COUNTRY PROFILE: Identifying the Core of Costa Rica’s Shrewd Sourcing Strategy

In 1996 Costa Rica shocked the sourcing world by winning a $300 million  deal with Intel to build a new semiconductor plant, against a host of seemingly better qualified countries. Since then, through coordinated government effort, the ‘new kid on the block’ has become a choice destination for high-end ITO and software development services. Can Costa Rica continue its winning ways or are there major hurdles on the horizon?

Not All Roses

As  more tech firms locate to Costa Rica, its small workforce and bureaucratic business environment are becoming apparent. The investment promotion agency CINDE is aggressively combating these concerns, and Costa Rica remains a very lucrative sourcing option. But can the Central American player continue its impressive growth streak in the coming years?

One of the reasons that Costa Rica is so ITO-friendly now is that Intel’s decision in 1996 was conditional. The tech giant stipulated that its investment would only materialize if Costa Rica delivered on certain provisions designed to improve the business climate and operating conditions in the country. And there was a deadline. With little time available, the government and CINDE immediately began restructuring the areas that Intel identified, and the result was a Costa Rica that investors more than a decade later are still finding beneficial. Apart from Intel, other large players in Costa Rica include IBM, Boston Scientific, HP, Procter & Gamble, and Fujitsu.

Some facts and figures on Costa Rica:

• Educational system is ranked highest in Latin America, according to the World Economic Forum’s Global Competitiveness Report 2008-2009
• Placed 23^rd in the 2009 AT Kearney Global Services Location Index, and 4^th in Latin America after Chile, Mexico and Brazil.
• Most politically stable country in Latin America according to the World Bank’s Study on Global Governance Indicators 2008.
• GDP is approximately $48.19 billion, and the foreign currency risk rating according to Standard and Poor’s is BB.

“CINDE’s vision is to get to the high end of the value chain. The objective is to bring revenue to the country, while for other promo agencies it is to create jobs. That’s why CINDE outperforms them” –  Juan Carlos Ruiz Coronado, Manager and Outsourcing Advisor at Deloitte Consulting LLP

The Case for Costa Rica

Proximity – When we say Costa Rica is close to the US, we don’t mean just geographically. Aside from the fact that it shares the Central Time zone, and a plane ride from New York to San Jose is less than 5 hours, Costa Rica has a real cultural affinity with the US. The main reason is its thriving eco-tourism industry, which not only created a friendly and welcoming attitude toward US nationals, but also made the Costa Rican population one of the most bilingual in Latin America. That high English proficiency may be the single biggest advantage of Costa Rica over the competition.

“Tourism is one of the pillars of the economy”, says Mario Chaves, CEO of Avantica Technologies, an IT services provider with offices in the U.S. and operations in Costa Rica and Peru.  “The locals had to learn English to interact with foreigners. A small country like Costa Rica without a self-sustaining economy needs things from outside, so interaction with foreigners is critical. There is the idea that if you learn English, you’re going to get ahead”.

Education – Costa Rica’s workforce is also extremely well trained and IT-proficient. The military was abolished in 1948, and since then those resources have been invested in educating the population. Education is mandatory and free until the ninth grade, and strongly emphasizes computer and technology skills. The result is that Costa Rica has one of the highest literacy rates in the American continent (95.8%), and a great value proposition for IT outsourcing firms.

“Costa Rica already has an excellent technical bench that they can call on, instead of creating that IT talent from scratch as other countries have to”, says Deepa Purushothaman, Principal at Deloitte Consulting LLP. Chaves agrees – “In general the companies that do well here are not the call centers, but the higher-end value-added types of operations”.

CINDE

The driving force behind Costa Rica’s attractiveness is CINDE, the private non-profit organization ranked by the World Bank as the best investment promotion agency in Latin America. CINDE upholds that reputation well by the range of services and support it offers companies even before they commit to Costa Rica. If you’re considering investing in Costa Rica, CINDE will arrange a full agenda of meetings with firms already there; with potential providers of services you may need (lawyers, recruiters, tax accountants); and also visits to potential sites you can be located, all at no cost. “CINDE’s vision is to get to the high end of the value chain”, says Juan Carlos Ruiz Coronado, Manager and Outsourcing Advisor at Deloitte. “The objective is to bring revenue to the country, while for other promo agencies it is to create jobs. That’s why CINDE outperforms them”.

In terms of monetary incentives, CINDE has set up a system of Free Trade Zone Industrial Parks which act almost as tax shelters for US firms in Costa Rica. The majority of the parks are in the greater metropolitan area of San Jose, and permission to locate there is through an application process. Requirements for firms to apply are a minimum fixed asset investment of US$ 150,000 and the condition that they must be exporting at least 50% of their services within 36 months. “The application process is relatively short”, says Irving Soto, Investment Promotion Director at CINDE. “A firm must be legally incorporated in Costa Rica which takes four to five weeks, and then application approval takes three months. So in about five months, you would be ready to set up an outsourcing operation in Costa Rica”.

It is important to note that the  agency in charge of the administration of special incentives provided to foreign investments in Costa Rica is PROCOMER.  This agency studies every proposal, reviews the paper work and coordinates with the Ministry of Foreign Trade to grant incentives.

Once firms locate in a Free Trade Zone, their tax burdens are drastically reduced – a full exemption from import and export duties is one example. There are no restrictions on foreign currency management or transfer of capital, and no requirement to register investments with the government. Corporate income tax is 30% in Costa Rica, but firms in the industrial parks are 100% exempt for the first eight years, and 50% exempt in the next four years. “There’s also a loophole”, says Soto. “If you re-invest at the end of the eight years, the clock starts from zero and you’re fully exempt again for the next eight years. We have companies here for the past 20 years that haven’t paid any income tax. In fact 75% of our investment revenue comes from firms re-investing, not from new investment”.

Challenges

Small labor pool – Despite its many advantages, Costa Rica is not a perfect sourcing destination. One criticism we’ve heard over and over is that its workforce (2.1 million) is too small for the multinational IT and BPO market it’s targeting. San Jose with a population of 346,000 is the only city in Costa Rica that can support a decent sized outsourcing operation, as compared to other cities none of which have populations over 70,000. “It’s a small country and that doesn’t work well for a growing company”, says Mario Chaves. “We didn’t want to rely on our ability to grow only in Costa Rica, so we looked at outside locations”. His company Avantica currently has around 200 employees. He’s looking to hire another 200, which he admits is difficult in Costa Rica. Not that it can’t be done. Intel’s operation has around 4,000 workers in Costa Rica, HP has 6,500 and Procter & Gamble has 1,350 – but you need those kinds of hefty resources to attract that talent, says Chaves.

CINDE is working at it though. The education system in Costa Rica has been ramped up and focused on IT, with the creation of one-year technical certificate courses in colleges like the Technological Institute of Costa Rica (ITCR) and the University of Costa Rica. According to Irving Soto, there were 2000 IT and software development graduates in 2009, and that number has been growing at 6.7% since 2001. He also mentions Costa Rica Multilingue, a program that aims at making 100% of the public school graduates bilingual by 2017.

We all know that a small labor pool means increased competition for workers, which drives up wages. Costa Rica is not as cheap as some of its competition. The monthly salary for a Support Technician is $1200, while a Junior Software Developer earns $1500 monthly, including benefits. If you’re looking for a comparison with other LATAM countries, on average Costa Rica would be more expensive than Argentina, but still cheaper than Chile.

Infrastructure and bureaucracy – Costa Rica also faces infrastructure challenges. Access to the telecom system is controlled by government-run firm ICE, which has limited internet service to companies in recent years and caused severe problems. But now because of the DR-CAFTA treaty, Costa Rica is being forced to open the telecom infrastructure to private competition. In 2009 the state monopoly was lifted, and a few US firms were allowed to offer internet services in San Jose. “We expect that by the beginning of 2011 it will be completely open to private companies”, says Soto.

Another concern is the large presence of red tape in Costa Rica’s business environment. The World Bank ranked Costa Rica only 121 out of 183 countries in its 2010 Ease of Doing Business index, as compared to Colombia (37) or Chile (49). In spite of CINDE’s initiatives it can be tedious for companies to get permits to open a local office or export services, which can increase operating costs.

All things considered, Costa Rica has a great value proposition as a sourcing destination. “In the next few years the IT service and BPO sectors will expand”, says Ruiz Coronado from Deloitte, on the future of the country. “Costa Rica has the right building blocks and the right approach to outsourcing. If they continue with that vision, they will be very successful”.