China:
software
outsourcing
industry
Solidiance examines the current market and
implications for growth
July 2009

China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
The software outsourcing industry is a symbol of
China’s great leap forward from a focus on industry to
service. In less than five years, China, by leveraging its
low-cost labor and driven by government ambition, has
become one of the most important software
outsourcing destinations in Asia.
Unfortunately, the global economic slump, the
appreciating RMB, and new labor laws in 2008 have
“ Even in the current downturn, we
are expecting margins to increase
at least 20% in 2009... The
Chinese software outsourcing
industry will emerge more
started to curb growth in this previously soaring sector.
For the first time, companies in this sector are mature by the end of this year.
”
experiencing declining orders, tougher contractual
terms, and the need to re-configure their talent pool to Dr. Liu Ji Ren – Board of Directors, Neusoft
meet irregular market demand.
In light of current changes, this paper presents our
views on the road ahead for China’s software
outsourcing industry, its challenges and opportunities.
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
When Healthy Growth Meets Economic Storm
A Giant Leap past 2 years), as well as rising human capital costs
resulting from more restrictive labor laws in 2008.
China’s software outsourcing industry achieved an
impressive growth rate of 38% year-on-year from 2004 This fast growth created a fragmented market with
to 2008. Driven by strong government support, active many small and medium size players. There were over
involvement from venture capitalists, and growing IT 8,000 players in 2008, and the largest, such as Neusoft,
budgets from clients experimenting with new hi-tech Insigma, Hisoft, and Vanceinfo, have roughly only 5%
productivity tools, the Chinese market size for software market share each. The number of players is expected
outsourcing reached USD 2.6 billion in 2008. to consolidate down to 3,000 over the next two years,
through both competitive elimination as well as
Many Victories, yet Many Challenges
potential mergers and acquisitions (M&A). This has
It all started in three cities - Dalian, Beijing, and been cited as a positive advancement for the Chinese
Shanghai - in early 2003. Having seen encouraging software outsourcing industry, because the remaining,
success, the China State Council offered incentives to stronger players will be those with a better chance to
grow the sector. As of Feb 2009, there were 20 cities compete for higher value outsourcing deals currently
designated as ‘window cities’ to house software served by Indian outsourcing companies.
outsourcing companies.
However, another challenge faced by the sector amid
An important development over the past five years was the economic slump is a drop in large value orders.
the gradual movement from low-value outsourcing work, Over the past six months, the industry has seen fewer
typically the result of multiple layers of sub-contracting, USD 10 million orders, yet it is still under pressure to
towards mid-end outsourcing work, involving greater maintain the staffing levels set during recent boom
levels of consultation and design. This was driven by years. Firms are starting to question when they will see
the improving technical competence of Chinese these multi-million dollar deals again, and in spite of the
outsourcing providers, the rising pressure on margins spending downturn and consolidation among peers,
for low-end work resulting from Renminbi (RMB) what steps should be taken to facilitate survival and
appreciation (RMB appreciated 15% against USD in the future growth.
+ Uncertain Future
Economic Storm
=
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Market: To Grow or Not To Grow – Drivers
Market Growth Drivers for China’s Software This trend creates a lucrative market for software
Outsourcing Industry outsourcing service providers.
1.Transfer of outsourcing business from India. 4. Strengthening of the Japanese Yen improves margins
earned by Chinese service providers.
Some recent events have damaged
India’s credibility as the world’s top choice for software Approximately 50% of China’s software outsourcing
outsourcing. For example: business comes from Japan and contracts are mainly
signed in the Japanese Yen currency (JPY). The chart
– The December 2008 terrorist assault in Mumbai.
above shows that the appreciation of JPY will lead to
– The billion dollar accounting scandal at Satyam, India’s
higher revenues and margins for Chinese software
4th largest software outsourcing company.
outsourcing companies. The strong JPY trend of the
−World Bank’s blacklisting of Wipro, India’s 3rd largest
first quarter 2009 will benefit the profitability of China’s
software outsourcing company.
software outsourcing industry.
“
2.Chinese government’s support of the software
outsourcing industry.
We have already seen some global clients
−The state council announced a special 15% tax cut shifting their outsourcing partnerships
effective February 2009, until the end of 2013, for
outsourcing companies. This incentive allows more room from India to China and the trend will
”
for outsourcing companies to learn to survive and no doubt continue.
compete.
−The economic stimulus package will also support
industries such as telecom and energy, which are key Ms. Sun Xin Fang - CEO of Chinasoft
customers of China’s software outsourcing industry.
3.The growing need for unified software and processes in
Exchange Rate (100 JPY Against RMB)
Neusoft’s Margin vs JPY Exchange Rate
China. 7.6 45%
Neusoft’s Margin%
7.4 40%
The integration of Chinese companies 7.2
7.0
35%
30%
into the global business arena and rising M&A activities 6.8
6.6
25%
20%
increases the need for unified software and processes. 6.4 15%
6.2 10%
Within the first two months of 2009, Chinese companies 6.0 5%
5.8 0%
spent USD 21.8 billion acquiring international companies,
a 40% increase year-to-year. Now Chinese multinational
JPY exchange rate Neusoft's margin
corporations (MNCs) face the challenge of integrating and
(The table above shows the relationship that Neusoft’s margin rate increase when JPY
consolidating supply chains, logistics, information appreciates and vise versa)
technology and human resources, among other functions.
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Market: To Grow or Not To Grow – Barriers
Market Growth Barriers for China’s Software
Outsourcing Industry
“
1.Global economic downturn.
The global software outsourcing industry
as a whole is affected by the current economic slump. In Of Beyondsoft’s past clients,
India for example, which holds approximately 40% of the
global software outsourcing market, the market is still approximately 30% were unprofitable
growing but the pace of expansion has slowed down. projects. We were backed by VCs and in
After expanding by 35% in 2007, growth was about 15% order to achieve high revenue, we
in 2008. Solidiance interviews show the market expects
growth to diminish further to around 7% in 2009. accepted all projects, even small
Reasons affecting growth for outsourcing include: orders. Oftentimes the sales cost was
−Global CIOs are cutting IT budgets and renegotiating already 25% of the price and there was
”
contract terms – in many cases a lower price for the
same amount of work.
very little room for margin.
−Outsourcing decisions are being delayed or canceled,
Mr. Wang Bin - CEO of Beyondsoft
which will affect the volume of contracts sold in Q1 and
Q2 2009.
Historically, companies would consider outsourcing
towards the end of a market downturn. Recent Solidiance
interviews show it could take even longer this time as the
overall investment sentiment has dropped significantly.
Executives are cautiously handling their outsourcing
budgets and will hold back investments until they see a
sustainable economic recovery.
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Market: To Grow or Not To Grow – Barriers
“
2. Reality check on profitability of projects.
The recent growth in China’s software outsourcing
industry was fueled by venture capital (VC) investment
We started to feel the heat of the
and initial public offerings (IPOs), and the main economic downturn several months
measurement for success was turnover, not profit. As ago. Customers started to demand 25%
a result, companies accepted all types of projects,
including non-profitable ones, to boost revenue growth more work for the same fees we charged
”
and client count. Now that labor costs are increasing a year ago.
and IPO listings are less likely to materialize,
outsourcers are re-examining their portfolio and will be
Solidiance interview with an anonymous medium sized
less inclined to accept projects that may appear
software company in China
unprofitable, thus reducing growth.
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Conclusion on Market Growth/Decline
To Summarize
China’s Software Outsourcing Market in 2009 Impact
Drivers
“
• Chinese government's economic stimulus package
• Chinese government's tax incentive to the software outsourcing
industry The Chinese market will keep
• Chinese companies increasing overseas M&A growing, but the growth rate will
• Indian outsourcer's diminishing credibility
decline to 15% in 2009 and will recede
• Expected appreciation of JPY against RMB
further to 10% in 2010.
”
Barriers
• IT budget cuts due to economic slump
Heiko Bugs - Director, Solidiance
• Delays in software outsourcing decisions
• Part of software outsourcing sales in 2007/2008 attributed to a
‘bubble’ as companies took up unprofitable projects
• Expected depreciation of USD against RMB
China’s Software Outsourcing Industry Market Size
3.5 3.3 60%
3.0
Market Size (USD Billion)
3.0 50%
2.6
2.5
Growth Rate
2.0 40%
2.0
1.4 30%
1.5
0.9 20%
1.0 0.6
0.5 10%
0.0 0%
2004 2005 2006 2007 2008 2009 2010
(The table above shows that market growth will slow down in 2009 and 2010)
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Market Player Structure – What’s Next
China’s Software Industry IPO Value
During the growth period between 2004 – 2007, high
4,000
growth potential attracted numerous VCs, including 3,250 -91.2%
3,000
Granite Global Ventures and Tiger Fund, to put 2,000
significant investment into China’s software outsourcing 1,000 286
industry. This helped companies to grow quickly and 0
2007 2008
launch their IPO. This growth model ended with the (The table above shows that China’s software industry IPO total value decreased 91.2% in
2008 compare to 2007)
advent of the current financial crisis.
World’s Major Venture Capital’s ROI
In 2009, major drops in the global stock markets have
30% 25.10%
resulted in low returns on investment (ROI). -79.7%
20%
Furthermore, IPO activity has all but dried-up. This
trend means other financing channels are needed. 10% 5.10%
Listed companies such as Neusoft and Vanceinfo, have 0%
2007 2008
an advantage since they are well capitalized. They also (The table above shows that world’s major VC’s ROI decreased 79.7% in 2008 compare to
have the option to issue new shares, which would fund 2007)
them to acquire additional resources from small to The chart below shows the level of fragmentation of the
medium-size companies that are in financial distress. Chinese software outsourcing industry. The small and
The most important strategic imperative for the medium sized players that are cash-tight will struggle to
software outsourcing industry is expansion. The size of survive through the current economic downturn, while
a company’s work force (along with its educational level, the larger players with a bigger pool of well-trained and
efficiency, and experience) is the measure of the ability experienced staff, will continue to capture more of the
to do large software outsourcing deals. Top Indian pie.
companies with staff of over 100,000 people have the Market Share in Terms of Off-shore Software Outsourcing Revenue Q3
capability of doing deals worth over USD 100 million. 2008
7%
Top Chinese companies, however, have fewer than 5%
20,000 staff and therefore are only able to do deals 4%
that are less than USD 20 million. 4%
3%
M&A is considered by industry participants as the best 3%
short cut to expand capacity and capabilities, and 3%
3%
conventional wisdom suggests that downturns are a 66% 2%
good time for M&A. However, the tightening of the 1%
availability of credit and capital investment, as well as Beyondsoft
Neusoft DHC
uncertainties in the market outlook will likely deter M&A Insigma SinoCom Hyron
activity in the software outsourcing sector for the Hisoft Achievo Others
immediate short term future. Vanceinfo Chinasoft
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Conclusion on Market Player Structure
What will likely happen
1. M&A initiatives in the future will likely come from 3. Unprofitable projects will no longer be accepted, as
large listed companies, while M&A targets will they once were, when VC’s pressured companies to
largely be companies that have qualified staff of grow clients, revenues and profits in anticipation of
over 2,000 people. an IPO.
2. Small to medium players (less than 2,000 staff)
will do their best to survive and be wary of
expansion, especially since it will be hard to find
financing. A dramatic change in the size of this
segment is not expected.
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Seeking Gold in 2009
Domestic Market is Key for Growth in 2009 Manufacturing and Retail: 10% of the overall
Chinese software outsourcing market belongs to the
Telecom - 3G: Telecom historically is one of the most
manufacturing and retail sectors, which have been
important markets for software outsourcing. The
severely affected by the drop in exports and global
Chinese government announced that from 2009
consumption in 2009. As a result, greater emphasis has
through 2010, USD 41 billion will be invested in 3G. The
been placed on improving sales related operations.
Ministry of Industry and Information Technology of
Unless a software outsourcing project benefits sales
estimates that this will contribute USD 2 – 3 billion of
directly, these sectors will likely see less IT spend for
growth to the software outsourcing industry.
the foreseeable future.
Energy: Traditionally, energy is another one of the
E- Government:
largest markets for software outsourcing. In February
2009, the Energy Bureau announced that USD 82 billion Mid-term: Due to a series of recent natural and human-
will be spent in 2009 on the energy sector which will error tragedies such as mine explosions and
speed the pace of nuclear and wind power development, earthquakes, China’s existing emergency and crisis
entailing significant software application development. management systems were deemed outmoded and in
dire need of upgrading. These events spur a major
Transportation: Transportation is a strong focus in
market opportunity for software outsourcing companies.
the new USD 570 billion Chinese economic stimulus
package. The Beijing government for example, will Short-term: Some successful e-government pilot-
spend USD 20 billion (topped up by another USD 120 programs, such as an IT platform allowing the police to
billion from the private sector) before 2010 to build four better serve their citizens, have been showcased as
new subway lines. The investment brings opportunities projects that could easily be transferred to other cities
for software outsourcing companies who are strong in nationwide, which offer good opportunities in the short
developing transportation IT systems. term.
Software Industry: China’s friendly Foreign Direct High
Investment (FDI) policies, large talent pool and huge Telecom
market potential have attracted many foreign software Energy
companies to setup R&D centers in China. Microsoft Potential Transportation
announced that starting in 2010, they will outsource Investment
USD 400 million worth of R&D every year to China. Finance Software
Amount
Manufacturing
Finance: In 2008, some 20% of outsourcing projects & Retail
focused on the finance sector. The main customers in Low
this segment came from the Japanese and US markets.
Long Term Short term
The current financial crisis has put heavy pressure to Timing
develop better financial accountability tools for global
players.
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China: Software Outsourcing Industry
Solidiance examines the current market and implications for growth
Solidiance is a marketing and innovation strategy consulting firm with focus on growth in Asia Pacific. We are devoted to working side-by-side with our clients to
outpace the competition, close gaps in growth and deliver breakthroughs in performance and profitability. Our Asia focus provides our clients with a better
understanding of intrinsic regional issues.
To subscribe to further white papers and to learn more about Solidiance please visit: www.solidiance.com
Shutin Wah - Principal Allen Lee – Consultant
Shutin Wah is a Principal based in the Solidiance Shanghai
office with more than seven years of consulting experience.
He has led over 50 national and multi-regional engagements
Allen Lee is a consultant in the Shanghai office of Solidiance.
for Fortune 500 clients across China, Hong Kong, and
Prior to joining Solidiance, Allen worked for McKinsey &
southeast Asia. Prior to joining Solidiance, Shutin managed
Company, as well as two other international consulting
the Shanghai operations of a global management
companies in China. Subsequently, Allen started his own
consultancy, establishing and managing client relationships.
venture, advising international clients on market entry and
With strong experience in combining numerical and
product launch strategies in China for fine chemicals and
qualitative analytics, Shutin specializes in customizing
luxury goods. Allen has worked on engagements across a
advanced market segmentation and size forecasting models
variety of industries including Information technology, Oil &
to help clients identify and prioritize market opportunities to
Gas, industrial components, construction materials, retail and
develop growth strategies. Shutin has rich experience across
healthcare. Based on his previous experience, Allen focuses
numerous growth sectors throughout China and Asia Pacific,
not only on comprehensive analysis but also on developing
including technology, engineering, and banking. He combines
practical solutions jointly with clients to successfully navigate
sector and cross-industry best practices, to leverage this
Asia’s markets. Allen holds a Bachelor’s Degree in Finance
knowledge to help clients develop successful market
from Fudan University, Shanghai.
strategies. He holds a Bachelor’s in Engineering from the
Hong Kong University of Science and Technology and an
MBA from the National University of Singapore.
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