The Future of China's Outsourcing Industry
August 26, 2013
How can China develop a domestic business services outsourcing industry that would leapfrog India? The undertaking would require covering a number of areas like contact centers in finance and accounting, help desks, software applications and development, managing IT infrastructure, server farms, and cloud and analytics applications.
A survey of more than 250 Chinese companies co-led by Duke University professor Arie Y. Lewin and Shanghai Jiao Tong University professor Liu Yi revealed that China's national goal of leapfrogging India may be more challenging than policy makers imagined. In addition, future plans of the fragmented China based industry indicate an increasing focus on the domestic market and away from competing for international business services outsourcing business. You can access his presentation and findings at the following link.
Professor Lewin unveiled these findings at a ceremony last month to celebrate the opening of Shanghai Jiao Tong University Antai College Chinese American Research Center on Global Sourcing. Lewin explains the latest survey findings in a Fuqua Q and A.
Can you explain the methodology for this latest survey?
The study surveyed China based business services outsourcing companies in five key cities - - Dalian, Beijing, Shanghai, Xian, and Suzhou. The survey was conducted in person. The respondents were C-level executives. Of the 250 service provider companies in the study, 179 (71.6%) are headquartered in China, 15% in Japan, and 6% in US.
The average size of providers in China is much smaller than their counterparts in the US. Small to medium providers (under 20,000 employees) account for 88% (220 providers), medium-large providers account for 11.2% (28 providers), and large providers (over 20,000 employees) account for only .004% (1 provider).
The business services outsourcing industry in China is still in its early phase of development. 79% providers in China have been in business for less than 10 years. In comparison, 71% of US providers have been in business for more than 10 years.
Based on this survey, what are the main challenges you see facing Chinese domestic providers competing for international services outsourcing business?
I would say that there are three:
1. Timing of entry into the global service provider market is a challenge for China because the global growth rate of the industry has leveled off and is entering a decline especially for mega IT outsourcing (ITO) and business process outsourcing (BPO) deals. It is much harder to gain market share in a declining market, especially in the face of aggressive pricing by India based providers to renew existing large ITO and BPO contracts. The best opportunities are in applications and software development (ADM), analytics, big data and mobile. Midsize companies offer the best opportunities for entering markets in the US and Europe.
2. Most domestic providers in China competing for international clients are handicapped by poor English competency, inflationary cost pressures, appreciation of RMB, high turnover and the never ending need to invest in staff training. Providers in most of the cities designated by the China's Central Committee to compete for and attract business outsourcing services do not have real cost advantages. Therefore, Chinese service providers must learn to compete on the basis of execution excellence, reliability, timeliness, security and robust processes.
3. There is a shortage of talent in general and specifically in high value added software development and analytics. High turnover rates indicate either tight labor markets and/or that the service provider industry does not offer attractive, exciting and fast moving career opportunities.
What role does timing play in China's outsourcing activities?
In 2009, China launched its national initiative at a time when the global market for sourcing of business services had started to level off and recently has shown evidence of decline mainly involving mega deals in ITO and BPO. Most of the actions by Forbes Global 2000 companies is centered on renewing contracts for large legacy IT infrastructure, business processes and staff augmentation contracts. Much of the effort is on pressuring provider margins on these contracts. At the same time many of same companies are focusing on getting more for the "buck."
You have been researching the offshoring practices of various companies in different parts of the world for many years through the Offshore Research Network at Duke University's Fuqua School of Business. How are companies doing in this area?
Our research shows that most companies are not very effective in their management of sourcing of business services. Very few companies that our project has studied in depth or who have participated in the 2013 sourcing capabilities survey consider sourcing of business services as a strategic capability beyond cost savings. Most responding companies do not manage shared services and outsourcing of business services as an integrated operation. Often the shared services organization and the outsourcing (offshoring) operations are literally at war.
However, our research reveals a slow but growing C-level attention to achieving higher sourcing effectiveness. Much of the effort is directed to simplification of procedures and processes, rationalizing number of providers, as well as adopting a holistic strategic approach to integrating internal shared services and outsourcing offshore options and to implementing fundamentals (including seamless coordination processes analogous to best in class supply chain management systems). This involves formal vendor management, clear measurable objectives, sourcing center of excellence, appropriate cost accounting systems (e.g. activity cost based accounting), defined processes for implementing existing and new service delivery structures (location, captive, outsource etc) and formalizing and communicating throughout the organization the allocation of realized savings. In one case involving a major Pharma company, all realized savings are allocated to augment the R&D budget. In another company a share of realized savings is allocated to a bonus pool for all employees involved.
What does China need to do to be more effective in attracting offshoring business services?
China needs to consider different strategies that are directed at capturing market share in the rapidly developing mid-cap market, competing in the applications and software development market and entering new markets such as analytics, big data and mobile. However, our survey suggests that many providers are choosing to focus on the less demanding domestic market. It is altogether clear that growth and development of the China based services outsourcing industry faces many challenges. However a few world class providers in China (domestic with international clients and US owned) provide concrete evidence that it is possible to build in China a high value added services provider industry.
The government designated 21 model cities to become hubs for attracting and nurturing the industry when it launched its national strategy to attract the business services outsourcing industry as new lever of economic. Most of the designated 21 hub cities have been very active in building "Tech Parks", offering various tax incentives and training programs. However, with the exception of Dalian which in 2009 already had in place significant sourcing activities for Japanese and Korea companies, success has been slow. Between 2009 and 2013 the domestic China based business services outsourcing industry has grown from $14 billion to $50 billion. To put this in perspective, the lowest estimate of the size of the global industry in 2012 was $600 billion. The share of India is approximately 20% whereas the share of China was under 8%.
What needs to happen for accelerating the impact in sourcing?
The success of growing the industry in China, however, will involve a multi-pronged strategy at the level of the two designated hub cities. There is a need for more investment in project management training, enhancing career opportunities and compliance and certification with ISO standards and six sigma methodologies (best business practices). Hub cities could also consider opening representative Chinese offices abroad to enable marketing activities by mid-size Chinese providers. Hub cities could also consider 'out of the box' initiatives such as guaranteeing the quality, timelines and security of intellectual property for services delivered by certified providers in their city.
The area of information security is also important. Eric Rongley, founder and CEO of Bleum (an American company headquartered in Shanghai which specializes in transaction systems), noted during our recent conference that 80-90% of all cyber attacks on western companies originate from China and that the pace was accelerating. Bleum spends almost 3 million RMB per year to maintain and further secure its fire walls and repel attacks. Information security is a significant threat that international companies need to consider and has the potential to negate other strategic advantages providers in China can offer.
Can you tell us about the Chinese American Research Center on Global Sourcing? Why was the center unveiled and what are its goals?
The center is one of fifteen country affiliates of the Duke Offshoring Research Network (ORN) which has been conducting research on the global business services outsourcing industry both from the client side (buy side) and from the provider side (how supply drives demand).
In 2009 the China Central Committee established a national priority for China to enter the global market for business services outsourcing. It designated 21 model cities (25 today) to become hubs for attracting the business services outsourcing business to China as new lever of national economic development.
The mission of the center is to focus on the development of the services outsourcing industry in China and determine what impact, if any, the China based services outsourcing industry has on national economic development.