2006.5.16(화) Watch Out, India

[khan]

Outsourcing to China

Watch out, India

May 4th 2006 | XIAN
From The Economist print edition

China is way behind India in the business of outsourced services, but it has now started to catch up

Imaginechina

IN A vast curtained room in Xian in western China, rows of dark, pony-tailed heads are silently bowed, fingers moving quickly and expertly. They might be in any Chinese factory—except that they are not assembling shoes, nor soldering circuit boards, but sitting at computer terminals processing medical-claim forms from New York and car-loan applications from Detroit and marking examinations for high-school students in Melbourne, Australia. “This is the future of the global back office,” says Michael Liu. Mr Lui, founder of CompuPacific International, one of China's few indigenous business-process outsourcing (BPO) firms, returned after a decade in health-care IT in America, determined to prove that China can do just as well as India in outsourced services.

It is fitting that this future should be emerging in Xian, an old imperial capital that was the final stop for caravans travelling east along the Silk Road from central Asia and the entry-point for new cultural and scientific ideas. Though tourists know Xian for its army of terracotta warriors, the capital of Shaanxi province is quietly becoming one of China's most modern cities. Xian is the birthplace of the nation's space programme, its aircraft-construction hub and home to one of China's biggest technology parks—a 35-square-kilometre Chinese Silicon Valley housing 7,500 companies and supported by more than 100 universities that churn out 120,000 graduates a year, half in computer sciences alone. And that is just the start. The Xian High-Tech Industries Development Zone will eventually span 90 square kilometres at a cost of 100 billion yuan ($12 billion), says Jing Junhai, its director.

The sheer size of this undertaking betrays China's ambition to become a global power in software and services to match its pre-eminence in manufacturing. Attracting outsourced business is central to this. The worldwide market for offshore spending on IT services for (predominantly) Western companies will reach $50 billion by 2007, according to Gartner, a consultancy, and is growing in double digits. The market for BPO, which encompasses processing bills and credit-card applications to managing entire human-resources operations, should be worth another $24 billion by next year, and is expanding even faster.

India has captured the bulk of this work. While China is the world's top location for contracting out manufacturing, it has just $2 billion of the outsourced-services market, reckons Bill Lewis, the founder of Temasys, a Singapore-based consultancy. What activity there is happens mostly in Dalian, a north-eastern city where, for reasons of history and geography, many locals speak Japanese and Korean, and which therefore handles back-office functions for companies from Japan and South Korea. Xian's annual outsourcing revenues are a tiny 300m yuan ($40m), according to official figures. Over 90% of that comes from Japan.

But China has plenty of potential. Its workers are well educated in basic computing and mathematics. They may lack creativity, but they are disciplined and readily trained, making them better at tedious jobs than most Indians are. This suits the BPO business. “These are repetitive, rules-based tasks which you can train an army of people to do,” says Sujay Chohan, Gartner's research director. “They are not tasks that require innovation.”

Army is the right word: this business needs millions of low-cost workers, and China has them. India used to be cheaper, but salaries for graduates, engineers and programmers have been climbing fast and staff turnover at IT companies can reach 30-40% a year. China, where an entry-level BPO staffer is paid around $300 a month, one-tenth of the comparable American wage, is now very competitive. Henning Kagermann, chief executive of SAP, one of the world's biggest software companies, gave warning in January that India was becoming too expensive to outsource work there. China's big coastal cities are getting more expensive, but prices inland remain keen. Foreign firms are looking beyond Xian at cities such as Chengdu and Wuhan. Kaoru Miyata, head of NEC Xian, says both rental and salary costs in Xian are 40-50% lower than in Beijing and Shanghai, while Yasuo Noshiro, head of Fujitsu Xian system engineering, says the city is cheaper than fast-growing Dalian; and staff, with fewer opportunities to job hop, are more loyal.

Throw in China's superior infrastructure, tax breaks (though India's are also generous) and strong support from the state, plus the desire of multinational companies to spread risk away from India, and it is clear why many large companies are turning to China. IBM, Hewlett-Packard, Microsoft, Siemens and Infineon have been in China for several years and all are busily adding staff. Japan's consumer-electronics giant, NEC, has 180 people doing research and development in Xian and rival Fujitsu has 120 writing software.

The latest lot of companies to discover China, is, revealingly, the very Indian firms that make their money from outsourcing services. Tata Consultancy Services (TCS), the biggest, has a campus in Hangzhou. Infosys and Wipro are in Shanghai and Beijing and plan to increase their workforces from a few hundred to 5,000-6,000 each over the next few years. Genpact, the former offshore BPO arm of General Electric, also based in India, intends to triple its staff in Dalian from 1,800 to more than 5,000.

This expansion is being driven by burgeoning demand from overseas clients who want lower costs, a better spread of risk and local support for their growing Chinese operations. There is also a trickle of business from domestic Chinese companies. TCS is designing and installing a new software system for Huaxia Bank, China's 12th-largest. With every Chinese state-owned company hungry for basic IT and back-office support, that trickle could turn into a flood. James Amachi who runs the Xian office of GrapeCity, a Japanese IT outsourcing firm, says the domestic market is taking off sooner than he expected it to: “We thought it would be two or three years before we saw Chinese clients, but we are already working on a big domestic telecom project.”

Yet China is still five to ten years behind India, say most observers. It has two big disadvantages. First, although many Chinese can read English, they speak and write it badly. That's a problem in services that require frequent communication with overseas offices. Infineon employs two full-time English teachers in its Xian outpost. Michael Tiefenbacher, the managing director there, says: “It looks bad if our people cannot talk to their counterparts elsewhere. People confuse language competence with technical ability.”

Theoretically yes, in practice no

What's more, few Chinese engineering and computer graduates are as good as their qualifications suggest. While they often have a more solid grasp of theory than their European counterparts, few leave university able to apply it to real-life problems, such as developing software. “It is as if they can describe a hacksaw and how it works perfectly,” says Mr Amachi, “but have no idea how to build a door with it.” On a recent hunt for software developers, GrapeCity received 1,200 applications from Xian's six best technical universities. Only seven of them were suitable.

One reason is a lack of vocational training and few links between business and academia. In Europe and India, by contrast, engineering degrees demand work experience. And university teachers educated in a rigid, theory-based system are not able to prepare students for the real world. Wang Yingluo, a professor at Xian Jiaotong University and a member of the Chinese academy of engineering, says “a lot of us are not from industry and have no experience of the commercial world.”

As a result, foreign companies in China are spending a small fortune “subsidising China's education system”, as one puts it. Fujitsu's Mr Noshiro has put some 40 Chinese workers through intensive training in Japan, at a cost of $30,000 a year each. “They need two years of full-time training just to become a middle-level engineer and four years to get to be a project manager.” Mr Amachi says even after three years of training “only 10-20% of programmers ever get to a really good level and can become an architect. China has so many colleges and so many graduates, but the degrees are not as good as they sound.”

The same can be true for China's infrastructure. GrapeCity found its building and its computers flooded when it rained heavily the day after it moved into its new home in the Xian office park.

The fragmentation of China's domestic outsourced-services sector does not help. Most companies have fewer than 1,000 staff. CompuPacific has under 600 employees, compared with 60,000 at India's TCS. Though small-scale mergers will happen—CompuPacific has been approached by a local rival, a venture capitalist, and an American outsourcer looking to diversify out of India—local politicians hinder consolidation, sometimes blocking mergers with firms outside their regions if they risk losing influence. India, by contrast, has a national trade body, Nasscom, which can encourage developments such as consolidation that look likely to help the industry.

Meanwhile fears about piracy of intellectual property—more rampant in China than India—will constrain growth. Though foreign companies in China say that copying sophisticated IT processes is difficult and can be thwarted by relatively simple safeguards, the perception that sensitive business information is at risk is likely to slow development.

All this suggests that, for the moment, China is likely to capture an increasing share of low-level BPO tasks, such as data entry, form processing and software testing, while India continues to dominate higher-value functions, such as research and design, which require greater creativity and language skills. However, this will change as more western firms demand support in China and domestic opportunities grow. And it isn't just pure competition between the two countries: last year, TCS signed a deal with the Chinese government and Microsoft to build China's first big software company, which aims to provide IT services for the Olympics.