To what extent is China a threat for India's software exports in future?

Overview of Indias Software Industry

NASSCOM 2009 As the figures and the forecast by Nasscom revealed, the overall Indian IT-BPO industry (including hardware) is estimated to aggregate revenues of $71.1 billion for FY 2009 (ended March 31), accounting for a sizeable 5.8 percent of gross domestic product of the country. Analysts believe that Indias fundamental advantages low cost and quality (which Egidio Zarrella, KPMGs global partner in charge of IT Advisory, described as the two big punches) will help India keep its competitive long-term advantage even in these recessionary times. With consistently rapid growth rates over the last eight years, the Indian software industry has rarely had time to sit back, introspect and weed out inefficiencies. The current slowdown is thus also being viewed as an opportunity to re-evaluate existing models, and gauge whether the linear growth model is still the right way to measure growth and profitability.

Clearly, apart from the usual diversification strategies and touting the move up the value chain mantra, the Indian software industry seems eager to formulate new strategies that will help it emerge stronger and more profitable when global spending on IT gets back on track.

In 2009-10, the Indian market has grown by merely four to seven percent and the software exports from India have been around $48 to 50 billion. Whereas in 2008-09, it increased at 16 percent and was at $46.3 billion, said Bhasin, who is also the chief executive officer of Genpact.

Overview of Chinas Software Industry Analysis on Chinas Software Exports 2008-2009

China's Ministry of Industry and Information Technology has published a report on the country's software industry and states that China's software exports increased by 54.2% in the first five months of 2009 over the previous year. Statistics show that from January to May 2009, China's software industry realized accumulated revenue of CNY329.14 billion, a year-on-year increase of 23.3%, but the growth rate was 5.7% lower than that of the last year. From January to May 2009, revenue from software products was CNY115.22 billion, accounting for 35% of the total revenue of the software industry. The software products

revenue increased by 24.2% year-on-year, but the growth rate was 0.8 percentage points lower than that of the last year. Revenue from software technology service increased by 28.2% year-on-year to CNY65.93 billion, accounting for 20% of the total revenue. In addition, China's software exports reached USD6.56 billion from January to May 2009, increasing 54.2% compared with the same period of last year. Of the total, the exports of software outsourcing services was USD670 million, a year-on-year increase of 59%.

Forecast on Chinas Software Industry 2009 2011

Points to be considered .. Introduction

China is today a vibrant, fast-developing, US$1.7 trillion economy, on a steady path to overtake the United States as the world's largest economy in the next few decades (current size of the US economy: $11.7 trillion; Japan: $4.6 trillion; India: $600 billion). With its impressive infrastructure and low labor costs, China is the undisputed manufacturing hub of the world, including for high-tech products - and there is no serious threat to this status in the near future. However, its global leadership position in the industrial and manufacturing sector does not directly translate into strengths in the knowledge-intensive, export-oriented IT services sector. The software industry, especially software exports, is a different ball game.

China software exports in comparison to India - % pie of Global Economy Strengths of China Software Industry
There exists a strong and growing market for China's software industry - largely based on the domestic demand fueled by IT spending of government and private industries. As the Chinese economy grows by leaps and bounds, its demand for IT services will also increase. The level of automation in Chinese government and businesses is still far below that of the US and therefore, China's domestic demand for its IT services will continue to provide the largest momentum of growth for China's IT industry in the foreseeable future. Due to this stronger demand for IT services by the Chinese economy as compared to the demand in the Indian economy, China's $27.8 billion IT industry is larger than its Indian counterpart. Product sales comprise more than one-third of the revenue of China's IT companies, unlike services-driven revenue of Indian IT firms. The strong presence of software products in the revenue portfolio of China's IT companies has the potential of leading to very healthy bottom lines for these firms. However, due to price under-cutting by the firms and scale inefficiencies of the existing software companies, so far this advantage has yet to be fully realized. The strongest advantage of the Chinese economy is the availability of skilled and low-cost manpower. With abundant availability of college graduates and substantial government investments being made to establish specialized software engineering institutes, the supply of low-cost human resources to meet the demands of China's growing IT industry is likely to be maintained at a healthy level.

Limitations of China Software Industry

The IT landscape in China is fragmented with thousands of small-sized firms. With more than 8,000 players (almost three-times that of India), the top 10 Chinese IT firms constitute only 20% of the entire Chinese software market (compared to 50% share of the Indian IT industry commanded by the top 10 Indian IT firms). The largest Chinese companies have 3,000-4,000 employees as compared to 30,000-40,000 employees in the top-tier Indian IT companies. This fragmented industry structure has resulted in lower productivity, inefficiency, poor human resources development, and lower standardization of processes among Chinese software companies. The West remains the largest buyer of software services in the world. But the capability of Chinese companies and resources to service this important market remains primitive. Numerous disadvantages exist for the Chinese, to say the least. Poor English-language skill is a formidable disadvantage in providing knowledge-driven services to Western clients. The Chinese government has launched numerous programs to "popularize" English but most of them have been ineffective on the ground. Rosy statistics, such as the availability of 24 million English-speaking graduates in China (according to McKinsey's latest Quarterly Report), merely mean that these graduates have "familiarized" themselves with the English language to some extent during their studies, but the overwhelming majority of them cannot effectively communicate in the language. This important skill remains a scarce commodity even among professional Chinese employees. Unlike Singapore and Hong Kong (both with predominantly Chinese population and where English is widely spoken outside classrooms), Chinese in the mainland shy away from regularly speaking in English. The only time English is spoken, even in the offices of multinationals in China, is while communicating with an expat or a foreigner. Other communications-related shortcomings among Chinese employees include a hesitation to voice opinion when it matters, not saying "no" when necessary, lack of clarity in communicating one's ideas, and not attaching due importance to client communications. Though China has begun producing software developers by the thousands, they still lack the potential to do high-quality, large-scale work to meet the demands of Western clients. Knowledge of programming languages without the experience of successfully managing structured software engineering projects has resulted in a poor capability of the Chinese companies to execute enterprise-level solution architecture, design, and implementation projects for the export market. Claiming to be prepared to execute large projects for Western clients when one merely possesses skills in programming languages is akin to demanding a spot in Manchester United because one has played on a school soccer team. Much has already been written about the nascent software project and quality management processes in China. The inability of Chinese software companies to bridge this gap in the last few years has been primarily due to resistance from the current generation of managers there. Most Chinese managers have been groomed for years in the regimented management practices of China's state-owned enterprises. Many of them now find themselves uncomfortable in the open, collaborative, and results-oriented environment required at progressive software companies. This is also the reason why multinational coorporations (MNCs) entering China do not find a ready pool of middle and senior managers from existing Chinese companies. It will be another 5-10 years before this large deficit of managerial talent is overcome. Even though China's software export is growing at an annual rate of 50%, on closer scrutiny one finds that the overall annual IT revenues from software export is still $2 billion (compared to India's IT exports of $18 billion), and the bulk of Chinese software exports have been of low-value application development and maintenance services to Japan (where, due to similarities in the written languages, language is an advantage for China rather than a disadvantage). Further, software exports as a percentage of overall IT revenue is only 10% for China, compared to 70% for India. This current structure of China's software exports coupled with all the other limitations translate into the fact that the export market for Chinese software services will primarily be limited to Japan, Korea, and to some extent Southeast Asia. Some attempts have been made by MNCs in China to provide low-end, legacy application maintenance services to Western clients, but there are no known significant success stories so far.

China to reach India --- forecast when and how ?

Crystal ball gazing By analyzing the current trends of China's economy in general and its IT industry in particular, one can make a fair assessment of how China's software industry will shape up in the next 10-15 years. Any assessment of the software industry's future beyond this period would be speculation. In the next decade or so, we are likely to see the following:

y y y y y y y y y

Continued and impressive growth of China's IT industry, fueled by expanding domestic demand. The growth of China's IT industry will also depend on how the government regulates the overall growth rate of the economy. China will have the largest IT industry outside the US and EU. China will replicate the success stories of Indian software technology parks on an exponential scale with overt government support. Consolidation of the Chinese software industry will occur. MNCs will capture a larger share of the high-end enterprise product market in China, whereas domestic companies will meet the low-cost and low-quality demands from the bulk of Chinese industry. With experience and foreign help, China's software development processes and management practices will evolve and mature, as has happened with its highly successful manufacturing industry. China's software exports will be primarily to Japan, Korea and Southeast Asia. It will also service lower-value maintenance projects from the West. China will find it hard to grab a significant pie of the largest software market - the US, which will continue to be largely serviced by India. The IT-enabled services (ITES) market will also have a similar story to tell. Though there will be acquisitions of foreign software companies by Chinese firms and vice versa, China will not be able to become the software factory of the world There will be greater demand for low-cost, skilled IT resources from developing nations. India will meet the bulk of this demand because even though India's population size will be almost the same as that of China, India's advantage will lie in having a younger, English-speaking population as compared to China's fast-aging population (due to its one-child policy) with limited English skills.

Chinese Challenge to Indian Software Industry While China seems to have outshone India in many hightech fields, India holds an unquestionable edge in the battle for the software industry. According to a report from the World Bank, India now ranks first in the world in terms of scale, quality and cost of software products export. Indian statistics shows that the countrys software export volume was only US$ 4 million in 1980, which increased to more than US$ 2.7 billion in 1998. India has set a fine example in the development of the software industry. India now has the largest pool of Englishspeaking software engineers outside the United States, with operating costs at roughly 25% of US levels. The resource pool consists of about 300,000 high-level software professionals compared with estimates of about 30,00035,000 in China, according to Indias National

Association of Software and Services Companies (NASSCOM). Chinas software exports were close to US$ 1 billion, while Indias software exports were around US$ 6.24 billion in the fiscal year of 200102, and US$ 6 billion the previous year. Indian software companies have also penetrated the Chinese market with many engineers taking part in the software development of Chinas telecom, aviation, textile, transportation and financial industries. With such a skilled labour pool and a mature IT professional education system, India has steadily produced so-called IT blue-collars to fill the large-scale assembly line of software programming in the country, which Chinese companies do not have. In India, almost 90% of IT professionals are blue-collars. By contrast, Chinas IT education has, for decades, focused on college students, following an approach of elite cultivation. The result is the output of only 50,000 IT-related graduates each year, compared with the market demand of at least 400,000 per year. Almost half of them pursue senior technological or managerial positions after a couple of years of work experience. This makes it difficult for the industry to grow. Most Chinese argue that the important difference is India What to do to maintain its supremacy
Options for Indian software firms Not much has been written about the choices before the Indian IT industry in devising its China strategy. Therefore let us specifically look at how Indian firms can benefit by engaging the Dragon next door, since there's no way to avoid it. For established Indian IT companies, building software development centers in China cannot come at the cost of their existing development centers in India merely to gain cost advantages. Software development capabilities in China can target only specific markets for software services - primarily the Japanese, Korean, Southeast Asian and the high-value spectrum of the Chinese market. Note that bulk of the domestic Chinese market - low-end software products and services - will remain elusive to multinationals. Further, Chinese capability will provide very limited scope for supplying large-scale IT services to Western clients. The experiences of Japanese and US investors in China since the last couple of decades show that an investor needs to have deep pockets, lots of patience, and a long-term outlook to ultimately profit from its investments in

China. Therefore, the Indian IT companies building presence in China will need to invest and stay committed to developing the entire gamut of software delivery capabilities, including the most important of all - building a pool of capable human resources. This will take time, patience, and a lot of effort. Thus achieving scale in operations and the desired returns will not come soon. Another option to successfully enter China is through buyouts. Chinese IT firms, which are relatively successful or have the potential to be turned around, can be acquired and further developed. But few good targets are currently available. Indian IT firms looking for inorganic growth in China will have to wait and watch for now until China's IT industry matures. Importantly, irrespective of the strategies pursued to build capabilities in China, managers and senior professionals of Indian software companies should be willing to relocate to China on a long-term basis and adapt themselves to operating and doing business in a very different culture. Finally, more than posing any significant threat, China presents an opportunity for the Indian firms to build capabilities to service those IT markets which have been previously unexploited to their full potential. However, what is needed is a clear intent to tap this opportunity, formulation of a well thought out "China strategy", and its unrelenting execution by Indian IT firms.

Conclusion .
1) Large domestic market But, rather than throwing in the towel, there is a school of thought developing in India which believes that the Indian IT industry can convert this apparent Chinese threat into an opportunity. Nasscom president Kiran Karnik is one of the main votaries of this opinion. He believes that while China will always remain a formidable competitor, a policy of engagement rather than a policy of isolated approach would perhaps be a better strategy. First, it would give Indian companies a door to enter the Chinese domestic market which is today dominated by MNCs. Plus, Indian IT companies based in China can address other East Asian markets like Japan and Korea. This view is also endorsed by Noshir Kaka, principal, McKinsey & Co. It is a well established fact today that Indian IT firms have an excellent opportunity waiting to be tapped in the Chinese domestic market, which is estimated to be four times the size of Indias. Also, with China becoming a part of the WTO, local banks in China will soon be forced to start upgrading their technology. As local players have not been able to provide the required expertise and technology in the domestic IT market, the Chinese market is currently dominated by MNCs. This in itself offers an excellent opportunity for Indian IT firms, whose development expertise is no way inferior to these MNCs. Another important aspect is the growing purchasing power of the Chinas 1.3 billion people which in turn is creating a strong massive base to build domestic technology companies. China is also expected to be the largest market in the world by 2004 for mobile phones and digital cameras, and the second largest for PCs after the US. A key reason why India is miles ahead of China in software exports is due to the simple fact that the efforts of Chinese software firms were spent in addressing the huge domestic market (estimated to be worth $16.2 billion).

But things are about to change, as China wants to emulate Indias success in the software sector and become a major global force. China has initiated a series of measures, which include plans to set up specialist IT training institutions on the lines of our IITs and Chinese firms are following the same strategy Indias IT majors did (bagging projects based on price) before going on to become software majors. Infosys Murthy believes China is an opportunity since its IT industry cannot even provide for domestic needs Yet, there is a bigger opportunity for Indian IT players in China. One, according to Infosys chairman N R Narayana Murthy, is that Chinese firms cannot meet the full demand from the Chinese domestic IT industry, resulting in the government allowing foreign firms like Microsoft, Oracle and IBM to operate through joint ventures. In addition, Kaka feels that Indian IT firms can take advantage of the fact that China offers Indian IT firms lower trade barriers, lower taxes and excellent infrastructure. No wonder Infosys is on the threshold of setting up facilities in Shanghai to tap the Chinese domestic market. 2) Window to Japan The second premise for looking at China as an opportunity is that it can provide Indian companies a gateway to Japan, a market hitherto virtually untouched. This logic is significant as currently, Japan is the worlds second largest economy-estimated to be worth a gigantic 70 percent of the entire Asian market and which contributes approximately 11 percent to the total outsourcing global market. There is obviously a huge gap to be filled as only four percent of Indias software exports go to Japan. A significant gainer in the Japanese market is China, which has been a favoured partner for Japans software imports. The synergy is easy to fathom. One, Japanese is the second language taught in the northeastern parts of China, where most Chinese companies are located. Also, most Chinese programmers are familiar with the double byte system used to generate Chinese and Japanese characters. Location wise also, China offers a great advantage to Japanese companies looking to outsource their projects. Due to these synergies, it comes as no surprise therefore that Japan continues to be Chinas largest trading partner. Though Indian IT firms have established bases in Japan (the list includes the likes of Wipro, Infosys and TCS and L&T Information Technology), it remains a tough market to crack. The reason primarily being that Japanese companies have traditionally resisted external help relating to their IT systems. But a gradual change is happening. The Japanese economy, which is in the throes of recession, is slowly but surely catching on the outsourcing mantra in a big way. According to industry estimates, spending on IT outsourcing is likely to exceed $15 billion in 2005. These figures are roughly one third of the market size in the US. Since China is a natural trading partner for Japan, it makes more sense for Indian companies to set up base in China by following a strategy of partnerships with local players who have knowledge and expertise about local markets. Since the Japanese culture is not as open as US culture, tapping the Japanese market will undoubtedly require a lot of patience. But as experts

say, once bonds are established they stay for a long time. Hence, it makes even more sense for Indian companies to tie up with Chinese players as China has been a long-time preferred trading partner for Japan. Also, Indias edge over China could come from the fact that it has a good record in quality and protection of intellectual property rights. Global software majors are wary of outsourcing their projects to Chinese companies as China has a terrible record in software piracy. And on the quality front, as of December 2001, India had 36 companies at the SEI CMM Level 5 assessment out of 58 organisations worldwide, while China had none. It is thus a win-win situation for both Indian and Chinese companies as organisations who were earlier wary about Chinese firms but wanted to avail of the cultural and locational synergies, can now do so in the case of a IndoChinese tie-up. 3) The hardware angle Even the hardware sector could gain from Chinas traditional strengths in this segment. K R Naik, managing director of D-link India proposes that Indian companies should set up hardware manufacturing facilities with technology know-how from companies both in mainland China as well as Taiwan. Most of the very few manufacturing facilities in India today deal merely in assembling, and unless they replicate the Chinese model of hardware development, the MAITE&Y estimate of $62 billion by 2010 in hardware will only remain a pipe dream. Naiks formula for success: Form a JV with a Chinese hardware major, procure the technology expertise, the R&D set up and then do actual manufacturing in India. You can even supply to the Chinese market, as our labour force is not only cheaper but much more intelligent, he adds. The key part of the strategy for Indian IT firms is to forge partnerships with Chinese firms and participate in the countrys explosive growth. Some Indian companies have already done this. NIIT, for instance, has seen huge demand for its courses due to its unique English and Mandarin courses. As Kaka says, Going forward, Indian software companies can outsource their work to Chinese companies to boost productivity, while maintaining a strategic relationship with the client. Indian software companies have an exponential opportunity to be tapped in the field of telecom software. Currently, major telecom players in China like Zhongxing and Huawei export their telecommunications equipment to India, while Indian IT firms develop the requisite software for them. Thats a great example of combining Chinas strengths in hardware manufacturing with Indias strengths in software. With Infosys receiving the green signal to set up a branch in China and Satyam too likely to jump into the fray, the future seems bright for Indian IT companies in China. While it is in the best interests of Indian IT companies to view China as a formidable competitor, the opportunities far outweigh the threats. Perhaps the question should be rephrased from, Is China as a threat? to Is China as a land of opportunities? For India Incs sake, we sure hope it is.

2) Sources of information

NASSCOM Software and Service Industry Research Center of CCID Consulting Co., Ltd. OOBP.org AsiaTimes