China Outsourcing Overview

China offers compelling reasons for relocation.

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 R&D, India has traditionally attracted the lion’s share of the services and IT projects. However, as China leverages its superior infrastructure and cheaper labor, and deepens 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 percent. China’s offshore software outsourcing market continued to grow rapidly in 2006, with reported total revenue reaching nearly US$1.4 billion, up over 48 percent year-on-year.

In addition to cheap labor, other drivers for the expansion of the Chinese IT outsourcing market include market de-regulation, large-scale investment in technical education, better IP 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 in order to step up its challenge to India in the global market.

Kenneth Wong, a Managing Partner of SmithWong Associates, a China-focused US consulting firm, comments, “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, comments, “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 develop strong embedded software capabilities to work with makers of mobile phones and other hardware devices.

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. Xi’an, a city of over 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 have attained profitability for two consecutive years.

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.

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 percent, with revenues rising sharply. As large enterprises pressed ahead with their globalization strategies, the R&D outsourcing market where SMEs 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 five percent of their total requirements to the mainland.

Although China’s biotech infrastructure is a work in progress, with a mix of first 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.

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 US$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.

The Beijing government is currently drafting a human resources training plan for Chinese outsourcing service providers. The plan outlines the development of 100 qualified outsourcing service providers in 10 outsourcing base cities in the next five years in an effort to attract around 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 locating 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. In order 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.

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