Outsourcing to China

Forbes  Feb 20  Comment 
What can the US do to bring back 25% of the manufacturing being outsourced in China right now in 10 years? This question was originally answered on Quora by Glenn Luk.
Cloud Computing  Sep 21  Comment 
Research and Markets (http://www.researchandmarkets.com/research/zsph2q/computeraided) has announced the addition of the "Computer-aided Engineering Software Market in China 2011-2015" report to their offering. read more
Cellular News  Jul 6  Comment 
Increasingly, third-party providers of what ABI Research calls Application Enablement Platforms (AEPs) - software designed to provide these core features for multiple M2M applications - are stepping up their efforts to abstract away much of the...
Sydney Morning Herald  May 15  Comment 
MYER will nearly double its direct outsourcing of fashion, homewares and merchandise from China to $200 million a year by 2016 to help support its program of opening new stores and profit from the growing proportion of sales generated by its Myer...
New York Times  Dec 10  Comment 
Trading firms based in the United States and Canada are recruiting inexpensive workers in China and teaching them to engage in speculative trading.
New York Times  Dec 9  Comment 
Trading firms based in the United States and Canada are recruiting inexpensive workers in China and teaching them to engage in speculative trading.
The Australian  Aug 24  Comment 
DEFYING conventional wisdom, the Palestinian owner of a $US1 billion business in China is packing up and relocating in the US.

China's economy is the largest in the world at this period in time surpassing Japan which was the second largest.

Investors betting on the growth of business process outsourcing (BPO) to China should focus on engineering and IT areas of investments, because these job functions are most easily bundled into a project format and moved offshore. On the other hand, industries that sell services to the U.S. government (e.g. aerospace and defense contractors), require significant U.S. government regulatory approval (e.g. pharmaceutical manufacturers), or rely heavily on proprietary intellectual property (e.g. high-end microchip design) may be a less appropriate bet for those hoping to profit from increase outsourcing to China.

Most of the plastic widgets at Wal-Mart Stores (WMT) seem to be made in China. Does this mean that the rest of our jobs will be moving to China soon as well? From an investment perspective, it is important to understand which service sector industries might be affected by competition from China and start to think about which companies may profit from that trend.

What Companies are Benefiting From Outsourcing

Case Studies

Chengdu Hi-Tech Development Zone - one of the most well-known state-owned development zone in China

  • Mr. Barreit, Intel CEO---Chengdu and Chengdu hi-tech zone can meet all Intel's requirements on human resource, infrastructure and government support.
  • John Thompson, CEO of Symantec---"Chengdu presents tremendous opportunities as a base for outstanding talent and we are deeply impressed with the local government’s cooperation and support to foreign investors. As we all know, a large number of top software and technology corporations have made investments in the city, which further proves that Chengdu is an ideal place for investment."
  • Mr. Graeme McCusker, vice executive president, GM of west region, Ericsson--- "We are very close to the airport, very close to downtown. The transportation is fantastic. This area is developing not only in business but also in societies." ,
  • Mr. Xie Zhifeng, vice president of marketing, SMIC--- "it only took us 1 hour to get the equipments after entering the custom, Chengdu really made this happen while other cities still can not."
  • Mr. Ye YouDe, vice president, Molex --- "Enterprises are pursuing the maximization of profit. It would be ideal if one could make money immediately once come. Chengdu has all the advantageous factors of time, place and people."
  • Xie Shengde, Board Chairman, UNISEM—"I never heard such word 'NO' from you."
  • Mr. Wang Tianyang, GM of SAP Chengdu---"To invest in Chengdu, is a strategic choice in our expectation, but I didn’t expect we could develop so fast in Chengdu like this."

What Companies are Not Benefiting From Outsourcing to China

  • Lockheed Martin (LMT), Raytheon Company (RTN) are examples of prime defense contractors which would have difficulty offshoring their support or technology functions overseas.
  • Pfizer (PFE) would not readily offshore production of their more profitable drugs (i.e. Viagra).
  • IP dependent industries would not likely outsource their most cutting edge R&D to China, unless their business is so capital-intensive that competitors would be hard-pressed to follow. Intel might fall into this category.
  • Companies dependent on Western language customer service workers, such as telecom operators and Internet Service Providers like SBC, AOL, and Qwest are less likely to benefit from Chinese outsourcing because many workers there lack sufficient English language skills to provide real-time assistance to Western customers.

Is China a Threat in the Service-Sector?

In high-wage countries like the United States and Western Europe, the services sector is the largest source of employment. For example, U.S. government statistics suggest that the service sector provides over 75% of all U.S. jobs. The WTO reported that service exports grew at a compound annual growth rate of 6.9% worldwide between 1980 and 2002 – a rate comparable to the growth rate in exported manufactured goods.

Both investors and workers are concerned about the possibility of service jobs moving offshore to locales like China. McKinsey & Co., however, believes this fear may be overstated. In its review of eight industry sectors (automobiles, healthcare, insurance, IT services, retail, consumer banking, packaged software, and pharmaceuticals), it calculates that only 18.3 million jobs worldwide could be effectively outsourced to another country. Projecting this outsourcing onto all sectors of the economy, only 160 million service jobs, out of nearly 1.5 billion service jobs worldwide, are suitable for outsourcing offshore.

Certain Occupations are Easier to Outsource

Engineering, finance and accounting occupations, for example, do not require much interaction with others and can often be broken down into discrete, well-defined projects and problems to be solved. This translates into more outsourcing risk for this employed in industries heavily reliant on such talents, such as software development and document processing. According to a presentation by Holly Muscolino, the Director of InfoTrends/CAP Ventures, at a meeting of the International Association of Outsourcing Professionals, Document Process Outsourcing will grow at a 17.9 percent CAGR from 2003 through 2008 – reaching a market size of more than $1.5 billion dollars in the U.S. alone. Already, Microsoft, Dell, SAP, Nokia, General Electric, Alcatel-Lucent and Unilever offshore, except perhaps the reading of x-rays and other data that can be conveyed electronically. The testing of physical samples, such as by a pathologist, by comparison, may be too time-sensitive to ship offshore for testing.

Based on the aforementioned distinctions between occupations, it is not a surprise that outsourcing is most likely to impact information technology (IT) and routinized business processes, such as customer service. At present, China lags in these areas. In 2005, McKinsey reported that China accounted for $3.4 billion of the world’s total business process (BPO) and information technology (IT) outsourcing, a pittance compared to $8.6 billion in Ireland and $12.2 billion in India.

Skilled Labor Bases in China and India Ready to Work

China and India both have a ready supply of skilled labor to take on outsourced tasks. A Duke University study by Gary Gereffi and Vivek Wadhwa shows that each year, the United States produces 137,000 engineers with full engineering degrees, while China produces 351,000 and India produces 112,000. By contrast, a Bain & Company report suggests that China produces 700,000 engineers per year, and Marty McCaffrey, executive director of Software Outsourcing Research in Salinas, Calif., says that China's universities could churn out 200,000 computer science graduates annually,

Bachelors and Sub Baccalaureate Level Degrees Awarded in the US, China, and India (2004)
  United States India China
Total Degrees Awarded222,335215,000644,106
Bachelors Degrees137,437112,000351,537
   In Engineering52,52017,000 
   CS, Electrical, and IT84,91795,000 
Sub Baccalaureate Degrees84,898103,000 292,569
   In Engineering39,65257,000 
   CS, Electrical, and IT45,24646,000 
Source: Duke University, Chinese Ministry of Education, National Center for Education Statistics

Table 1

According to Forbes magazine, one-quarter of all foreign PhD candidates in the United States are from China. Over 170,000 Chinese who have studied abroad have now returned home, with 30,000 of those returning in 2006. This may be affecting China's R&D capabilities positively. China reportedly surpassed Germany in the number of patents filed and spent more than Japan on R&D in 2006. Overall, China's expenditures on R&D have doubled as a percentage of China's Gross Domestic Product (GDP) - despite the fact that China's GDP is growing as well.

CNET reports that China has around 8,000 software services providers, yet only five have more than 2,000 employees. By comparison, India has fewer than 3,000 software services companies, yet at least 15 of these have more than 2,000 workers – and several, such as Infosys Technologies, Tata Consultancy Services, and Wipro Technologies, have a world class clientele.

In 2004, the China BPO services market was valued at $683.3 million, based on five key horizontal business functional segments: customer care, finance and accounting, human resources, training, and procurement. IDC predicts that, although India will remain the major hub of BPO activities over the next few years, China will increasingly attract large BPO investments, and it will move from just processing services contracts to higher level BPO activities. IDC expects that the China BPO market will increase at a 34.8% compound annual growth rate (CAGR) between 2004 and 2009.

A typical Chinese IT [outsourcing information] is VanceInfo (VIT) , founded in 1995 in Beijing, and now boasting over 10,000 employees. Its clients include large firms like Expedia (EXPE) , Microsoft (MSFT) , and Citigroup (C) . In 2010 it received a Quality Excellence Award from Microsoft for playing a critical role in the Japan MSN Next Entertainment project, covering product design (both front and back end) for the Web services initiative.

VanceInfo is not without competitors. Foreign firms have already begun setting up bases in China and international companies won 90 percent of the $4.3 billion in contracts for computer services awarded in China in 2004, according to Gartner.

In August 2005, Infosys announced that it would spend $65 million over the next five years to build software development centers in Shanghai and Hangzhou, employing 6,000 engineers. Its Indian competitor Satyam plans to hire 5,000 workers in China within three years. Another Indian competitor, Wipro, runs development centers in Shanghai and Beijing. Meanwhile Indian market leader Tata Consultancy Services, agreed to become the controlling stakeholder in a venture with Microsoft, Uniware of China, and two state agencies, in addition to its existing development center with 250 engineers in Hangzhou.

Overall, Indian companies expect to increase their investment in China ten-fold to as much as $1 billion by 2009, according to the New Delhi-based National Association of Software and Service Companies (NASSCom).

The E-Commerce News reported that the China Development Bank (CDB) will issue 5 billion yuan ($632.7 million) worth of credit to foster service outsourcing in five cities; Chengdu, Xi'an, Shanghai, Shenzhen and Dalian. At the inauguration ceremony for the five cities, Chinese Minister of Commerce Bo Xilai said the ministry will take measures to promote the fast growth of service outsourcing in the next five years. Under the country's Sixth Five-Year Plan (for 2006 to 2010), the Chinese government aims to build service outsourcing bases in ten cities, encourage one hundred multinationals to outsource services from China, and foster one thousand medium and large-sized service outsourcing enterprises. Of course, the market may have its own thoughts about this plan…

IT Week reports that businesses in the Asia Pacific region outside Japan will spend more than $16 billion per year on IT outsourcing by 2010. China may be able to secure a larger share of this market than it does of Western outsourcing because Asian countries may have a greater affinity to China or at least less discomfort about China as a foreign culture. In 2004, Japan awarded only $257 million of IT contracts to Indian companies, while it awarded $828 million in contacts to Chinese IT outsourcing companies, according to Gartner Group.

From an investment perspective, many factors need to be considered in order to determine which businesses and industries will gain and which will lose from outsourcing to China.

Some Industries are Better Suited for Outsourcing Than Others

Service businesses with low margins are more likely to benefit from offshore outsourcing than those still commanding a high margin. Thus, a move of customer service abroad for a high-touch, high-margin business may save a few dollars, but dramatically reduce a company’s market share among competitors. By comparison, a business in a oligopolistic industry, such as utilities and telecom, can provide lower-touch customer service without dashing as many customer expectations.

China’s poor intellectual property protection may limit its share of service outsourcing - To the extent that businesses rely on proprietary technology and processes to provide services to their customers, Western companies may shy away from locating those aspects of their business in China. While China has joined with the World Trade Organization and acceded to the related TRIPS treaty protecting intellectual property rights, in practice China’s record is still poor. Counterfeit merchandise in China abounds, reportedly accounting for 20% of all consumer products there, and the United States recently filed two intellectual property protection cases against China through the WTO dispute resolution organization.

Government Restrictions Limit Outsourcing

For national security reasons, it is unlikely that defense contractors or even manufacturers of high-end dual use services will be able to move significant portions of their operations abroad. The May 2006 flap over the U.S. State Department’s purchase of $13 million of computers and related equipment from Chinese-owned Lenovo, despite the routing of the purchase through U.S. government contractor CDW Corp, highlights this issue. One can only guess how large of an uproar would be created by Lenovo also providing after-sales service and support…

Other arms of the U.S. government may not restrict overseas activities, but they still regulate them. For example, the FDA must approve all drug clinical trials before such drugs can be marketed in the U.S. Trial represent a huge expense for pharmaceutical manufacturers – and perfect opportunity to lower costs by shifting overseas. On average, drug companies spend about 37% of their overall R&D budgets on clinical affairs. USA Today reports that 21% of drug industry spending for human drug testing was outside of the United States in 2004, up from 18% in 2000; however the number of U.S.-based clinical trials is not declining as "much as foreign ones are increasing." According to GlaxoSmithKline’s head of development, companies can reduce human testing costs by 10% to 50% by conducting trials in Eastern Europe, Asia, and Central and South America because clinical and hospital costs are lower outside of the United States, and patient recruitment is less time consuming. Merck concurs, as it now conducts approximately 35% of all its clinical trials overseas.bwa bwa


One of China’s largest impediments to success in gathering outsourcing business is its low degree of English literacy compared to other developing countries, like India and the Philippines.

Management Skills

India has spent more than a decade developing its project management skills, as demonstrated by worldwide outsourcing players like Wipro and Infosys. By comparison, until recently, many Chinese worked for state-owned enterprises where management skills were either inessential or not well-honed. In order to scale an outsourcing business, China needs more trained managers whom foreign companies can trust from afar.

One company which is highly focussed on project management and customer satisfaction is Bamboo Technologies located in Guangzhou, China. They cater to both China and US market providing IT/Software application development and support services to their clients. They have heavy foreign investment and interests, helping their customers to gain confidence in their delivery capability by constantly thriving on customer requirements and providing valuable suggestions to customers on how to optimize their product and services.


  1. NWL Q1 Earnings Call 4/24/2008 (transcript)
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