Vietnam: Asia’s Newest IT and Outsourcing Tiger

January 28, 2010

Pages: 1 2 3

1. Overview
While Vietnam has clearly emerged as an alternative to China for manufacturing work, the country is also increasingly showing up on the radar screen of companies seeking an alternative destination for outsourced IT work and outsourcing in general. However, does Vietnam, a country more known for exporting basic commodities and manufactured goods, really have the potential to become a major IT services and outsourcing player?

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

• What are the key characteristics and drivers for IT services and outsourcing markets in Vietnam?
• 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 Vietnam?

2. Key Facts and Trends
Although Vietnam has felt the pinch from the global economic crisis and the slowdown in American demand for imports, the country’s economic fundamentals and the potential for its IT services and outsourcing industry remain strong. In fact:

• Nearly two-thirds of Vietnam’s population of 85 million is under the age of 35 and the country has one of the highest literacy rates in Asia at 90%. Moreover and for the 10 years leading up to the global financial crisis, Vietnam was consistently Asia’s second-fastest growing economy after China with average growth rates of 7.5%. For 2009, Vietnam is expected to have had 5.5% growth compared to 6.2% growth for 2008 while for 2010 the government is targeting a growth rate of 6.5% to 7% [1].

• On the export front, Vietnam’s strategy has been to carve out niche markets where it could either deliver quality products or specialized products that its major competitors like China could not. In 2009, the USA was Vietnam’s biggest export partner accounting for nearly a fifth of the country’s total exports. Hence and during the first 10 months of 2009, Vietnamese exports fell 13.8% compared with the same period the year before. However, this export drop is still less than the declines seen in most other developing countries [2].

• IT is considered to be one of the fastest growing industries in Vietnam. From 1995 until the end of 2008, the country had attracted 332 foreign-invested IT projects worth US$2 billion [3]. Moreover, IT spending is predicted to grow at a compounded annual growth rate of 10.5% between 2008 and 2013 and reach US$3.51 billion in 2013 [4].

• While IT services often account for a significant part in the total revenue turnover of IT industries in other countries, they remain insignificant in Vietnam. In 2008, one media source estimated that IT services reached a turnover of only US$2 billion while a second media source quoted US$648 million or 0.5% of GDP for the entire software and IT services industry [5] [6]. Meanwhile, the chairman of the Ho Chi Minh City Computers Association has stated that if the entire software and IT services industries maintains a year-on-year growth of 40%, it will reach US$6.2 billion in revenue or 2.5% of the country’s GDP by 2020 [7].

• However, other local industry experts are quoted as saying that if the Government continues investing in and encouraging the IT and IT services industry, it could contribute from 8% to 10% towards Vietnam’s GDP by 2020. Furthermore and by 2025, theses experts predict that the entire industry could equal the role that the construction industry plays in the country’s economy [8].

• Meanwhile, Ho Chi Minh City’s Municipal Information and Communications Department estimates the city is home to nearly 12,000 IT firms and by the end of 2009, these businesses are expected to earn around US$1.9 billion or approximately 40% of the country’s total IT revenue. Of these 12,000 IT related firms, 4,000 hardware businesses will likely contribute nearly US$1.6 billion in revenue while the remaining 8,000 software and digital businesses will likely contribute nearly US$325 million in revenue [9].

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
As in many emerging markets, the general IT and outsourcing industry in Vietnam is highly fragmented. The country currently has around 10,000 firms licensed to provide IT services but only about one-third of these firms are actually operating [10]. Moreover, up to 70% of companies operating in the IT and related industries have capital below VND1 billion and less than 10 employees [11].

However FPT Software, considered the biggest IT market player (whose parent company, FPT Corporation, is a highly diversified conglomerate with US$1 billion in revenues) employs 2,700 software engineers and had revenues that reached US$42 million in 2009 [12]. Other major domestic IT players include CMC, Global CyberSoft (headquartered in California but with a Global Delivery Center in Ho Chi Minh City) and TMA. And while major domestic IT industry players have expressed plans to aggressively expand regionally, such plans are still largely a work in progress.

Meanwhile, multinational firms such as Accenture, Alcatel-Lucent, Anheuser Busch, Bayer, BMG, BP, Cisco, Critical Path, Daiwa, Flextronics, Fuji, Harvey Nash, Hitachi, IBM, Intel, Juniper Networks, Merrill Lynch, Microsoft, NEC, Nortel Networks, NTT, Oracle, Sony, Spacebel, Toshiba and Unisys have all reportedly outsourced IT related work either directly or via third parties to Vietnam while some MNCs have either setup or are looking to set up global delivery centers (For instance, IBM has already set up global delivery centers in both Hanoi and in Ho Chi Minh City). Moreover, a number of Japanese companies in particular have been outsourcing IT services work to Vietnam for several years. In fact, Russian IT outsourcer Luxoft has even opened a delivery center in Ho Chi Minh City with the intention of tapping the Japanese outsourcing market as Vietnam is considered a preferred destination for Japanese companies to outsource work to.

In addition, several publicized mergers or acquisitions have occurred involving MNC or foreign based companies and Vietnamese IT related firms. This includes Japan-based CPR International’s purchase of a 15% stake in the Sarah Group (a local software developer) for US$2 million, UK-based Harvey Nash’s purchase of SilkRoad Systems Limited (a local software developer) for up to US$1.8 million plus payments of up to US$232,000 over three years, the Japan VietnamGrowth Fund’s purchase of a 5% stake in Dinh Gia Net Joint Stock Corp (DigiNet), the local subsidiary of Japan based NEC Solutions’ merger with Sang Tao Corporation (a local software and web developer) and the merger between France-based Capgemini and IACP Asia (a local subsidiary of France-based IT Consultancy, IACP Informatics).

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

Date

Buyer

Acquisition or Merger Target

Amount

December 2009 Avnet Inc Hong Quang (Sunshine) Joint Stock Company Undisclosed
November 2009 Capgemini IACP Asia* Undisclosed
June 2008 NEC Solutions Vietnam Co. Sang Tao Corporation Merger
March 2008 Japan VietnamGrowth Fund (JVGF) Dinh Gia Net Joint Stock Corp (DigiNet) 5% Stake
June 2007 Harvey Nash SilkRoad Systems Limited Up to US$1.8 + payments of up to US$232K over three years.
February 2007 CPR International Sara Group US$2 million for a 15% stake.

* Merger. Software outsourcing company IACP Asia is based in Ho Chi Minh City and is a subsidiary of IACP Informatics in Paris, France.

3.2. Government Support
In recent years, Vietnam has made strides in liberalizing the investment environment around technology startups and these efforts have attracted the attention of technology focused private equity funds like IDG Capital and Mekong Capital. Some of the incentives specifically meant for technology firms include no VAT tax and no corporate income taxes for the first 4 years and a 50% tax exemption for the subsequent 9 nine years.

In addition, Vietnam now has at least 186 industry zones and five software zones that cover nearly 45,000 ha and 737,000 sqms respectively and these zones play a central role in the country’s strategy to attract foreign investment into the country’s IT sector [13]. Such zones attract firms via tax incentives and value added-tax rebates and they also offer services for processing tax and business applications, relaxed rules for the entry and exit of expatriates and excellent infrastructure compared to what is often found outside of the parks.

Five software zones (the Quang Trung software park, the Sai Gon software park, the E-Town 1 & 2 zones and the HCM City hi-tech zone) are now located in Ho Chi Minh City as the city has adopted a number of policies and measures that are designed to attract both domestic and foreign investment into the IT and software industry. One zone worth noting is the 430,000 m2 Quang Trung Software Park which was founded in 2001 and is now home to 104 IT businesses (55% of which are foreign owned) with a total investment of 6.6 trillion VND (US$360 million). These IT businesses employ 3,500 engineers and technicians and have an annual turnover of more than 1 trillion VND (US$54 million) [14]. In addition, two other large software parks are being constructed in the city and this includes the US$610 million Vietnam-Japan Knowledge Park and the US$1.2 billion Thu Thiem Software Centre [15].

Moreover and in July of 2009, it was announced that the government of Vietnam will spend VND980 billion ($58 million) by 2012 to boost the development of the country’s software and digital content industry [16]. The funds will be used to train IT professionals who are in high demand by both local and foreign companies. In addition, Vietnam’s government already provides tax credits for engineering and computer science students.

Vietnam-Outsourcing Tiger

3.3. Regulatory and Legal Structures
The Vietnamese legal system and legal thought is based upon three major influences: Confucianism from China, the Napoleonic Code from France and Marxist-Leninist thought. However, Vietnam is also a one party state with all Vietnamese political organizations under the control of the Vietnamese Communist Party. Hence, there is no separation of powers between executive, legislative and judicial branches of government. Moreover, a Party Congress meets every five years to set the general direction of the party and the government with the next Party Congress set to meet in 2011.

Nevertheless, the involvement of the state in Vietnam’s economy has gradually declined and the government had plans to partially privatise 1,500 state-owned enterprises out of the remaining 2,100 by 2010 but the weakening economy during the global financial crisis has slowed such plans. Today, 40% of Vietnam’s GDP and 30% of credit in the Vietnamese economy comes from state owned enterprises.

Meanwhile, corporate tax rates were cut by 30% in 2008 for small and medium sized businesses and new laws have been approved covering business operations in an effort to improve the business environment and to stimulate the economy. However, corruption remains a widepread problem while the judiciary system remains relatively weak.

Moreover how Vietnam fairs against other countries on various competitive rankings is mixed. In the World Economic Forum’s Networked Readiness Index for 2008-2009, Vietnam ranked #105 (between Turkey and Belgium) for having a score of 2.74 (1 being burdensome and 7 being not burdensome) for the burden of government regulations; ranked #44 (between Namibia and Saudi Arabia) for having a score of 4.03 (1 being ineffective and 7 being very effective) for the effectiveness of its national lawmaking bodies; ranked 72nd (between Indonesia and Romania) for having a score of 3.73 (1 being nonexistent and 7 being well developed and enforced) for its laws related to ICT; ranked #75 (between Benin and the Slovak Republic) for having a score of 3.67 (1 being heavily influenced and 7 being entirely independent) for judicial independence; and ranked 15th (between Tajikistan and the United States) for taking 295 days to enforce a contract.

Table 2. Key Indicators of the Business Environment (2008)

Indicator

2009

Business start-up

Cost (% of GNI per capita)

13.3%

Duration (days)

50

Dealing with construction permits

Time (days)

194

Cost (% of GNI per capita)

248.1%

Employing workers

Rigidity of employment (index)

21

Ratio of minimum wage to average value added per worker

0.27

Redundancy costs (weeks of salary)

87

Tax rate

Total tax rate (% profit)

40.1%

Corporate tax rate (% profit)

19.2%

Labour tax and contributions (% of commercial profits)

19.2%

Exporting

Documents for export (no.)

6

Time to export (days)

22

Cost to export (US$ per container)

US$756

Importing

Documents for import (no.)

8

Time for import (days)

21

Cost to import (US$ per container)

US$940

Protecting investors

Investor protection index

2.7

Closing a Business

Time (years)

5

Cost (% of estate)

15%

Source: Euromonitor International based on the World Bank (Vietnam: A Country Profile. November 6, 2009)


Comments

One Response to “Vietnam: Asia’s Newest IT and Outsourcing Tiger”

  1. legal offshoring philippines on April 27th, 2010 7:26 am

    Frankly, I am surprised to know that Vietnam has already surpassed China one of the best in Asia, in Outsourcing and IT businesses. I am really dumbfounded by the short time given to have this kind of progress. However, this was also not that surprising given that Vietnam has been working out several economic strategies relative to outsourcing and IT for several years already.

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