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Analysis of China as an Offshore Services Location

Published: 2 November 2011 Analyst(s): Tina T. Tang, Frances Karamouzis

This research analyzes China's suitability for offshore services, based on 10 criteria: language, government support, labor pool, infrastructure, educational system, cost, political and economic environment, cultural compatibility, global and legal maturity, and data and intellectual property security and privacy. Sourcing managers can use this report to judge whether China might be a good location for their offshore services requirements.

Key Findings

The leading Indian offshore players set up global delivery centers and training campuses in China to train offshore talents based on their global standardized English program, which leads to more people speaking English at a global level. According to the 12th Five-Year Plan on Recruiting Overseas Students, from 2011 through 2015, China will recruit 500,000 overseas students with mostly high-tech talents, which will bring volumes of skilled resources to China's IT labor market. The government continues developing efforts to set up regulations and give fiscal subsidies for intellectual property (IP) and data security issues. In recent times, protection of intellectual property rights (PIPR) and intellectual property rights (IPR) conditions have improved, and new goals made in 2011 will help China send a good message to investors.

Recommendations

Ensure that you closely track the world's economic development trends, and perform a thorough total cost of sourcing analysis for a multiyear period to determine both cost-benefits and manage risks, such as yuan appreciation and fiscal inflation. Consider China as your primary offshore destination for shared-service centers, customized application development and business intelligence (BI)- and data warehouse (DW)-related business analytics outsourcing services when your organization is expanding directly into the Chinese market.

The IP protection environment changed based on the Chinese government's issue of related regulations and reinforcement of these regulations. Therefore, end users need to pay much attention to these changes and prepare the contract part of IP-related items to adapt to these changes.

Analysis
Table 1 summarizes Gartner's rating of China, based on our 10 criteria (see Note 1). Figure 1 shows China's location and time-zone difference compared with selected cities.
Table 1. China: Outsourcing Rating Criterion Language Government support Labor pool Infrastructure Educational system Cost Political and economic environment Cultural compatibility Global and legal maturity Data and intellectual property security and privacy
Source: Gartner (October 2011)

Rating Fair Very Good Very Good Very Good Good Very Good Very Good Good Fair Poor

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Figure 1. China: Location and Time-Zone Differences

China

Los Angeles -16 hours

New York -13 hours

London -8 hours

Paris -7 hours

Delhi -2.5 hours

Beijing +0 hours

Tokyo +1 hour

Source: Gartner (October 2011)

Language

The authorized 21 offshore outsourcing cities are encouraged (provided incentives) by the local and central governments to set up alliances among universities and private training centers to offer foreign-language training programs that are related to the demands of offshore services. The major language training courses are English and Japanese. About 30,000 training centers are offering English classes in China. In 2010, the English language training market size was valued at about US$3.1 billion in China.
1

Besides local offshore players providing services in the English language, about 10% of them are also providing services in other languages, such as Japanese and Korean and some European languages; for example, hiSoft can deliver R&D engineering services in multiple languages.

Analysis: English training has become a priority area for the Chinese government. English education is being provided in academia, which will significantly increase the English-speaking population, but the quality of English being taught in China could be an issue. However, China allowing foreign organizations to teach English in China is seen as a positive step. Gartner rating: Fair

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Government Support

The government is providing subsidies for firms exporting technology services and software. All firms whose export deal is equal to or more than US$100,000 can apply for a subsidy, which could be up to US$736,420.
2

China provides tax holidays for eligible software firms. A company's income tax holiday would begin from the first profit-making year to the end of December 2017. In addition, the government also encourages companies to get Capability Maturity Model (CMM) and International Organization for Standardization (ISO) certificates by granting them subsidies.
4 3

As a result of China's government fully supporting offshore services industries, some leading local offshore players have a staff of more than 10,000, such as VanceInfo and iSoftStone. In addition, the improved capabilities of these local offshore players have led to small and midsize "sweet spot" deals in the application and business process outsourcing (BPO) markets. Offshore Chinese local players are challenging Indian players in terms of small and midsize deals.

Analysis: The Chinese government has initiated several projects to make a favorable business environment for the IT industry. Government support includes offering long-term tax benefits, building IT parks and providing subsidies for export-oriented companies. The ample supply of skilled low-cost IT labor, along with strong government support, is helping China to emerge as an important offshore destination in the Asia/Pacific region. However, there are some restrictions in the application of government subsidies. Gartner rating: Very Good

Labor Pool

The Human Development Index (HDI) by the United Nations Development Programme (UNDP) is a comparative measure of life expectancy, literacy, education and standard of living for countries worldwide. In 2010, China was ranked 89th out of 169 countries. China has improved its ranking by three positions from 2009, when it placed 92.
6 5

Every year, a high number of engineers graduate in China (about 600,000 annually). This situation helps companies get less-expensive employees.
7

The high rate of students returning from abroad (about 50% in 2009) is working like a bridge between the West and China. They are helping to create a better working environment with foreign nationals. In addition, the 12th Five-Year Plan on Recruiting Overseas Students mentioned China will recruit 500,000 overseas students during 2011 through 2015. China's incentive recruiting policy is mostly related to high-tech talents, and this plan would bring volumes of skilled resources to China's IT labor market.
9 8

Analysis: China is known for its low cost and huge labor force. The government is running programs (directed toward the IT and IT-enabled services [ITeS] industries) with the private sector to train people for outsourcing services. IT companies can take advantage of, as well as leverage, the large

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number of engineering graduates; however, due to a poor proficiency in English, some graduates do not meet multinational corporations' basic employment requirement. Another big concern for China is its aging population, which can be seen as a recruitment risk by companies. Gartner rating: Very Good

Infrastructure

Major cities in China have state-of-the-art infrastructure (transport and telecommunications); in total, China has more than 500 airports, and it has the world's second- and third-largest roadways and railway transport facility, respectively. The frequent high-speed railway accidents as a result of weather and equipment quality control issues have put pressure on the Chinese government. The central government and the Ministry of Railways are quickly reacting to them by, for example, adjusting the railway dispatching system and lowering the speed of the railways.
10

From 2011 through 2015, China will spend about US$1.0558 trillion on public infrastructure.

11

The power demand-and-supply dynamic is very unbalanced in China, with Western and Northern China being net power producers and Eastern China being a net power consumer. This situation will improve once several ultra-high-voltage transmission lines are finished in the coming years.

Analysis: China has an excellent ground transport network and is well-connected with other foreign countries, especially the U.S. and the U.K. Following the Beijing Olympics, the government spending to improve infrastructure has risen every year. Steps such as improving the information and communication technology (ICT) infrastructure and increasing connectivity with the U.S. are clear indications of China's prime focus toward the outsourcing business. In addition, the big portion of investment and enforcement for all areas of "green IT" will be the priority at the strategic level. Gartner rating: Very Good

Educational System

In 2011, China's education spending as a percentage of GDP is 3.6%. In China's 2011 budget, the government has decided to spend 4% of the GDP on education by 2012. The government also plans to spend US$1.78 billion annually.
13

12

Beijing is one of the 21 outsourcing model cities, and it accounted for many universities and research institutions, including 263 government-aided research institutes and 650 scientific research institutes affiliated with universities and colleges.
14

Analysis: With a large number of universities, China produces many skilled human resources. The government also seems very keen to improve the educational facilities in the country by adding more budgets for education. Some of China's universities are ranked among the top universities in Asia/Pacific. But the educational system must consider the needs of the IT industry and provide

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domain-specific education by introducing more practical-oriented courses. It will help the quality of graduates. Gartner rating: Good

Cost

The central government's tax-free policy for registered offshore providers in the 21 outsourcing cities will help offshore providers overcome the high cost pressure. The policy is still available, and the local governments of the 21 outsourcing bases (cities) will follow up on the central government's regulations that provide more detailed guidance based on regional characteristics (for more information, see "Emerging Market Analysis: China's Top Regulatory Issues Impact the IT Market"). In China, the annual average salary of a senior software engineer is about US$21,819, which is 67% less than the salary for the same position in the U.S., based on one to four years' experience. Compared with India, the Tier 2 and Tier 3 cities' labor costs are still lower (10% to 20%) than that of India's labor costs.
16 15

Inflation is rising in China, and it crossed 5% in April 2011. It will increase the cost of goods. The 100-city real estate prices index by China Real Estate Index System (CREIS) shows that the index rose 0.53% on a month-over-month basis in May.
18

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Analysis: China's one major advantage to attract foreign investment is its low cost. There is a significant difference in salary of IT professionals in the U.S. and China, but this advantage is narrowing due to the continuous increases in wages and real estate occupancy rate in some Tier 1 cities of China, such as Beijing and Shanghai. Thus, most of the providers leverage Tier 2 or Tier 3 cities to share the risk of cost increases (that is, they transfer mainly labor-intensive service offerings, such as call center support and data entry). That means the high-end offshore service offerings remain in Tier 1 cities, where offshore providers can find more senior IT talents to deliver these kinds of services. Gartner rating: Very Good

Political and Economic Environment

According to the World Bank estimation in 2011, China's GDP will grow 9.3%, which is less than the 2010 growth rate of 10.3%. This growth illustrates that the Chinese government recognizes the importance of keeping a steady and healthy growth rate rather than chasing a high GDP rate.
19

In 2011, China is seeking to reduce its budget deficit and bring it to 2% of GDP, compared with 2.5% in 2010.
20

In 2010, China's GDP was US$5,879 billion, which surpassed Japan and became the world's second-largest economy.
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In 2010, the Corruption Perceptions Index placed China at 78 among 178 countries, with a score of 3.5 out of 10, which indicates that a certain amount of corruption exists in China. The best one is Denmark, with a score of 9.3 out of 10.
22

China has one of the most stable governments in the Asia/Pacific region, but there is no substantial opposition to stop the government on any issue.
23

Analysis: China is one of the biggest economies of the world, and its growth rate is among the top 10 in the world. A very stable Communist government is one of the reasons for its consistent growth, which also can bring trust and reliability among investors. But the absence of opposition in China creates a monopoly in government. Another issue concerns corruption, which could significantly hinder growth. In addition, foreign enterprises must be aware of the need to contribute financially to speed up some seemingly bureaucratic processes or to remove administrative barriers there might be. Gartner rating: Very Good

Cultural Compatibility

According to the IMD World Competitiveness ranking, China, in 2011, ranks 21 out of 59 countries on an index of 5.58 out of 10 in terms of "ease of doing business is supported by regulations." China's score is higher compared with other selective offshore countries in the Asia/Pacific region and is only slightly lower than Malaysia's score. According to the IMD World Competitiveness Yearbook, in 2011, China ranks 21 out of 59 countries on an index of 7.38 for national culture, which means the country is open to foreign ideas. Its score is better than the U.S. score. Compared with other selective offshore countries in the Asia/Pacific region, China's score is only slightly lower than that of Malaysia's, India's, Thailand's and the Philippines'. In the 2011 Travel & Tourism Competitiveness Index, China has been ranked 39 out of 139 countries in terms of a good place to visit; in 2009, it was placed at 47. The ranking shows that foreigners are quite comfortable in China and that they like to visit the country.
24

Analysis: Understanding of Chinese culture is very important to start a business. People in China have a different working culture, and it becomes more challenging with a language barrier. It is wise to develop a good relationship with locals, including government and business partners, to avoid any conflict or setback. The increasing number of tourists and improving tourism competitiveness show that the language or cultural barrier is diminishing, and these factors will provide a better possibility for doing business in China. Gartner rating: Good

Global and Legal Maturity

In trying to create a better investment environment and attract investors, China has provisions to improve the legal environment for foreign investors. The provisions deal with various issues,

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such as the Trial of Disputes Involving Foreign-Funded Enterprises. This development is considered encouraging for foreign-invested companies.

25

China recently implemented a bribery law. China has been criticized for corruption and bribery. This law will help to improve the business environment in China.
26

China is liberalizing its trade laws and allowing foreign companies to invest in new sectors. For example, China has allowed American companies to invest in some government contracts and mutual funds.
27

China is a member of many major organizations, such as Asian Development Bank (ADB), Group of Twenty (G-20), Group of 24 (G-24 [Observer]) and Group of 77 (G-77), and the country is among the BRIC (also known as Brazil, Russia, India and China) emerging markets. Being a member of some major organizations has helped China build good trade relations with other countries.
28

Analysis: China has provisioned new laws to improve business conditions, especially concerning foreign investors. The new bribery law will help to reduce the bureaucratic system and can also help to reduce strong interference of local bodies prevailing in the system. The government decision to ban voice over Internet Protocol service (Skype) will give a wrong message to investors, and it can be seen as a bias for state-run companies. Gartner rating: Fair

Data and Intellectual Property Security and Privacy

To address intellectual property issues, the Chinese government has taken various steps, such as the following:

Launching a campaign for intellectual property enforcement.

30

29

Launching a campaign against copyright violation. The Chinese government realizes that to become an offshore destination, it must have a good IPR environment.
31

There are 10 administrative departments and more than 20 administrative agencies that are closely related to the management of intellectual property. The Business Software Alliance's (BSA's) report said China's piracy rate dropped from 79% in 2009 to 78% in 2010. BSA defines software piracy as "the illegal use and/or distribution of software protected under intellectual property laws." For this point, compared with other Asia/ Pacific offshore locations, such as India (64%), Malaysia (56%), Philippines (69%) and Thailand (73%), the software piracy rates in these countries are better than that of China.

Analysis: The government continues developing efforts to set up regulations and give fiscal subsidies for IP and data security issues (see "Emerging Market Analysis: China's Top Regulatory Issues Impact the IT Market"). In recent times, PIPR and IPR conditions have improved, and new goals made in 2011 will help China send a good message to investors. Despite some signs of improvement, China has a long way to go to improve the piracy issue and IP protection situation.

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Gartner rating: Poor

Recommended Reading
Some documents may not be available as part of your current Gartner subscription. "Analysis of China as an Offshore Services Location" "Leading Locations for Offshore Services in Asia/Pacific and Japan, 2010-2011" "Emerging Market Analysis: China's Top Regulatory Issues Impact the IT Market" "Market Insight: What IT Services Providers Need to Know About China's 12th Five-Year Plan" "Emerging Market Analysis: China's Top Regulatory Issues Impact the IT Market" "Market Insight: IT Services Market Assessment, China, 2011" Evidence
1 2 3 4

"Battle intensifies for $2bn English-teaching business in China," The Guardian, 13 July 2010 "China to provide subsidies for tech exports," China Daily, 25 July 2010 "Tax incentives for high technology industries in China," China Tax, May 2011

"What are the specific policies that encourage the development of software and integrated circuit industries?"
5 6 7 8 9

HDI 2010 Rankings, UNDP Human Development Report 2009, UNDP. 27 August 2009 "Keeping Engineering in the U.S. Relevant," The Engineer Leader, 25 February 2011 People and Life-Human Resource, Mycos, 24 February 2011 Ministry of Human Resources and Social Security of the People's Republic of China World Factbook, CIA, 26 May 2011

10 11

"Chinese public infrastructure spending could reach RMB 7 trillion in 2011-15," SteelOrbis, 26 January 2011
12 13

Economic and Social Indicators, Comparison of BRICS Countries "China's Budget for 2011," China-Wire, 4 January 2011

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14 15 16 17

Beijing Municipal Science & Technology Commission Salary by Job, China, PayScale, 1 June 2011 Salary by Job, U.S. PayScale, 25 May 2011

"China Inflation Over 5% Signals Officials May Boost Yuan, Interest Rates," Bloomberg, 11 May 2011 "China: Real Estate Prices Rose By 0.53% In May," Business Insider, 2 June 2011 "GDP growth to slow in 2011," Global Times, 29 April 2011 "China targets 2011 budget deficit of 2 pct of GDP," Reuters, 5 March 2011 "China Overtakes Japan as World's Second-Biggest Economy," Bloomberg, 16 August 2010 Corruption Perceptions Index, Transparency International, 2010 The World Factbook, CIA, 26 May 2011 The Travel & Tourism Competitiveness Report 2011, World Economic Forum, 24 February 2011 "China Issued New Provisions to Improve Its Investment Environment," CIIPP, 20 August 2010 "CSR and Business Legislation - The Bribery Act comes to town," tutor2u, 5 May 2011 "China Eases Trade Rules, Allows US Fund Sales," CNBC, 10 May 2011 The World Factbook, CIA, 26 May 2011

18 19 20 21 22 23 24 25 26 27 28 29

"China Stepping Up Intellectual Property Rights Campaign, Says Attache," BroadbandBreakfast.com, 11 February 2011 "China Pledges Stronger IPR Protection as Microsoft CEO Visits," Intellectual Property Protection in China, 31 May 2011
31 30

"Intellectual Property (IP) Protection in China," HengTian Services, 9 June 2010

Note 1 Objective, Methodology and Limitations Objective This report is part of Gartner's annual analysis of 30 leading offshore locations, which began in 2007. Organizations seeking an outsourcing arrangement, or those wanting to set up a captive center, should use these reports to evaluate a country's current suitability for offshore service work.

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Each report includes key data points and insight to provide a brief, high-level perspective so that organizations can easily compare potential locations. As each organization will have a different view of which factors are the most important for its needs, the reports aren't intended to rank each country and don't include an overall rating for each country. Methodology We applied a rigorous and repeatable methodology to assess each country's state. This involved:

Identifying 10 categories that organizations should consider when looking at a potential location for offshore or nearshore IT or business process services. Applying the insight, knowledge and experience of Gartner analysts as well as consulting credible secondary sources to evaluate the countries against these categories. Rating each category on a 5-point scale, in which 1 is poor and 5 is excellent, to provide an ata-glance view of the status of that country. Performing a comparative analysis at a regional and global level to ensure balance in the assessments.

Limitations These reports assess each country's current status. They will not reflect the benefits of investments some countries are making to improve an area of weakness or enhance current strengths, where these investments have not yet visibly come to fruition. For example, investments in Englishlanguage education will take some time to demonstrate improvements in the workplace. Although organizations could apply these reports to applications, business processes or infrastructure, the reports don't address this level of granularity. If organizations were to apply these reports to one specific service line, they may need to adjust some of the ratings (for example, the availability of specific skills in the labor pool).

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