IT outsourcing to China increases despite drawbacks

When it comes to information technology and business process outsourcing, China has been on a tear. Global services exports from China nearly tripled, from $1.2 billion in 2007 to $3.5 billion in 2010, with IT services accounting for 65 percent of the total, according to a report released this month by outsourcing consultancy and analyst firm Everest Group.

That, says Everest's analysts, officially makes China a mature market for offshore IT outsourcing. And the growth is expected to continue: Everest predicts that China will rake in nearly $10 billion by 2015 and remain a viable option for IT leaders seeking to cut labor costs for the next 13 years. According to Everest's offshore locations survey conducted earlier this year, China now ranks third in attractiveness to IT buyers behind India and the Philippines.

But China has a markedly different value proposition for IT leaders than its two biggest rivals. While an American CIO might go to India or the Philippines to support U.S. operations at lower costs, the reasons for engaging a service provider in China are more complex.

"Except for modest risk diversification beyond India and the Philippines," China does not offer a clear advantage, the Everest report states. Rather, CIOs leverage outsourcers in China to serve their regional businesses in Japan, Hong Kong or Korea, or to support their growing Chinese operations designed tap into the domestic market. The choice to outsource to China is not one made in isolation, says H. Karthik, vice president of global sourcing for Everest. "The China decision needs to be viewed in context of the global strategy," he says.

Consider the drawbacks to outsourcing to China: The country can be 30 to 45 percent more expensive than India or the Philippines for IT and business process services. Quality English skills, even in large cities like Shaghai and Beijing, are lacking. And the typical size for a global delivery center is 400 to 600 full-time employees; only a few global companies set up operations of 1,000 workers or more.

The upside is that China produced 5.8 million graduates in 2010--more than half of them in engineering and management disciplines, according to Everest. The country's market growth has been propelled by strong government initiatives and incentives and the investment of multi-national IT service providers like U.S.-based Accenture and IBM and India's Wipro and Tata Consultancy Services. In the last year, more than 15 delivery centers were established or expanded, according to Everest. And U.S. companies, including Chevron, Marriott and Bank of America have set up captive service centers in China.

While expensive relative to offshore rivals, operating costs in China's biggest metropolitan areas are still 60 to 70 percent cheaper than major U.S. cities, such as Dallas, Texas, says Everest. And the country now has more than 20 cities offering IT and business process services, with customer interest growing in often lower-cost, tier-two cities such as Dalian, Guangzhou and Chengdu.

The Everest report offers an updated snapshot of China's strengths in the IT service market:

Labor Pool

5.8 million annual graduates in 2010 in China, fueled by government investment in education.

Operating Cost Arbitrage

Tier-one cities (e.g., Beijing and Shanghai) 60 to 70 percent cheaper than U.S., 50 to 60 percent cheaper than Tokyo or Singapore.

Tier-two cities are another 5 to 10 percent cheaper than tier-one cities.

Asian Language Support

Geographic proximity, as well as cultural and linguistic similarities with Japan and Korea.

Large pool with Asian language skills (870,000 Japanese learners in China; two million Koreans living in China).

Access to other Asian languages such as Thai and Bahasa Indonesia.

Domestic Market Opportunity

Global companies expanding their businesses in China require local service delivery.

Increased outsourcing by domestic enterprises.

Operating Environment

Infrastructure investments in power, transportation and high-speed broadband network in outsourcing cities.

Government support

Significant investments in education and incentives to develop the services industry.

National level initiatives bolstered by provincial and city government incentives.

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