China outsourcing EXPRESS DELIVERY FROM CHINA

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1 EXPRESS DELIVERY FROM CHINA [ 32 ] A Plus + August 2009

2 China s outsourcing industry may soon give India a run for its money, writes Naomi Martig Illustrations by Emilio Rivera III As the U.S. slides into the worst recession in decades, industries worldwide that depend on the U.S. market are sharing its pain. The financial crisis has hit India s technology outsourcing sector particularly hard as companies in the United States and Europe, which make up 60 percent of its clientele, have succumbed to profit erosion and bankruptcy. India s revenue from offshore outsourcing, which has steadily grown by around 30 percent, is expected to clock in at only 14 percent this fiscal year, according to the National Association of Software and Service Companies, the country s top outsourcing trade body. Som Mittal, president of NASSCOM, recently predicted that growth will slow to a single digit in In China, however, the picture is different. Wang Chao, China s assistant minister of commerce, surprised many last month when he said revenue from information technology and business process outsourcing in the mainland grew a whopping 1.6 times to US$3.8 billion in 2008 compared to a year earlier. Despite the downturn, the value of outsourcing contracts in China reached US$2.59 billion in the first quarter of the year, up 25.9 percent from the same period last year. It wasn t long ago when outsourcing in China was limited to manufacturing in the Pearl River Delta, but that has changed. China s two big subcontracting services, information technology and business process outsourcing, cover everything from finance and administration, telecommunication to human resources, customer relations and logistics. Egidio Zarrella, a KPMG China partner and co-author of the firm s recently released report, A New Dawn: China s Emerging Role in Global Outsourcing, says India s IT and businesses process outsourcing industry is still much stronger than China s in terms of revenue, with India s offshore outsourcing reaching US$47 billion this fiscal year despite slower growth. But he says it would be wise for Indian companies to keep an eye on China s quickly evolving market. Silicon Valley (in Bangalore) is in square kilometres probably about two. But there is one technology park just outside Shanghai that is 40 square kilometres. And for those wondering just who is there, there are big Chinese banks and foreign insurance companies that have set up their offshore offices. Every IT company is there. General Electric has one of its largest research and development centres in Shanghai. This is definitely a very exciting time, Zarrella says. Michael Rehkopf, partner and North Asia director of TPI, a U.S. outsourcing advisory firm, says megasized outsourcing contracts those typically worth US$100 million a year have slowed down amid the economic uncertainty, which is not surprising. But smaller contracts, including those in China, are being signed, he says. Experts predict that some Chinese subcontractors may benefit from having the economy on its knees. It s actually going to get better for some during a crisis. It s a US$1 trillion industry, and during bad times, more and more firms turn to outsourcing, says Zarrella. Tapping Japan China is targeting its Asian neighbour, Japan, where corporations from information technology to manufacturing are struggling to cut costs. Eighty percent of all the outsourcing from Japan s market comes to China, says Fanny Chan, senior vice president of ChinaSoft International, a Hong Konglisted company that provides outsourcing and training services for clients in China, the United States and Japan. Many industries in Japan and the government as well have recognized that they need to outsource some of their non-core services and most who do go to Dalian, says Ning Wright, a KPMG China partner who co-authored the outsourcing report. Located in a southwest suburb, Dalian Software Park is home to some August A Plus [ 33 ]

3 450 businesses, half of which are foreign Indian tech giants Infosys Technologies, companies including Panasonic Corp. Wipro Technologies and Tata Sons. and Sony Corp. Wright says Japanese Interestingly enough, those same firms are especially attracted to the companies are also moving to China Chinese city because of its proximity, to tap the growing demands of the and that China in general has become country s domestic market, which Japan s natural choice for third-party has provided a stable alternative for services because the two countries outsourcing firms wary of U.S. and cultures and written languages are European clients, adds Zarrella. relatively similar compared with India. Zarrella says KPMG has strengthened Rise of the domestic market cooperation between its Japan and As Chinese banks and financial China offices to help large Japanese institutions have emerged as some of corporate clients move their back offices to the mainland. Bao Shuping, chairman of Shanghai Hyron Software Co., a mainland-listed software developer that caters to Japan s China industrial automation companies and revenue electrical manufacturers, agrees that from IT China is a logical choice for Japan s and business offshore needs. process outsourcing Around 95 percent of Hyron s grew a whopping 1.6 customers are from Japan and the company has grown by 30 percent 1.6 times to US$3.8 billion in annually over the last nine years. Bao 2008 compared to says he sees demand from Japanese firms continuing. At present, China only accounts for 2 percent to 3 percent of Japan s software outsourcing market, says Bao, adding that he expects this figure to increase by up to 30 percent in the next several years. Other foreign IT companies, mostly from India, are relocating to China to benefit from Japan s need for thirdparty services. They are aggressively hiring Chinese employees who have experience working with Japanese clients and can help them get into the Japanese market. Among them are the world s biggest companies, they are tapping the capabilities of outsourcing companies. Chinese demand for IT and business process outsourcing services is projected to reach US$20 billion next year, almost doubling the US$10.5 billion recorded in 2006, according to the KPMG report. China Data Group is among the few mainland companies that help big financial institutions take care of their back office support in human resources, finance and accounting. Its top clients include Bank of China and Bank of Communications. Roc Yang, China Data Group s chief executive who co-founded the company in 2005, says the firm started with 50 people and brought in US$100,000 in the first year. Today, it has 3,500 staff working in cities including Beijing, Shanghai and Guangzhou, with an annual revenue of US$20 million. It grew 50 percent in the first six months compared to the same period last year. We ve now established long-term partnerships with more than 30 leading financial services institutions in the market and work with 15 of the top 20 insurers in the Chinese market, Yang says. ChinaSoft s Chan, meanwhile, says the domestic Chinese market now accounts for 20 percent of its total outsourcing revenue. There is a trend growing in China in which companies that are growing are realizing that they can save costs and increase productivity by leveraging on a third party, she says. [ 34 ] A Plus + August 2009

4 Multinationals doing business in China, long accustomed to outsourcing, are a boon to Chinese subcontractors, says TPI s Rehkopf. As they go in, they realize that they may not have all the skill sets to do everything themselves. How do I deal with payroll in China? How do I deal with marketing, with procurement? It s quite natural to outsource some portion of that, he says. U.S. software giant Microsoft partnered with ChinaSoft several years ago. The mainland firm runs a training and certification programme for Microsoft employees and employs more than 900 engineers throughout China to work on Outsourcing firms with clients that had a strong U.S. focus were hit rather heavily. But for companies like us, whose primary market is China, we were actually not affected at all, he says. China vs. India KPMG projects that China s IT and business process outsourcing industry will grow 30 percent annually between now and 2013, compared to a more modest 19 percent growth rate elsewhere in the world. India, however, won t fall off the outsourcing map any time soon. Its business process outsourcing industry alone is expected to generate annual revenues of around US$30 billion by 2012, according to NASSCOM, compared to its current annual revenue of around US$11 billion. Prudently speaking, I think that in three to five years, China will catch up with India in terms of its IT and business process outsourcing, says KPMG s Wright. projects outsourced by Microsoft. China Data Group works with Outforeign banks and insurers such as sourcing Deutsche Bank AG and Prudential PLC, contracts in which all use the local subcontractor to China reached help tap the domestic market. US$2.59 billion Automatic Data Processing Inc., a in Q1 of 2009, up U.S. company that provides business outsourcing services, set up an office percent from the in Shanghai three years ago to target same period last year. multinational companies wanting thirdparty mainland assistance. Around 90 percent of ADP s China revenue comes from multinational clients that target the mainland market, including Citibank (China) Co., Philips Consumer Electronics, Motorola and Nike Inc., says Jessica Zhang, vice president of ADP China. The remaining 10 percent comes from domestic mainland companies. Zhang says subcontractors with that China Data Group s Yang shares. multinational clients have been little affected by the financial crisis, a viewpoint PERCENT August A Plus [ 35 ]

5 She believes China s booming domestic market, advanced infrastructure and government support will propel development much faster than India s when it first took off as a major outsourcing destination in the late 1990s. Zarrella says one big obstacle for India s subcontracting business was the lack of talent. A lot of the outsourcing companies in India have set up their own universities in recent years. Why? Because the level of education is not that good. China, on the other hand, is graduating some six million university students this year, in addition to a growing number of Chinese returning Eighty percent of all the outsourcing from 80 Japan s market comes to China. PERCENT home after studying and working abroad. The talent pool is huge and diversified. It s ready to take China s outsourcing to the next step, says Wright. Each year, India is only generating US$70 billion of a US$1 trillion industry. So if you look at the proportion, the pie is absolutely huge. Despite the optimism over China s potential in this business, Wright says the country needs to overcome a few issues, such as reducing destination fragmentation. There s not a lot of internal competition between Indian cities like Mumbai and Chennai. Whereas in China, everybody is competing with everybody, she says. An industry association similar to India s NASSCOM would be a boost for the sector. The mainland has thousands of subcontractors offering similar services and should consider mergers and acquisitions in order to grow in size and value, she says. Automatic Data Processing China did just that a few months ago, acquiring a majority stake in ChinaLink, a mainland human resources subcontractor, says Zhang. TPI s Rehkopf says China no longer enjoys a cost advantage over India. One thing that really shocks people is that by and large the costs of doing business in Shanghai and Beijing exceed the costs of doing it in Bangalore. Sure, there are other Chinese cities where cost is low, but China may not be able to play the cost advantage game the same way India did 10 years ago, he says. What that means is they have to develop unique specialties and characteristics of what customers want to buy, and then push those areas. For example, China can market Shanghai companies that offer thirdparty services for financial companies as the city pushes to become an international finance centre, he says. Wright agrees that China needs to lift the quality of its services rather than compete on price if it aims to target medium- to high-end subcontracting services. We are not talking about a factory line production anymore. We are talking about something that requires brain power and process, so it s important to emphasize that China s outsourcing arena is also excellent in quality, she says. Intellectual property rights enforcement is an area where the Chinese government needs to keep pushing. Already, the government has passed laws and prosecuted some people and companies who violated intellectual property rights. People should keep in mind that a lot of research and development centres are set up in China. General Electric has its largest R&D centre in China. Clearly, if there was a problem with intellectual property protection, they would not be here, she says. Despite these problems, the growth potential of China s outsourcing business is clear. It doesn t mean China is going to get it right immediately, says Zarrella. But they ll crack the code. And anyone who says they won t is severely underestimating 1.3 billion people. [ 36 ] A Plus + August 2009