South China Morning Post
Enrico Benni, Alex Peng, and Art Hu
January 19, 2009
In its bid to shift the economy from manufacturing to services, China has in recent years tried to position itself as a destination for offshoring and outsourcing.
The global market for such services is expected to exceed US$160 billion by 2012, up from US$60 billion in 2007. Yet today, China still holds less than 10 percent of this market. Subscale companies, shortages of project managers, and the lack of an outsourcing culture among domestic firms are just a few of the barriers holding back the sector.
Recent McKinsey research shows that attractive opportunities await domestic and global service providers that can figure out how to address these challenges.
To be sure, China's IT services sector has made progress. Our survey of 75 Chinese software and IT services firms shows that while the industry is still relatively fragmented, individual firms are getting bigger. The number of companies with more than 1,000 full-time employees rose from 8 percent in 2005 to 38 percent last year.
And, rather than compete head-to-head with India, China has managed to carve out a niche in the industry. With its 2 million Korean and Japanese speakers, China is a leading destination for "near-shoring" of services to Japanese and South Korean companies.
Our research highlights some issues that Chinese firms face. For one, China's IT services firms still come up short when looking for qualified managers to run their offshoring and outsourcing businesses. This problem is particularly acute for companies seeking to expand overseas. Indeed, 48 percent of the companies we surveyed said talent was their key barrier to global expansion.
Chinese firms' hesitancy to embrace outsourcing is constraining one of the key sources of demand for IT services firms. Half the companies we surveyed cited reluctance by their Chinese customers to outsource critical business support functions as the top reason why their customers did not outsource more.
China's image as the "factory of the world" has proved very hard to shake. IT decision makers at multinational firms believe the country is still better suited as a manufacturing center than as a destination to outsource important business processes. Multinational customers continue to be concerned about, among other things, the perceived lack of protection of intellectual property in China.
Thus, despite double-digit growth, the mainland's top service providers still cannot keep pace with Indian providers. Over the past five years, the country's top four offshoring providers grew 15 to 20 percent. By contrast, Indian providers grew 30 to 40 percent.
So what can Chinese firms do? Domestic service providers need to get bigger and better. Snapping up and consolidating subscale firms is one way to do this.
Stepping out of China to look for global deals is another option. The economic crisis has pummeled the valuations of service providers in developed markets such as the United States, creating a window for cash-rich Chinese companies to acquire assets and expertise. Some Chinese firms are already hunting for deals.
Chinese firms also need talent. The economic crisis is shaking up less resilient players, putting a pool of experienced professionals on the market. And while bringing in talent through acquisition is one option, Chinese firms can also consider building up their overseas business organically by directly recruiting top-flight talent.
Entering into joint ventures with global IT service providers is another way to bring in skills. Chinese players can trade their deep understanding of the local market and access to Chinese companies for the skills and global reach of multinational providers.
Finally, by helping well-funded government and state-owned enterprises to modernize their IT, whether through installing more computers on the desks of public servants or implementing "e-government" solutions, China's IT services firms can tap an enormous source of demand.
By stepping up to the challenges they face today, China's offshoring and outsourcing firms will be more likely to succeed tomorrow.
Enrico Benni is a partner and head of McKinsey's Business Technology Practice in Greater China; Alex Peng is a partner in Beijing, where Art Hu is an associate principal.
