Enter the Dragon: China’s Potential as a Global IT Services and Outsourcing Leader

October 11, 2009

1. Overview
While India remains the undisputed leader of the global IT services and outsourcing industries, China has increasingly shown up on the radar screen of companies who are seeking an alternative location for third party outsourcing or for setting up a shared services operation. In fact and in the latest A.T. Kearney Global Services Index, China once again ranked #2 (between India and Malaysia) out of 50 countries surveyed and this ranking has not changed since the index’s inception in 2004. However, does China really have the potential to become a global IT services and outsourcing dragon?

In this research report, we will examine this potential by addressing the following questions about the Chinese IT services and outsourcing market:

  • What are the key characteristics and drivers for IT services and outsourcing markets in China?
  • What is the government doing and not doing to encourage the growth of these markets?
  • What are the key operating factors, costs and risks to be aware of when outsourcing to China?

2. Key Facts and Trends
Although feeling the pinch from the global economic crisis, China is still the largest economy in the world and growing at approximately 8% per year. Hence, China’s IT services and outsourcing industries have enormous potential for growth stemming from both domestic and international demand. In fact:

International Data Corporation estimates the growth rate for the Chinese IT industry in general will slow to below 10% for 2009 as clients become cautious, especially over long-term projects, and buying cycles become longer. On the other hand, the Chairman of International Association of Outsourcing Professionals believes that China’s outsourcing industry potential is so huge that it would surpass the 13% estimated annual compound growth rate for the Asia-Pacific region.

Moreover, the Ministry of Commerce estimates the contract value for China’s outsourcing industry to have reached US$2.59 billion during the first quarter of this year – an increase of 25.9% over the same period last year while some analysts expect China to take up outsourced service work from around the world worth US$30 billion by 2013. Moreover, an estimated US$10 billion in outsourced deals from around the Asia-Pacific region will be up for renewal this year – providing the opportunity for the Chinese to make further market inroads.

ŸAlthough thirty-five countries were among the destinations for IT service exports from China, Chinese firms have developed a strong niche writing software for Japan and other East Asian nations [5]. In fact, the shared Confucian heritage of both China and Japan generally makes it much easier for the Chinese rather than the Indians to win business from the Japanese. Moreover, while the Indian software model stresses the delivery of software quickly and then testing and fixing it later, Japanese firms tend to expect perfection no matter how long it takes – a requirement that better fits the character of the Chinese.

ŸAccording to the latest (3Q2009) employment and market trends report by executive search firm Hudson, 33% of respondents from IT related firms expect to hire more staff, up from 25% during the previous quarter. In addition, the sector has experienced the smallest fall in hiring expectations year-on-year, from 38% in the 2Q2008 to 33% for the present quarter. However, respondents expecting staff cuts rose from 0% to 29% – indicating that some IT related sectors are doing well while others are facing steep declines in business. Likewise, respondents from IT related firms were the most conservative among overall respondents regarding whether the economy was in recovery with 53% unsure that an economic recovery is underway and just 28% of respondents anticipating a recovery by mid-2010 – indicating that many IT related firms, which are dependent upon business from firms in other sectors, are under pressure from the current economic downturn.

Nevertheless and while many local IT services and outsourcing vendors are obviously suffering as their SME clients are impacted by the global export slump, the those firms who have relied upon business from overseas markets should be able to use the expertise they have gained to further penetrate the domestic market while foreign IT services and outsourcing vendors looking to tap a more resilient market will continue to seek opportunities in China.

chinaOutsourcePotential Enter the Dragon: Chinas Potential as a Global IT Services and Outsourcing Leader

3. Market Characteristics and Factors to Consider
While the above facts and trends shed some light about the overall potential for the Chinese IT services and outsourcing industries, the following market characteristics and other factors need to be considered by any firm considering setting up a presence in or planning to outsource work to China:

  • Industry Structure
  • Government Support
  • Regulatory and Legal Structure
  • Intellectual Property (IP) Protection
  • Infrastructure
  • Human Capital
  • Operational Costs
  • Quality Track Record
  • Risk

3.1. Industry Structure: Highly Fragmented and Underdeveloped
China’s IT services and outsourcing industries are highly fragmented with small firms dominating the vendor landscape. In fact, it is estimated that there are 3,000 or so companies involved in IT outsourcing alone while a so-called major industry vendor will typically have only 1,000 to 3,000 full-time employees – the equivalent to Tier 3 Indian vendors such as Hexaware and Sonata

Moreover, while the IT services and outsourcing industries have long been considered ripe for consolidation and some potential industry leaders or consolidators have emerged (namely Chinasoft International, Sinocom Software, Shenyang Neusoft and VanceInfo Technologies), China still lacks the equivalent of globally recognized brand leaders to the likes of Infosys, Tata and Wipro. In addition, another hindrance for further consolidation is the general lack of M&A experience among local managers and the local management culture largely favors organic growth rather than growth via acquisitions.

Nevertheless, a few small publicly disclosed (but not particularly eye catching) M&A deals have occurred over the past few years involving either local or international players. Furthermore, a small handful of Chinese IT services and outsourcing vendors have even sought growth via foreign acquisitions and taking this path increasingly makes sense given the economic turmoil in the USA and Europe that is leaving many high-caliber professionals in these markets looking for work.

Table 1. Selected Mergers & Acquisitions Involving China Based IT Services or Outsourcing Vendors

Date

Buyer

Acquisition or Merger Target

Amount

June 2009Exigen ServicesTaihoo TechnologiesUndisclosed
January 2009Softpark Consultancies & ServicesAITACAUndisclosed
January 2009Softpark Consultancies & ServicesNICUndisclosed
September 2007Longtop GroupGuangzhou FenetUndisclosed
August 2007SofttekI.T. UNITEDUndisclosed
July 2007Longtop GroupAdvanced Business Services (Beijing)Undisclosed
July 2007Yucheng TechnologiesEasyconUS$3 Million
July 2007China Investment FundKingdeeHK$132 Million
December 2006SunGard Data SystemsShanghai Fudan Kingstar ComputerUndisclosed
December 2005China Unistone Acquisition Corp.Beijing SihitechUS$4 Million*
December 2005China Unistone Acquisition Corp.Channels Century TechnologyUS$4 Million*

* Beijing Sihitech & Channels Century Technology acquisition combined.

However and by and large, most Chinese IT services and outsourcing vendors still have difficulty scaling up to meet the demands of a large-scale client while many local IT or outsourcing projects remain largely project based and are small or below optimal scale. Moreover, the nature of the domestic market means that Chinese IT services and outsourcing vendors must typically compete on price to win business from local SMEs, leading to operating margins that tend to be smaller than elsewhere in the world, while demand for more sophisticated outsourced services is largely driven by foreign MNCs with a presence in the country or elsewhere in the region, local Chinese MNCs or export orientated firms who compete directly with foreign companies and domestic Chinese firms are seeking an edge in the local market.

Hence, few Chinese IT services or outsourcing vendors have moved up the value chain. Instead, they continue to largely take-on projects that involve basic tasks rather than high value projects while those firms who have ventured abroad and beyond the East Asia region to tap the USA market will largely stick with low skilled tasks such as coding or program testing. Moreover, since most Chinese vendors still see the local market as their biggest source for future growth, they generally lack a large in-country presence abroad to support a significant on-site component to any outsourcing delivery model.

3.2. Government Support: Strong but Local Policies are Confusing and Disjointed
Beijing has long viewed the creation and the development of an IT industry and increasingly an outsourcing industry as the keys to the country’s continued economic growth and success. Beginning in the 1990s, Beijing embarked upon a program to create economies of scale by encouraging industry clusters through the use of “industry guides” that identified the types of industries and sectors that could operate in every government created business parks in the country. This policy led to the emergence of dedicated software or IT parks and eventually the creation of eleven so-called “National Software Export Bases” in the major cities of Beijing, Chengdu, Dalian, Hangzhou, Jinan, Nanjing, Shanghai, Shenzhen, Tianjin, Xi’an and Wuhan. Moreover, firms that set up in specially designated outsourcing zones were given two-year tax waivers and subsidies of up to US$700 per employee for training and hiring and these incentives were further supplemented by a range of special incentives from local governments such as special deals for rent and land and even cash to attract locators from particularly desirable sectors [8].

In addition, the Chinese government announced earlier this year a new round of tax breaks and incentives along with intellectual property rights protection measures for the outsourcing industry with 20 cities being identified as pilot service outsourcing regions. Some of the incentives include a subsidy of up to 4,500 Yuan a year for every university graduate who is employed on at least a one year contract while other measures are intended to encourage consolidation by domestic IT services and outsourcing firms [9].

However and although all of these policies have helped to create an IT services and an outsourcing industry and should continue to fuel their growth, they have also led to increasingly unintended and negative consequences. Unlike in India where the generally held view is that any IT or outsourcing related activity is good for the country as a whole, it is not uncommon to hear Chinese officials in one business park/zone, city or province “badmouthing” other business parks/zones, cities or provinces in order to win new locators. This cutthroat competition between locations has also led to a confusing array of local (and often overlapping) investment incentives and special economic zones, many of which are not actually legally sanctioned by Beijing, are difficult to compare and may even leave companies facing substantial tax bills when such incentives are determined to be illegal. Moreover, China’s outsourcing industry lacks an effective and centralized PR machine to market the country as a whole and to provide foreign outsourcers with objective advice. Hence, foreign outsourcers should not expect the same level of objective advice in China about real estate, human capital or operational matters that they might receive in other countries.

3.3. Regulatory and Legal Structures: Incomplete and Inconsistent
Excluding the Special Administrative Regions of Hong Kong and Macau whose legal systems are based upon British common law and Portuguese civil law respectively, the Mainland Chinese legal system is largely a hybrid civil law system influenced by varous Continental European legal systems (and early 19th and 20th century German civil law systems in particular). Given that the Communists had largely abolished all legals systems after 1949, the current legal system in place is one that has slowly developed incrementally after the late 1970s and hence, remains a largely incomplete and inconsistent work in progress.

3.3.1. Legal Systems of the World
Further complicating matters is the fact that the law and regulations are subject to different levels of interpretation and enforcement from jurisdiction to jurisdiction. For example: While Shanghai has a reputation for being legalistic, the Guangzhou region tends to be more laissez faire while in some Western provinces and in many local jurisdictions around the country, personal connections outway any laws or regulations. Thus, many foreign enterprises choose to avoid domestic courts altogether by seeking foreign arbitration to resolve legal disputes.

In addition, although hiring and firing procedures have been simplified to some degree in recent years, there are still restrictions on layoffs by foreign-invested enterprises. And while labor unions exist in China, they remain largely passive and tend to support government efforts to tightly control labor unrest. However, Chinese workers at all levels are increasingly aware of their rights under the law and are becoming more willing to assert their rights – especially those who are working for foreign enterprises.

3.4. Intellectual Property (IP) Protection: Still Poor but Improving
China’s record for protecting intellectual property has long been and continues to be problematic for foreign investors. In fact and in the 2009 TaylorWessing Global IP Index report, China ranked dead last (behind India) out of 24 countries surveyed and ranked by their IP regimes. Nevertheless, while the report noted that the Chinese government is starting to do a better job of protecting IP rights and IP courts are becoming more effective, some survey respondents still had harsh words for the generally protectionist nature of the Chinese IP regime.

Table 2. The Taylor Wessing Global Intellectual Property Index 2009
The Taylor Wessing Global Intellectual Property Index is based upon an analysis of surveys of senior industry figures globally plus an array of published empirical data.

Jurisdiction

Tier

GIPI Rank

GIPI Rating

Trade Mark Rank

Patent Rank

Copyright Rank

Design Rank

Domain Rank

UK

1

1

776

1

1

2

2

1

Germany

1

2

760

2

2

3

1

3

USA

1

3

751

6

3

1

5

2

Australia

1

4

748

3

4

5

6

11

Netherlands

1

5

745

4

5

4

8

6

Canada

2

6

737

5

6

11

4

5

Ireland

2

7

731

7

8

7

7

4

New Zealand

2

8

723

8

9

9

11

12

France

2

9

713

9

11

6

3

7

Singapore

2

10

708

10

7

8

10

8

Japan

3

11

690

12

10

10

9

9

Israel

3

12

679

11

14

13

12

13

Spain

3

13

661

13

16

15

14

14

South Africa

3

14

656

14

13

14

17

20

South Korea

3

15

638

16

12

12

13

10

Mexico

4

16

617

15

18

17

16

15

UAE

4

17

610

17

15

18

18

17

Italy

4

18

601

18

19

16

15

16

Turkey

5

19

585

19

17

20

24

23

Poland

5

20

574

20

20

19

22

24

Russia

5

21

567

21

21

21

19

18

Brazil

5

22

537

22

23

23

21

19

India

5

23

521

23

22

22

20

22

China

5

24

491

24

24

24

23

21

Source: http://www.taylorwessing.com/ipindex/getfile.php?file=global_ip_index_2.pdf

Nevertheless and although IP piracy and enforcement of IP laws remain serious problems in China, it should not be an issue for companies engaged in low level IT outsourcing work if proper due diligence procedures are performed and strict guidelines are put in place when dealing with third party vendors. Moreover and when sensitive IP data is involved, a captive model will still be the best and safest strategy to pursue in China while implementing proper internal protection systems in general will go a long way towards protecting IP from theft.

3.5. Infrastructure: Excellent and Improving
China has spent considerable resources to build and upgrade its physical infrastructure in order to sustain economic growth and when the country sets about building an infrastructure project, the project will generally be completed no matter the human or capital costs. Hence and generally speaking, if a foreign investor needs a reasonable infrastructure improvement, they can almost be assured that the project will be considered by officials and completed within a reasonable timeframe.

And although China’s motorway network is considered inadequate to handle the growing volume of traffic, transportation links are nevertheless well developed and outsourcers will find that major technology parks tend to be located near modern airports and hence, getting around is generally not a problem. Furthermore, China’s major cities are well serviced by international and regional flights while even medium and smaller Chinese cities will have extensive domestic air links.

Moreover, China’s telecommunications infrastructure is excellent with relatively high penetration rates for both mobile telecommunications (41 per 100 people) and broadband internet (90 million subscribers)[10][11]. However, China was ranked 56th (between Venezuela and Egypt) out of 70 countries profiled in the 2009 E-readiness report from the EIU and ranked 46th place (between Italy and Thailand) out of 134 countries surveyed for networked readiness by the World Economic Forum’s Global Information Technology Report 2008-2009. Nevertheless, this was a better showing than India which ranked 58th and 54th respectively.

Table 3. The Economist Intelligence Unit’s (EIU) E-readiness Rankings and Scores (2009)
The Economist Intelligence Unit (EIU) assesses the world’s largest economies on their ability to absorb information and communications technology (ICT) and use it for economic and social benefit. While China’s ranking (#56) was ahead of both India (#58) and Vietnam (#64), it was behind the rankings for the Philippines (#54), Argentina (#45), Brazil (#42), Mexico (#40), Malaysia (#38) and nearly all Central and Eastern European countries.

2009 Rank

2008 Rank

Country

2009 Score

2008 Score

5053Jordan

4.92

5.03

5146Saudi Arabia

4.88

5.23

5258Colombia

4.84

4.71

5351Peru

4.75

5.07

5455Philippines

4.58

4.90

5552Venezuela

4.40

5.06

5656China

4.33

4.85

5757Egypt

4.33

4.81

5854India

4.17

4.96

5959Russia

3.98

4.42


Source: http://graphics.eiu.com/pdf/E-readiness%20rankings.pdf

Table 4. The Networked Readiness Index 2008–2009 Rankings
The World Economic Forum’s Networked Readiness Index takes into account the presence of an ICT-conducive environment and the degree of preparation needed to use ICT along with its actual use by individuals, the business sector and the government. While China’s ranking (#46) was ahead of India (#54), Brazil (#59), Mexico (#67), Vietnam (#70), the Philippines (#85) and Argentina (#87), it was behind the rankings for Malaysia (#28) and some Central and Eastern European countries.

2008–2009 Rank

Country/Economy

Score

40Saudi Arabia

4.28

41Hungary

4.28

42Puerto Rico

4.23

43Slovak Republic

4.19

44Jordan 4.19

4.19

45Italy

4.16

46China

4.15

47Thailand

4.14

48Latvia

4.10

49Croatia

4.09

50Oman

4.08

Source: http://www.insead.edu/v1/gitr/wef/main/fullreport/index.html

However, there are growing concerns over the January 2009 announcement that the National Certification and Accreditation Administration will require product certification for 19 different types of security products. While the new rules appear harmless, industry players are concerned primarily about the speed and scope of the planned implementation and the potential that these new rules will be used to block or slow the introduction of foreign technologies into the Chinese marketplace (hence, impacting the IT services and outsourcing industries).

3.6. Human Capital: Skills Shortages and Language Barriers
The Chinese education system remains inadequate and still focuses on the teaching of theory rather than practical knowledge and problem solving skills. Hence and despite having a large and generally well educated workforce, many Chinese graduates still lack project management, business analysis and soft skills while many employees lack deep subject matter expertise or technical knowledge.

Furthermore, there has long been a shortage of experienced project managers and middle managers and a relative lack of English language business skills among IT graduates, managers and employees in general as Mandarin is still the main language of business. Hence and when Chinese outsourcers engage foreign clients, the project or account manager will generally have the best English language skills and will be responsible for all communications with the client. However and since other team members will often have little to no English language skills (aside from basic reading), inefficiencies and quality control problems often occur.

However, larger domestic Chinese firms and MNCs are addressing these shortfalls in education through training programs while the Chinese themselves are increasingly venturing abroad to work or to study for a period of time.

3.7. Operational Costs: Competitive but with Hidden Costs
China has both an advantage and a disadvantage when it comes to operational costs. While the per hour rate charged for outsourced work in China is generally less than the rate charged in India, hidden costs in the form of communication problems, data and IP security, knowledge transfer rates and regulatory issues may easily erase any competitive cost advantage.

However, given the fact that the Chinese government is the ultimate determiner of exchange rate direction and has largely sought to keep the Renminbi or Yuan undervalued to protect its exporters and pegged to the US dollar, China provides a much more stable exchange rate environment compared with many other outsourcing destinations.

Table 5. Exchange Rates (Rmb:US$)
table5 Enter the Dragon: Chinas Potential as a Global IT Services and Outsourcing Leader
Source: Economist Intelligence Unit (EIU) end of period data.

Meanwhile, salary packages are now declining for many Chinese IT professionals due to the fallout from the global financial crisis. According to the latest (3Q2009) employment and market trends report by executive search firm Hudson, 43% of respondents from IT related firms indicated that salaries for new managerial hires are now falling (44% of respondents indicated new hires are accepting 11-20% reductions and another 12% indicated a cut of 21% or more) and although there are new projects in some IT related sectors, the industry has the highest proportion of employers (10%) planning actual staff cuts.

However, overall demand for IT and other professionals in general is mixed with some professionals being forced to accept lower pay packages while other professionals, especially those with excellent English language capabilities, are still in demand and will command a salary premium.

Table 6. 2009 Hays Salary Survey for Asia
(All salaries are annual and in local currencies)

Analyst Programmer

MS.Net / J2EE

VB6 / ASP / SQL / Delphi / C++

Oracle Forms / Reports

Hong Kong500 – 600k400 – 550k450 – 600k
Singapore48 – 60k48 – 60k60 – 75k
China150 – 260k140 – 250k160 – 280k
Japan8 – 12m8 – 12m8 – 12m

Senior Analyst Programmer

MS.Net / J2EE

VB6 / ASP / SQL / Delphi / C++

Oracle Forms / Reports

Hong Kong500 – 600k400 – 550k450 – 600k
Singapore48 – 60k48 – 60k60 – 75k
China150 – 260k140 – 250k160 – 280k
Japan8 – 12m8 – 12m8 – 12m

Data Specialists

Data Architect

DBA

Data Modeller

Data Warehouse Consultant

Hong Kong500 – 750k400 – 550k400 – 650k400 – 650k
Singapore80 – 130k80 – 130k100 – 175k70 – 150k
China200 – 330k200 – 350k200 – 330k180 – 320k
Japan8 – 14m8 – 16m7 – 12m6 – 10m

Management Roles

Development Team Leader

Development Manager

Hong Kong900k – 1.5m1 – 2m
Singapore90 – 200k150 – 260k
China220 – 400k300 – 550k
Japan8 – 15m10 – 16m

WAN

Cisco Engineer

Voice/Comms Engineer

Network Design

Technical Architect

Solutions & Enterprise Architect

Hong Kong450 – 600k400 – 600k450 – 600k650 – 750k850k – 1m
Singapore36 – 48k36 – 45k42 – 60k35 – 80k80 – 130k
China150 – 230k150 – 250k150 – 250k190 – 400k200 – 450k
Japan7 – 14m7 – 14m7 – 14m8 – 16m8 – 16m

Technical Specialist

Security Engineer

Security Consultant

Messaging Specialist

Unix Consultant

Pre Sales Engineer

Hong Kong500 – 600k600 – 800k600 – 800k400 – 600k400 – 600k
Singapore60 – 100k45 – 72k60 – 90k72 – 120k80 – 130k
China170 – 300k220 – 420k220 – 400k200 – 300k200 – 300k
Japan7 – 14m6 – 12m7 – 14m7 – 14m8 – 14m
Management Roles Helpdesk ManagerNetwork Manager IT Manager
Hong Kong600 – 850k600 – 800k840k – 1.2m
Singapore66 – 120k72 – 130k80 – 150k
China200 – 400k250 – 450k400 – 800k
Japan8 – 14m8 – 14m12 – 18m

Analysis & Project Role

Technical BA

Business / Process Analyst

Systems Analyst

Hong Kong550 – 750k450 – 800k400 – 700k
Singapore100 – 180k100 – 180k72 – 110k
China220 – 320k220 – 320k180 – 250k
Japan8 – 10m8 – 10m8 – 10m
Analysis & Project Role Project Manager Program DirectorIT Audit
Hong Kong600k – 1.5m1 – 2m350 – 550k
Singapore90 – 180k180 – 300k80 – 160k
China150 – 400k400 – 800k200 – 350k
Japan8 – 12m8 – 14m8 – 11m

ERP / CRM

PeopleSoft Technical

PeopleSoft Functional

Basis Administration

SAP Analyst

Hong Kong550 – 750k550 – 700k350 – 500k350 – 550k
Singapore70 – 130k90 – 150k80 – 130k60 – 110k
China200 – 350k250 – 400k180 – 300k180 – 300k
Japan8 – 12m7 – 12m7 – 12m8 – 16m

ERP / CRM

SAP Functional Consultant

ABAP Developer

Oracle Developer

Hong Kong450 – 650k350 – 550k600 – 800k
Singapore70 – 130k48 – 72k60 – 110k
China200 – 350k180 – 280k200 – 350k
Japan8 – 12mN/A7 – 14m

Source: http://www.hays.com.sg/salary/pdfs09/InformationTechnology.pdf

Table 7. Hudson Salary Survey: Asia IT&T (2009)

HONG KONG

SINGAPORE

SHANGHAI

Years of experience

HK$ Annual package

S$ Annual package

RMB Annual package

General Manager

15+

1.5M – 2.5M350K – 600K1M – 2M
Managing Director

15+

2M – 5M380K – 750K1.5M – 3M
CEO

20+

3M – 6M600K – 1.5M
VP of Sales

15+

2M – 3.5M350K – 600K800K – 1.5M
Country Manager

15+

2M – 5M300K – 450K1M – 2.5M
Sales Manager

8+

900K – 1.4M120K – 240K400K – 800K
Sales Director

12+

1.5M – 2.5M220K – 380K700K – 1.5M
Professional Services Executive / Director

10+

700K – 2.2M120K – 450K700K – 1.5M
Post-Sales Executive / Director

8+

600K – 1.6M80K – 320K650K – 1M
Pre-Sales Executive / Director

8+

700K – 2.2M100K – 240K650K – 1M
Project Manager / Director

8+

600K – 1.8M120K – 260K500K – 1M
Business Analyst

7+

500K – 800K100K – 150K200K – 500K
System Architect

7+

600K – 1.3M120K – 200K300K – 800K
Marketing and Product Management

8+

700K – 1.5M120K – 180K500K – 1.2M

Source: http://china.hudson.com/documents/Hudson-Asia-IT-Telecommunications-Salary-Information.pdf

3.8. Quality Track Record: Lack of a “Service Culture”
China still lacks an overall “service culture” that can be found in countries such as India that have well established IT services and outsourcing industries catering to foreign clientele. Moreover and generally speaking, the majority of domestic Chinese organizations still focus on cost rather than quality or value creation when making IT or outsourcing related decisions and generally speaking, they are not willing to pay for implementation and consulting services.

Nevertheless, an increasing number of Chinese firms are becoming more quality conscious and are beginning to seek quality certifications while IT services and outsourcing vendors who are catering to the Japanese market (where perfection is largely expected) have developed a reputation for both quality and on-time project delivery.

3.9. Risk: Moderate but Rising
Despite the recent protests in the Western regions of Tibet and Xinjiang along with rising economic and social conflicts and tensions (i.e. corruption, land seizures, urban versus rural income disparity and urban unemployment), the Chinese Communist Party (CCP) remains firmly in control – tolerating neither widespread dissent nor crime. However and with that said, the next few years will be a difficult period for the CCP as it will become increasingly difficult to maintain strong economic growth and to contain rising dissent.

Nevertheless, China has minimal exchange rate fluctuations while the risks of a Mumbai-style terrorist attack are also negligible and the country’s relations with its neighbors are largely stable and peaceful. However, foreign outsourcers who are operating in or considering setting up operations in China should be most concerned about the generally high level of corruption and inconsistent regulatory and policy implementations at the local level. Moreover, the continued chaotic finances of many local jurisdictions may lead to more ad hoc charges and fees being levied by local governments in order to raise funds.

However and at the end of the day, the authoritarian nature of the Chinese government inevitably means that when government attention is focused on a particular issue or problem, something significant will likely and quickly be done to address it.

Table 8. Economist Intelligence Unit (EIU) China Risk Assessment (July 29, 2009)
The EIU concludes that the overall risk of doing business in China is moderate to high. In particular, the EIU notes that while security and macroeconomic risks in China is low, legal and regulatory risks are relatively high.

RISK RATINGS

Current

Current

Previous

Previous

Rating

Score

Rating

Score

Overall assessment

C

46

C

46

Security risk

B

32

B

32

Political stability risk

C

55

C

55

Government effectiveness risk

D

79

D

79

Legal & regulatory risk

D

62

D

62

Macroeconomic risk

A

20

A

20

Foreign trade & payments risk

B

36

B

36

Financial risk

B

29

B

29

Tax policy risk

B

38

B

38

Labour market risk

D

61

D

61

Infrastructure risk

C

50

C

50


Source: Economist Intelligence Unit (EIU)

4. Conclusion
For IT services and outsourcing vendors looking at tapping business in an economy that will continue to grow and may one day become the largest in the world, establishing a presence in China before the inevitable shakeout and consolidation of local industry players should be a top priority. However, foreign IT services and outsourcing vendors along with foreign MNCs potentially thinking of outsourcing work to China need to be aware that success may be hampered by language barriers, human capital deficiencies, inconsistent government incentive policies, IP issues and a legal and regulatory structure that is still largely a work in progress. Nevertheless, the Chinese government is determined to turn the country into a major global IT services and outsourcing player and the country is fairly competitive on cost (albeit when hidden costs are kept in mind), has excellent infrastructure, offers a stable exchange rate environment and comes with few other surprises given the authoritarian nature of the country’s government. In other words, China has the potential to become a true global IT services and outsourcing dragon.

References
1. Lee, Woods. “IT outsourcing firms see risks, openings in downturn.” South China Morning Post. January 20, 2009.
2. Ibid.
3. Outsourcing Still Hot Business in China. Chinadaily.com.cn. June 19, 2009.
4. Perez, Bien. “China and India play balancing act in lucrative outsourcing market.” South China Morning Post. April 30, 2009.
5. China 07 Exported USD1.9bn Software and IT Services. SinoCast. June 19, 2008.
6. Lee, Woods.
7. Blount, Greg and Schmidt, Paul. Proceed With Caution When Considering Large-Scale ADM Outsourcing in China. TPI. August 2008.
8. Lee, Don. “China marches into outsourcing Los Angeles Times. April 8, 2008.
9. “China vows to create 1 million service outsourcing jobs for graduates.” BBC Monitoring Asia Pacific. April 10, 2009.
10. “The Global Information Technology Report 2008-2009.” World Economic Forum. 2009.
11.  E-readiness rankings 2009. EIU. July 2009.


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