China currently accounts for less than 10 percent of the global market for the offshoring and outsourcing of services, which reached more than US$60 billion in 2007. While the industry has expanded rapidly in recent years, it is not growing quickly enough to achieve China’s aspiration of becoming a leading global offshoring and outsourcing destination.

McKinsey research—including a survey of 75 leading domestic software and IT services firms in 14 cities across China, as well as interviews with officials at Chinese government agencies and managers at Chinese services-outsourcing parks—identifies several challenges such as the lack of large-scale firms and severe talent shortages that, if left unaddressed, could prevent the industry from realizing its full potential.

Our study suggests that domestic providers should substantially increase their scale by moving into higher-value-added services such as R&D and expanding their global footprint through M&A. At the same time, building on recent efforts to facilitate the development of the sector, the government could collaborate more extensively with service providers and companies in the promotion of a number of industry "growth engines."

Global service providers also have an opportunity to substantially ramp up their presence in China, while playing their part in spurring growth of the overall industry. While the global economic crisis will likely hinder industry growth in the short term, it could also serve as an important catalyst for the broader development of the sector.

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