Rise Of A Powerhouse

How the young knowledge workers of Central Europe are pushing the region to a new level

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They came from around the world, young men with handles like SnapDragon and Bladerunner attacking computing problems so complex that even experienced coders could only stare at the screen in bewilderment. Only one mastered the final algorithm problem: Eryk Kopczynski, a.k.a. Eryx, a reticent Warsaw University student who wears his long hair in a ponytail and says his life's ambition is to "discover some interesting notion."

Kopczynski's triumph in this year's TopCoder Open, sponsored by Sun Microsystems, was no fluke. He was following in the footsteps of a slew of computing geniuses to emerge from the monolithic Soviet style buildings of Warsaw U. "Poles like to compete," says Warsaw U computer science student Marek Cygan, winner of this year's Google Code Jam. No kidding. Warsaw University is ranked No. 1 in the world in top coder events, ahead of the likes of Massachusetts Institute of Technology. Just like India's best tech schools, Warsaw U has confounded a scarcity of resources to identify and nurture bright students.

As the race for top talent heats up globally, it turns out that Central Europe houses one of the planet's richest creative pools. U.S. movie director Brian De Palma recently wrapped up filming in Sofia of The Black Dahlia, a version of the James Ellroy noir novel starring Hilary Swank and Scarlett Johansson. The producers painstakingly recreated the streets of 1940s Los Angeles on a Sofia movie set. Why Bulgaria? Super low costs is one reason. But there's more: "The crew is probably the best I've seen anywhere," says David Varod, head of Bulgarian operations for Los Angeles-based Nu Image/Millenium Films, which co-financed the picture.

Next stop on the tour: a Budapest neighborhood where new office buildings encroach on older factories. Here outsourcer Genpact, a spin-off of mighty General Electric Co. (GE ), employs 550 workers to handle business processes such as accounts receivable for corporate clients. At one terminal, a young woman uses SAP (SAP ) software to process an invoice from a German supplier to a French company. It's cheaper to do such work in India: Gross pay for Genpact workers in Budapest ranges from about $950 to $1400 a month, four times the Indian pay scale. But it would be very difficult to find French-speaking Indians to do the job. And clients just want their work handled by someone who is in the same time zone. "The nice thing about Hungary and Romania is that they are a two- or three-hour flight from anywhere in Europe," says Patrick Cogny, President and CEO of Genpact Europe. Proximity is key, says David Morgenstern, a managing director at Sunnyvale (Calif.) supply-chain specialist Ariba Inc. "Even if China is 5% cheaper," he says, "that sways the argument back to sourcing in Central Europe."

It has been more than 15 years since the collapse of the Iron Curtain opened up Central Europe to the world. In that time the region's 10 countries have survived bouts of gangster capitalism, waves of painful reforms, and dramatic changes in government. Yet the region's economies have somehow managed to thrive, easing entry (for most) into the European Union. In the process, Central Europe has made a wholesale transformation into the low-cost manufacturing zone of the continent.

Today the region is sucking in foreign investment at a rate of $37 billion annually, which places it second to China in the international competition for capital and light years ahead of India. Central European stock markets are taking off, too. Growth ranges from 3.5% in Poland to 6.8% in Estonia. Poverty rates are declining, and the area's 100 million citizens are turning into a potent consumer market. Most of the region's countries have flat taxes, with rates as low as 15% for corporations -- a big investment draw. The mightiest of multinationals, from Hewlett-Packard (HPQ ) to SAP to GE, have been piling in. On Sept. 21, IBM (IBM ) announced plans to build a new software development lab in Krakow that will eventually employ 200 Poles. And LG.Philips, the liquid-crystal-display producer, recently announced plans to spend $430 million to make flat-screen TVs in Wroclaw, Poland, creating 3,200 skilled jobs.

What few anticipated is that the once-bankrupt economies of Central Europe would move up the industrial food chain so quickly and attract research jobs in knowledge-driven industries ranging from telecoms to autos to pharmaceuticals. Now, thanks to their growing ranks of high-skilled workers, these countries are shaping up as the next outsourcing haven for engineering and software development, just behind China and India.

Evidence of this next chapter in the global outsourcing saga is everywhere. In offices above an Audi dealership in Sofia, for instance, engineers working for Idaho-based AMI Semiconductor Inc. (AMIS ) are busy developing next-generation chips for automobiles and medical equipment. AMIS set up an office in the Bulgarian capital after its managers in Belgium noticed they were getting a lot of applications from qualified Bulgarian semiconductor specialists. Anelia Mladenova Pergoot, a native Bulgarian who worked 16 years for AMIS in Belgium, returned home to run the new office, which plans to double staff, to 40, by next year. "I'm impressed by the level of quality the technical universities have been able to support," she says.

In the Czech Republic, investments in such sectors as software and customer-service centers rose 150% in 2004. According to IBM, Hungary, Poland, and the Czech Republic ranked among the top 10 global destinations for research and development jobs in the first half of 2005. In Europe, only Britain attracted more R&D work. Some 67% of the Polish economy is already made up of services, says the Organization of Economic Cooperation and Development (OECD). Case in point: Hewlett-Packard's five-year-old information-technology outsourcing center in Warsaw, which employs 1,000, and its new $54 million business-process outsourcing center in Wroclaw, which opened in April and is expected to create another 1,000 jobs. HP already generates $550 million in revenues in Poland.

"The Spirit Is There"

To develop these service businesses, the multinationals are seeking talent, and finding it, in the region's top schools. Poland boasts one of the highest percentages of university graduates in the world among younger workers. The country mints 460,000 new grads each year.

It isn't just key locales like Poland, the Czech Republic, and Slovakia that are attracting the attention of some of the world's top tech players. Bulgaria now hosts a number of U.S. software companies, and Romania has become a new engineering and R&D hub for auto makers and other industries. Just a few years ago no one even in Central Europe thought these two countries could break the destructive cycle of hyperinflation, misgovernment, and crime. "Conditions for doing business [in Bulgaria and Romania] have improved very significantly," says Francesca Pissarides, an economist at the European Bank for Reconstruction & Development in London. "The spirit is there."

Problems? There are plenty, of course, just as there are in India and China. Central Europe's top cities boast state-of-the-art infrastructure, but second-tier cities and the countryside are another story. Management talent, as opposed to technical and manufacturing knowhow, is scarce. Judicial corruption is still a big problem in Romania, and the mob remains dangerously active in Bulgaria: In October, Emil Kyulev, head of the DZI Financial Group and one of the country's richest men, was shot dead as he rode down a Sofia boulevard.

What's more, wages are creeping up across the region. A Polish factory worker earns slightly more than $3 an hour, compared with $19 for his counterpart in Western Germany, according to data compiled by supply-chain specialist Ariba Inc. (ARBA ) And an engineer might make only about $950 a month. But wage inflation, expected to hit more than 9% this year in Lithuania, Latvia, and Bulgaria, is already driving labor-intensive industries such as textiles to cheaper locales in Russia and Ukraine. "One day the manufacturing jobs will relocate somewhere else," says Sebastian Mikosz, executive vice-president of Poland's Foreign Investment Agency.

Still, considering what the region endured through 40 years of communism and a decade of tumultuous transition, these problems look manageable. Today, Central Europeans have an optimism that few in Western Europe can muster. Local companies are bulking up and beginning to buy up foreign rivals. MBA programs are mushrooming, and thirtysomething managers are running big businesses. Restructured banks are finally lending to credit-starved companies and consumers. "You can feel the energy in the streets," says Dragostina Grancharova, who helps train aspiring network specialists for Cisco Systems Inc. (CSCO ) in Sofia, Bulgaria.

There's even a feeling that Europe's center of gravity is shifting eastward. The commercial center of Budapest, with its coffee bars, late-model autos, and restored turn-of-the-century buildings, could be a chic neighborhood anywhere in Western Europe. The city's sense of drive is personified by Janos Koka, 33, who was president of an Internet service provider before becoming Hungary's Minister of Economy & Transport in 2004. "We are in the middle of everything," Koka boasts. Hungary ranked third worldwide, behind New Zealand and India and ahead of the U.S., in the number of people starting up new businesses, according to a study by the German Institute for Economic Research in Berlin. "In 1990 you had a lot of enthusiasm and not much experience. Now you have a lot of enthusiasm and a very entrepreneurial climate," says David Keresztes, a principal at Euroventures Capital, a Budapest private-equity firm that has backed startups such as SkyEurope, a budget airline based in Bratislava, Slovakia.

How did Central Europe gain this momentum? It started with the manufacturing plants coming in from the West. Even now, carmakers and their suppliers are plowing billions into Central Europe to build brand-new plants and add production lines at existing ones. Toyota (TM ) Motor, Volkswagen, General Motors (GM ), PSA Peugeot Citroën (PEUGY ), Renault, and Fiat (FIA ) are among those building complete cars in Poland and the former East Bloc. Even Porsche (PSEPF ) does most of the assembly for its luxury Cayenne sport-utility vehicle at VW's Bratislava plant in Slovakia. Countries in Central and Eastern Europe also produce everything from Whirlpool washing machines to Siemens (SI ) streetcars to American Standard bathroom fixtures.

Yet as the manufacturing powers have learned, workers in Central Europe are good for much more than assembly. Say this much for communism: Marxist regimes supported excellent universities and technical schools, which are still churning out top-notch graduates in engineering, mathematics, and computing. "The previous system didn't spoil these kids," says Jan Madey, professor of computer science at Warsaw University.

It took awhile for Western companies to seize on this hidden advantage. Hari N. Nair, executive vice-president, Tenneco Automotive for Europe, says his company never planned to hire skilled engineers in Poland. But as they moved low-cost production of auto parts to that country, Tenneco executives realized that Poles on-site were able to handle the engineering. They even had an edge over their German counterparts, who think in terms of complex designs. Polish engineers, who under communism became accustomed to working with limited resources, approach problems with no preconceptions. "If you give them advanced tools and design knowhow, they bridge the gap between complex technology and low-cost systems," says Nair. The Poles won an internal bid, for example, to make shock absorber replacements for the global market. They had the fastest, cheapest solution.

American and European tech companies have picked up on what the manufacturers started. The Czech capital of Prague has emerged as an info-tech hub, attracting millions in investment from the likes of express delivery and logistics company DHL International or LogicaCMG, a London-based outfit that provides tech services, such as processing text messages for mobile-phone companies. "In France, the prestigious universities to go to are management, economics, law. But here, technical schools are also prestigious," explains Jiri Turek, operations director for LogicaCMG's Corporate Global Telecom Products unit. With its lively bar and music scene, Prague has become a magnet for youth from all over Europe, and also the U.S. So companies there have their pick of talented workers fluent in several languages. "Young people like Prague because it's a cool place to be," says Ladislav Kadlec, a 23-year-old Slovak who studied human resources at Baruch College in New York City before becoming head of HR for Internet job exchange Monster.com in Prague.

More companies are also realizing that Central and Eastern Europe are competitive with Asia on price. An engineer in Bulgaria costs his employer less than his counterpart in China and India, according to data assembled by Ariba. And the competition for top talent is not as intense as in some of Asia's boomtowns. That's one reason why Tumbleweed Communications Corp. (TMWD ), a Redwood City (Calif.) maker of network-security software, chose Sofia over Bangalore for its 130-person software-development center. In Bangalore "it was difficult to get the right people at a reasonable cost when you have Microsoft across the street," says Eric Dumas, Bulgaria Country Manager for Tumbleweed.

Abundant Ambition

Moreover, deficient protections for intellectual-property rights remain a serious concern in China. "Auto companies are afraid to move core R&D knowledge to China -- it can be very dangerous," says Peter Fuss, a partner at consultancy Ernst & Young in Frankfurt, which recently completed a report on automotive investments in the region. "The move is rather to Central and Eastern Europe."

Central Europe's relationship to Western Europe increases the comfort level for investors. In 2004, the EU admitted the Baltic States, Poland, the Czech Republic, Slovakia, Slovenia, and Hungary. Bulgaria and Romania will be eligible to join as early as 2007. That eases cross-border shipping and provides a consistent legal framework for the region. The drive to qualify for EU membership has also forced Romania and Bulgaria to clean up their deficits, reform their governments, and become more attractive to investors. The move to join the EU "kicked off a virtuous cycle in Romania," says U.S. lawyer Gilbert Wood, head of Romania's Foreign Investors Council.

What ultimately sets Central Europe apart from the rest of the continent, though, is the ambition of the younger generation. Poles work an average of 1,984 hours a year, well above the 1,777 hours clocked by U.S. workers on average and far more than the 1,362 hours Germans work, according to the OECD. "These people are really hungry. They work day and night," says Stefaan Vandevelde, managing director at Delphi Europe (DPHIQ ), which has set up two engineering centers in the region, one in Krakow and another in Ineu, Romania.

If there is anything multinationals miss in their Central European employees, it's solid management expertise. Employers say they have more trouble finding a good human resources professional or marketing manager than a software programmer. "What's missing in our students is the soft skills: How do you cope with change, how do you motivate people and how do you work in teams?" says Adriana Dutescu, director of the Graduate School of Management Romanian-Canadian MBA program in Bucharest. Management education is improving fast, though, thanks to a slew of new MBA programs across the region, many with links to U.S. or European institutions. Bucharest alone boasts four international MBA programs.

A pioneer in this area was Central European University Business School in Budapest. Way back in 1988, Hungarian-born investor and philanthropist George Soros recognized the need and endowed the school, which offers both full-time and part-time MBA programs. Since then the institution has generated some of Central Europe's top managers, such as Zoltan Major, chief operating officer for the Hungarian operations of Genpact, the GE spin-off that provides outsourcing services. More such schools are needed. "Finding middle management and senior management will be our biggest challenge in Budapest," says Ahmed Mazhari, vice-president for business development at Genpact Europe.

How sustainable is the growth in Central Europe? All the elements are there: pent-up demand, robust foreign direct investment, excellent universities, and improving infrastructure. The region is still relatively free of the labor regulations that stifle job growth in Germany, France, and Italy. What's more, even by 2020 wages in most of the region will still be one-third to half the EU average, according to the U.N. Conference on Trade & Development.

Still, Central Europe has to keep building on what it has accomplished so far. "The big question is how we position ourselves," says Henryka Bochniarz, former Minister of Industry in Poland and founder of a Warsaw consultancy called Nicom Consulting Ltd. that helps small businesses qualify for European Union funds. "We have to build our future based on the quality of our education." Top-notch schools have seeded change. Now government needs to make sure those algorithmically gifted TopCoders remain a high priority.

By Jack Ewing and Gail Edmondson, with Patricia Kranz in Prague, Andy Reinhardt in Krakow, and bureau reports

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