Mid-term Assessment of China's Outsourcing Strategy

China: A Mid-Term Assessment of the "1000-100-10" StrategyThe days of multinationals shying away from setting up captives in China, or contracting out work to a Chinese vendor, are all but gone. In fact, growth of the Chinese outsourcing market has outpaced any other location. China, to the surprise of many, has been second only to India as the most attractive location for some years now. Shanghai has topped Bangalore as an attractive location for service outsourcing, and major outsourcing summits are now hosted in Chinese cities such as Zhengzhou or Dalian â outnumbering events organized by leading outsourcing associations in the USA and Europe.How has China become a service outsourcing powerhouse in such a short time?Unlike many other locations where the main thrust behind increased competitiveness for offshore work was achieved through favourable government financial incentives, such as low corporate tax, Chinaâs story is far more complex. While the country does offer financial incentives in the same way as many other locations, and rightly proclaims its availability of engineering and IT talent, the role government plays in supporting outsourcing is unprecedented.The Chinese government has been investing in manufacturing for years. Part of its strategy for developing a strong manufacturing industry was to ensure its competitiveness through special economic zones. It was not a surprise, therefore, that when China realized the impact service outsourcing would have on its competitive position, it considered its options.[inlinead]A Five-Year Plan, launched in 2006, aimed to improve Chinaâs service outsourcing industry long after India had secured its leading position as an attractive offshoring location.Did the Chinese Government Get Its Strategy Right? There are parallels between the approach the Chinese government took with respect to developing its outsourcing capability, and that followed by President John F. Kennedy when he pulled all his resources together in order to beat the Russians in the race to the moon: In 2006, with a lot of fanfare, the Chinese Ministry of Commerce (MOFCOM) announced an ambitious target, coined the "1,000-100-10"project. The project aimed to (i) establish 10 Chinese cities as outsourcing bases, (ii) attract 100 multinationals to offshore work to these cities, and (iii) assist in developing 1,000 outsourcing vendors.Objective ONE With its centralized approach, the Chinese government achieved objective number one, fairly quickly. In fact, there are now 21 service outsourcing cities: Beijing, Tianjin, Shanghai, Chongqing, Dalian, Shenzhen, Guangzhou, Wuhan, Haerbin, Chengdu, Nanjing, Xian, Jinan, Hangzhou, Hefei, Nanchang, Changsha, Daqing, Suzhou, Wuxin and Xiamen. In each of these cities there is an outsourcing park that provides IT and BPO services, by either local vendors or captive centres.Objective TWO The Chinese government also succeeded in attracting 100 multinationals. In fact, it managed to attract more than 100 multinationals to set up service operations in China. Many of the multinationals that set up operations in China are on Fortune 500 and Forbes 2000 lists. So objective number two has also been achieved.Objective THREE Objective number three has been a challenge for the Chinese government. Indeed, there are many Chinese IT and BPO vendors, but none of them has reached the size, scope and impact of the top five Indian vendors. In this respect, a recent article in CIO.com rightly concludes that Chinese vendors are still struggling to gain foothold in the global outsourcing industry.So, What Went Wrong With Chinaâs Service Outsourcing Strategy?Most commentators (such as CIO.com) and Chinese officials compare Chinaâs evolutionary path with that of India. Indeed, replicating the success of the Indian ITO and BPO sector would have been a major achievement for China. However, achieving success in todayâs outsourcing markets requires a different evolutionary path, one that suits China capabilities and offering.Put simply: Instead of the â1000-100-10â government scheme, China needs a â500-500-50â project.China has developed an impressive captive sector, which has so far been its strength. Indeed, China has become the fastest growing location for captives, outpacing India and many other attractive locations. Many of the captives set up in China focus on value-adding activities such as Research & Development or software development â areas in which many Chinese vendors struggle to secure contracts with western multinationals. In addition to these captives, there are also many "virtual" captives: BPO and IT operations set up and run by Chinese vendors for multinationals.So, while the promise for the Chinese outsourcing industry lies in its captive sector, the current scheme is focused on growing the IT and BPO vendor sector, which, though technically advanced, is struggling to demonstrate business acumen.I have visited numerous offshore development centres in China over the course of the last three years. When I asked about their evolutionary path, I learned again and again that the vast majority of virtual captives in China provide services only to the parent company. The executives of Chinese vendors have not yet realized the potential of their virtual captives, and therefore have not made the necessary investments in support of growth and expansion.Chinese vendors should not lose hope of becoming true competitors to leading Indian outsourcing vendors such as Infosys or TCS. Success, however, will not be achieved by populating the Chinese outsourcing sector with more and more vendors. On the contrary, Chinese IT / BPO vendors are likely to succeed on the basis of a strong and value adding captive sector â one that will evolve and transform over time and will become the engine of the Chinese outsourcing industry.For this to happen, however, the Chinese government should consider appropriate incentives for multinationals and local vendors with regard to captives:First, the Chinese government should incentivize captive growth through measures like additional tax concessions beyond the current corporate tax.Further, the Chinese government should encourage and negotiate an appropriate growth plan for multinationals seeking to establish captives in China. The plan should offer additional benefits to the multinational as long as the captive expands and takes on an international clientele.Last but not least, the Chinese government should look for ways to relax the procedures for changing ownership of virtual and foreign captives, to help them become independent vendors once they have evolved and acquired foreign clients.Clearly, such government policies require cooperation from Chinaâs outsourcing leadership. These executives should consider the success of Indian captives that grew to become successful BPO providers, and seek opportunities to replicate the same pattern of growth and success, in China.While many of Chinaâs numerous outsourcing parks have already agreed terms with multinationals concerning their captive investments, the Henan Outsourcing Park in Zhengzhou, which is very likely to become the 22nd outsourcing hub city in the governmentâs scheme, is still in its infancy. Local government and the parkâs management team should consider implementing some of the policies outlined in this article to speed up the growth of captives in the park and ensure their transformation into an independent vendor eco-system.Snapshot of Chinese Outsourcing MarketChinaâs IT and business process services industry worth $50 billionSlow growth/leveling offRisk concerns remaining around IP protectionTalent needs further development; currently common to pay 20% premium for talentNeed to focus on Project Management skills; suggest incentives for hitting ISO standards to encourage "process" rather than "short cut"U.S. mid-market may be a good target, but would require representative offices in U.SIn a recent Fuqua School of Business/Shanghai Jiao Tong University survey of 250 providers in China (71% of whom are headquartered there) the majority of respondents turned out to be undersized, young companies struggling to compete for international business. Small providers (under 500 employees) account for nearly 90% of the market. The majority expects new work to come from China and Asia, rather than Europe or the U.S., and plan to focus more on the domestic industry than on international clients. "They're not ready to leapfrog India," says Professor Lewin, Director of the Center for International Business Education and Research, Duke University's Fuqua School of Business.Source: Arie Lewin, Director of the Center for International Business Education and Research, Duke University's Fuqua School of Business on CIO.com: China Struggling to Compete in the IT Outsourcing Arena Read more about China:View from China: Big (Entry) DataChina: Yesterday, Today and TomorrowTop 10 Reasons to Have a BPO Presence in ChinaAbout Ilan OshriIlan Oshri is the author of "Offshoring Strategies: Evolving Captive Centers Models"(MIT Press, 2011), and the co-author of "The Handbook of Global Outsourcing and Offshoring" (Palgrave, 2009), "Knowledge Processes in Globally Distributed Contexts" (Palgrave, 2008), "Standards-Battles in Open Source (Palgrave, 2008) and the co-editor of "Global Sourcing of IT and Business Processes" (Springer, 2010) and "Outsourcing Global Services: Knowledge, Innovation and Social Capital" (Palgrave, 2009). His work has been published in numerous journals and magazines including the Wall Street Journal, Business History, MISQ Executive, Communications of the ACM, IEEE Transactions on Engineering Management, European Journal of Information Systems, Journal of Information Technology, Management Learning, Journal of Strategic Information Systems (2007 Best Paper Award) and others. His work on outsourcing has been featured on BBC Radio 4, BusinessWeek, the Financial Times and many other journals and magazines. He is the European Regional Editor of the Journal of Information Technology. His main research interest lies in the area of learning, knowledge processes, and innovation in global teams. Ilan is a regular speaker at international conferences and corporate events and seminars. He is also the co-founder of the Global Sourcing Workshop (www.globalsourcing.org.uk). He teaches strategic management core modules at executive levels. www.ilanoshri.com

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