Something unexpected is happening in the global outsourcing industry. While everyone’s attention has been fixed on India, which practically invented the concept of hiring someone offshore to carry out back-office functions at half the price but twice the quality, some other country has been quietly building up outsourcing capabilities and may be on course to eclipse the Indians.
The Philippines? Malaysia? Singapore? Vietnam? It’s actually China, according to accounting and consulting firm KPMG. “In the last three years, we have seen a dramatic change in the outsourcing scene within China,” says Egidio Zarrella, Global Partner, IT Advisory, at KPMG. “Our clients have been very surprised at the quality of infrastructure and even the English-language skills [in China].”
It’s a bold claim, but one that Zarrella backs up with evidence and analysis in a new report, Inside the Dragon: Outsourcing Destinations in China
. If KPMG’s projections pan out, the trend has implications on multinationals and other large companies in Asia that are outsourcing IT services, business processes and even R&D and other knowledge processes. If your competitors are going to China instead of India, will you find yourself at a competitive disadvantage?
That’s a question that CFOs will increasingly be asking. According to Zarrella, the key reason behind outsourcing is no longer just cost arbitrage. Equally or even more important is the need to ensure access to a reliable supply of abundant and skilled talent, among them engineers and finance specialists. There is also the issue of establishing shared services in a location that many companies expect will become their biggest market. China has already surpassed the U.S. as the world’s largest car market.
In 2007, says KPMG, China’s onshore and offshore outsourcing market stood at only US$7.5 billion. That figure nearly tripled to US$20 billion last year, according to the country’s Ministry of Commerce. By 2014, KPMG predicts, China’s total outsourcing market will stand at US$43.9 billion.
India is still the leader, accounting for 13% of the global offshore outsourcing market last year. But China is fast catching up; it had 8% of the offshore outsourcing pie. The Ministry of Commerce reports that the contract value of China’s offshore outsourcing reached US$14.8 billion in 2009, an increase of 153.9% over 2008.
Zarrella credits the Ministry of Commerce’s “1,000-100-10 Project” launched in 2007 for the impressive results. The goal is to establish ten Chinese cities as outsourcing bases, attract 100 international customers to offshore in these cities, and assist in the development of 1,000 large and medium-size outsourcing vendors to meet the needs of these multinational clients. The chosen cities enjoy supportive macroeconomic and other policies from Beijing as well as special-purpose funds to construct public information platforms, develop human resources and improve the infrastructure and investment environment.
The project has been expanded to a total of 21 Chinese cities. The KPMG report examines these 21 and three other cities that the accounting firm believes can also excel as offshore outsourcing bases. (Hong Kong is not included.) “I have seen 18 of these cities first-hand,” says Zarrella. “People don’t realise the profound changes that are happening there.” A top executive at one of his clients, a major U.S. investment bank, recently visited Shanghai, Hangzhou, Beijing and Guangzhou. “He’s never been to China,” Zarrella recounts. “He said: ‘I thought Hong Kong was fast and dynamic, but those four cities are all moving with vibrancy. We’re looking at operations now in those four cities.’”
The more foreigners get to see the 24 cities in KPMG’s list, the more they start to say, “Why can’t I go here?” says Zarrella. “Look at what the government’s giving me, look at what the skill sets are, look at what companies [like IBM, Microsoft, GE] are doing.” The mayor and other local officials take a direct hand when companies complain of problems. And each city competes with the rest in offering tax and other incentives, with some even picking up the tab for training outsourcing workers.
The world’s biggest MNCs have long been in China to manufacture and sell their goods abroad and, increasingly, in the domestic market. Now they’re coming to set up in services as well. “Microsoft’s R&D centre is in Hangzhou, which is trying to play the very high end,” notes Zarrella. “After Bangalore, it’s going to be the biggest R&D centre for Microsoft. For one of our clients, IBM, Wuhan is going to be its big global delivery centre. And IBM’s global head of procurement now sits in Shanghai.”
But the cities are also trying to differentiate themselves from each other by focusing on specific services and markets. Thus, northern China around the Bohai area, comprising Beijing, Dalian, Daqing, Harbin, Jinan, Qingdao and Tianjin, leverages on its established software enterprises to focus on IT services and on its supply of Japanese and Korean speakers.
“A shared culture and language are important in outsourcing,” notes Zarrella. They encourage empathy, a key ingredient in establishing and nurturing relationships. There are many similarities among Chinese, Japanese and Korean cultures, in the same way that the Philippines relates to the U.S., its former coloniser, Vietnam relates to France (also a coloniser) and India to the British. Northern China is also home to a number of Korean speakers displaced by the south-north tensions.
While English-speaking India and the Philippines, for example, look primarily for outsourcing clients in the West, northern China is finding growth from Japanese and Korean multinationals that cannot find enough young talent at home. Part of the strong growth of China’s outsourcing industry is due to Japanese business, which is outsourcing back-office functions to northern Chinese cities and to Brazil, which hosts a large Japanese community.
Eastern China around the Yangtze River Delta, comprising Hangzhou, Hefei, Nanjing, Nanchang, Ningbo, Shanghai, Suzhou and Wuxi, leverages on the development of Shanghai as an international financial and shipping centre. With a population approaching 20 million, Shanghai is the key hub in eastern China, with the other cities as its spokes. Suzhou, for example, is less than two hours away. Travel time will be cut when high-speed railway services become fully operational.
Southern China, comprising Fuzhou, Guanzhou, Shenzhen and Xiamen, boasts of geographical proximity to Hong Kong, Macau and Southeast Asia, and well-developed manufacturing and processing industries, including electronics and garments. Shenzhen, especially, is trying to establish itself as an outsourcing hub for high-end telecom services – it hosts China’s biggest telco equipment makers, Huawei and ZTE.
Even midwestern China, which lags all other regions in infrastructure and number of foreign businesses, is getting on the outsourcing game. Beijing has named Chengdu, Chongqing, Changsa, Wuhan and Xi’an as among the 21 “Model Cities for Service Outsourcing,” and as such are eligible for central government incentives.
But why does KPMG’s report contain 24 cities? The three extra locations are Qingdao, Ningbo and Fuzhou, which the accounting firm sees as having strong outsourcing potential despite being by-passed by the central government. Qingdao, for example, is close to Japan and hosts 145 software enterprises, 28 of them foreign, which employ more than 5,000 software professionals.
Can China keep the momentum going? Zarrella has no doubts. Only two countries have the means to become volume players, he says, and those are China, with 1.3 billion people, and India, with 1 billion. India has the head start, largely because of efforts by the private sector. The industry group, Nasscom, has essentially been left alone by the government.
China is taking a government-led approach. After all, only the state can provide the three basic ingredients for outsourcing: infrastructure, education and regulations. China has invested US$586 billion in ports, highways, airports, power plants and a modernised telecommunications network with high-speed broadband connections. About 1.8 million young people are currently enrolled in universities. China’s higher education system is ranked the world’s second-largest after the U.S.; India’s is No. 3.
But more needs to be done on the legal front. “I won’t say it’s a major downside, but it is an important downside,” says Zarrella. “The laws in China are still not clear. You’ve got one ministry telling you one thing and another telling you another. It’s still cumbersome to work out what legal structures you need to put in place in China. But to give the government their due, as time goes by, they’re not [automatically] saying no, no.” He sees Beijing as becoming more open to reforming the legal business environment.
KPMG does not necessarily see the future in terms of China versus India. The world is big enough for two outsourcing giants, Zarrella argues. Indeed, Indian majors like Infosys and TCS are establishing beachheads in China to serve Japanese and Korean clients. Indian companies have failed to penetrate these two Asian markets from home, but they are meeting success by going through their production bases in China.
The same is true of Asia’s other outsourcing centres. “If you look at the economic and geo-political climate, companies will not want to outsource and locate their shared services in one city or country anymore,” Zarrella says. China and India may become volume hubs, but the Philippines, Malaysia, Vietnam and Singapore can serve as important back-ups as well as specialist spokes in their own right. Tiny Singapore, for example, is carving out a niche for itself in R&D and knowledge areas, while the Philippines excels in call centres and business process outsourcing.
And don’t forget Hong Kong. Zarrella says the city remains an important financial hub despite Shanghai’s determined bid to regain its pre-communist status as a pre-eminent global financial centre. However, Hong Kong has not really upped its game even as the 24 Chinese cities in the KPMG report have been rapidly moving forward. Among MNCs, warns Zarrella, Hong Kong is being surpassed by the likes of Shanghai, Beijing and Guangzhou.
KPMG is now working on separate reports focusing on Hong Kong and Singapore and their outsourcing prospects. These should make interesting reading for governments and businesses in Asia and around the world. As companies and their CFOs know, the more suppliers there are, the more bargaining power buyers get in terms of cost, quality and performance.
About the Author
Cesar Bacani is senior consulting editor at CFO Innovation.