnumber those with all levels, from entry-level workers to landlines and the mobile phone has made the managerial level. In this way, investing in costly fixed line infrastructure developing countries can acquire unnecessary. experience and put in place the In addition to the economic logic behind conditions necessary to foster local developing an offshoring sector, the wider entrepreneurship. context of global demand for services also Developed countries provide the majority of shows the benefits of engaging in services trade. demand for offshore business services. The The global market for offshoring has been McKinsey Global Institute estimates that growing at 30 percent annually between 2003 approximately 225,000 jobs--or 1-2% of total and 2010, far outpacing the growth rate of goods jobs created in the United States--will be trade and even other services trade.4 Similarly, offshored on average per year and that in total the percentage of the total workforce engaged in up to 11% of worldwide service employment services is expanding at a rapid pace, which could be performed remotely, suggesting that up demonstrates the job-creating nature of services to 18 million jobs are likely to go offshore.7 sectors. Furthermore, since many service sector On the supply side, India has emerged as the Nigeria and the Drivers for Services leader in the international offshoring space, with Offshoring Growth as much as 65 percent of the market. However, as a larger number of firms look to diversify Companies engage in offshoring activities for a their service sources to prevent dependence on a variety of reasons, the most important of which single provider, more countries are competing to is that offshoring can often reduce labor costs. gain a share of the expanding market. It was Since salaries comprise a significant portion of estimated by the consulting firm A.T. Kearney variable costs, offshoring business processes can in its Making Offshore Decisions report in 2004 provide sizeable savings to firms in developed that more than 4,000 companies in 150 countries countries. In addition to cutting costs, firms can were then competing to offer offshored services use offshoring to increase their productivity and to a handful of wealthy nations, and that number competitiveness. Offshoring generic business has likely increased since the report's processes allows firms to focus on their core publication. A 2009 report from A.T. Kearney competencies and increase innovation initiatives, argued that Africa has the potential to "redraw" which often enables firms to expand their the global offshoring map by attracting operations and broaden their customer base. In relatively more foreign firms than other regions.8 addition, in some instances offshoring can Table 1: Offshoring Attractiveness Index Category Sub-Category Key Factors Financial Compensation Costs Average wages and median compensation costs for Structure relevant positions (40%) Infrastructure Costs Electricity and telecommunications costs Real Estate Costs Office rents per square meter Regulatory Costs Corporate tax rate and quantification of other regulatory costs People Skills Workforce availability Population and total workforce and Availability Labor Force Quality Literacy rates and English-speaking ability (30%) Proportion of population pursuing tertiary education Education expenditure as a % of GDP Availability of information skills Reputation Existing IT and BPO market size Quality rankings Business Infrastructure Connectivity, availability of telecommunications, Environment electricity, transportation (30%) Regulatory Policies Security of intellectual property and piracy rates Barriers to doing business Economic Stability Fluctuation of exchange rates Political Stability Corruption and governance Source: Adapted from A.T. Kearney's Offshore Location Attractiveness Index Table 2: How Attractive is Nigeria as an Offshoring Destination? Financial Structure People Skills/Availability Business Environment Compensation Costs Labor Availability Infrastructure Infrastructure Costs Labor Quality Regulatory Policies Real Estate Costs Reputation Stability Regulatory Costs Factor Rating (1-4) 3.5 Factor Rating (1-3) 0.75 Factor Rating (1-3) 0.75 Source: Authors' estimates present an opportunity for better risk examines in more detail how Nigeria scores in management and diversification, which can each of these key categories. reduce a firm's liabilities and direct responsibilities. By offshoring certain business services, therefore, multinational and foreign Financial Structure companies can accelerate the delivery of work products, improve customer satisfaction, and Financial structure is a key determinant of an reduce costs. offshoring location's attractiveness. Countries that can offer reliable services at a low cost will There are several key factors that determine be more competitive than those countries with whether a particular region would be an higher costs or less reliable services. attractive offshoring operation. The Offshore Location Attractiveness Index, presented below, Labor Costs: Labor costs in Nigeria are can be used to evaluate different locations relatively low, making Nigeria attractive around the world in terms of their attractiveness in terms of average monthly and annual for offshoring activities. The index consists of labor costs. three major categories including financial Infrastructure: Infrastructure in structure, people skills and availability, and Nigeria is relatively poor, making business environment (see Table 1 for details of Nigeria unattractive in terms of the key elements). Financial structure is given possessing cheap and reliable 40% of the total weight, since cost advantage infrastructure. was determined to be the primary driver of Telecommunications and Internet: offshoring activities, while people skills and Nigeria is relatively unattractive in business environment each accounts for 30% of comparison to its competitors in terms the remaining weight. of telephony costs (which are high), and access to reliable Internet and broadband Nigeria is typical of Africa as a possible services (which are low). destination for foreign firms in that it has a mix Electricity: Developing a reliable of strengths and weaknesses for these indicators. source of energy for Nigeria is a key This framework could be useful for other challenge. The high cost and low African countries that are interested in attracting reliability of electricity often deters foreign firms. The results are summarized in international investors from relocating Table 2 above, and the remainder of this section to Nigeria. Transportation: The Nigerian Business Environment transportation system will remain an area of weakness in the country's When selecting potential investment locations, business environment unless resources international firms generally look for a stable are devoted towards improving the road political, legal, and macroeconomic network, especially in the major urban environment. Providing such an environment areas. has been a challenge for Nigeria, but there have been some positive developments. Labor Quality and Availability Contracts: Contract enforcement is an Beyond cost, the quality and availability of labor area where Nigeria has become stronger, is an important factor in determining the yet further progress can be made. A attractiveness of a country for offshoring contract still takes more than a year to activities. be enforced and costs 27 percent of the claim in Nigeria, but this is considerably Population size: Nigeria has the faster and less costly than in many of population size to compete successfully Nigeria's competitors. in global markets. Labor regulation: Flexible labor Literacy: English is widely spoken in regulations present a significant Nigeria, and this can provide the country advantage for Nigeria. Unlike many with a competitive edge. In terms of other developing countries, Nigeria's adult literacy, Nigeria ranks ahead of labor system is straightforward and not many countries competing for a share of overly complex, allowing firms to the offshore services market, with male employ the most efficient number of literacy at 75 percent and female literacy workers while also providing adequate at 60 percent. protection to workers. Education quality: On the other hand, E-commerce: The lack of electronic Nigeria needs to expand its tertiary communication and e-transaction education and offer more technical and legislation has hampered growth in the scientific subjects. Nigeria lags other Nigerian offshoring sector and has kept offshoring destinations in tertiary potential investors away. Information education enrollment, a trend that could technology industries in developed hamper Nigeria's ability to grow its countries are extremely protective of offshoring sector. intellectual property and want to operate Education investment: The in countries that have a tradition of government continues to under-invest in protecting and respecting intellectual the education system compared to South property rights. However, the fact that Africa, India, and China. In the medium Asian countries are also struggling with term, Nigeria will have to pay closer this means that Nigeria has some space attention to educational outcomes to to develop its own intellectual property become truly competitive in the global protection regime. economy. Export processing zones: Nigeria has a Technical training: The quality and long experience with export processing availability of technical and vocational zones (EPZs), and similar zones such as training, particularly in information offshoring parks can play a facilitating technology, must be improved. Nigeria role in the industry's growth. Building has very few specialized technology, IT, on the experience of its "one-stop-shop" and management colleges, and the EPZs, Nigeria should consider similar effectiveness of existing schools is streamlined mechanisms to attract typically hampered by financing and information technology and other human capacity constraints. businesses interested in setting up in the country or outsourcing business Potential Target Markets functions to Nigerian offshoring firms. Reputation: Nigeria's reputation in the Nigeria should begin by focusing on the lower international arena remains poor, with end of the BPO value chain. Before it can the Niger Delta crisis, kidnappings, and venture into higher value added business the country's reputations for scams services, it should explore the following areas in being the predominant news stories from order to become competitive in offshoring. Nigeria. Nigeria's reputation will have to be addressed in order to attract Domestic Industry: Nigeria can begin significant foreign investment and by developing its domestic outsourcing successfully develop an offshoring industry, creating call centers for sector. domestic companies and government services as a first step to offshoring. Summary of Nigeria's Competitive Position Back office processes: Nigeria can compete effectively for back office Nigeria's main strengths as a potential jobs, such as accounting and data offshoring destination lie in its relatively low management. However, back office wage and cost structure. The country's large processes add less value, and Nigeria size and youthful population are also assets for should eventually try to move into high companies wishing to establish large-scale call value added services. centers and similar such operations. The Customer contact: This is a space in country's good record on contract enforcement which Nigeria can effectively compete and flexible labor market regulations all increase due to its large pool of human its competitiveness, as do recent steps to resources and English language ability. streamline business registration. Nigeria does not yet have the ability to focus on There remain several challenges, however, that the knowledge services and research and the country will need to overcome before it can development market segments, and firms increase its role in the offshoring industry. looking to offshore these services are likely to These include a relatively low number of look at more established markets. However, if university graduates and their low productivity Nigeria can develop a successful domestic in comparison with competitor nations, the outsourcing capability in higher value services relatively high costs of telecommunications such as research and development, it will be connectivity, and the limited availability of better able to attract international investors who broadband technology. The country's poor are looking to move up the value chain. infrastructure, especially regarding electricity and roads, also challenge potential offshoring Creating the Brain Gain operations. Despite steps in the right direction, there remains tremendous scope for improving Nigeria can increase its reputation by leveraging the business environment and improving the its large overseas population as a network for state of the country's basic infrastructure. outsourcing. It is estimated that 15 million Nigerians are living and working overseas Conclusions and Policy around the world. Since personal connections Recommendations play an important role in determining the choice of a particular country as an offshore The following section proposes policy destination, the Nigerian diaspora could be used recommendations for developing an offshoring for a "brain gain," where Nigerians living industry in Nigeria. overseas create a channel for developing the reputation of Nigeria's offshore service industry. The Nigerian government could encourage this by promoting dual citizenship, compiling a database of expatriate Nigerian professionals, and mobilizing its embassies to support such an Government Policy Framework and Suggested effort. Reforms Enterprise-level Strategies The government of Nigeria could play a useful role in creating awareness for both locals and Local enterprises wanting to provide services to potential international clients regarding foreign firms must make a concerted effort to opportunities within the country's services market their unique strengths and develop industry. The recent efforts made to rebrand focused business plans with clearly established Nigeria--the "good people: great nation" goals for long-term growth. Local firms should campaign--are an excellent start. The be proactive in searching for local partners and government can work with private companies should look internationally to expand both their using the investment promotion commission and funding resources and client base. Key issues to the country's network of overseas embassies to tackle include: promote a Nigerian role in the provision of international services. Other possible policy Cost competitiveness: Firms should initiatives could include: research the cost structures of competitors as well as the services IT park development: International provided and constantly aim to provide experience suggests that tax incentives higher quality services at the lowest are likely to have limited impact. More cost possible. It is important to important in Nigeria are measures to achieve regular innovation and ease the constraints to doing business tailoring of services to client needs as and the establishment of dedicated IT efficiently as possible in order to retain parks providing reliable power, high a noticeable cost advantage. bandwidth and security to encourage Human resources: In order to ensure multinationals and other international that employees can meet customer firms to locate to Nigeria. service demands and keep up with new People skills and availability: Nigeria techniques and innovations, firms must refocus on education with should initiate in-house or on-site resources specifically devoted to certified training programs with a developing the service and information continuous focus on improving technology skills of students. The performance and the quality of services curricula of universities and schools provided to ensure customer could be revised to give students the satisfaction and attract international specific skills that offshoring firms investors. seek. This is a policy that has been ICT systems: Local firms must ensure successful in India and more recently that they have well-developed Egypt. information and communications Incentives for training: The technology systems. Unreliable ICT government can create incentives for infrastructure hinders the ability of firms to provide workers with suitable firms to provide services promptly, training programs that enhance the reliably, and efficiently. Companies quality of services provided by the should make detailed assessments of country. ICT requirements and address any Improved telecommunications and resulting gaps as quickly as possible. information technology Firms should also engage with public infrastructure: Improved authorities to highlight where infrastructure is a prerequisite for government support is needed in developing an offshoring industry. relevant sectors. Fostering the development of ICT infrastructure in areas outside major cities will also yield benefits to Nigeria Economic Management unit. This work is funded by in the long run, as it will allow services the Multi-Donor Trust Fund for Trade and to be delivered across the country. The Development supported by the governments of the government should encourage United Kingdom, Finland, Sweden and Norway. The views expressed in this paper reflect solely those of technologies, such as voice-over- the authors and not necessarily the views of the Internet protocol, that lower funders, the World Bank Group or its Executive communications costs. Directors. Legal framework: From a regulatory standpoint, the Nigerian government must also address the lack of a robust legal framework for offshoring, intellectual property rights, and e- commerce, which is currently deterring 1 FDI. The legal framework should be This policy note is based on a longer World Bank conducive to emerging industries and report published in 2009 entitled "Transforming enable business to start up without Nigeria into Africa's Offshoring Hub." 2 presenting an array of administrative January 2010, Global Services Media. 3 See E. Ghani (2010) The Services Revolution in barriers. Although Nigeria has made South Asia, OUP, Oxford positive steps in this direction, more 4 McKinsey Global Institute, 2005. "The Emerging could be done with respect to reforms Global Labor Market: Part III--How Supply and such as property registration and Demand for Offshore Talent Meet," McKinsey: San reducing the time taken to pay taxes. Francisco, p. 19. Outsourcing government services: 5 UNCTAD, 2003. "E-Commerce and Development Government can provide a push to this Report 2003," UNCTAD: New York and Geneva. 6 industry by outsouring services such as; International Labor Office, 2003. Employment and data entry e.g. for health, education and Social Policy in Respect of Export Processing Zones land records, establishing a three-digit (EPZs). Geneva: International Labor Office, p. 13. 7 McKinsey Global Institute, 2005, p. 28. number for emergency services (e.g. 8 A.T. Kearney, 2009. "Geography of Offshoring is 911 in the US), establishing a Shifting," Global Services Location Index. government information center to provide information over the phone on the most essential public services. Such reforms would go a long way to making Nigeria an attractive country for foreign investors, and would considerably help Nigeria's efforts to develop a strong offshoring industry. These lessons are also applicable across the region, and in this way the development of Nigeria's offshoring sector could be an example to other African countries for how to successfully build a strong offshoring industry. About the Authors Ismail Radwan is Lead Private Sector Development Specialist in the Africa Financial and Private Sector Development unit. Nicholas Strychacz is a Consultant in the Africa Poverty Reduction and