China takes a chip off India model

Mention software outsourcing and one thinks of Bangalore which has more than 150,000 software engineers. India's Silicon Valley and other well regarded technology hotspots around the country are at the cutting edge because of a highly skilled pool of computer science professionals who have a good command of English. They have made outsourcing software development a viable option for multinationals and overseas businesses.

This was not always the case, but by proving its critics wrong India has made it easy for China to follow suit, says John Cestar, co-founder and co-CEO of Freeborders, which develops outsourced software links on the mainland.

"India is our best ally in this - when India started no one thought it would work," he says. "But now India has already broken through so none of our clients ask themselves should we outsource. The question is rather where we should go and with whom. Because India can do that, you don't have to spend time convincing people that can be done."

While the firm's headquarters are in San Francisco, Freeborders employs just under 500 staff at its facilities in Shenzhen, developing custom software for the financial services, retail, and high-tech/software industries. With a further 120 business experts and analysts based in the US and Europe, the company develops software in China and delivers to a US-based, mostly Fortune 500 clientele.

"The trick to this business is being on both sides of the world. You can't just have a tech team in Shenzhen," notes Cestar.

From retail to banks

Freeborders began its Shenzhen operations with retail clients, principally because of that category's familiarity with doing business in China. "The evolution of the business is interesting. We started with retailers such as GAP and Levis. The reason is that these companies consume a lot of custom software, but they are also very comfortable in China. They get core products from China and are in the supply chain. China is not so mysterious to them," says Cestar. "We went to school with them, developed our map on process maturity and built up a track record."

But while the retail category still constitutes half of Freeborders business, the big money is in financial services. Banks typically budget 10 per cent of their revenue on technology of which half is spent on software development, of which half again can be outsourced, explains Cestar. This can run into the low billions of US dollars. Retailers, by contrast, may spend just 2 per cent of revenues.

Momentum for financial services to outsource to the mainland began to pick up two years ago. "When we started the business six years ago you couldn't find a single bank in the world to go to China with their software. They didn't think the IP (Intellectual Property) security situation was firm enough," says Cestar.

China's higher profile over the last two years in this hugely sensitive industry can be attributed to a number of conditions both inside China and beyond its borders. The mainland's emergence has occurred partly because India has become a victim of its own success: rising wages makes Freeborders about 40 per cent more cost-effective, says Cestar. "There wasn't a problem in India two years ago, but India has had 60 per cent wage inflation in the last 18 months and they are passing it on to their clients now. Also a lot of banks say they have to diversify somewhat just as a matter of risk mitigation and cannot be 100 per cent in India. The Indian model works, but they are asking where else in the world can they get the scale and a huge talented pool of software engineers? The only other country is China."

India's own success and China's position as a top growth market in the financial services industry has also helped demystify the PRC. But the aim of any outsourcer is for a financial service to become confident enough in the firm to entrust it to operate inside its firewall where the largest-scale projects are. While it has entered the firewalls of some of its retail clients, Freeborders has yet to achieve that with a bank. "We're not there yet, no one in China is. But if you get to that level of trust, then the business is massive."

Pros and cons

Despite cost advantages, China does have unique challenges, says Cestar, citing language and IPR security as foremost among them. "But you can solve them at a company level," he adds.

For instance, one strength of the Indian industry has traditionally been its native level proficiency in English. Not necessarily the case, says Cestar. "My view is that if they are hanging their hat on that peg, it is a very weak peg," says Cestar. "Our facility is English speaking, our people know that it makes them valuable."

Fluency in English is recognized as being critical to a successful career in software development in China. Without it, even the most gifted engineer will be restricted to dealing with China's domestic market where margins are much thinner. Moreover, a computer science PhD in China will already have ten years of spoken English and strong English skills, and full-time teaching staff are employed to improve proficiency. "An all-English environment is very important in this business. We will not promote someone without passing English exams. You can be the greatest technologist in our company, but if you are not good at English you are not going to get promoted."

Secondly, the issue of IPR can be tackled with the right investments in security and processes. "The systems we use require a lot of investment in systems and in processes which is very expensive," says Cestar.

He emphasizes Freeborders' CMMI (Capability Model Maturity Integration) level 5 (the software industry standard on a company's competence, security and reliability) - saying that only 34 companies worldwide have achieved that level.

"You have to convince the client that you are outsourcing to a company rather than a country. We happen to be in China and we happen to enjoy the structural cost advantage. But if you have made those kinds of investments that are recognized as world class, then you can pass the tests. We have never had a client not come with us because of IP issues," he says.

Within China, the company sees limited competition. In northern China, Dalian and Qingdao also boast some world class software outsourcers but they specialize in the lucrative Japanese market - equally as demanding in standards as the US and Europe.

Large multinationals like IBM and Microsoft localize their products to sell in China and should not really be considered to be outsourcing operations, says Cestar.

He believes that complacency in India over competition from China may end up hurting it. "The good news is that they are very dismissive of it (China) right now," he says, but China's superior infrastructure will also give it a healthy edge.

"What we tell our clients is to go to Bangalore first then fly over the Himalayas and land in Shenzhen. The traffic moves, the infrastructure is new. Bangalore is a third world city, it's a mess."

Bangalore's world-class privately funded facilities operate within a congested traffic system and unreliable power-grid. Moreover, China has invested impressively in provincial technology education, producing between 250,000 to 350,000 software engineer graduates every year, in contrast to India's less broad based education system. This equates to six times as many as in the US and three times the number in India.

'HR more important than tech'

Such advantages have not been lost on Indian companies, with some setting up shop in China. While Cestar acknowledges that competition is fiercest from India, whose companies provided the original blueprint for success, he believes that translating their business model may prove problematic. "No matter where in the world the Indian company is, the Indian managers are running the show. In the US and Europe this is fine, we are very multicultural societies. But it's a little more challenging in China," he says. "For example, I could never run our facility in China: they would look at me and say we are all working 20 hours a day why is that guy getting paid more than I am. This leads to big morale problems and it's a highly sensitive issue in our industry as people are highly educated and extremely talented. The Indian model tends to use an Indian manager. I don't know for sure, but in our experience that wouldn't work for our company."

Instead, Freeborders has a top-layer management team made up of mainland Chinese but recruited from the West. "These are people who really understand what it means to deliver to Western quality levels."

But perhaps the biggest challenge for software developers is maintaining an effective HR (Human Resources) programme. "Running a very tight HR programme is what this game's all about - HR is more important than technology actually," says Cestar. Being able to scale up while keeping the standards is an ongoing process and staff are reviewed "at least" five times a year. "You can be on a team and that is outstanding, but 10 per cent of that team will be fired because we want to keep the bar extremely high."

Cestar believes that India will enjoy the majority of the outsourcing business for the next ten years, but says that with its track record, process, and HR screening, Freeborders will be well placed to grow its Shenzhen operation to 1,000 people early next year. "India is the model. With 500 people we are tiny by Indian standards - Infosys has 30,000 people and Wipro hired 2,000 people last quarter. But if the banks send 10 per cent of their business to China which they will do - just out of risk mitigation they'll do it - it will be huge business."