It was three years ago when I first visited a Chinese IT firm in Shanghai, which was in the process of transforming its core focus from hardware to IT outsourcing. When asked about the reason for the change, the firm's CEO replied that China was positioned to develop into the global outsourcing leader in just a few years - a result of its huge store of low-cost labor and well-developed infrastructure. At that time, such a claim seemed far-fetched. In retrospect, the CEOs statement made perfect sense.

Some sources say that it may take China another five to ten years to pose a serious threat to India, but three to five years is more realistic.

China has rapidly closed the gap by consistently maintaining an average growth of over 35 per-cent in software exports. It has also successfully made headway in the Japanese market - a market in which Indian companies have not been very successful.

Currently, China is not a preferred destination for IT offshore outsourcing, and India still firmly holds the largest share of the market. But this is quickly changing. China still faces some major obstacles, but over the past two years the coun-try has appeared prominently on every sourcing manager's radar.

Reality Check

When comparing the IT capabilities of China and India it is usually assumed that India is so far ahead of China in software as to be unsur-passable. However, such an assumption may be .awed. It will probably come as a surprise that, in fact, China's software output is almost double that of India, and its domestic market is more than six times larger.

Though China lacks experience in outsourcing to the Western world, it is moving at a spectacu-lar pace in acquiring expertise in areas such as business domains, processes and offshore project implementation, all of which are essential for penetrating the Western outsourcing market. Many large Chinese IT product companies such as UFIDA and Kingdee are diversifying their portfolios to include offshore outsourcing. These companies have experience in developing software products and are well acquainted with software processes and models. With strong .nancial backing and market reach these com-panies are capable of breaking into the American and European markets.

Major IT services companies such as Neusoft and Powerise, which have gained invaluable experience in providing services in the Chinese domestic market, are poised to expand into the global market. "The key to executing large projects from China is scale and processes," says Dr JC Chen, Vice-President at Powerise, a listed company with headquarters in Beijing. "Many Chinese firms have started to realize this and are taking steps to nurture talent and build quality processes." Powerise.s nearly one thousand engineering staff provide application development and enterprise solutions for China.s vertical industry sectors.

Though the assertion that Indian providers, given their scale and experience, would dominate China.s outsourcing industry may seem logical, it is far from the reality. This is because as long as India remains an attractive destination, Indian firms will continue to staunchly promote their homeland to global customers as a preferred offshore destination, instead of promoting China. Such a paradox may hinder the efforts of Indian companies to capture a commanding stake of the outsourcing market in China, and in the long run, local Chinese firms will emerge as leaders. These Chinese firms, along with the government.s support, will actively sell China as the next outsourcing destination, while Indian firms will continue to use China to gain access to high-quality low-cost talent and to tap into the Japanese market.

Asian Giants China and India are often perceived as similar in many respects. However, deeper analysis reveals disparities in their cultural backgrounds, their economic development and their political sys-tems . just to mention a few . all of which will affect their performance on the world stage.

Two important factors contributing to the at-tractiveness of an offshore outsourcing destina-tion are low cost base and availability of technical workforce. Salaries and living costs in China and India are substantially lower than those in the West, enabling the two Asian countries to maintain competitiveness over other offshore destinations like Canada or Ireland. However, the recent revaluation of the yuan has sparked specu-lations over sustainability of China.s long-term cost advantage. Similarly, India is experiencing cost in.ation due to a rapid increase in salaries. Nevertheless, China and India will continue to retain a competitive edge over other destinations for the foreseeable future.

Both countries are also home to a vast pool of engineering graduates. China has 3.7 million engineering graduates, which is ten times the number of graduates in the US, and produces around 700,000 engineers per year, while India produces 350,000 engineering graduates.

However, compared to India, China lacks experienced middle managers and project man-agers. China is making efforts to bridge this gap by attracting overseas talent and training their employees. "Currently there is a high demand for experienced engineers especially at project management level," says Wang Bin, President and CEO of Beyondsoft, whose 800 staff serve multinational clients in the US and China. "Tal-ented engineers are our biggest asset. We offer training and other incentives to retain the best talent."

The governments of both countries are proac-tively supporting their IT outsourcing industries by offering tax rebates, providing infrastructural backing and access to global markets. Software technology parks in India have been instrumen-tal in boosting growth, especially for the small and medium companies. China has adopted a similar approach and set up ten software bases to promote IT services.

Unlike India, where software services provid-ers focus primarily on customers in the US and Europe, China has a different customer base made up of not only Western customers, but also Japanese, Korean and domestic customers. Its domestic market caters to multinationals, state owned enterprises and private enterprises. In order to serve these individual customer bases it is essential for Chinese and Indian providers to understand the speci.c requirements of each group and to customize their services accord-ingly.

Size is essential for executing large scale outsourcing projects, and in this area Indian providers have a clear edge over Chinese provid-ers. While the top Indian outsourcing firms have more than 25,000 employees, there are currently no IT companies in China with more than 10,000 employees. Moreover, Chinese IT companies speci.cally focused on outsourcing may have even fewer employees. The Chinese IT industry, which consists of more than 9000 companies, is highly fragmented. Unless Chinese providers scale their operations it will be impossible to compete with Indian providers in bidding for large projects. Consolidation may be the best means of achieving scale in a short period.

Most Indian outsourcing firms have mature software development processes and are CMM (Capability Maturity Model) certi.ed, a software quality measure used to rate outsourcing firms. From a customer's perspective, CMM certi.ca-tion ensures software development reliability and predictability. In contrast there are very few IT outsourcing providers in China that posses CMM certi.cation, although most are quickly realizing the value of such a certi.cation.

Infrastructure is an area where India fares miserably. China's rapid economic develop-ment is complemented by stellar infrastructure development. In India development has been slow, and much of its infrastructure is in tatters. Though the government has taken measures to improve infrastructure it may take a while for India to catch up with China.

Chinese hurdles

Though not an of.cial language in India, English is widely used in daily life. English pro.ciency is one major area in which India has the obvi-ous upper hand. It is true that language levels in China are simply not up to par with international standards. Although English is taught at school as part of the curriculum, few people are able to speak it .uently. To overcome this shortcoming the Chinese government has taken major steps to promote English language and training. It is estimated that currently more than 300 million people are learning the English language. Though Chinese are making commendable progress it may take many years for China to reach the same comfort level as Indians.

On the other hand many Chinese speak other eastern languages such as Japanese, Korean and Cantonese, with a command far surpassing that of Indians. Chinese firms have taken short-term measures by recruiting project managers with excellent language skills who can interface with customers. They are also investing long-term in resources to impart English language to their employees in order to make them competitive in the market.

The troubling issues of piracy and IPR pose another problem to the development of the Chinese market. Although laws exist in China to curb infringement, enforcement has not been effective. While software piracy is also an issue in India, the government and individual software companies have taken stronger measures to con-trol violations. India's National Association of Software and Service Companies (NASSCOM) is playing a major role in in.uencing policy making and checking software piracy. To control piracy, NASSCOM has set up an anti-piracy hotline - a toll free number to report piracy activity - and is actively cooperating with the Indian police to set up IPR departments in order to make enforcement more effective.

Though control is important, many Indian firms have also established company-based se-curity regimes to help curb IPR infringement and software piracy. Chinese companies are coming to realize the importance of establishing internal processes to ensure protection of intellectual property. Thomas Reilly, Regional CEO of Cap Gemini, explains some of the measures currently in force in the Guangzhou center: "Our operators are barred from using any storage media such as .ash disks to copy data or .les. As well, our offices are equipped with surveillance cameras to detect any IPR thefts." While this is clear evi-dence of a rising trend in IPR protection, China still has a long and winding road to navigate.

Cooperation vs competition

Speculations are rife about who will win the outsourcing war. The reality is that China is emerging as a serious contender to India and threatening to shake the Indian domination over global IT outsourcing.

The key to success for both China and India, however, is to avoid engaging in competition with each other and to cooperate in securing a larger share of the mammoth outsourcing market. Both sides should attempt to recognize each other's strengths and force partnerships to leverage their core competencies. Such part-nership would allow Indian firms to explore untapped markets such as the Japanese, Korean and domestic Chinese markets, while allowing Chinese firms to acquire capabilities to execute large-scale projects.

Chinese and Indian firms naturally have disparate maturity levels and thus the services they offer are positioned at different levels of the value chain; optimum results will be achieved by cooperation rather than competition, thus enabling each to provide spectrum-wide services to their customers.

Mithras Consulting Group is a management consulting firm headquartered in Shanghai. Mithras offers services to senior management on business strategy, organizational restruc-turing and technology. You may email Sridhar at sridharfivedala@mithrasgroup.com