China's Position in the Global Outsourcing Industry: Then, Now and Beyond

www.neoit.com China Outsourcing Fair 2005 09 June 2005 China's Position in the Global Outsourcing Industry: Then, Now and Beyond Sabyasachi Satyaprasad Research Director neoit neoit 2005. All rights reserved

2 Agenda Introduction Services Globalization Trends Global Services Sourcing China: An Emerging Offshore Destination Mature Service Providers Will Emerge Wrap up

Our Mission To help clients better manage the Services Globalization Lifecycle & realize superior outcomes (Informed Practical Advise) (Manage Operations) (Strategy Development) (Offshore Business Model) 3

4 Industry Recognition Merrill Lynch neoit is the most aggressive outsourcing consultant CLSA neoit has defined a new business around sourcing advisory services SUPERSTAR

Outsourcing Accelerates Business Transformation BTO Outsourcing Managed Services Outtasking Evolution of Service Models Broader IS operations applications, help desk 1990 1995 2000 2005 2010 Agile Business Broader company noncore operations, human resources. customer service, accounting, logistics Desktops, networks data center operations Evolution of Business Priorities Cost Control Focus on Business Core Competence Transformation Mutual Gains Re-invest Mutual Gains 6

Globalization: Enters Mature Growth Phase $ Billion $ Billion 1200 1000 800 Total Offshore IT Services Revenue (20% of ITO) 140 120 100 Total Offshore BPO Services Revenue (13% of BPO) 600 80 60 400 40 200 20 0 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 0 Global BPO Revenue Global IT Services Revenue 7

Key Offshore Trends Market! Over 70% of Global 1000 companies focus on getting at least 5% to 20% of IT labor force offshore in next 2 years! Over a half of the large U.S enterprises offshore close to 30% of their ADM work! China, Philippines, CEE, South and Latin America are emerging as key offshore destinations! Large enterprises key thrust in 2005 and 2006 will be around de-risking their offshore operations IT operations spanning 3 different time zones Services! Convergence of ITO and BPO! Increasing focus on application management and BPO! Adding consulting arm! Offshore Infrastructure service offering! Significant investment in Transition and Governance frameworks to minimize failure! BPO players focus on competency in delivery platform development! BPO players targeting at higher end (underwriting, research/ analytics) and full-process outsourcing 8

9 Key Considerations in Choosing an Offshore Location Exogenous Factors Catalyst Factors Business Environment Factors that define the characteristics of the country, beyond influence of organization. Government support Educational system Geopolitical environment Infrastructure Factors that drive offshore service delivery in a country. Some of these factors could be exogenous as well. Physical and Time Zone Displacement Cultural compatibility Labor pool Language Proficiency Relates to the direct advantages, competencies of suppliers and supportive business issues. Cost advantage- Direct labor Cost advantage- Indirect Process maturity/ competitiveness of suppliers Supportive people factors Security, IP protection

10 The Landscape of Offshoring Destinations CANADA IT Services Exports (2003): $ 8B BPO Exports (2003): $7B POLAND IT Services Exports (2003): $22 M BPO Services Exports (2003): $10M INDIA IT Services Exports (2003): $9.5B BPO Exports (2003): $3.1B CHINA IT Services Exports (2003): $700M BPO Exports (2003): $210M MEXICO IT Services Exports (2003): $150M BPO Exports (2003): $80M CZECH REPUBLIC IT Services Exports (2003): $26 M BPO Services Exports (2003): $15M HUNGARY IT Services Exports (2003): $22M BPO Exports (2003): $10M PHILIPPINES IT Services Exports (2003): $300M BPO Exports (2003): $600M RUSSIA IT Services Exports (2003): $475M

The Evolution of Global Sourcing " Client Global Sourcing Portfolios will grow " India will remain the value destination " Competition will heat up " China will emerge Client Portfolio Client Portfolio Client Portfolio Value Value Value Strategic Impact Strategic Impact Strategic Impact 2004 2006 2010 12

The Role of China in Global Sourcing " Software companies leverage as buyer market " Large domestic market " Low-end ADM/ASM " Indian companies as partners " Improving English proficiency " Growth in middle management & program management " Expansion in niche markets " Software development/nonvoice based BPO " Supplier consolidation " Maturing sales & marketing " Position as premium " Maturing in high-end niches Value Value Value Strategic Impact Strategic Impact Strategic Impact 2004 2006 2010 13

China Outsourcing Market Size and Potential 7 China IT Services Export Market 6 5 5.6 $ 350 Mn $ 880 Mn US$ Billion 4 3 2 1.8 $ 150 Mn 1 0 0.38 0.62 2002 2003 2005 2008 IT Services Product R&D BPO Source: neoit, Gartner! Most outsourcing companies have fewer than 500 people, the largest IT services company has 1000 FTEs! Fewer than a dozen product development companies handling outsourcing! Domestic IT services market is over 4 Billion USD 15 Forty percent of buyers expect to outsource some IT functions to China over the next three to five years, versus eight percent who were making those plans only a year ago. Diamond Cluster, 2005 outsourcing study

16 Assessment of IT Services Industry in China Excellent Infrastructure - Overall infrastructure very good for IT services industry - Several IT parks at various locations with ready to move in office space Favorable Government Policy - Faster regulatory clearances to set up legal entity - Tax and fiscal benefits to IT companies Cost Attractive savings in line with India - Beijing and Shanghai are equally or more expensive to India. Tier 2 cities offer attractive cost advantages - Comparable operating costs as of India People - Excellent programming skills hardworking and focused workforce - Spoken English capability is an issue; capability of fresh graduates is encouraging - Limited domain experts - Attrition rate around 15% - Reverse brain drain will significantly help

17 Assessment of IT Services Industry in China Services and Quality - Mainly software development and system integration projects - Limited AM experience - Established experience and capabilities in ERP and large projects - Good project management skills - Well versed with developmental technologies and tools - CMM Process awareness moderate Outsourcing Services Maturity Limited exposure to U.S and European Companies - Limited market understanding and marketing presence - Lack of English language capability has been the major inhibitor - Japan remains the major contributor to outsourcing services. ITO industry will benefit from the rub-off effect of changing Western perception about Chinese economy

18 China An emerging offshore destination Why China? Risk Management Availability of Skilled Manpower Cost Advantage Regional Market Opportunities Currently majority of offshoring happen from India Need for alternate location-geopolitical & natural disaster risks China is a credible offshore destination Excellent location for DR-BCP & risk mitigation "Largest pool after India over 100,000 added every year "English language skills is set to improve amongst fresh grads "China has high potential to grow certain niche skills (telecom, embedded systems) where scale may not be available by considering only India "Differential cost structure Tier 2 cities provide significant cost advantage with good infrastructure &comparable manpower "Demand is expected to surpass supply from India "China offers good demand-supply balance and will provide long term cost advantages "Domestic market - Greater China is already bigger than Japan "More and more MNCs set operations in China & set to grow "Cultural proximity with Japan and Asia-Pacific "Large pool of Japanese speaking workers Over time, China will graduate from an alternate location to a preferred location

19 Best Positioned to Garner Asian Revenues Hong Kong 15% Taiwan 2% Others 15% Japan 53% U.S 13% Sources:CCID Feb. 2004, neoit estimates! More than 70% of ITO exports contributed by Asia countries! Catering to more mature US and European markets in the future requires global orientation, process expertise, global vertical domain skills and a global vision for Chinese companies! Positive trends are visible in the recent past the key is to build on short successes to create globally oriented organizations

20 Key Centers of Excellence Regions Why? Beijing and Shanghai Tianjin and Hangzhou Xi ang and Chengdu Dalian Nanjing " Good infrastructure and standard of living " Largest number of universities teaching software development/service " Location of the country s best talent " Better protection of IPR compared to other cities " Good international links " Local business opportunities " Close to Beijing and Shanghai respectively but significantly cheaper " More international exposure owing to proximity to big cities " Potential Japanese outsourcing business with a lot of work already happening specially Tianjin " Historically strong science and technology infrastructure " Good number of higher education universities " As number of companies in the area are lower, relatively easier to recruit skilled professionals " Low wage cost approx. half of Beijing " Tax incentives provided for investment in western China " High standard of living and good infrastructure " Strong trade links with Japan and a strong outsourcing industry tuned to Japanese needs " Lower wages compared to larger cities " Third highest number of universities " Lower wages " Proximity to Shanghai

21 Customer Perceived Challenges in China Intellectual Property! Protection of competitive advantages, preservation of IP rights and sharing in gains from knowledge acquisition and transfer in a highly entrepreneurial environment presents contractual and governance challenges. Data Privacy! Need to establish data security and privacy protections comparable to US and Europe- Gramm-Leach Bliley Act, EU Data protection directive, Right to Financial privacy act English Skills! Perceived and real English proficiency issues with many customers Regulatory Compliance! The SOX Act enhances controls for US public companies. The customers retains the liability of non-compliance. This implicitly increases oversight requirements for offshored financial accounting functions (e.g.sas 70) and underlying applications. Scale! Need generally referenceable clients with sufficient scale and process maturity to compete for larger deals Address these issues upfront with customers

Global client focus Global supplier focus MARKET OPERATIONS Business Environment Competitive Positioning Market Risks Market Potential Customer Trends Future Growth Opportunities HUMAN RESOURCES Process Domain Knowledge & Experience Process Transition models support & Implementation Global Distribution QUALITY Employee Distribution Employee Skills and Domains Recruiting and Hiring T&D, Compensation & Career Growth Attrition Management Resource Utilization INFRASTRUCTURE SEI/CMM Certifications ISO Certifications COPC Standards Six Sigma Center-Specific Certifications Certification Roadmap Approach and Processes STRATEGY Global Vision IT/BPO Integration Market Approach Physical Infrastructure IT Infrastructure Disaster Recovery Business Continuity 23

Global Suppliers Emerging! Home grown service providers realizing need for global vision and global commitment! Internal competition to intensify as market matures true global organizations will further emerge 24

25 Creating global leaders Opportunity realization capability Market need alignment

26 Key Take Aways 11 Global Sourcing is going through a maturation process Client demand remains high, open to emerging markets 12 China will continue to expand as an outsourcing destination for US firms drivers are access to Chinese domestic market and Asia Pacific Services 13 China has the potential to be on par with India it is time to revisit the global sourcing strategy 14 China s role in the global sourcing industry will be driven by ability to mature, consolidate, expand and position effectively need to address perceived issues upfront. 15 Leveraging China entails thorough capabilities market & supplier assessment, program & relationship management 16 Strategic partnership leveraging complementary skill sets can create global leaders

27 Questions

28 Contact Information Sabyasachi Satyaprasad Research Director ssatpathy@neoit.com +91 (98) 4546 6005/cell neoit Global Headquarters 2603 Camino Ramon, 2nd Floor San Ramon, CA 94583 USA neoit Asia Headquarters 210, Bellary Road Upper Palace Orchards Bangalore - 560 080 India neoit Philippines 8/F Pacific Star Building Senator Gil Puyat Ave. cor Makati Ave. Makati City, Metro Manila, 1200, Philippines

29 neoit: A Brief Introduction! Founded in 1999 to address the imbalance in the global supply and demand for IT and BPO services! Since its founding, the company has heavily focused on establishing itself as the industry thought leader through industry content, public relations and client success! In 2003, alone the company advised on over $1 billion in offshore transactions for premier clients such as JPMorgan Chase, Visa, Cardinal Health, Hewitt Associates and many others! With offices in the US, India and The Philippines the company has advised clients on a wide range of services globalization issues that include sourcing strategy and execution, M&A, joint ventures, captive operations, security and risk, performance improvement, transition management and governance! The company has developed a proprietary set of frameworks and methodologies and an extensive knowledge base that enables process-oriented, knowledgebased consulting for offshore IT and BPO