Paradise found? Outsourcing in the Philippines: A growing success

(This article was previously published in Frontiers in Finance December 2009 by KPMG International Cooperative (“KPMG International”), a Swiss entity, based on an interview with the three authors.)

The Philippines has established itself as one of the world’s leading centers for business process outsourcing (BPO) – both outsourcing to third party service providers, and offshoring to captive subsidiaries undertaking a range of back office and support functions for multinational companies. In the financial services context, it is notable that companies in many industrial sectors are increasingly locating their finance and accounting operations in the Philippines, and that multinational banks and insurers are themselves doing the same. We explore some of the factors behind this success.

The Philippines is moving rapidly up the global outsourcing league table. It is the third-largest provider of business process outsourcing (BPO) services, behind India and Canada, and the sector is the fastest growing industry in the country. Total revenues in the sector were estimated at $5 billion in 2007; as at the end of 2008, there were over 600 companies operating in the sector, with over 400,000 employees. The rate of growth is such that the sector aims to earn revenues of about $13 billion by the end of 2010, and directly employ close to one million people.

Major companies providing outsourced services include multinational firms in banking, technology and communications. The Philippines has also attracted the back-office finance and accounting functions of many global names in insurance, energy, consumer goods and other sectors. The Philippines was named Offshoring Destination of the Year in 2007.

The argument for outsourcing and offshoring is familiar. Besides the key cost advantages from relocating activities to lower-cost destinations, outsourcing allows the creation of a center of excellence, stimulating the adoption of industry best practice and enabling process improvements in a single focused operation. In financial functions, it can provide a platform for the convergence of accounting standards and interpretation among previously disparate operations. But the particular success of the Philippines in attracting outsourcing business rests on a number of specific foundations.

First among these is the explicit Philippine government policy of promoting the outsourcing industry as an engine of economic growth and of the transformation of the country away from low-margin agriculture and dependence on expatriate remittances to the high added-value services characteristic of a developed nation. With a population of 90 million people – the twelfth largest in the world – but GDP ranked at only 47th, the potential is clear.

To stimulate the growth of the services sector, the Philippines has established a network of special economic zones which benefit from minimum government interference and administer their own economic and financial development. Companies located in these economic zones receive special tax incentives (e.g. a special tax rate of five percent of gross income in lieu of national and local taxes) and other benefits. There are also arrangements for corporate tax holidays for the first four to six years after establishment. In addition, multinational companies which establish captive Regional Operating Headquarters (ROHQs) in the Philippines also receive tax breaks: whereas the normal corporation tax rate is 30 percent, the ROHQ only pays 10 percent. Expatriates working for the ROHQs in a management or highly technical function pay only 15 percent tax on income, as opposed to the standard 30 percent. Filipinos doing similar work in ROHQs also benefit from this advantageous rate.

Besides this concerted government support and encouragement, the Philippine outsourcing sector benefits from a number of other competitive advantages. Language is a key factor. English is an official language, and most Filipinos speak a relatively accent-free Americanized English. Voice services (the operation of call centers etc) account for approximately 70 percent of total outsourcing business in the country, with 178 different service providers at 260 sites, employing nearly 200,000 people. This area of business is growing at more than 50 percent a year, and the ease of understanding Filipino English is one of the key reasons why the Philippines is winning call center business from other countries.

Education is a further factor. The Philippines produces nearly half a million college graduates each year, a quarter of them qualified in business and accountancy. This reinforces a business culture which is westernized and even quite American in its management style. By building a strong indigenous outsourcing industry, the Philippine government hopes to retain a cadre of well-trained business professionals who will help develop the country.

Like other outsourcing destinations, the Philippines seems to be a low-cost business environment, with comparatively low wages and can have a low cost of living when compared to other countries. This should help increase its attractiveness to the expatriates working in ROHQs for multinational companies.

Not everything is rosy, however, and there are some clouds on the horizon. Accounting and disclosure of related party transactions of entities arising from process outsourcing could be problematic especially if not undertaken on an arm’s length basis. While regulators in the financial services sector have tended to be relaxed about back-office functions being outsourced to locations like the Philippines, the new focus on oversight and constraint may lead to it being harder in future to meet regulatory and management reporting requirements. Country-specific reporting issues may be harder to resolve where the service provider is manned by professionals from other locations. The attitude of external auditors could be radically changed if significant financial reporting risks resided outside auditee-managed processes and controls.

So far, the Philippines seems to have got it right, with the BPO sector delivering the strategic benefits for which the government hopes. Whether the country’s current competitive advantage can be sustained, or will be eroded as the economy develops further is a matter for debate. Achieving the sector’s future growth aspirations will depend on the outcome.

(Emmanuel P. Bonoan is the Chief Operating Officer and Vice Chairman for Tax & Corporate Services, Paul Bernard D. Causon is an Audit Partner and Jude B. Ocampo is a Tax Principal of Manabat Sanagustin & Co., CPAs, a member firm of KPMG network of independent member firms affiliated with KPMG International Cooperative (“KPMG International”), a Swiss entity

The views and opinions expressed herein are those of the authors and do not necessarily represent the views and opinions of KPMG in the Philippines. For comments or inquiries, please email [email protected], [email protected] or [email protected])