Indian outsourcing may be the poster-child of the global services industry, but the battle for predominance in the offshoring marketplace is far from over. Corporations considering offshoring work to low cost countries have become accustomed to seeing India as the obvious location, but recently China has started to emerge as an option. Does China have what it takes to be the new epicentre of offshoring, or is India’s pre-eminence unassailable?

Indian exuberance

India has good reason to celebrate its offshoring performance over the past 20 years. Covering activities ranging from IT, call centres to ‘Business Process Outsourcing’ (BPO) activities such as finance or HR, India’s share of the offshore market is typically estimated at around 60%.

India’s success is reflected both by the plethora of household names setting up in-house facilities, such as Tesco, Aviva or Google, and the range of outsourcers anchoring their ‘global delivery models’ in India. Significantly, outsource service providers encompass not only the established global brands such as Accenture, IBM and HP, but also the increasingly confident and successful Indian brands, such as Satyam, Wipro, Infosys and TCS.

But India’s dominance of the offshore market can be exaggerated. 40-50% of the offshore market is not controlled by India, and this is predicted to grow. Periodically news headlines question the quality and security of Indian offshoring. Recruiters complain of rampant wage inflation and attrition, whilst executives find it impossible to ignore the infrastructural shortcomings on the streets of Mumbai or Chennai.

Whilst India tackles these growing pains, companies considering offshoring (both inhouse and outsourced), have started to explore China as a sourcing location. At a time when China’s profile in corporate thinking has never been higher (think commodity prices or manufacturing), Chinese government bodies, local sponsors and conference organisers are starting to bang the drum for China in Europe and America. Executives are starting to ask whether China can upgrade from being the ‘workshop of the world’, to the ‘world’s back office.’

Ticking all the boxes?

At first glance, China appears to have many of the characteristics necessary to become an attractive offshore location, plus assets that set it apart from India. Analysis typically starts with China’s 1.3 billion population, setting it apart from all other offshore locations except India in terms of size nearshore locations such as Canada or the Czech Republic; the well developed university system, which tend to act as in other countries as ‘finishing schools’ for IT and BPO graduates alike; and very low labour costs, the primary driver of global sourcing. Chinese resource costs are in many cases comparable with India (particularly away from Beijing and Shanghai), with entry level employees for BPO tasks typically estimated at costing around $200 a month, with junior programmers at around $300-400 a month.

Additionally, China has transport infrastructure and technology superior to that of India, better communications bandwidth and connectivity, and a population that appears more technology orientated than that of India (with 3 times as many PCs and internet users, and 20 times as many mobile users than India). According to Sumeet Chander, General Manager for research and knowledge process outsourcer Evalueserve China, these are the basic building blocks of the sourcing industry: ‘If you have good universities, and good infrastructure, BPO will follow.’

Despite the absence of a strong industry group equivalent to NASSCOM in India, recent offshore investors in China have pointed to attractive tax breaks, land grants and support from local and central government agencies. According to Chander, ‘in terms of government support, in many ways China is ahead of India’, reflected by continuing government spending on science parks, infrastructure and financial concessions.

Complex realities

However, on closer inspection, offshoring to China is more complex that this, above all in terms of the employability of China’s abundant human resources. Although employability remains a major issue in India, China has its own set of HR challenges. Chander’s observations on the matter are typical: ‘in China employability is still a big concern - out of every hundred graduates we interview maybe only 10% are employable’.

Outsourcers cite two key employability issues – business skills and language. In terms of skills, outsourcers often complain of a dearth of management experience, and question levels of creativity and initiative shown by typical Chinese graduates. Clearly there are dangers of stereotyping here, and this does not deny that China has certainly has deep pools of talent that are there to be tapped, but many recruiters would agree with one outsourcer’s conclusion that ‘in terms of talent, India will continue to score above China’.This experience deficit is reflected by the fact that many Chinese offshore operations are lead, managed or trained by Indian expats.

The key employment issue in China is language ability. Unlike India, China has limited abilities in English or other foreign languages, with the exceptions of some Japanese and Korean ability. In a global market where three quarters of deals are managed in English, this constitutes China’s greatest offshore challenge. But the picture is slowly changing, above all through concerted investment in the education system, and outsourcers expect each new generation of graduates to have better English skills. The Chinese government is keeping up momentum, announcing plans to spend an extra $5.4 billion on language training to target the BPO market.

As a result, many outsourcers look forward to significant improvements in language skills. Evalueserve’s Chander believes ‘language will remain a big factor, but China will catch up on this front very rapidly - India’s language advantage will not be a lasting factor.’ In the meantime, corporations ramping up in China need to bridge the language gap themselves. In the words of Srikanth Iyengar of Infosys, ‘language is still an issue in China, requiring some strong induction and training, especially for mid-level resources’.

In addition to skills and language issues, China’s offshore prospects are also tempered by perceptions of the regulatory and political climate. Question marks around China’s political regime have generated heated debate, above all in the US, but these have visibly abated in the last two years. More tangibly, question marks regarding the legal system loom large for a country that only recently legally recognised the concept of private property, and where contract enforcement and intellectual property rights are far behind Western norms. China’s legislators are moving fast to address these points, but companies offshoring to China have had to mitigate these issues through closely managed security systems and processes to protect intellectual property.

Offshoring in China – the leading locations     [Map of China, showing:] Established locations: Shanghai Beijing Dalian   Emerging locations: Guangzhou / Shenzen Hangzhou Tianjing Wuhan Chengdu Nanjing Xi’an Chongqing

Out of the starting blocks

Whilst China may not be the perfect global sourcing location, with clear issues that need to be overcome on the ground, equally China is not terra incognita for offshoring. In fact the past 5 years have seen a steady acceleration in activity – both outsourced and inhouse. Despite a lack of reliable statistical data on the subject, the broad horizons of China’s offshore landscape are becoming clear in a few key directions:

1. Geographical spread.
• As is the case with India, China is not a homogenous location. Different regions within China offer different labour costs, political and regulatory conditions and infrastructural assets.
  
• The picture now emerging from China is of a select group of locations where IT and BPO offshoring is already taking place in some scale. The first investments were made 5-10 years ago, primarily in IT or R&D related facilities. These ‘established locations’ include Beijing, Shanghai and Dalian, where the availability of deep language or technical skills have coincided with demand from multinational clients.
  
• After a few years of investment in established locations, many outsourcers are building up scale and capabilities in a range of untapped emerging locations. These emerging locations include cities such as Hangzhou, Chengdu and Xi’an (where a 35 sq km ‘Chinese Silicon Valley’ is being built by the government). These cities are relatively distant from the more established locations, but significantly cheaper and with substantial capacity to grow [SEE DIAGRAM]. Their emergence mirrors the range of ‘tier 2’ cities in India, and the ‘hub and spoke’ operations that emanate from the leading cities such as Mumbai and Bangalore.
  
  
2. Players
• China’s offshoring expansion is driven by a range of participants. The first major offshore players were the in-house shared service and research centres for global brands such as Motorola and Oracle, from the mid 1990s onwards.
  
• Then came the global consultancies and outsourcers such as Accenture, IBM, BearingPoint and EDS. These organisations are continuing to accelerate their ramp up in China. For example, EDS is adding to its China capabilities in applications support, by developing BPO and network management offerings in China. By the end of 2007 EDS China is looking to double its presence to 2 locations with approximately 2000 staff.
  
• Thirdly, and revealingly, the major Indian outsourcing providers such as Satyam, Genpact and TCS have been investing in Chinese capabilities for the past 5 years. Infosys has been one of the leading Indian offshorers moving into China, with capacity for 250 software engineers in Shanghai, and up to 6000 IT and BPO workers in Hangzhou.
  
• The final entrants to Chinese offshoring are the indigenous Chinese service providers, which unlike India, have been slow to come to the fore. There are as yet only a small number of home-grown IT and BPO companies, such as Bleum, that are starting to raise their profile in Europe and America. This lack of Chinese service providers is likely to change in the coming years, organically or through acquisition.
  
  
3. Offshored activities
• China has been a location for manufacturing for decades, and this has contributed to an early offshore emphasis in hardware and software R&D facilities for the likes of Oracle, IBM and Motorola - the number of foreign R&D centres in China jumped from 200 to 600 between 2002 and 20041.
  
• However, in the core offshoring activities of IT and BPO, developments to date have been less spectacular. According to most commentators, IT support activities such as applications development and testing make up most of offshore work done in China today.
  
• BPO activities, such as Finance or HR, have lagged behind IT, but there is an expectation that this will change. According to Infosys’ Iyengar, ‘Chinese BPO activities are at the same level that IT was at 2½ years ago’. Research group IDC forecasts that the Chinese BPO market will grow rapidly over the next five years at a rate of nearly 40% a year.
  
• Many analysts indicate that due to limited Chinese foreign language skills, it will at present remain best suited to lower-end, transactional or rules-based processing, rather than more creative or analytical IT or BPO tasks. This will be a key factor in China’s offshore success.
  
  
4. Customer base
• China’s offshore customer base is built on two levels – regional, and global. Given cultural affinities and Japanese language skills in locations such as Dalian, around 80% of China’s current offshore activity is consumed by Japanese clients. Of the remainder, many are Cantonese language services via Guangzhou and Shenzen for Hong Kong clients. As a result, only a small part of China’s offshoring activity is currently offshored to more global markets such as the USA or Europe.
  
• This regional focus is a view backed up by Mitsuru Maekawa, CEO of Genpact China, whose services portfolio currently include Finance & Accounting, Collection Support, IT Infrastructure Management and Remote Help Desk Support. Whilst the range of services in China is growing, he concludes that for most service providers ‘voice-based services in Chinese or Korean are OK, but are very limited in English’.
  
• This regional focus is beginning to shift, as outsourcers gain business with multinationals operating (in English) in China. Evalueserve for example, has a number of global banking clients it provides research and analytical support to. Infosys too expects offshoring in China to become more globally orientated as capabilities and maturity increase.

Competitive or complementary?

This survey provides a picture of growing momentum behind China as an offshoring location, underpinned by regional language capabilities and driven by the growing importance of China as an operating priority for multinationals. As a result, offshore investments are accelerating and some analysts are predicting China reaching up to a 20%-30% share of the offshore market within ten years.

So China’s progress to date is significant, and its future looks promising - but it is also clear that comparisons with India are premature. India still has a headstart that will not be easily overturned. But extrapolating into the future, the question remains, will China’s gain be India’s loss?

The answer is no. India will continue to grow as an offshoring location despite China’s acceleration. China’s own internal issues regarding language and employability will act as a brake on China’s growth in global sourcing, as will the need for companies to avoid dependence on any one location. Srikanth Iyengar notes that ‘for Infosys, China is a derisking strategy, part of a strategy of building up globally distributed talent pools’. China and India look set to becoming mutually bound up in the business continuity plans of offshoring strategies, where one location backs up the other in the event of a disaster. This will mean that the two locations continue to develop together, not separately.

This is reinforced by the fact that the activities of Chinese offshoring facilities are becoming integrated into the wider architecture of global sourcing. Supply chains, process flows and development cycles are already interwoven geographically with facilities in India, Europe and America – and China is becoming part of this collaborative, distributed system.

Endorsement of this ‘complementary future’ is probably most clearly provided by NASSCOM, the Indian software industry lobby group. Progressive in its denial of the ‘China threat’ as long ago as 2003, NASSCOM was instrumental in promoting Indian corporate investment in Chinese offshoring, and the new wave of Indian facilities opening across China bear out the success of this engagement.

However, as a result of this integration, we can also expect to see specialisation – and China will start to start assert global leadership in specific offshore market niches. As is happening in other locations, clusters of offshore expertise will form in Chinese cities with the right blend and critical mass of skills, in specific aspects of application development, pharmaceutical R&D, or security systems. How China identifies these areas of specialisation, whilst addressing its language and management shortcomings, will be its primary challenge for the next few years. In so doing it will find its place in the offshoring market, alongside India - not instead of India.

Paul Morrison is a Managing Consultant at Alsbridge, specialist sourcing advisers. Paul helps organisations to develop offshoring and sourcing strategies, for clients across a range of sectors, both in the private and public sectors. Paul is a member of the Outsourcing and Offshoring Management Committee at Intellect, trade association for the UK’s High Tech Industry. Paul writes and speaks on a range of globalisation issues, most recently in ‘Technology and Offshore Sourcing Strategies’ (Palgrave). Paul can be contacted at paul.morrison@alsbridge.com.