China Business

China IT Outsourcing Rising

International lawyer

If I had to pick one area in which my firm has seen the most growth over the last six months, it would be foreign companies outsourcing IT work to China. Paul Denlinger of China Vortex has come out with a white paper explaining why this is the case. The paper is entitled, Why Indian Software Companies are Outsourcing to China: Why your next major software project may actually be made in China even if you award it to an Indian service provider, [link no longer exists]

The paper’s thesis is that Indian outsourcing companies need to expand and India is not producing talent fast enough to fuel this expansion. “China is the logical service provider of talent and services they need.” According to Denlinger, “when it comes to size and scale of market, China is the last frontier for IT talent and is the only market which can come anywhere near the size of India’s IT pool of talent.” The Chinese government is investing heavily in both hardware and software infrastructure, English language skills are rapidly improving, and China “is now poised to make a great leap forward in the field.”

Denlinger rightly points out Beijing’s emphasis on developing its IT sector:

Economic development in China is largely charted out by the Chinese government, with policy decisions and incentives to encourage new industry development. The latest new Chinese economic policy directives came from the 17th party congress held in October 2007. The new policy directives are aimed at the encouragement of clean industries and services which do not pollute the environment and contribute higher value-added to the country’s exports.

Since software development and outsourcing fall within these directives, they are an industry which the Chinese government now encourages, opening up the Chinese market to foreign investment and participation.

Our China tech lawyers are finding that securing Chinese government approvals for our IT clients is generally easier than for any other industry.

The paper notes that IT outsourcing in China is quickly expanding beyond Beijing and Shanghai to second tier cities like Chengdu, Hangzhou, Guangzhou, Jinan, Nanjing, Shenyang, Shenzhen (I think of Shenzhen as a tier one city), Tianjin, Wuhan, Xian, and Dalian. Not sure if it is a trend or not, but most of our clients lately have been focusing on Chengdu, Wuhan, Xian and Dalian. Just this week, I asked a software company client why it had chosen Chengdu to establish its China outsourcing presence. I expected the client to respond by talking about the low cost there as compared to Beijing or Shanghai, but he talked only about the excellent talent coming out of the universities there.

Denlinger notes how China’s second tier cities have better infrastructure than those in India:

When comparing China’s tier two cities to India’s tier two cities, China’s are infinitely better in education and hardware infrastructure, including roads, water, electricity, broadband access and office space. In addition, the Chinese have been aggressively courting outside investment for years. Investment deals in India take months, even years to negotiate, but in China, as long as the mayor and city government get behind a deal, it can be completed within a very short time. Moreover, since the office buildings are already there, all the investor has to do is focus on hiring and training personnel. Since many of the personnel have already been working in Chinese companies for several years, it is only a question of hiring them and bringing them up to speed quickly enough.

One of the biggest fears I, as a international lawyer, have with China’s tier two cities is IP enforcement. Denlinger seems to think this issue has been solved:

For many American companies considering software outsourcing for the first time, many are afraid of China fearing that their intellectual property will be stolen. Knowing this, the leading Chinese software outsourcing firms offer to sign IP agreements with their American customers which are governed by US intellectual property laws.

This is not necessarily a solution. Saying US IP laws will govern says virtually nothing about enforcement. US IP laws governing does not mean a Chinese court will issue an injunction forcing the Chinese company to stop using the American companies IP. Nor does it mean that a US issued injunction will have any impact on China. One of the things we are starting to see is Chinese IT companies forming US companies and then using those US companies to contract with American companies wanting to outsource in China. This seems to give great comfort to the American companies, but the reality is that much of that comfort is false. Unless the Chinese company’s US company has enough assets to matter, entering into a contract with the US arm of the Chinese company may actually reduce the legal protection. This is a very complicated and fast changing area of law and the best party with which to contract should be determined on a case by case basis.

Denlinger sets forth the following ways Indian companies are adopting to the Chinese market:

  • Identifying and partnering with a Chinese city government in a second-tier city. In return for investment incentives, they guarantee to create x number of job opportunities for university graduates and recent university graduates.
  • Forming a joint venture company with a Chinese city government. This is a much more tightly integrated entity than the previous example which would bind the JV closely to one Chinese city.
  • Identifying a leading Chinese software outsourcing firm, and forming a BOT (build, operate and transfer) operation where the Indian company commits a certain value of contracts and the Chinese company commits a certain number of technical persons devoted to contract delivery. At a negotiated point in time, the Chinese company transfers operations to the Indian company.

Almost all of my law firm’s clients (most of which are American, European or Australian, and few of which are Indian) are going into China under the third option set forth above.

I would love to hear what IT people think of all this. Is it really fair to act as though China is going to be the only game in town beyond India? Does that not ignore Russia and the rest of Eastern Europe? What about the IP issues?