From Manufacturing to Outsourcing

Transcription

1 From Manufacturing to Outsourcing China is intent on transforming its economy from a manufacturing engine into a services hub, and the government has been pushing the growth of the country s service outsourcing market. Aided by strong investments, extensive infrastructure, a developing domestic market and a vast talent pool, China s outsourcing industry is set to become one of the largest in the world. 3 0 I N S I G H T O C TO B E R

2 IMAGINECHINA C OV E R S TO RY B Y E L A I N E W U The global service outsourcing market has grown into a trillion-dollar industry within the past decade, expanding into emerging markets and brimming with untapped opportunities. A relatively new industry, service outsourcing is a way for companies to transfer service operations to outside, professional providers and focus on their core businesses. Known for its big added values, low resource consumption, minimal environmental pollution, and high level of internationalization, outsourcing enables companies to attain profits through standardization and scale, and is increasingly seen as a method for optimizing strategic and operational business processes. Although still largely dominated by the field of information technology (IT) outsourcing, the service outsourcing market has expanded to include business process outsourcing (BPO) such as financial services, accounting and legal process outsourcing, engineering research and development (R&D), and human resources management. Exhibiting rapid growth, the global service outsourcing industry was valued at US$1.5 trillion in Worldwide IT outsourcing revenue, the largest segment within the entire outsourcing industry, reached US$592 billion in 2007 and is expected to hit US$829 billion in 2012, according to market research firm Gartner. Global BPO spending reached US$156 billion in 2007 and is projected to rise to US$239 billion in 2012, says Gartner. The popularity of offshore outsourcing has also risen. In 2002, only 10 percent of multinational companies (MNCs) outsourced their IT work offshore, but that number rose to 70 percent by 2008, according to a recent KPMG report on global outsourcing. As more companies choose to outsource O C TO B E R I N S I G H T 3 1

3 China is now focusing its energy on transforming its reputation from the factory of the world to balancing its manufacturing capabilities with the development of more skillbased service industries. their services offshore, multiple outsourcing destinations around the world have surfaced as attractive service provider bases. Countries like India, the pioneer of the global IT outsourcing industry, the Philippines, Malaysia, Romania, Ukraine, Brazil, Mexico, and increasingly, China, are viewed as top outsourcing locations. Companies who elect to offshore their needs to foreign countries must account for a variety of criteria when determining which markets are best suited, including language capabilities, labor pool, infrastructure, cost, information security, and intellectual property rights (IPR) protection. A new pattern is emerging where MNCs outsource to several different markets, diversifying their portfolio and combining the strengths and flexibility of several markets rather than relying on a single location. Under this new model China is asserting its rise as a leading global outsourcing destination. China is going to become more and more a place that companies look towards to service their outsourcing needs. A lot of companies are not only looking to China because of cost, but to de-risk their portfolios, says Charles Hunting, managing director of Accenture s Greater China outsourcing practice. Many companies are also using outsourcing in China as a means to first gain experience in the country and access to 1.3 billion potential consumers, with the ultimate goal of exposing their own products and services to the domestic market. China s ascendancy Long known as a global manufacturing hub, China is now focusing its energy on transforming its reputation from the factory of the world to balancing its manufacturing capabilities with the development of more skill-based service industries. During the time it took China to cultivate a hugely successful export economy that took advantage of its cheap and ample labor market, India managed to capture the majority of the market for offshore outsourcing of IT services. In an effort to change this, the Chinese government has committed to building an economy propelled by innovation, technology and service. As the economic crisis deepened last year, the Chinese government realized that they could no longer sustain the path they ve taken in the past of being the manufacturing base of the world, which not only consumes a lot of natural resources but produces a lot of pollution, says Walter Fang, vice president of Neusoft Corp., the largest IT outsourcing company in China. In many developed countries, the service sector contributes to more than 60 or 70 percent of GDP. In China, that figure is less than half. [The government] has recognized that outsourcing is the next wave of income for China, and they are determined to build up a service industry. In 2007, the Chinese outsourcing market was worth US$15.2 billion, with IT services valued at US$9.04 billion and BPO at US$6.16 billion, according to government numbers. Offshore revenues grew more than 40 percent in 2007 to US$2.28 billion, more than 15 percent of total volume. By 2010, China s offshore work is likely to more than double to US$5.6 billion. By June 2009, there were more than 6,600 service providers based in China, employing more than 1.21 million people, announced China s Ministry of Commerce However, China s outsourcing market is still in its infancy, compared to its neighbor India. China holds less than 10 percent of the global market for outsourcing and offshoring services. In 2008, India s service outsourcing volume amounted to US$42.2 billion, nine times that of China s, reported a 2009 McKinsey & Company study. More than 2 million people were employed in India s outsourcing sector, nearly double that of China. Despite this, China s service outsourcing market is burgeoning. While the economic downturn has impacted India deeply, largely because contracts with the U.S. and Europe have been reduced, the outsourcing industry in China has maintained strong growth. In the first three months of 2009, the contract value of China s outsourcing industry reached US$2.6 billion, an increase of nearly 26 percent compared with the same period last year, said Chinese officials. China s outsourcing market has also been shaped by different factors than that of India. Growth of the industry has been founded on demand from neighbors Japan and Korea, as well as MNCs in China that need support for their China operations and the country s own domestic market. China is taking advantage of the current downturn to expand into new markets, playing to its strengths in infrastructure and a diverse and wide talent pool. Keep in mind that India were pioneers in the IT industry 20 years ago and China started much later. Given time, they will without a doubt catch up, says Girija Pande, executive vice president and head of Asia Pacific for India s Tata Consultancy Services (TCS). Some analysts believe this could be sooner than 3 2 I N S I G H T O C TO B E R

4 IMAGINECHINA expected. China is learning from India s mistakes and is catching up very quickly. China is going to be up there with India in the next three to five years, says Ning Wright, a partner in KPMG s advisory services. Strong government support, the evolving maturity of Chinese outsourcing firms, and strong demand in the Japanese and domestic markets will drive exceptional growth in [the outsourcing industry]. China s edge China s rise as a center for IT and other service outsourcing industries is due in large part to strong government support, relatively low labor costs, and an abundant labor pool. In recent years, the Chinese government has passed a slew of policies directed at boosting the development of the service outsourcing industry. In 2006, China implemented the 1, Project, which seeks to establish 1,000 Chinese outsourcing enterprises with international qualifications, encourage 100 MNCs to shift their outsourcing businesses to China, and develop a base of 10 internationally competitive cities for service outsourcing. The plan aims to double the export value of the outsourcing industry and has more than US$1 billion in funding. In addition to the selected cities such as Beijing, Shanghai, Suzhou, Hangzhou and Xi an, 10 more cities have been designated as pilot service outsourcing regions, where companies are eligible for favorable policies such as tax breaks, subsidies, financial support, and IPR protection. Service outsourcing companies located in Suzhou Industrial Park, for example, can enjoy an enterprise income tax rate of 15 percent until 2013, compared with 25 percent elsewhere in the country. Companies located in central and western parts of the country will also be eligible for favorable loans to start up service outsourcing projects. In an effort to provide jobs for millions of graduating students, the government is offering service outsourcing companies subsidies of up to RMB4,500 a year for every college graduate employed for at least one year. No other country in the world has invested in infrastructure as much as China has in recent years. The country is investing US$586 billion in ports, highways, airports, power plants, as well as a modernized telecommunications network with high-speed broadband connections in major cities and other strategic locations. On top of key improvements in infrastructure, expansive new state-of-the-art software parks have been built in several cities including Shanghai, Beijing, Suzhou, Dalian and Hangzhou, attracting numerous companies to set up facilities. Dalian Software Park, spread over three square kilometers, is an example of a major outsourcing zone where nearly 400 companies employ 25,000 people, home to MNCs such as GE Capital and SAP. Compared to prevailing wage levels in India, wage rates are oftentimes 30 to 50 percent lower in China, although they tend to be higher in firsttier cities. In stark contrast, a recently graduated Chinese engineer might earn between US$250 to $300 per month, while Indian graduates can expect to receive an average salary of US$750 to $1,000 per month, according to India s IT trade association NASSCOM. Perhaps most crucially, China has a massive talent pool of skilled technicians and engineers that are entering the workforce every year. The big difference between a manufacturing and servicesbased economy is that the service industry is all about developing talent and skills, says Fang. Official statistics from 2005 put China s engineering graduates at more than 600,000, compared to around 90,000 in the U.S. and 200,000 in India, according to a study published by Duke University. This year, more than 6.1 million students graduated from China s universities, and many of these graduates come armed with critical language skills. Recognizing the importance of English language skills in winning business from western markets, the Chinese government has prioritized English instruction in schools and universities. By 2020, China will have the largest English-speaking population around the globe, says Hunting. In addition, the country has 2 million Japanese and Korean speakers, a boon to its two largest offshore clients. ENTRY-LEVEL EMPLOYMENT: The Chinese government is offering substantial subsidies to service outsourcing companies for every college graduate employed for a year in an effort to generate jobs in the industry. O C TO B E R I N S I G H T 3 3

5 IMAGINECHINA PRIMING PROFESSIONALS: China aims to train 1.2 million new service outsourcing professionals by China s Ministry of Commerce has announced that China hopes to train 1.2 million new service outsourcing professionals by 2013, in addition to the current number of industry professionals, while one million college graduates are expected to find jobs in the sector during the same period. Considering the volume of people coming through its university system today, the levels of capacity in China will far exceed anywhere else in the world, says Hunting. Industry challenges Despite the strides China has made to lay the groundwork for a strong outsourcing industry, there are still hurdles that need to be overcome. China is primarily still an exporter of BPO services rather than a consumer. At the moment, MNCs make up the majority of consumers of outsourcing work in China; Chinese organizations have expressed little understanding or reluctance to turn over IT or BPO duties to external service providers. IT outsourcing presently accounts for less than 10 percent of the IT market in China, compared with nearly one-third in the U.S. Both foreign and domestic clients remained concerned with issues of trustworthiness, confidentiality, the expertise of Chinese service providers, and the potential value of outsourcing. For a country determined to build a successful outsourcing market, the ability of domestically owned Chinese companies, including state-owned enterprises (SOEs), to embrace the importance of outsourcing and its potential to deliver high-level results is of the utmost importance. The problem is that a lot of these [SOEs] have huge numbers of employees, and they tend to do everything under their own umbrella. There are no real financial or political incentives to outsource, says Charlie Liu, President of VXI Enterprise Management, a BPO company specializing in call center services. But the mindset is slowly changing; you re beginning to see more awareness and outsourcing is becoming more popular across all business sectors. Ironically, although China has no shortage of entry-level engineers and technicians, the talent crunch affecting many sectors of China s economy is especially prevalent in the outsourcing industry. Senior-level managers still comprise a low percentage of the workers in the domestic outsourcing market. There is a shortage of professionals in China with the level of management and technical experience required to deal with large, complex cross-border projects, says Alan Fung, senior manager of risk advisory services at KPMG. However, large numbers of Chinese with overseas experience and skills are flocking back to China, driven in part by the financial crisis, and are being snatched up by service providers as project managers and senior-level executives, says Fung. Another major challenge to China s growth as an internationally competitive outsourcing market is that the industry is currently highly fragmented with thousands of small providers all competing for a share of the market. The sheer number of choices can make choosing a vendor a daunting task for a company unfamiliar with China s market. MNCs coming into China need international service providers who have scale, credibility and global reach, and you don t have players who are large enough yet in China, says Pande. Smaller Chinese vendors may find it difficult to compete with foreign providers like TCS, who have the advantages of size, branding, global and regional reach, and international quality standards to attract larger contracts from more prominent clients. Chinese companies need to concentrate their efforts on making themselves bigger and better in order to compete in the global market, says Wright. In order to do that, Chinese providers need to pursue mergers and acquisitions (M&A) and focus on internal growth, she says. Another concern that clients raise when considering outsourcing in China involves the protection of IPR. There is still a negative perception of IPR protection in China, despite government efforts to combat it. Most vendors in China have adopted strict security measures for IPR treatment, and government measures such as more stringent regulations and encouraging the installation of licensed software at companies have reduced the occurrence of piracy. But many in the industry believe that IPR issues 3 4 I N S I G H T O C TO B E R

6 in China are often misconstrued to be much worse than they really are. IPR protection is not a unique problem to China. There is a risk, but it is no more inherent in China than it is elsewhere, says Hunting. The government is doing everything it can to reduce the risk and instance of fraud as it relates to IPR, copyright, patents, and information security. The rapid escalation of patent applications in China in recent years is a sign of this. China has had the fastest growth of new patents in the world, ranking sixth in the world in 2008 with 6,089 patent applications. Last year, Chinese telecommunications company Huawei Technologies Co. became the first Chinese company ever to file the most patents in the world. A global outsourcing hub China is well on its way to becoming a global outsourcing base and significant progress is being made, although more still needs to be done. Chinese providers are continuously moving up the value chain, evolving from early low-end work such as back-office administrative work and software testing to increasingly more high-end IT, business process and knowledge management procedures. There is a trend towards the diversification of outsourcing where you are seeing outsourcing companies moving up to higher value sectors such as finance and accounting, legal, human resources, market research and analytics outsourcing. As China s talent pool grows, more companies will have the capacity to deliver these kinds of services, says Fung. The numbers of domestic service providers who are obtaining international certifications and qualifications are steadily increasing, allowing them to compete seriously with foreign companies for larger offshore contracts. The McKinsey & Company study found that the number of Chinese vendors who obtained the highest levels of Capability Maturity Model (CMM), the qualification for software development management, grew by 39 percent annually from 2003 to These certifications have raised the profile of Chinese providers. By 2006, of the approximately 80 Chinese software companies with more than 1,000 employees, 35 had annual sales greater than RMB1 billion, compared to only 12 companies in In addition to branching into specific knowledge-intensive fields, the Chinese outsourcing industry is bulking up on R&D and contract research outsourcing in the life sciences and pharmaceutical fields. There are currently more than 1,100 R&D centers operated by MNCs in China, focused on a range of sectors from electronics and communications to pharmaceuticals and chemicals, compared to less than 800 in India. International companies such as Microsoft, Nokia, Oracle, Fujitsu, Philips and DuPoint have all set up prominent R&D operations in China. By 2020, the Chinese government hopes to increase spending on R&D to US$110 billion, as part of a strategy to make China a world leader in science and technology. The highly segmented outsourcing market in China has resulted in the beginnings of a mass consolidation effort. A flurry of M&A activity has occurred in recent years, as larger industry players jockey for leadership. In a big way, the financial crisis and economic downturn of the past year are going to help consolidation efforts, says Liu. Many Chinese service providers are also expanding beyond the traditional markets of Japan and Korea and aiming to break into more diverse markets. As one of China s largest vendors, Neusoft is looking to build up a reputation and presence in western markets. Especially in today s environment, outbound investment into developed regions like North America and Europe is a very good way for us to acquire the necessary skills, talent, and customer base to penetrate the industry much faster and to leapfrog [competitors], says Neusoft s Fang. Most importantly, China still needs to improve upon its outsourcing image, say many industry insiders. There are a lot of misconceptions about outsourcing in China, from language capability to IPR protection and a too-fragmented market. China really needs to brand itself and promote what it has to offer to the world, says Wright. With government investments in infrastructure, technology and education, China is unlocking its vast potential to become one of the world s leading outsourcing hubs. China is becoming an outsourcing origin as well as an outsourcing destination. As China develops more skillful service providers and they continue to scale up their size and capabilities, they will attract more and more work to China, says Fang. China s outsourcing industry will maintain a very healthy growth momentum for a long time. Elaine Wu is an Editorial Associate at AmCham Shanghai. She can be contacted at elaine.wu@amcham-shanghai.org. China is becoming an outsourcing origin as well as an outsourcing destination. O C TO B E R I N S I G H T 3 5