At a recent analyst and advisor event held by Luxoft at its Kiev, Ukraine delivery center, the agenda went beyond the standard set of executive briefings and client case studies. It also included meetings with Ukrainian economic development organizations and a Member of Parliament. From these interactions, it was clear that Ukraine sees IT delivery as a key opportunity for growth, and is intent on demonstrating its commitment to growing this sector (which currently accounts for ~$2.5bn and ~3% of GDP) with a goal of surpassing ~$5bn by 2020. 

However, while Ukraine has strengths that could enable it to take on India and the Philippines as IT delivery hubs, it also faces a number of challenges that must be addressed if it is to succeed. Here I take a look at the outlook for Ukraine as an IT services delivery hub.

Key Strengths: Education, Location & Government Commitment

Among Ukraine’s strengths as a remote IT services delivery hub is its educated population. Its heritage as a former member of the Soviet Union has driven a strong mathematics and science education system capable of turning out graduates with the base knowledge to deliver IT services. Luxoft estimates that 60% of the population is university educated and that every year ~16k students graduate from Ukrainian universities with an IT-related degree.

Ukraine’s proximity to central Europe is another important strength. Only one time zone east of central Europe, and less than two hours away by airplane, Ukraine has a significant advantage over Asian countries for interacting with Europe-based clients. Its location also provides greater overlap with the entire U.S., as it is nine hours ahead of the Pacific time zone.

Possibly its greatest strength, though, is a commitment to creating IT capabilities. It is increasing funding for IT-based education, targeted for 3% growth in 2016 and potentially as much as 15% in 2017. This compares with a 7% reduction in education spending overall. Universities are also expanding IT-focused offerings including introducing targeted programs such as IoT, big data and FinTech.

Additionally, in parliament, there are efforts underway to introduce legislation targeted at supporting IT and communications firms, including a public trust initiative to standardize eSignature and bank ID standards with the EU. It is also looking at the potential to identify tax incentives for IT companies.

In part to demonstrate the country’s commitment, Member of Parliament Oleksandr Danchenko now heads a Committee for Information and Communications. Danchenko is a former CEO of telecoms firm Data Group, and he had two meetings with the visiting analysts to discuss Ukraine’s plans, and to take advice on how to develop Ukraine’s position as an IT services hub.

Key Challenges: Geo-political Instability & Corruption

Ukraine’s greatest weakness is the real and perceived geo-political issues it faces. While the ongoing conflict with Russia in the eastern part of the country doesn’t impact the major cities such as Kiev and Odessa, that nuance can get lost the further west one travels. It is worth noting that, upon my arrival back in the U.S., the first question from the Customs agent at the airport was about the ‘war with Russia’. Beyond the question of conflict, Ukraine also faces a reputation for corruption, with Transparency International ranking it 130th in the world (of 168 countries) in its 2015 Corruption Perceptions Index. While these should have little or no impact on the delivery of IT services (as demonstrated by the success of firms such as Luxoft, EPAM, and SoftServe), negative perceptions are hard to counteract.

A further weakness is the relatively high cost of resources. Ukraine’s delivery cost levels sit somewhere between onshore European locations and remote locations such as India. The country seeks to offset this cost difference with better educated and experienced resources, driving higher productivity. However, on a straight comparison of hourly rates, it lags behind the competition in remote offshore regions.

Similar to many other nascent delivery locations, Ukraine also lacks key business acumen. This is a common weakness of countries that have focused on building strong technical capabilities. However, as local companies concentrate on specific industries, the ability to enhance these industry and business function skills will grow.

Opportunities & Threats

Going forward, Ukraine’s greatest opportunities lie in its technical and engineering capabilities. As clients move from traditional labor arbitrage-focused application outsourcing to digital transformation, the need for key technical skills will outweigh the need for the lowest hourly rate. Ukraine is well situated to deliver these higher-value skills at costs lower than onshore.

The threat that most concerns the Ukrainian leadership is other central and eastern European countries (who are also vying to build IT services capability) poaching the home-grown talent it has invested in. In particular, concern was voiced about Poland building in incentives to lure Ukrainian IT-skilled workers.

However, rather than building in as many mechanisms as possible to keep young, IT-skilled resources from traveling out of the country, IT firms would be wise to follow Luxoft’s example in allowing its employees temporary relocation (in Luxoft’s case, to Poland and Bulgaria).

By instituting a structured program that allows workers to work for an agreed period of time out of the country, companies would benefit more than if they had stayed. Not only does this reward employees seeking a different environment for a period of time, it builds employee loyalty and also expands the skills and experiences of the domestic resource pool. As an example, this could potentially help improve the current lack of vertical and business function skills.

Summary

While the Ukraine is laying the foundation to become an IT hub through investments in education and the technology industry, it currently sits at a crossroads. Among much larger consequences, how it addresses the perceptions of pervasive corruption and conflict, as well as its relationships with Russia and Europe, will go a long way towards determining its future as an IT services delivery market.