Offshore outsourcing, once the engine that drove the Baltic IT industry, is running out of steam as the Baltics become expensive compared with other transition economies. But the good news is that local software firms are finding an increasing amount of work to do at home.
Outsourcing has helped the IT industry in the Baltics to grow into one of the most promising sectors of the economy.
But the playing field has changed. Offshore outsourcing - industry terminology for finding someone in a developing or transition economy to do it cheaper - is slowing down in Latvia.
"Quite frankly Latvia can't compete anymore with countries like Belarus, Romania and Bulgaria," said Thomas Raapke of IBM Germany.
Latvia's relative prosperity and increase in wages has seemingly priced it out of the offshore outsourcing market. And no wonder, when a software engineer in Latvia makes about $1,000 per month, far below Western salaries but more than his or her counterpart in Belarus.
Consequently, companies like IBM and Siemens have set up outsourcing offices and training centers in Minsk, where universities churn out an estimated 3,000 IT specialists a year who will make on average less than half the salary of IT workers in the Baltics.
The Baltic countries' IT markets, says Raapke and others, should focus more on research and development.
"I don't believe in your outsourcing," said Harry Piela, a member of the board of the Finnish Trade Association and Baltic director of the software firm Sybase. "Only innovation can put the Baltics anywhere near the top of the IT world. Doing subcontract work for Nokia or IBM or anybody else is not going to get you there."
Outsourcing has been critical in building companies like DATI, Latvia's largest software developer. Starting six years ago with a handful of programmers working mostly on a contract basis for Western companies, it has built systems platforms for the German mobile telephone maker Siemens and designed defenses against the Y2K bug for companies around Scandinavia.
Other clients have included Citibank, automobile giant Daimler-Chrysler and even Saudi Arabia's Ministry of Planning and Malaysia's National Power Utility Authority.
But these contracts have dried up as the services of DATI get more clever, and consequently more expensive. Fortunately, local clients are taking up some of the slack.
In recent years DATI has begun to focus more on home grown outsourcing, designing software for several government institutions. More than half of the company's projects last year were for local clients.
"We're never going to be a 'little India,' said company spokeswoman Baiba Gulbe. "We have seen the value of going after local customers."
As a result, DATI has developed and built the entire data network for the Latvian Postal Service and the Latvian State Employment Service.
And it is not alone. Latvia's second-largest IT firm, Fortech, is also going local.
Bought by the Estonia-based Microlink in 2000, Fortech is combining software design and systems maintenance with hardware. The company sets up a computer system from top to bottom and teaches its customers' employees how to use them.
Fortech head Janis Bergs said he sees two trends in the IT market in Latvia that make local customers worth chasing. First, there is a shortage of quality IT workers in Latvia. Companies prefer to farm out IT labor when they need to keep a large, costly staff of programmers and computer maintenance people on hand.
Second, new state regulations that cover computer systems are beginning to take hold. Government servers must now be stored in rooms that have prescribed security measures, air temperature and electricity supplies.
"It's expensive to build one of those things," said Bergs.
Fortech will do it for them, for a price.
There are dozens more software companies across the Baltics that are moving in a similar direction. Many, like DATI and Fortech, are now turning to local clients over international ones.
However, industry sources believe that the next stage of development could be tougher.
Gulbe believes in the concept of the "Amber Valley," the dream of software developers to create scaled down version of the United States' Silicon Valley in Latvia.
But first the companies need to build up capital.
"Research and development requires a lot of money, and for us it's obviously a lot harder than for IBM," said Gulbe. "We work on a different playing field."