Leaks in the Great Wall

There is growing interest in outsourcing software development to China, but some CIOs worry about their intellectual property. Is that perception accurate?

An increasing number of software companies as well as CIOs from a variety of industries are looking to China to outsource some of their software development. Good experiences in India have made the prospect of going far offshore more palatable. And as prices in India and other markets rise, cost-conscious CIOs are looking for even less-expensive alternatives.

If done properly, outsourcing to China can be a great opportunity. Chinese development is considerably less expensive than in most other places now being used. And China's capabilities are growing rapidly, thanks to increasing economic development and improving technology education.

But there is one big red flag that gets raised when executives talk about sending work to China - weak intellectual property (IP) protection. A recent survey by China's Ministry of Information Industry found that 61 percent of foreign companies operating in China see software piracy as the number-one problem of doing business there. Indeed, the IP issue may be why the Chinese outsourcing industry is facing fragmentation and low market share. In 2004, China captured only $US700 million of the global IT outsourcing market, valued at $US198 billion, and there are virtually no outsourcing players there with more than a few thousand employees. Multinational companies fear that disreputable service providers could resell their software under a different name or even sell the code to competitors.

However, while there has been a high rate of theft of personal productivity and entertainment software at the consumer level (software that usually ships in a few CDs and does not require customization or expert knowledge for installation), there are few, if any, documented cases of IP being stolen or compromised when a Chinese development company was involved. The low theft rate of Chinese-developed software is due in part to the fact that most of the software work now done in China is for the Japanese market, which splits the source-code development across many vendors so that no one vendor has access to the complete code.

In reality, software developed for corporations is difficult to copy because it invariably is tailored to specific business requirements and so is not easily replicable, and it's likely to require expertise to install. The China head of a leading ERP software company confirmed that the company does not face issues with piracy in China because its software "does not come shrink-wrapped in a CD, and you cannot just press 'install' to install it". Its software requires complex configuration, and companies can't derive business benefits until such configuration happens.

The perception that China is an unsafe place to develop code may be based on the fact that China's enforcement of IP rights lags behind its enactment of IP laws. Historically, there has been little consequence to the domestic use of pirated software, especially if developed by foreign companies and used for personal use. In the recent McKinsey China Software Industry Survey, which surveyed the top 100 software companies in China, 60 percent of the executives interviewed were sympathetic toward local customers' propensity to use pirated software developed by foreign companies. China tends to deal more harshly with stolen software sold to foreign entities than with software sold domestically. The laws themselves are not clear-cut. An attorney from a leading IP law firm in China said that "laws to protect software copyright resemble those in Europe . . . There is a grey area as to what constitutes 'significant' resemblance - hence, copyright infringement - of two products".

The risks can be mitigated if companies follow some basic guidelines to manage the development environment, educate and manage the staff, and pursue breaches and illegal users. Companies that are outsourcing (or offshoring) successfully in China set and enforce standards in these three areas:

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