Look East

To further improve communication, Risse confers mostly with senior managers at Freeborders, the San Francisco vendor that provides his company with outsourcing services at its development center in Shenzhen. English proficiency is mandatory for mid- and senior-level employees at Freeborders, which registers annual sales of $15 million to $20 million and expects a growth rate of about 100% this year, co-founder John Cestar says. Frequent inquiries come from businesses that have seen costs in India rise over the past two years. "A number of Indian companies have had three-year price guarantees and haven't been able to honor them," he claims.

But the scarcity of Chinese IT workers fluent in English skews China's own low-cost advantages. Those workers who are proficient in the language command a higher salary than their counterparts--as much as 10% to 15% more than similarly skilled Indian programmers, Gartner estimates. It's one reason officials at Sierra Atlantic Inc., a Fremont, Calif., company that specializes in offshore software development, passed on China last year as a site to complement its facilities in India. "It's a significant issue," says Marc Hebert, executive VP at Sierra Atlantic.

A more pressing concern for CommerceQuest and others is containing the type of work outsourced to China, given the country's reputation for ignoring infringements on intellectual-property rights. Freeborders mostly performs peripheral work on CommerceQuest's business-process-management applications. Risse says his concerns are such that he most likely wouldn't send development of an entire application to China. "We don't give them every piece of the puzzle," he says.

The problem can be exacerbated when companies contract with Chinese outsourcers that are themselves software-product companies. That's pretty common. For example, both Kingdee International Software Group Co., a leading enterprise-resource-planning soft- ware vendor in China, and Shenyang Neusoft Co., which had outsourcing sales of $35 million last year for BPO and software-development services to Japanese customers, also are software-product companies.

"Anyone who's concerned about [intellectual property] is still going to be concerned of that," Rongley says. Customers are "concerned about their IP turning into the Chinese product one day." Even though Bleum isn't in the product business, Rongley says that employees are subject to background checks and must sign a separate intellectual-property contract in both English and Chinese. In August, the company will be the first in the country to have ISO 17799 certification, an internationally recognized standard for corporate information security, he says.

Not everyone agrees with Rongley's assessment that pure outsourcing companies in China are more likely to offer better intellectual-property protection than hybrids that offer services and sell their own software products. "It cuts both ways," says Ralph Eckardt, an intellectual-property specialist at the Boston Consulting Group. "If a company is developing its own software, it has an interest in promoting intellectual-property protection across the board."

Chinese officials say they're cracking down on piracy and improving the country's reputation as a place to conduct IT work. Some of this is happening at the local level as major cities seek to gain an edge in attracting outsourcing business. Last year, Zhu Xiaoming, deputy director of the Shanghai People's Congress Standing Committee, speaking at Shanghai's Global IT Outsourcing Summit, said his city is working to stamp out software piracy. The Shanghai Municipal Foreign Economic Relations and Trade Commission, which has a standing delegation in the United States to forge ties with Silicon Valley, says it's closely cooperating with the Shanghai Intellectual Property Administration on intellectual-property protection and educating software-outsourcing companies on the issue. But it's "a gradual process," says Feng Cheng, director of science and technology development and the technology trade division at the commission. "The problem will not be solved within one day."

Another problem is that it isn't unusual for a large Chinese software company to have government officials on its board or even be owned by the government. One analyst whose firm does work in China admits that the close government ties are a potential concern. The Chinese government heavily promotes the competitive interests of Chinese companies, the analyst says. It isn't unheard of for the government to provide indigenous companies with confidential information about foreign companies doing business in the country, he says.

Questions also swirl around whether China's IT industry has all the skills companies need. Sierra Atlantic's Hebert notes that, while Chinese programmers tend to be strong in broad-based technologies such as Java and .Net, it's difficult to find individuals with experience working on specific business applications such as PeopleSoft, SAP, or Siebel Systems. "Those skills really don't exist in China," he says. Hebert also believes that, for now at least, Chinese IT workers are generally less productive than Indian workers, a notion that's supported by McKinsey's research. Operating margins at Chinese software-services companies tend to average about 7%, compared with a worldwide average of 11%, McKinsey says.

But a more disciplined approach to IT may improve China's productivity stats. That's being fostered in companies such as Bleum, which is continuing to refine its processes as it plans for CMM Level 5 certification by May. And foreign vendors also are bringing their own expertise in processes to their Chinese operations, helping to raise quality in the country. Cognizant uses its established facilities in India to train new Chinese workers. "We have to transplant not just our knowledge but also our culture," says Francisco D'Souza, Cognizant's chief operating officer.

Ultimately, China's biggest advantage in IT services is simply its size. "It's the next big destination because it's the only one that can rival India in terms of scale," Karamouzis says. A few hundred thousand software engineers graduate from colleges in China every year, versus 30,000 in India. That, says Freeborders' Cestar, will prevent the kind of wage inflation India is experiencing as demand there moves closer to supply.

Overall, CommerceQuest's Risse says he's satisfied with Freeborders' work, which represents 5% to 10% of his application-development budget. Satisfied enough that, going forward, China will account for half of any staff additions to CommerceQuest's development team. "They're good at certain areas, and we want to take advantage of that," Risse says. Undoubtedly, so will many more IT execs as China becomes outsourcing's next hot spot.

Read our online interview with the CEO of China-based outsourcer Bleum Co.