China starting to look good for outsourcing

By Maria Trombly | Securities Industry News | May 10, 2004

May 10, 2004 - Last fall, Boston-based Bain Capital Ventures needed a database to track its investments. It was a job just right for one of Bain's portfolio companies, E5 Systems.

The fact that E5 did most of the actual development work in China wasn't a problem, said Mike Krupka, a managing director at Bain, which has 300 employees and $16 billion in capital under management.

"Our IT guys were looking to get a project done quickly, at a low cost," he said. "China made a lot of sense--it costs about 40 percent less than India for software development. And, over time, the cost differential will increase as India gets more and more expensive."
China, with its enormous population, isn't likely to see the same kind of wage inflation any time soon, he added. "For us, the long-term direction is China rather than India."

Distance wasn't a barrier, he added. Like many offshore development firms, E5 had people in the United States who intermediated between Bain and the Chinese developers.

"What our guys saw was a U.S.-based company," said Krupka. "They got all the hand-holding and relationship and structure, but at a much lower cost than if E5 had been a completely U.S. company."

E5 actually has development teams in both India and China, with about 200 employees currently in China, or about two-thirds of its global employees. But according to founder and chairman Gordon Brooks, that number will rise to 500 by the end of this year.

"China is the only other place in the world that's got the infrastructure, education, literacy and the resources to compete with India," he said. "But a lot of the technology development, the coding work, is 35 to 40 percent cheaper in China than in India, including benefits and other overhead costs."

Although many people still pick India as the safe choice, China is starting to become increasingly attractive, he said.

For financial services firms, there's a second advantage to moving work to China: to establish a presence in what will become the world's biggest market for financial services.

"China is a very big market for investment banks and a lot of other financial services firms," he said, "because of all the reform, and how the whole market is just being invented right now. It's very important, if you want to win business in China, to be doing business in China. And if it's a big strategic market for you, why not outsource in China, be spending money in China, have credibility and government acceptance? That will help you get more business."

In addition to Bain Capital, Brooks said that E5 has a "handful" of other securities industry clients but declined to provide names.

"We're developing custom applications and doing maintenance and support for those applications," he said. "There's portfolio management, a lot of customer relationship management, and then some technology-migration projects."

Another Boston-based firm, securities services giant State Street Corp., has also decided to move some development work to China.

"We are an extension of the State Street IT department," said James Lin, VP of the global division of ZheDa Innovation Technology Co. Ltd., based in Hangzhou, China. "We do trading systems, securities system. We write applications for them, we do enhancements for them. Whatever the IT department does, we do the same thing."

State Street was one of the first securities firms to come to China, with the relationship dating back two-and-a-half years.

ZheDa has 120 employees working for State Street alone, and that number is expected to double by the end of this year, Lin said.

He admitted that Chinese firms don't necessarily have deep financial industry expertise, not the least because the financial industry in China is only just now getting going, having previously been limited to state enterprises.

"But that's not really a problem," he said. "[Financial services companies] are looking for good technology staff to work for them, and will actually spend a good amount of time to train our staff to learn the systems. They're not looking for business people, or they have come to the wrong place."

The Big Boys Take Notice
ZheDa and E5 may have a head start in China, but they're about to get some competition from the big boys. The very, very big boys.

A year-and-a-half ago, Girija Pande began bringing programmers to China's honeymoon capital, Hangzhou. It was only fitting, as Pande's company--billion-dollar Tata Consulting Services (TCS)--was itself having a bit of a honeymoon with China in general. That honeymoon doesn't look like it's about to end.

Tata, a major global technology consulting firm, is mostly known for its development centers in India, where it is headquartered, but its 24,000 employees are scattered throughout 53 countries. The headcount of its Chinese subsidiary, TCS China, seems tiny at 150, but it's slated to grow fast.

"This is already probably the fastest ramp-up anyone has had on the IT services side," said Pande, regional director for TCS in Asia-Pacific, and chairman of Tata Information Technology, based in Shanghai. "And we hope to do much more. We are very clearly projecting to hire many more people--we will be doubling our employee base in China in next 12 to 18 months."

TCS is India's first global billion-dollar software organization, but it will have a pitched battle on its hands if it wants to make a similar mark in China. Boston technology research firm Gartner Group predicts that China will almost catch up to India in total outsourcing revenues by 2007: $27 billion for China vs. $30 billion for India.

China is home to about one-fifth of the total world population and boasts around 400,000 IT professionals, according to analyst and vendor estimates. This year alone, the country will graduate an additional 50,000 English-proficient IT professionals with degrees in computer science. This number is expected to rapidly grow to more than 200,000 IT professionals per year within the next two years, according to E5.

As China produces such a prodigious quantity of IT pros, and as their project management skills and English proficiency mature, it's no wonder competitors are nervous.

TCS rival Infosys, which has more than 23,000 global employees, has opened an IT development subsidiary in Shanghai, with a $5 million investment. The company says it expects to employ 200 professionals and offer programming services to both Chinese clients and multinational companies doing business in China.

BearingPoint, with 16,000 employees around the globe, is also in the race. The consultancy recently opened its first so-called Global Development Center in Shanghai. It already has more than 200 employees in the center, and plans to grow the operation to 400 to 450 by this summer.

A Whole New World
According to Ling Sheng Chen, managing director of BearingPoint China Global Development Center, China offers all the cost advantages of India, plus the opportunity to really make a mark on the country.

"The Chinese software industry is still relatively young and in a rapidly growing stage," Chen said. "BearingPoint has a vision to grow our Global Development Center so that it will be the number-one player in that country. In China, we have the opportunity to become the number-one player. In India, our chance of becoming number one is a pretty long shot."

But BearingPoint and TCS have different plans for the market. TCS is starting out with Asia-focused development work: working on Chinese versions of international software projects, serving Japanese and Korean customers and doing work for Chinese firms.

By comparison, some 80 percent of BearingPoint's development work is for its international clients, working on global development projects. Chen added, however, that the opportunity to enter China's growing market for services was a very attractive aspect to building its Global Development Center in Shanghai.

A relatively late arrival to the party, Cognizant Technology Solutions Corp. has just hired a country manager and is about to open up a small development center in China to start getting experience providing services for the market.

It's still early stages, though, said Cognizant EVP and CFO Gordon Coburn. Cognizant hasn't even picked out the city yet-that will be the first job for the new country manager.

"We hope to have 50 people there by the end of the year," said Coburn.

With 10,000 employees worldwide--7,000 of them in India--Cognizant generates half its revenue from its financial services customers.

"On a long-term basis, we expect to deliver services to our financial industry clients from China," he said. "Our clients want us to have locations beyond India, and China is the best additional location."

But even though the new office hasn't been opened yet, or even sited, Coburn said that Cognizant has already begun working in China.

"We're currently doing a small project for a financial services client," he said. "It's local support for one of our global clients, which has a China subsidiary. It's a very small project, with a handful of people. In the long term, we plan to service Japan, as well as European and North American customers."

Coburn said that Cognizant considered diversifying to a few other areas before settling on China. Eastern Europe was a possibility, and quite attractive in the short term, but as the countries in that region join the European Union, wages are expected to shoot up, he said. In addition, the talent pool is limited.

He added that Cognizant also looked at Russia, which has formally turned away from Communism and became a free-market state. However, China looked better from a business perspective, he said.

"It's still a Communist state, but everything that we're seeing is that the government wants to do exactly what India did 15 years ago, which is strengthen their economy on the shoulders of technology, and they will do the things they need to do to incent global companies."

Priming the Pump
The business climate is already looking up, according to firms on the ground in China.

"The physical infrastructure is exceedingly good," Pande said. "It's brand new, and the Chinese have spent billions of dollars creating a physical infrastructure that must be seen to be believed."

Pande said that he was also pleasantly surprised by his programmers' English-language skills.

"The people who we have hired have a reasonable level of English-language skills, because for the last 15 years, China has been switching over to English and the people coming out of its universities are reasonably conversant with it," he said.

But he added that the Chinese programmers sometimes lack the process knowledge that Indian companies have developed over the last few years. "We have a very large training program to bring them up to scratch on our way of writing software," he said.

Pande also said there are still regulatory and compliance issues when setting up an offshore facility in China, though the regulatory climate is steadily changing for the better.

Problems with the regulatory climate is one reason that Stephanie Moore, an analyst at Giga Information Group, gives for recommending against moving software development maintenance to China just yet.

"The market is too immature," she said. "And the problems associated with this immaturity--a lack of English-language skills, the legal and regulatory environment, and lack of intellectual property laws--make China too risky today."

But she added that for Japanese and Korean companies, China is a much more viable option than for U.S.-based companies, primarily due to language affinity and proximity to China.

China is now making changes to encourage the outsourcing trend, with enhancements ranging from intellectual property reforms to tax breaks for foreign direct investment.

For TCS, all this is money in the bank. "Our experience has been exceedingly good, with over $20 million in orders pending," said Pande.

If the regulatory climate continues to improve, more and more companies will be following TCS, BearingPoint and Infosys to their own Chinese honeymoons.