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February 28, 2007

A new business model for China off-shoring

Steve Hamm

People have been talking up China as an IT off-shoring location for years, but, so far, not much has happened. I'm not sure why. The shortage of English language skills is probably a factor. Also, the fact that India is so advanced and so well known makes it harder for another location to grow rapidly. Ultimately, though, I believe China will become an outsourcing powerhouse. The talent pool is just too attractive to pass up. China's education system produces 350,000 engineering grads per year. When China blossoms, it's possible that the successful approach will be the one pioneered by Achievo, a four-year-old outsourcing firm with its headquarters in Silicon Valley and most of its programmers in China.

Even though Achievo is only four years old, it already has a global footprint. It has offices in 14 cities in the US, Canada, Germany, China, Taiwan, and Japan. About 1,000 service delivery people are in China--not just in the big cities but in second-tier burgs such as Jinan and Dalian. "We say we're a US corporation, a global company, and a China back end," says Robert Lee, the chief executive, who has 30 years of experience in the software industry.

The other thing that's notable about Achievo is what it calls its "local front end." While most Indian outsourcers have a ratio of 20% of their service delivery people on site in customers' offices and most of the rest off-shore, Achievo puts 30% to 35% of its delivery people close to the customer. It also hires local people in the countries where it serves clients rather than sending employees from low-cost countries on temporary assignments to work directly with clients.

That means Achievo can't match the top Indians' operating margins of 25% to 35%. But Lee figures the investment will pay off longer term by gaining the trust and confidence of clients.

Over the long haul, Lee believes China will become more and more attractive to clients because it has a vast pool of engineering talent in its second- and third-tier cities, so it will be able to keep a lid on salaries and turnover rates. "We can maintain a quality service at a sustainable cost. India won't be able to do that," he says.

I wouldn't bet on that. India also has second- and third-tier cities and tech services outfits are quickly expanding there to take the pressure off of Bangalore and Gurgaon. It seems to me the crucial factor will be the abilities of these countries to educate a large number of people with excellent software skills. India already has a viable software economy. China, by tolerating software piracy, has stifled the development of a home-grown software industry. Until China deals with its piracy problem, I don't believe it will become a major factor in tech services.

01:07 PM

Off-shoring

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When the Indian offshoring first started in the early and late 90's the onshore ratio was 50% to 60%. As the process maturity as well as pressure on margins set in the ratio of on-site workforce started to come down to the current levels of 20% or less. Therefore, this is not something new and depending on the life cycle of where the company is in its state of maturity of process. I don't agree that trust and confidence of clients are built by on-site presence - eventually it is the delivery, the quality and costs that matter, not necessarily in that order.

Posted by: Srikanth at February 28, 2007 03:28 PM

Steve:

I do not see China become an IT outsource destination for a long time to come simply because of Chinese poor English skill and blatant disregard of IP. On the other hand, I can foresee that Vietnam and Philippine will eat India?? outsource pie. There are several areas not in favor of India.

1). Pilipino speaks much better English than strong accent Indians. Vietnamese is also Latin language based. It is easy for Vietnamese to pick up English.

2). Vietnamese etc. are better educated especially in Math. India with its billion+ people never score better than Vietnam or Iran in any Math/Informatics Olympiad

3). Vietnamese and Pilipino have higher IQ than Indian average IQ 81

Posted by: nicknguyen at February 28, 2007 10:06 PM

I always wonder what kind of work gets outsourced to China? Undoubtedly China has a quality talent pool which can be dipped into. But there is not much of data/evidence around process maturity, delivery track record of Chinese companies, Customer satisfaction metrics in dealing with Chinese companies, attrition related issues within Chinese companies, Salary Inflations, Domain capabilities, Demonstrated ability to scale up, Large program delivery capability, financial stability and strength of balance sheet. While I am a firm believer that the Indian edge is going to get blunted in the next five years, it is not going to be blown away out of existence even in the next couple of decades.

Also one strong competitive advantage that Indian companies have is their profit margins. Today a majority of the companies (including some of the leading Tier 2 companies)have double digit profit margins. Even at these levels of margins companies are able to grow at 30% on an average. If push comes to shove -- Indian companies will be able to sacrifice the margins to gain market shares -- which I think the relentless globalisation will without a doubt will ensure.

Indian companies are also moving up the value chain firmly but slowly. The largest pool of talent for SAP, Oracle Apps, Supply chain, PLM and a host of other packages today resides in India and this is only growing.

Steve, may be it is a good idea that you persuade Businessweek to allow you to spend six months in China to understand the real situation. In the process you will be able to report on the shifts that are taking place in the tech industry -- a passion that you got so far . May be NASSCOM can part fund your stay in China

Posted by: Vish at March 1, 2007 12:16 AM

Comment on Comment:

For outsourcing it is sheer numbers that counts more than brains, because inspite of repeated claims of Indians moving up the value chain, it is still mundane work that makes up the larger share of the outsourcing pie.

In fact, most of the outsourcing work won't require a Maths Ph.D. or an Olympiad medalist, only a handful shall do.

Accents: South Indians find it difficult to shed those, but Northerners do it easily: that's why you'll find call centers concentrated in North Indian city of Gurgaaon and not Bangalore. For the rest of the outsourcing business, I don't think accents count that much- you just need to convey your point. After all it's a fight for bottomline, not accents.

Posted by: SKy at March 7, 2007 09:24 AM

I have experience of getting Control system software work done for my project in China and the engineers that I found were good in English skills, talented and good at their work. I see no reason why they cannot be competitive with Indians. Quit subscribing to stereotypes, check out reality. Wake up & smell the coffee!

Posted by: Mandar at March 12, 2007 06:56 AM


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