What you should know about outsourcing to China

In 2004, Joseph Rottman of the University of Missouri-St. Louis took a tour of outsourcing hubs in India, hopping from Bangalore to Hyderabad to Mumbai. The trip kicked off four years (and counting) of research on IT services offshoring set to culminate in the publication of a new book by Rottman and colleague Mary Lacity, Offshore Outsourcing of IT Work: Client and Supplier Perspectives, next spring.

A few weeks ago, Rottman took a similar trip to what some say is the next big IT outsourcing destination: China. This time he focused on Dalian, a city in the northeastern province of Liaoning dubbed “the Bangalore of China.” Fresh from his fact-finding mission, Rottman shared his initial impressions with CIO.com, including how Dalian compares to Bangalore, the biggest impediments to China’s success as an outsourcing destination for [North American and European] IT services, and why any IT leader who offshores to Dalian solely for labor cost savings is likely to lose his shirt.

CIO.com: Why did you decide to go to Dalian?

Joseph Rottman: I’ve been interested in China for a while. Dalian is being marketed by the Chinese government as “the Bangalore of China,” a hub for IT outsourcing (ITO) and business process outsourcing (BPO). I happened to have a little luck because while I was in Dalian, two national conferences were being held, one featuring a lot of national officials looking at the services model in general for China, and the other about outsourcing to China.

Whom did you interview?

Rottman: When I went to India in 2004, I interviewed customers and then asked if I could talk to their suppliers. In China, we started with the suppliers. I talked to individuals at five Chinese software companies. I looked at three U.S. companies who had captive centers [a company-owned, not outsourced, IT service delivery center] in Dalian. I also spoke to officials who run the technology parks there. In all, I conducted 37 interviews.

What captive U.S. centers did you visit?

Rottman: The only one I can name is Oracle. They have a 100-person center in Dalian. The other two wanted to remain anonymous. They were a Fortune 100 financial services firm and a 25-year old, privately held professional services firm who had set up a captive center to serve one client. Rottman: Mary (Lacity) and I went through the same thing in India with outsourcing. At the beginning of the movement, the companies want to hold their cards close to the vest.

The Oracle center does Japanese-facing BPO. There’s a large population of Japanese-speaking Chinese people in Dalian, since it was once occupied by Japan. So about 80 percent of the work done in captive centers and Chinese development companies supports the Japanese market.

What Chinese IT services providers did you talk to?

Rottman: I talked to people at Neusoft, which has 12,000 employees; Dalian Hi-Think Computer Technology Company, which has 2,800 employees; NewLand, which has 40 employees; Crystal, a small computer graphics and CGI, which has 100 employees; and a small startup called Netai-Techno, which has 40 employees.

I also conducted interviews of people running the software parks. IBM was there, Dell, HP—multinationals wanting a Chinese or Asian face to serve those customers. While we were there, I visited Intel’s $2.5 billion manufacturing center, which will employ 2,500 people (2,000 of them Chinese).

How did the software parks compare to those you saw in India?

Rottman: In some ways, you could have picked up the software centers in China and placed them in India. As general rule, the Dalian infrastructure was far more advanced and stable. But India’s BPO and IT infrastructure, once you get inside a software park or inside the campus of a Wipro, there’s a big difference. Dalian, as a city, is more advanced. But software parks within Bangalore are more advanced than Dalian.

The other really big difference between India and China is scale. It felt like, when you went to one of Dalian software parks that housed dozens of software development and BPO companies, that you could have fit it all within Wipro’s campus. A Dalian software park is like a campus for a single Indian firm. We gathered some data—if you took the 10 largest software development companies in China, the combined revenue is equal to just the fifth largest Indian supplier. And if you add up the head count for the top 10 in China, you’re at about the seventh largest Indian supplier. The Chinese market is very fragmented with a lot of smaller players.

Is that fragmentation simply a product of China’s maturity level as an outsourcing provider?

Rottman: Yes. India had an incredible start, going all the way back to the Y2K days. There was a national movement toward a service-based economy that predates that. They had national government efforts that help get the Infosyses of India off the ground. China just now started that movement.

Do you envision future Tatas or Wipros coming out of China?

Rottman: If you look at some of the market leaders, like Neusoft and DHC, they have goals to grow at the same speed as the Indians. But when you look at their base of growth, it’s going to be a long time. They can’t just grow to catch up. Today, Neusoft has 12,000 employees. Infosys has 85,000 employees. HP has 156,000 employees.

They want to go there. I got the sense that they have a good plan and some great year-over-year growth.

They’re doing things to try to improve the talent pipeline, like starting their own schools. Neusoft has its own system of private schools called the Neusoft Institutes of Information. It’s not a money-making proposition, only 5 percent of their revenue comes from the Institutes. It’s an effort to secure talent and secure quality. Approximately 15 to 20 percent of the graduates end up working for the company.

Do these Chinese companies want to move beyond serving the regional market?

Rottman: Yes. Neusoft has a few multinational customers. They do some embedded software work for Alpine Electronics on their GPS systems and they have a number of large Fortune 100 customers. But the majority of revenue still comes from Asia. That’s their sweet spot right now. According to people we interviewed, salaries in Tokyo are three to five times as high as Dalian, so Japan has nice labor arbitrage situation going there.

How does China compare to India, in terms of IT salaries?

Rottman: Is it cheaper in China? I hear contradictory information.

The U.S. companies I talked to saw wage inflation and housing inflation eating away very quickly at their savings. The staff augmentation company saw 30 percent wage inflation in 18 months. I think increasing demand and competition for talent from multinationals setting up captive centers in Dalian are helping to fuel the increases. And Dalian is cheaper than Shanghai or Beijing.

When you compare the cost of a C++ programmer in Dalian and Bangalore, you can’t make the comparison based on the hourly rate. So much goes into that, and the transaction costs – everything that goes into creating the mechanisms for work to be done like infrastructure, travel costs, rework costs, training, knowledge transfer, IP protection – are different. It usually ends up being a wash.

The companies that I interviewed were not going to China for cost savings, but either for a Japanese “face” to customers or for risk diversification. They cited things like the nuclear tensions between India and Pakistan. If you have all your eggs in that geopolitical basket and something happens, you need Plan B. So the large companies we talked to are looking at other places, whether it’s Costa Rica or China. They’re not chasing the cheapest programmer. In the case of Dell, they’d like to sell computers to China. With Oracle, it’s the same thing. What better way to service and understand an area than to set up a captive IT center there?

If I had no interest in selling my goods to Asia or servicing my customers in Asia, I’d stick with India. With the gigantic hurdles of [intellectual property protection] and English, it doesn’t make sense. If you were outsourcing to China just to save money, you would lose your shirt.

Let’s talk about some of those concerns for U.S.-based IT leaders looking at China as an outsourcing destination, like English language skills.

Rottman: English proficiency is the elephant in the living room. It’s a gigantic hurdle for Chinese development firms who want to go after the U.S. and English-speaking market, and you cannot underestimate how difficult that is going to be for them to solve this problem. To give you an example, the brochures for these conferences that were targeting U.S.-based multinationals were riddled with poor translations.

The government is going after this problem full force. English is required in universities. Corporations like Neusoft have a lot of English courses. A great example is Oracle. They have a game the general manager of the captive center put in place. If a manager catches an employee speaking Chinese, he can fine them one Yuan. But if an employee catches a manager, he can fine him 10 Yuan. It’s a fun game and people try to trick each other. And all the fines go into a kitty for parties. The GM says the only way to get better is to speak English all day, every day. It seemed to be paying off. The IT professionals in China view English proficiency as critical piece of their advancement. [But overcoming the language challenge] is still several years away…. I was surprised by how bad the English proficiency was. Many of the conference sessions I went to feature speakers speaking Chinese with English translation, and the English was incoherent. You couldn’t take any content away from some of the sessions. So you can imagine how the requirements definition phase would be going from English to Chinese to code.

How long before they start to overcome the language issue?

Rottman: It’s still several years away.

But, you know, what they’re really lacking is a NASSCOM [National Association of Software and Service Companies, India’s IT industry trade organization]. China has so many small players, but no forward-looking, outward-facing organization to coordinate things. It would be great to have a Chinese version of NASSCOM in place to help with marketing and act as a single clearinghouse of data on the market.

How deeply involved is the Chinese government in the outsourcing industry– for better or for worse?

Rottman: I never saw any communism, per se. Some officials I met with had the word “party” on their business card. I was never questioned. The visa was easy to get. It was just as easy to go there as anywhere else I’ve been. I asked the guy who set up the captive center for Oracle about government bureaucracy. He’s from Singapore, went to college in the U.S. and spent his whole career with Oracle. He said the bureaucracy and rules within Oracle made the transaction more difficult than anything the Chinese government did.

Tell me about the “10+100+1000” project.

Rottman: It’s a national initiative set up by the government. It’s a five-year plan, set up last year, to do with the service industry what they did with manufacturing. The goal is to have 1,000 Chinese IT and business process services companies, 100 multinational services companies with a significant presence there, and 10 service center hubs like Dalian.

Will that transformation from “made in China” to “serviced in China” be difficult? Is it one China is capable of making?

Rottman: They certainly think so. They’ve got a long way to go. But they want to be in the race. They’ll tell you, sure, we’d like to be India, but right now our goal is just to stay in the race. It’s my personal impression that they’re happy being a supplement or complement to India. They don’t need to replace India. And India doesn’t have that many Chinese- or Japanese-speaking people like China. So there’s definitely a role they can play.

Is China’s outsourcing market dependent on the investment of big multinationals? Why?

Rottman: They’re a key part of this. China needs the multinationals to come in and build up the intellectual infrastructure. In terms of understanding Western business models, Chinese companies almost seem to need a mentor. They need to see, up close and personal, how things work.

Part of that is happening with the return of expatriates educated in the West. The CTO of Neusoft was with IBM for 21 years. He’s their mentor. That’s why he was hired.

Having those 100 multinationals in China will help the outsourcing market. If my memory serves me right, that’s not how India grew. They grew organically with the TCS’s and Wipros leading the way. GE was there early on, but it was the Indian companies that attracted the attention.

Did you find that China was trailing India in areas like leadership and project management skills?

Rottman: Actually, it was similar to India. I think both suffer from what seems to be an Asian problem. China has a collective thinking mentality. When the boss asks the employee what he thinks, he says, “I think what you think.” You really have to work hard to encourage productive disagreement, debate, and individualism and tell them, “I don’t want you just to agree with me.” It’s an ingrained issue. India is getting better at dealing with it, but part of it may be that U.S. managers have come to expect it and manage around it.

When you ask Chinese managers what’s lacking in their new college graduates, they cite things like leadership skills and project management skills. They’ll tell you they need to teach them how to lead and how to be led.

What’s the employee turnover situation like in Dalian?

Rottman: Turnover is an issue. Job hopping is an issue. I don’t think it’s as severe in Dalian as it is in Bangalore. But it has the potential to be. When the multinationals start waving money in front of China’s IT professionals, it certainly could be. When I talked to the employees at Oracle, that name on the door was certainly a draw.

What about concerns about IP protection in China?

Rottman: That’s the other elephant in the living room. You walk down the street in Dalian and see pirated CDs and software everywhere. It’s still a big issue. According to the manager of one of the captive development centers in Dalian, that’s why China is not ready for hardcore development work yet. The safeguards are not in place.

Neusoft will tell you they have IP protections in place and your IP is safe with them. But the U.S. managers at the captive center will tell you they wouldn’t put that kind of development in China yet. But “yet” is the important word. It’s getting better. The Chinese government realizes it has to fix this because the first thing anybody asks is, “What about my IP?”

If you look at India, the market forces were stronger than any government efforts to protect IP. If Infosys let a flagship customer’s IP walk out the door, they’d be devastated. And that’s where IP protection in China is going to come from, the market forces.

In what ways was Dalian most different from the cities you visited in India?

Rottman: The security in India was almost oppressive. I had to pop the battery out of my Apple laptop before going into an Indian company. On the street and in the hotels, private security was everywhere. I didn’t see two police officers while I was in Dalian. It was much different. In India, I got the impression that it was rich and poor existing side by side but never interacting. And maybe that’s what the security was for.

Dalian was a much more comfortable city—very Western feeling and modern and clean. I was surprised at how Western the city felt. It was amazing the growth going on. It was like a forest of construction cranes. The concrete never stops pouring. You’d never mistake any city in India for a Western one. India is clearly India. It seems very decrepit (compared to Dalian). In India, you might see IBM’s beautiful building right next to a slum.

The chapter devoted to Dalian in your book will be titled “Can China Compete with India in the ITO/BPO Market?” What’s your answer?

Rottman: China will not replace India. And it will be years before they seriously compete with India for the larger market. It’s a small, immature, and fractured market. Even with China’s impressive growth, it’s not quite ready to capture significant market share.

I can’t imagine Neusoft and Infosys competing for the same business and Neusoft winning. [Neusoft lacks the depth and size to compete against companies like Infosys for large projects.] But if Alpine needs Japanese-speaking developers or Dell needs to service the Chinese market worth $1.3 billion in potential revenues, they’re not going to go to India.

So what’s the message for CIOs?

Rottman: Keep an eye on China. India surprised the market and U.S. companies had to catch up. Every firm should have a China plan. Every firm wants to sell things there, and outsourcing to China is a good way into the market.

If I were a CIO, though, I’d put BPO there before ITO. With BPO, there are processes that can be replicated. Tasks are well-structured and you can use the BPO center to benefit your Asian customers. That’s what Oracle is doing. China’s a pretty good spot to put Asian-facing customer service representatives.

Related reading:

• Outsourcing lessons learned in China
• The China gambit
• China struggling to compete in the IT outsourcing arena