WHY OUTSOURCE TO CHINA?

Executive SUMMARY hina is fast emerging as one of the world's leading suppliers of offshore IT outsourcing services. While India is the uncontested leader of offshore outsourcing globally today, China is quickly closing the gap and is the best alternative for large-scale, high-quality development services. "China is the hotspot right now, obviously for its enormous market opportunity. says Yankee Group analyst Laura Didio. "If you're a technology company and you're not thinking about China, then you're already behind. This paper will look at the market forces driving buyers to look at China, the advantages China outsourcing offers, 1 as well as the challenges China faces supplying outsourcing services to the Western world. 2015 BLEUM 1

India is Overheating In the early part of the decade India's software industry started to overheat with the only relief supplied by the IT recession. The gradual improvement in the world economy is increasing demand to levels that the Indian service industry cannot handle alone. This has led to upward pressure in prices and reduced quality of service. After several years of decline, the Indian outsourcing association NASCOMM reports that in prices in India stabilized in the US$18-$24 per hour range for junior technical resources. Buyers of outsourcing services are aware of the rising wage inflation. As a result, some are quickly establishing a presence in China to mitigate this risk1. 1 As talent supply dwindles, one can expect prices to start climbing again similar to the IT bubble burst. Gartner and other offshore analysts forecast that global demand for offshore IT outsourcing will increase 860% by 2025. Despite its enormous population, India will not be able to supply this surging demand. Because there are effectively two classes in India, the educated and uneducated, the portion of the population with an education suitable for software development is small when compared to China, which enjoys a literacy rate over 90% compared to India's 64.8%. 2 This effectively limits the ability of the Indian industry to continue absorbing demand. Although revenues for offshore outsourcing increased 25% in 2010, the country will have to work around an anticipated shortage of 500,000 staff. As this gap between supply and demand widens, one may reasonably expect price increases to accelerate and the quality of service to erode. Multi-Sourcing Improves Outsourcing Results To reduce geographic and vendor risk, global corporations are increasingly turning to a strategy of multi-sourcing. This strategy enables customers to diversify their geopolitical risk and often provides leverage when negotiating with one's primary vendor in India. Once in a state of "over-outsourcing" to one vendor, firms may find that they have lost the internal ability to support their mission-critical systems and become beholden to a single vendor. Multinational companies may also experience a geographic or cultural benefit by adding a China-based vendor to their portfolio. Asia plays an increasingly important role in the operations of multinationals resulting in increased demand for systems that can adapt to language and regulatory environments in those markets. While India's English heritage results in a perceived advantage for English-based systems, China has the advantage of supporting multilingual systems in the Far East. Talent Pool The biggest advantage for the future of the Chinese software industry is the incredible ability of the Chinese Government to mobilize resources. China s population is larger than India and has a higher average education level. Since 2000, the Chinese Government has identified software as one of the country s six favored industries. The progress made in the past few years has been dramatic. From 2008 to 2014 the number of computer science graduates in China has increased from roughly 140,000 per 2 Why Outsource To China?

year to over 570,000. India, however, will have to work around an anticipated shortage of 500,000 staff. This trend is sure to continue as the Chinese Government continues to invest heavily in the software industry. India's inability to keep pace with the growth of offshore outsourcing demand for talent directly translates into an eroding quality of service. With an inelastic university system, second-tier technical colleges and institutes have emerged, endowing candidates with a substandard level of knowledge. In fact, this gap is so large that 28% of the current talent pool in India is from these secondary education sources. 3 At the same time, Chinese leaders noticed the importance of technical education in India and have begun to make serious investments in higher learning academies to train resources specifically for IT outsourcing providers. The Government has established 35 national schools to provide software training, especially in technologies such as.net, Linux, Java, and Web services. Its goal is to have 800,000 trained software professionals by the end of the year, versus 600,000 in India. 4 Infrastructure Infrastructure is a critical factor when selecting a country for offshore software outsourcing. The ability of the Chinese government to dedicate enormous resources to an initiative such as improving basic infrastructure without the debate required in undeveloped democracies like India's is incredible. In a few short years China has transformed itself from an Asian backwater into a modern state with high tech infrastructure rivaling most developed countries. From new airports and highways to broadband internet access widely available in China's major cities, China is wired for business. When considering infrastructure, China is a much more suitable country for offshore development than most of its neighbors. Anyone who has travelled from the airport to downtown Bangalore understands that India's high tech industry is choking from a result of poor Government planning and development. Rather than weaving through the chaos of Bangalore's roads to get to one's hotel from the airport, visitors to Shanghai can rocket from the airport to downtown on the 430 km/hour MagLev train in relative comfort. It is obvious that poor infrastructure in India has reached crisis proportions. K.S. Suryaprakash of Infosys technologies stated that if India " can't resolve its infrastructure problems soon, China will increasingly become a more attractive place to do outsourcing". Furthermore, travel to China is relatively easy. There are daily direct flights to major cities in the U.S., Europe and Japan. Once in China, one can easily find hotels and restaurants meeting the highest international standards for reasonable prices. Hotels in India are significantly more expensive than those in China due to the low supply of quality accommodations. In fact, Bangalore is at the point where it is now advisable for executives to book their hotel two months or more in advance. On the other hand, major cities in China boast premium world class hotels, and for the budget conscious, 3 and 4 star accommodations featuring free broadband internet access may be found for as low as US$20-30 per night. 2015 BLEUM 3

Why Outsource To China? Challenges for China Language Lack of English language skills is the most frequently cited challenge to China's offshore outsourcing industry. However, China is making substantial progress in bridging the English gap. In most major Chinese cities, elementary school students are required to learn English. At the university level, undergraduates are required to pass the Chinese English Testing Level (CETL) 4 and graduate students are required to pass CETL 5. It is very easy to find IT workers in China's major cities who have passed the even more rigorous CETL 6 exam. To prepare itself for the 2008 Olympics in Beijing, the Government led an intense effort to increase the population's proficiency in English, which yielded positive results. Overtime, the language impediment will decline as more students move through the school systems and as China increases its business with English-speaking countries. Capability While China's IT industry is growing quickly, it does not have a pool of resources with deep experience in software development standards. It is hard to find skilled project managers or developers with a minimum of ten years experience, and few companies have attained Capability Maturity Model (CMM) Level 5 certification. Once again the Chinese Government is playing a key role in closing this gap with India. Most major Chinese cities see knowledge workers as a benefit to their societies and have programs subsidizing companies focused on achieving high levels of maturity such as CMM Level 5. As a result, there are now companies emerging in China that are every bit as good as the best software outsourcing companies worldwide. Although warranted based on historical business practices, China recognizes the importance of protecting intellectual property and is rapidly improving its enforcement of IP. As part of its entry into the World Trade Organization (WTO), China adopted laws and enforced practices conforming to the WTO's Agreement on Trade-Related Aspects of Intellectual Property Rights (TRIPS). In Beijing and Shanghai, dedicated IP courts have been set up with judges trained in the U.S. and Europe. These courts are active now and monetary judgments have been won in favor of IP holders, including foreign firms. For the first time there is finally a competent enforcement mechanism to provide the protection in practice that the earlier legislation provided in theory. To boost enforcement in the face of growing international pressure, in 2004 China's highest courts announced stricter interpretation of China's existing IPR laws. According to the courts, China has lowered the threshold for punishable offenses to U.S. $6,000 from U.S. $12,000-$24,000 and has increased prison sentences from three to seven years. Now, for the first time, dissemination of pirated goods or software over the Internet is explicitly forbidden. As McKinsey recently pointed out in their quarterly report on IP protection in China, litigation is no substitute for strategy. It is recommended that firms find professional partners with high ethical standards, focusing on suppliers with both physical and technological security measures. Some firms may want to choose vendors that are pure services companies, eliminating the risk of their IP being used in a competitive product. There are numerous indicators of the rapidly improving capability of China's software companies. Between 2010 and 2014 the number of project managers who had achieved the Project Management Professional (PMP) certification in the city of Shanghai grew from 80 to over 5,000. By 2014, 150 Chinese companies had achieved CMM certification of Level 2 or higher. To date, twelve outsourcing companies with operations in China have attained Capability Maturity Model Level 5, the highest ranking from Carnegie Mellon University's Software Engineering Institute. Among those, seven are local Chinese companies. Security Another common concern with outsourcing to China is the country's negative image for protecting intellectual property. 4 Why Outsource To China?

The Long-term Outlook From a business and technical standpoint, China is becoming an increasingly viable complement, if not alternative, to Indian outsourcing services. Changes in China are creating an ideal venue to outsource software. These include an emphasis on education, a rapidly developing economy, liberalization of laws and policies and growing English-language capability. In addition, China s global manufacturing industry has created the support services infrastructure necessary for expatriates working and living in China. As the number of global corporations investing in and entering China's growing economy increase, there will be greater opportunity to produce software products and services for the China market. Finally, China is becoming an attractive alternative to India where surging demand is making outsourcing to India increasingly difficult. Access to quality resources and receiving adequate attention from overwhelmed vendors are two major reasons companies are looking for alternatives to India. China is the only country in the world with a large enough skilled talent pool to be a viable long-term alternative to India.

Why Outsource To China? Sources 1 Frauenheim, Ed.,. Outsourcing Moving to China? Zdnet, [internet]. Available at: http://news.zdnet.com/2100-9589_22-142301.html 2 Agarwala, Ramgopal. Catching up with China: India needs to focus on social factors. Economic Times Online, [internet]. Available at: http://economictimes.indiatimes.com/articleshow/msid-3434132,prtpage-1.cms 3 NASSCOM s Education Intitiatives. NASSCOM, [internet]. Available at: http://www.nasscom.in/nasscom/templates/normalpage.aspx?id=51761 4 McDougall, Paul. Microsoft and TCS to Open Outsourcing Centers in China, Information Week, [internet] June. Available at: http://www.informationweek.com/news/management/outsourcing/showarticle.jhtml?articleid=164904223 Dietz, M., Lin, S.., Yang, L. Protecting Intellectual Property in China, McKinsey Quarterly, [internet] August. Available at: http://www.mckinseyquarterly.com/protecting_intellectual_property_in_china_1643 Bleum,. Intellectual Property Protection in China, Bleum Series of Whitepapers, [internet] February. Available at: http:// www.bleum.com/whitepaper/software-outsourcing-ip/request-ip-protection.shtml Special thanks to Peter Neumann of Faegre and Benson LLP 6 Why Outsource To China?

About ounded in 2001, Bleum is a China-based IT outsourcer to U.S. and European companies in financial services, retail, software development, manufacturing and industrial products as well as non-profits. Bleum drives improved performance for clients by developing, managing, testing and maintaining applications that are core to their businesses. Led by senior executives from top global technology and consulting firms, Bleum's Western management practices, English-only workplace and dedicated development centers enable it to become an integral extension of its clients' IT organizations. To learn more, visit www.bleum.com 2015 BLEUM 7