By Rohit Verma
Most reports and columns on global information technology (IT) outsourcing published lately leave us thinking that beneath the surface of India's current supremacy in global software outsourcing lurks the threat of the growing Chinese Dragon. However, based on first-hand experience of working in mainland China, India, and in the Western markets, Rohit Verma, a senior project manager with a US-based software development company, finds that there are considerable opportunities for Indian software firms to grow and profit from investing in China rather than worrying about the Chinese threat to their existing lines of business.
First, a brief introduction to set the context for further discussion. China is today a vibrant, fast-developing, US$1.7 trillion economy, on a steady path to overtake the United States as the world's largest economy in the next few decades (current size of the US economy: $11.7 trillion; Japan: $4.6 trillion; India: $600 billion). With its impressive infrastructure and low labor costs, China is the undisputed manufacturing hub of the world, including for high-tech products - and there is no serious threat to this status in the near future. However, its global leadership position in the industrial and manufacturing sector does not directly translate into strengths in the knowledge-intensive, export-oriented IT services sector. The software industry, especially software exports, is a different ball game.
Strengths of China's software industry
There exists a strong and growing market for China's software industry - largely based on the domestic demand fueled by IT spending of government and private industries. As the Chinese economy grows by leaps and bounds, its demand for IT services will also increase. The level of automation in Chinese government and businesses is still far below that of the US and therefore, China's domestic demand for its IT services will continue to provide the largest momentum of growth for China's IT industry in the foreseeable future. Due to this stronger demand for IT services by the Chinese economy as compared to the demand in the Indian economy, China's $27.8 billion IT industry is larger than its Indian counterpart.
Product sales comprise more than one-third of the revenue of China's IT companies, unlike services-driven revenue of Indian IT firms. The strong presence of software products in the revenue portfolio of China's IT companies has the potential of leading to very healthy bottom lines for these firms. However, due to price under-cutting by the firms and scale inefficiencies of the existing software companies, so far this advantage has yet to be fully realized. The strongest advantage of the Chinese economy is the availability of skilled and low-cost manpower. With abundant availability of college graduates and substantial government investments being made to establish specialized software engineering institutes, the supply of low-cost human resources to meet the demands of China's growing IT industry is likely to be maintained at a healthy level.
The limitations
The IT landscape in China is fragmented with thousands of small-sized firms. With more than 8,000 players (almost three-times that of India), the top 10 Chinese IT firms constitute only 20% of the entire Chinese software market (compared to 50% share of the Indian IT industry commanded by the top 10 Indian IT firms). The largest Chinese companies have 3,000-4,000 employees as compared to 30,000-40,000 employees in the top-tier Indian IT companies. This fragmented industry structure has resulted in lower productivity, inefficiency, poor human resources development, and lower standardization of processes among Chinese software companies.
The West remains the largest buyer of software services in the world. But the capability of Chinese companies and resources to service this important market remains primitive. Numerous disadvantages exist for the Chinese, to say the least. Poor English-language skill is a formidable disadvantage in providing knowledge-driven services to Western clients. The Chinese government has launched numerous programs to "popularize" English but most of them have been ineffective on the ground.
Rosy statistics, such as the availability of 24 million English-speaking graduates in China (according to McKinsey's latest Quarterly Report), merely mean that these graduates have "familiarized" themselves with the English language to some extent during their studies, but the overwhelming majority of them cannot effectively communicate in the language. This important skill remains a scarce commodity even among professional Chinese employees. Unlike Singapore and Hong Kong (both with predominantly Chinese population and where English is widely spoken outside classrooms), Chinese in the mainland shy away from regularly speaking in English. The only time English is spoken, even in the offices of multinationals in China, is while communicating with an expat or a foreigner.
Other communications-related shortcomings among Chinese employees include a hesitation to voice opinion when it matters, not saying "no" when necessary, lack of clarity in communicating one's ideas, and not attaching due importance to client communications. Though China has begun producing software developers by the thousands, they still lack the potential to do high-quality, large-scale work to meet the demands of Western clients. Knowledge of programming languages without the experience of successfully managing structured software engineering projects has resulted in a poor capability of the Chinese companies to execute enterprise-level solution architecture, design, and implementation projects for the export market. Claiming to be prepared to execute large projects for Western clients when one merely possesses skills in programming languages is akin to demanding a spot in Manchester United because one has played on a school soccer team.
Much has already been written about the nascent software project and quality management processes in China. The inability of Chinese software companies to bridge this gap in the last few years has been primarily due to resistance from the current generation of managers there. Most Chinese managers have been groomed for years in the regimented management practices of China's state-owned enterprises. Many of them now find themselves uncomfortable in the open, collaborative, and results-oriented environment required at progressive software companies. This is also the reason why multinational coorporations (MNCs) entering China do not find a ready pool of middle and senior managers from existing Chinese companies. It will be another 5-10 years before this large deficit of managerial talent is overcome.
Even though China's software export is growing at an annual rate of 50%, on closer scrutiny one finds that the overall annual IT revenues from software export is still $2 billion (compared to India's IT exports of $18 billion), and the bulk of Chinese software exports have been of low-value application development and maintenance services to Japan (where, due to similarities in the written languages, language is an advantage for China rather than a disadvantage). Further, software exports as a percentage of overall IT revenue is only 10% for China, compared to 70% for India. This current structure of China's software exports coupled with all the other limitations translate into the fact that the export market for Chinese software services will primarily be limited to Japan, Korea, and to some extent Southeast Asia. Some attempts have been made by MNCs in China to provide low-end, legacy application maintenance services to Western clients, but there are no known significant success stories so far.
Crystal ball gazing
By analyzing the current trends of China's economy in general and its IT industry in particular, one can make a fair assessment of how China's software industry will shape up in the next 10-15 years. Any assessment of the software industry's future beyond this period would be speculation.
In the next decade or so, we are likely to see the following:
- Continued and impressive growth of China's IT industry, fueled by expanding domestic demand. The growth of China's IT industry will also depend on how the government regulates the overall growth rate of the economy.
- China will have the largest IT industry outside the US and EU.
- China will replicate the success stories of Indian software technology parks on an exponential scale with overt government support.
- Consolidation of the Chinese software industry will occur. MNCs will capture a larger share of the high-end enterprise product market in China, whereas domestic companies will meet the low-cost and low-quality demands from the bulk of Chinese industry.
- With experience and foreign help, China's software development processes and management practices will evolve and mature, as has happened with its highly successful manufacturing industry.
- China's software exports will be primarily to Japan, Korea and Southeast Asia. It will also service lower-value maintenance projects from the West.
- China will find it hard to grab a significant pie of the largest software market - the US, which will continue to be largely serviced by India. The IT-enabled services (ITES) market will also have a similar story to tell.
- Though there will be acquisitions of foreign software companies by Chinese firms and vice versa, China will not be able to become the software factory of the world
- There will be greater demand for low-cost, skilled IT resources from developing nations. India will meet the bulk of this demand because even though India's population size will be almost the same as that of China, India's advantage will lie in having a younger, English-speaking population as compared to China's fast-aging population (due to its one-child policy) with limited English skills.
Options for Indian software firms
Not much has been written about the choices before the Indian IT industry in devising its China strategy. Therefore let us specifically look at how Indian firms can benefit by engaging the Dragon next door, since there's no way to avoid it.
For established Indian IT companies, building software development centers in China cannot come at the cost of their existing development centers in India merely to gain cost advantages. Software development capabilities in China can target only specific markets for software services - primarily the Japanese, Korean, Southeast Asian and the high-value spectrum of the Chinese market. Note that bulk of the domestic Chinese market - low-end software products and services - will remain elusive to multinationals. Further, Chinese capability will provide very limited scope for supplying large-scale IT services to Western clients.
The experiences of Japanese and US investors in China since the last couple of decades show that an investor needs to have deep pockets, lots of patience, and a long-term outlook to ultimately profit from its investments in China. Therefore, the Indian IT companies building presence in China will need to invest and stay committed to developing the entire gamut of software delivery capabilities, including the most important of all - building a pool of capable human resources. This will take time, patience, and a lot of effort. Thus achieving scale in operations and the desired returns will not come soon.
Another option to successfully enter China is through buyouts. Chinese IT firms, which are relatively successful or have the potential to be turned around, can be acquired and further developed. But few good targets are currently available. Indian IT firms looking for inorganic growth in China will have to wait and watch for now until China's IT industry matures.
Importantly, irrespective of the strategies pursued to build capabilities in China, managers and senior professionals of Indian software companies should be willing to relocate to China on a long-term basis and adapt themselves to operating and doing business in a very different culture. Finally, more than posing any significant threat, China presents an opportunity for the Indian firms to build capabilities to service those IT markets which have been previously unexploited to their full potential. However, what is needed is a clear intent to tap this opportunity, formulation of a well thought out "China strategy", and its unrelenting execution by Indian IT firms.
Asia Times