In 2009, China launched a national initiative to attract outsourcing business to 21 designated ‘hub’ cities. Four years on and China’s ambition to fast-track its way to a position of recognised global leader is still a goal, not yet a reality.
Offshoring Research Network (ORN), founded at Duke University’s Centre for International Business Education and Research, estimates that India’s share of the global outsourcing market was worth $87bn in 2009 while China’s was worth $14bn. Four years later, China has more than tripled its stake to $45bn but is still a challenger, not a leader. To put this in perspective, estimates of the size of the global industry in 2012 range from $600bn to $980bn with India’s share at approximately 20%, whereas China’s share was below 8%.
With the exception of Dalian, which in 2009 already had in place significant outsourcing activity for Japanese and South Korean companies, success has been slow in coming. One reason is the timing of China’s entry into the global market for sourcing business services. Through 2012 and most of 2013, IT and business processes outsourcing has levelled off and even experienced a slight decline. This is a reflection of the fact that most Fortune 1000 companies have already adopted business services outsourcing practices.
In conjunction with Shanghai Jiao Tong University professor Liu Yi, ORN conducted a survey of 250 business service outsourcing companies in five of the hub cities: Dalian, Beijing, Shanghai, Xian and Suzhou. Results suggest that the national goal of leapfrogging India may be a greater challenge than policymakers originally envisioned.
One contributing factor to the lower than hoped for rate of growth is the chosen markets China-based outsourcing companies are operating in. ORN’s survey suggests that many of the providers are focusing on the less demanding domestic market. Meanwhile, potential rich pickings are to be had in the rapidly developing $2bn to $6bn mid-cap market. A move into the apps and software development market could prove fruitful for Chinese companies, as could the new and growing markets of analytics, big data and mobile. However, selling costs may be just as high as those for large contracts.
When China’s Central Committee designated its model cities as ‘hubs’ to attract and nurture the business services outsourcing industry, it viewed the opportunity as a new lever for national economic growth. Most of the hub cities have been very active, building tech parks and offering employees tax incentives and training programmes. However, there is a need for more investment in project management training as well as in a commitment to enhance career opportunities and, at the same time, compliance and certification with internationally recognised ISO standards and six sigma methodologies.
In this way, companies seeking a partner to outsource their business processes to can feel confident in experiencing execution excellence as indicated by the quality of the service delivery and robust processes as well as the commitment of their provider to be in it for the long haul. Hub cities could also consider opening representative offices abroad that can serve as a marketing base for the smaller providers trying to market their services to the under-served mid-cap client base.
Rising to the challenge
Information security is also critical. Companies trusting their data to a third party are ever more aware of the value of that data, and the potential damage to their business should it be compromised. Eric Rongley, founder and CEO of software development provider and transaction systems specialist Bleum, an American company headquartered in Shanghai, recently noted that 80% to 90% of cyber attacks on Western companies originated from China. It is a global challenge faced by all industries and domestic and global operators alike, but with the pace of cyber attacks increasing, it highlights the need for all service providers to prove due diligence in their ability to repel attacks.
To accelerate its charge on the global international services outsourcing market, Chinese providers need three aims baked into their strategy:
- Focus on market growth opportunity areas
- Do not try to compete on cost
- Recognise the value of key skills and invest in people
The problem of gaining market share in a declining market is exacerbated by aggressive pricing from India-based providers motivated to renew large contracts. Additionally, these established providers are increasingly seeing their margins squeezed – at our estimate down from 25% in 2007 to 17% in 2010. The best opportunities, therefore, are to be found in other high-growth areas such as apps and software development, analytics, big data and mobile.
Guarantee of quality
Providers in most of China’s designated hub cities face mounting costs. With a never-ending need to invest in staff training, the rise in the currency’s exchange rate, high staff turnover rates and the challenge of bridging a cultural divide, would-be market leaders need to forget cost leadership. Instead they need to pitch their competitive advantage in the areas of excellence in execution, timely delivery, reliability, robust processes and the aforementioned security. Hub cities could also consider ‘out of the box’ initiatives that would, for example, guarantee the quality, timeliness and security of intellectual property for services delivered by certified providers in their city.
Skills in the desirable high-growth areas of software development and analytics are in short supply and, where they are found, turnover of staff is high. Losing employees is not only a loss of training investment, it is also a potential threat to quality while replacements are sought or brought up to an acceptable standard of delivery. To attract and retain these skills, China-based service provider companies need to invest in people and demonstrate this by providing employment terms that are sufficiently attractive, as well as opportunities for employees to further develop and get ahead in the industry.
Although it is clear that the growth and development of the China-based services outsourcing industry faces many challenges, a few world-class providers – both domestic and internationally owned, working out of China – prove that it is possible to build a high-value-added services provider industry.
The industry in China is still in its infancy. About three-quarters of providers have been in business for less than 10 years. In the US, the opposite is true. Launching its national initiative at a time when the global market had begun to plateau has meant major efforts have yielded minor results. Competing for ‘traditional’ outsourcing IT and business process contracts when provider margins in this area are under intense pressure can only compound the issue.
At ORN we have been researching offshoring practices among companies in different parts of the world for many years and have uncovered opportunities for more effective management of business service sourcing. Very few companies our project has studied in depth, or who have participated in the 2013 sourcing capabilities survey, consider sourcing of business services as a strategic capability beyond cost savings. Cost is king. In many cases the outsourced business services and their own internal shared back office services are not managed as an integrated service operation. Often, internal services and outsourced compete.
However, there is evidence that executives at the highest level in organisations are now paying more attention to how effective their outsourcing contracts are. Much of the effort is directed towards simplifying and improving procedures and processes, rationalising the number of providers, and addressing the tussle between internal and outsourced. This involves formal vendor management, clear measurable objectives, a sourcing or procurement centre of excellence, the right sort of cost accounting systems (such as activity cost-based accounting), defined processes and the allocation of realised savings. Cost is still king, but quality counts.
In this climate of evaluation, there is scope for China-based companies, armed with the right strategy, to capture market share in the rapidly developing mid-cap market if they compete in new and growth areas such as apps and software development, analytics, big data and mobile, and offer a quality service from skilled, well-looked-after employees.
Arie Y Lewin is professor of strategy and international business and director of the Centre for International Business Education and Research at Duke University’s Fuqua School of Business. He is also lead principal investigator at the Offshoring Research Network, a network of research partners that tracks and studies organisations’ globalisation of services (including but not limited to business functions, processes and administrative services). Professor Lewin unveiled these research findings at the celebratory opening of Shanghai Jiao Tong University Antai College’s Chinese American Research Center on Global Sourcing.
Full results from ORN’s research, ‘Providers in China and USA: Preliminary Comparison’, are available on the Fuqua School of Business website at http://www.fuqua.duke.edu/offshoring