China, India vie for outsourcing market
By Daniel Allen
BEIJING - Asian heavyweights China and India continue to battle it out for major slices of the increasingly lucrative outsourcing pie. While China has long been considered a hub for manufacturing and research and development (R&D), India has traditionally attracted the lion's share of the services and information-technology (IT) projects.
However, as China leverages its superior infrastructure and cheaper labor, and expands its pool of highly qualified, English speaking personnel, the dynamics are set to change.
According to a recent report by the market-intelligence firm IDC, total revenue from China's offshore software outsourcing market will grow fivefold over the next five years, and the compound annual growth rate of the market will reach nearly 38%. China's offshore software outsourcing market continued to grow rapidly in 2006, with reported total revenue reaching nearly US$1.4 billion, up more than 48% year on year.
In addition to cheap labor, other drivers for the expansion of the Chinese IT outsourcing market include market deregulation, large-scale investment in technical education, better intellectual-property protection, IT core standards and infrastructure development, and the flourishing Chinese economy. Despite promising growth, however, China still needs to consolidate its workforce capabilities in terms of English-language proficiency, project-management skills, and experience to step up its challenge to India in the global market.
Kenneth Wong, a managing partner at SmithWong Associates, a China-focused US consulting firm, commented: "Language issues are no longer the major handicap to China-based outsourcing that they were before. In the past, the big advantage of the Indian market was that a lot of Indians spoke English. However, many IT personnel in China today are US-educated with undergraduate and graduate degrees.
"Soon there will be more people speaking English in China than in the US. The Chinese government knows it has a way to go in this area, but the signs are encouraging."
Tao Ye, president of Objectiva Software, a leading provider of software outsourcing services to China with offices in the US and Beijing, commented: "More and more customers are confident of doing business in China.
"Two years ago potential clients would say to us, 'Why China?' Now they say to us, 'Why you?' Since I founded this company in 1999, we have employed two full-time English teachers - language skills are very important in China's outsourcing sector. To say Chinese employees have no English is a myth."
While Chinese IT companies are increasingly bidding for international outsourcing projects, they are also leveraging their proximity to markets such as Japan and South Korea, where they have an advantage in both geography and language. Last year the Korean electronics firm Samsung outsourced about US$18.5 billion of business to China in an attempt to lower production costs.
To take advantage of China's low wages and Asian-language skills, a growing number of Indian outsourcing service providers are hedging their bets by directly investing in China. In a trend officially supported by the Chinese and Indian governments, many Indian firms - including Infosys, Satyam Computer Services and Wipro Technologies - have already established operations in China.
Learning from Indian companies, the best Chinese outsourcers are gradually incorporating more advanced applications, integration and infrastructure services into their offerings. Some are developing strong embedded software capabilities to work with makers of mobile phones and other hardware devices.
Edwin Ye is engagements manager at Beijing-headquartered MDCL-Frontline, the China-based subsidiary of pan-Asian IT company Frontline. He commented: "Compared to India, the Chinese IT outsourcing market is still very young. I believe the future is promising if we keep refining our products and services, investing in personnel and infrastructure, and exploring new markets and opportunities."
MDCL Frontline has recently registered strong license sales of its China-developed software products, and won strategic multimillion-dollar deals with Dalian Techport Systems and Dalian Port Group for software application development and management.
IDC analysis also showed that in contrast to India, the Chinese market features considerable domestic demand. In 2006, more than 40% of offshore software outsourcing revenue came from multinational companies that were actually located in China. It is predicted that this demand will continue to grow rapidly over the next three to five years, providing an excellent opportunity for service providers by allowing them to expand while avoiding direct competition with Indian companies in European and North American markets.
Shenyang-based Neusoft Group is China's largest IT outsourcer, employing more than 10,000 staff, and providing software and IT services, as well as medical technologies. Most of Neusoft's revenue is derived from domestic software and service sales.
"One of the top reasons for outsourcing to China these days is that companies in the US or Japan are trying to align their target overseas markets with their outsourcing destination," said Neusoft chief technology officer Walter Fang.
This means such companies as Microsoft, Motorola and Nokia, eager to tap China's enormous consumer market, need outsourced services to support their China-based expansion strategies. Only last month Microsoft announced outsourcing service orders worth $100 million to Chinese companies.
Though Beijing, Shanghai, Guangzhou and a handful of other seaboard hubs remain the destinations of choice for most foreign companies, they may not be the best locales for businesses on a budget. Wong said: "Many of China's 'second-tier' cities like Xian, Dalian and Chengdu are becoming prominent players in the IT outsourcing market due to lower costs of doing business and improved infrastructure."
Companies looking to cut costs should bear in mind that China has nearly 100 cities with a population of 1 million or more - nearly all of these are actively trying to attract foreign investment. Businesses that select second- or third-tier cities can expect favorable treatment that can translate into substantial savings. Xian, a city of more than 4 million in China's rapidly developing west, for example, has a "High-Tech Zone" that offers foreign companies heavily discounted office space and tax exemptions until they've attained profitability for two consecutive years.
Objectiva Software is in the process of setting up a second office in Xian. Tao Ye said, "We chose Xian because of cheaper setting-up and running costs, and the fact that it has excellent infrastructure and a good enough supply of well-qualified staff to meet our needs."
In addition to IT and business process outsourcing, China is also becoming an increasingly attractive market for international biotech companies, with low set-up costs for manufacturing and R&D units, a regular supply of inexpensive professional personnel, and a relaxed regulatory environment. At present, overseas companies generally operate in the Chinese market by establishing joint ventures with local firms, by setting up manufacturing bases, or by outsourcing R&D to domestic companies. At the end of 2005, China had about 750 R&D centers supported by foreign capital in the form of joint ventures.
Wong said: "Many of the people involved in the biotech fields in China are expatriates from the United States. Due to the high level of competency found in China now, many companies here in the US are looking to outsource their R&D to China. This work can now be done at a fraction of the costs without compromising the quality of work being done."
The biopharmaceutical industry, underpinned by strong government support, the machinations of some major multinationals, and a rising demand for prescription drugs, is a key driver of the biotech industry in China. Last year China's biopharmaceutical industry grew by 15%, with revenues rising sharply.
As large enterprises pressed ahead with their globalization strategies, the R&D outsourcing market, where small and medium-sized enterprises play a leading role, experienced remarkable growth. However, the scope for outsourcing business in the biotech sector to China is still huge, with global firms still only outsourcing about 5% of their total requirements to the country.
Bridge Pharmaceutical Inc, a US biotech company, opened a research center in Beijing last year employing 200 people. The company says that even though it operates along US regulatory guidelines, its drug-development costs are about 80% lower in China than in the US; salaries of research scientists in China are estimated to be one-fifth to one-tenth those in North America. Pharmaceutical giants such as Novartis and Pfizer have also established research facilities in China, and AstraZeneca is opening a new "Innovation Center" in Shanghai this year.
Although China's biotech infrastructure is a work in progress, with a mix of First World and Third World support, the growing number of industrial and science parks that are opening around the country guarantee power, water and Internet access to high-level specifications. While many cities offer support and incentives for biotech firms, the top destinations are still Beijing and Shanghai, where the intellectual workforce tends to congregate and where services are most reliable.
Animal testing is China's specialty, with virtually non-existent regulations and severe penalties for animal-rights activists. If the research process of companies looking to outsource involves a significant amount animal testing, especially with primates, then China is the No 1 choice.
China certainly has the potential to outpace India and become the world's top outsourcing destination over the course of the next decade. There is room for growth - the McKinsey Global Institute estimates $18.4 billion in global IT work and $11.4 billion in business-process services have been outsourced overseas so far - just one-tenth of the potential offshore market.
Looking to the future, Wong said, "With developments in infrastructure, technology and personnel, China is closing the gap with the Western world. The country has a huge hunger for success, and will continue to strive toward higher goals and to be competitive with other nations. I have no doubt that it will become the outsourcing country of choice in many sectors before too long."
Beijing is drafting a human-resources training plan for Chinese outsourcing service providers. The plan outlines the development of 100 qualified outsourcing service providers in 10 base cities in the next five years in an effort to attract about 100 well-known multinationals to outsource to China.
As desirable as building a highly qualified, English-speaking army of workers may be, the trend toward offshore outsourcing is a lot more complex than simply finding language skills and resources in the lowest-cost locations. Major drivers in the outsourcing market include quality, innovation and speed to market, not just cost of services. To maintain their competitive strengths as competition intensifies, Chinese outsourcing service providers need to increase their attractiveness to users by offering high standards, demonstrable creativity, and an array of value-added benefits.
http://www.atimes.com/atimes/China_Business/IF02Cb02.html