I recently led an Info-Tech Research Group study that reviewed the key low-cost Asian destinations of China, India, and the Philippines for IT Outsourcing services like helpdesk and application/Web development and maintenance. The study included in-depth interviews with clients and vendors, site inspections, and analysis of published data. My intention was to take the guesswork out of choosing the most suitable offshore outsourcing destination. This post pinpoints some the key findings of one report based on the study, entitled China for Outsourced IT Services [1]. Philippines and India are covered in other posts.

Info-Tech’s Eight Location Criteria: How Does China Stack Up?

We put together eight evaluation criteria: (1) affordability, (2) language, (3) cultural affinity, (4) resource availability, (5) government support, (6) geopolitical stability, (7) infrastructure, and (8) data security. Here is how China stacked up:

  1. Affordability: China offers affordable labor, with average IT salaries in China at approximately $10,000 US per year, lower than India [2]. China also has low real estate and power costs compared to other outsourcing destinations. However, a shortage of qualified English-speaking IT professionals allows these workers to command a higher salary. Costs also tend to be higher in special economic zones, as these locations often have a large number of qualified staff who can demand higher wages. A shortage of experienced managers means that these employees can also command higher pay. External factors, such as inefficiencies from poor language skills and inexperienced project management can also lead to an increase in the total cost of projects outsourced to China.
  2. Language: Censorship and isolation from other countries have contributed to a lack of English proficiency in China. Chinese providers tend to leave project communication requirements in the hands of a project manager responsible for the initiative, since individual team members do not often have the English language skills to communicate effectively. Written English skills of Chinese providers are generally adequate for e-mail communication; however in most cases, verbal skills are not adequate for helpdesk services. The Chinese government is attempting to improve English proficiency in the country; however, at present many organizations struggle with English language issues with Chinese providers. This lack of English language proficiency can lead to other issues such as inefficiency and poor quality, and also means that the customer must be vigilant when it comes to requirements gathering and other project communications.
  3. Cultural Affinity: In general, China does not have a strong affinity towards Western cultures. Censorship and a general isolation of the country have led to a lack of influence from and knowledge about western countries. The 2008 Beijing Olympics helped China to increase its ties to other nations; however it will take a long time to fully rectify the years of isolation that China has experienced from other countries.
  4. Resource Availability: China has a large labor pool, with graduates from 1,300 colleges and universities, and around 15.6 million students enrolled in post-secondary education. The number of graduates located in cities with technology parks is between 10,000 and 100,000 per city per year [2]. Despite this large labor pool, there tends to be a shortage of qualified individuals for middle management positions. Staffing demands often outstrip supply, which can cause hiring and retention problems. The primary experience of many Chinese outsourcers is with small projects. Thus, Chinese providers might lack the ability to handle large application development or maintenance initiatives. For example, leading Chinese outsourcing providers have an average of 1,000 to 3,000 full-time equivalent employees, which is equivalent to a Tier 3 Indian outsourcing provider [3]. However, small to mid-sized organizations can sometimes benefit from this situation, as they might be able to get more attention from Chinese providers due to their smaller size. It can be difficult to fire workers in China, as most terminations require communication with local labor bureaus and unions. These requirements vary depending on location, making it important to check in with providers about termination regulations.
  5. Government Support: The Chinese government has been making strides in increasing its support for the IT outsourcing industry. Due to this increased government support, China has begun to establish technology parks with solid infrastructure and technological capabilities. Many of these technology parks have completed at least Phase 1 of their build-out plans. China’s technology parks are designated Special Economic Zones. Providers in these areas are eligible for tax incentives. Suzhou technology park for example, allows providers to pay an income tax rate of 15 percent as compared to the rate of 25 percent found elsewhere in China [4]. Outsourcing providers are also eligible for favorable tax policies in 20 Chinese cities, and providers based in central and western China have been given favorable policies for loans to get IT outsourcing projects up and running.
  6. Geopolitical Stability: China is controlled by the Chinese Communist Party, which is an autocratic but highly stable government. The Chinese government tends to be business-oriented and has contributed to China’s growing wealth, with an expected GDP growth of 8% in 2011 [2]. China’s political and economic environment does pose some risks, with a tendency for inflation, a decline in the rate of GDP growth, and strong control of apparently private organizations by the government. In general, China’s political and economic landscape provides a bit of a mixed bag for organizations interested in outsourcing to this destination. China’s economy is expected to remain strong, and so far the Communist government has not hindered the country’s ability to increase its wealth.
  7. Infrastructure: China has very strong infrastructure in its Tier 1 cities, and major efforts have also been introduced to develop the infrastructure of Tier 2 cities. The country also has a strong internal transportation system, with 1,870,661 kilometers of roadways, 74,408 kilometers of rail transport, and 123,964 kilometers of water transport [2]. Infrastructure is particularly strong in the technology parks, which are all within 20 to 40 minutes of the airport and are able to meet the technological needs of providers in these areas. Long-term energy demands are somewhat of a concern; however, China currently has a solid infrastructure to meet its customers’ demands.
  8. Data Security: China has historically had issues with Intellectual Property (IP) and data security. For example, the Business Software Alliance estimates that up to 80% of business software used in China is pirated [5]. IP rights infringements tend to go unpunished by the government. China also continues to lack comprehensive data privacy laws. Despite these problems, Chinese providers are making strides to improve their IP and data security. For example, Chinese providers are increasingly implementing IT governance standards and process controls such as ISO and CMM. Chinese companies are also increasingly training their employees about IP protection and data security. China’s membership in the World Trade Organization (WTO) also brought with it a commitment to comply with the WTO’s Trade-Related Aspects of Intellectual Property Rights (TRIPS).

      9. While not uncommon for offshore destinations to have weak IP laws or law enforcement, there is evidence to suggest that the Chinese government is behind cyber-attacks intended to access private data and steal IP from Western companies like Google and Adobe [6] [7]. Although companies with high-value intellectual property could be targeted regardless of the location of their development activities, locating activities within China could serve to increase an organization’s vulnerability to industrial espionage. Companies with highly valued IP must carefully weigh these risks against potential benefits.

      Additionally, organizations interested in outsourcing to China should assess potential providers’ security controls and monitor their providers closely. Organizations also need to include appropriate IP protection clauses in their outsourcing contracts and insist on no subcontracting. A SAS 70 audit is one way to mitigate intellectual property and privacy risks, but rigorous due diligence with auditors is required since graft is possible. Also, consider consulting with firms that specialize in Chinese IP laws before inking an outsourcing contract with a Chinese provider.

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      China’s Strengths

      There are several factors that make China a strong offshoring location:

      1. Large labor pool. China has a large workforce with many post-secondary graduates every year. However, organizations should be prepared to pay more for workers with high quality English speaking skills.
      2. Strong infrastructure. China has invested heavily in its infrastructure, particularly in designated technology parks. It is also very easy to get from place to place in major areas.
      3. Low cost. Salaries for IT employees in China are comparable to India, and are quite low compared to what an organization would pay for the same services onshore.
      China’s Weaknesses

      China also has several weaknesses that need to be taken into consideration:

      • Poor intellectual property and data security. China is taking steps to improve its IT governance standards and process controls; however, IP laws are not often enforced and organizations must often create their own data security laws contractually.
      • Lack of English language skills. A lack of English fluency can make it difficult for Western organizations to communicate with Chinese providers. The Chinese government has invested in English language education, but it could take years before these changes make a noticeable difference.
      • Project management deficit. Many Chinese providers deal primarily with small outsourcing projects, and thus lack the project management maturity to handle large application development or maintenance initiatives.
      • Asynchronous time zones. North American customers sometimes find that communicating with Chinese providers means meeting very early in the morning or late at night. This can strain resources in both the client and vendor organization when compared to near-shore locations. While some projects leverage the time zone difference with around the clock development – for example handing off changes at the end of the business day and getting them back first thing in the morning – only a minority of outsourcing clients we spoke to were able to get time zone differences to work in their favor.
      Recommendations

      Follow these recommendations when considering China as an offshore destination:

      1. Shortlist vendors. In some respects vendors are more important than locations because a skilled provider can work around the limitations of their location, but a location cannot control all of its vendors. Find prospective vendors through a professional association like the International Association of Outsourcing Professionals, from colleagues, or thorough an advisory service. For outsourcer selection advice, refer to the ITA Premium research note "Selecting an Application Outsourcer: Eight Key Criteria."
      2. Discuss weaknesses with prospective vendors. In addition to evaluating a vendor’s general outsourcing strengths such as technical competency, governance, and project management, questions them about how they handle location specific limitations. Be prepared to walk away from a vendor if the answers are unconvincing. For China, include questions like:
        • What level of English language proficiency can we expect from your managers and technical professionals?
        • How do you ensure effective English language skills among your managers and technical professionals?
        • How do you deal with cultural differences between onshore and offshore team members?
        • How do you recruit and train middle managers?
        • How do you ensure data security and protect intellectual property?
        • How do you deal with time zone differences?
        • How do you manage time zone stress in your staff?
      3. Assess and monitor providers’ IP and data security. China’s security issues are far from resolved, making it important to audit prospective providers’ physical security, processes, and technical controls. If necessary, consult with a legal firm that specializes in Chinese IP laws, and create contractual terms to protect the organization.
      4. Consider China for small, low-end projects. Due to a lack of project management experience and specialized expertise, much of the outsourcing work done in China is low-end, involving basic applications and software testing. Small to mid-sized organizations might actually benefit from the relatively smaller size of Chinese providers as these providers can devote more attention to the initiatives of smaller organizations.
      5. Avoid China for helpdesk services. China’s low English speaking skills make it a poor candidate for helpdesk outsourcing. Other destinations, such as the Philippines or even India, have higher English proficiency and more experience in this area.
      References
      1. A copy of the full report is available from Infotech Research Group
      2. Introduction to The Services Shift: Seizing the Ultimate Offshore Opportunity, FT Press, Ajay Sharma and Robert E. Kennedy, January 2009
      3. Proceed With Caution When Considering Large-Scale ADM Outsourcing in China, Technology Partners International, Greg Blount and Paul Schmidt, 2011
      4. China Approves Tax Breaks and Subsidies for Service Outsourcing Industry, China Briefing, February 2009
      5. SIXTH Annual BSA-IDC Global Software – 08 PIRACY STUDY, Business Software Alliance, May 2009
      6. Capability of the People’s Republic of China to Conduct Cyber Warfare and Computer Network Exploitation, Northrop Grumman Corporation, Bryan Krekel, October 2009
      7. A new approach to China, Google, January 2010