AnalysisofofInformation
the role of transaction
in supplier
selection
Journal
Technologycosts
(2003)
18, 53–67
53
What will it take for China to become a competitive
force in offshore outsourcing? An analysis of the
role of transaction costs in supplier selection
ZHONGHUA QU and MICHAEL BROCKLEHURST
The Business School, Imperial College, London, South Kensington Campus, London SW7 2AZ, UK
Using transaction costs theory this paper argues that transaction costs are almost as significant as production costs when it comes to offshore outsourcing and, moreover, that it is in the field of transaction costs
where China has been unable to compete with India in the supply of information technology outsourcing.
The paper outlines a framework for analysing transaction costs and uses the framework for pinpointing
where China is unable to compete. The paper concludes with a review of the policy implications for the
Chinese Government.
Introduction
Information technology outsourcing is said to have originated with the Kodak–IBM outsourcing agreement of
1989 (Loh and Venkatraman, 1992). Yet the form and
range of IT outsourcing have undergone two key transformations since that date. First, it has expanded beyond
just the outsourcing of IT to encompass entire business
processes, which are underpinned or enabled by IT.
Such business process outsourcing, such as customer
interaction centres, have grown rapidly, but the claim is
that the growth will accelerate. Thus, the Gartner group
estimate that the market grew from $100 billion in 1999
to $150 billion in 2001. However, this is predicted to
reach $300 billion by 2004 (Bravard, 2002). The second
transformation is the spread from onshore to offshore
outsourcing. This trend to offshore outsourcing is largely
serendipitous. The enormous amount of reprogramming
required by 2000 meant that domestic suppliers could
not meet the demand and firms in the USA and Europe
had to take a chance on overseas suppliers in spite of
concerns about quality. However, most of these concerns
proved groundless and offshore outsourcing began to
mushroom.
The split between onshore and offshore outsourcing is
difficult to determine with any degree of precision.
However, companies in the USA will spend more than
$17.6 billion on offshore outsourcing in 2005, tripling
from $5.5 billion in 2000 (Prencipe, 2001). Another
approach is to look at it from the supply side. India is
known to be the principal offshore vendor of IT services,
claiming at least 80% of the world’s business. The India
software and IT-enabled services export industry has
achieved an annual growth rate as high as 62.3% for the
last 5 years. Total exports of $7.78 billion were achieved
in 2001 and are expected to reach $23 billion in 2005
and $50 billion in 2008 (www.nasscom.org).
The immediate question is why it should be India that
has the lion’s share of this market and not China. After
all, in the last decade China has been hugely successful
in attracting offshore manufacturing. However, the story
is different in the IT offshore outsourcing market. In
2001, Chinese export revenue in software and IT-enabled
services was only $720 million, less than one-tenth of
India’s (www.nasscom.org). One of the most important
factors in the growth of offshore outsourcing in manufacturing was the global market channel built up by
companies and individuals from Hong Kong and Taiwan,
particularly in the early stages. However, Hong Kong
and Taiwan have no experience in the software
outsourcing market and so cannot help in this respect.
This is of concern to the Chinese Government. In
common with other developing countries such as Malaysia
(Tidd and Brocklehurst, 1999), the Chinese Government
wants to try to move away from labour-intensive and low
value-added manufacturing to more highly value-added
services which the offshore IT market provides. This will
become essential as Chinese living standards rise and it
ceases to be competitive as a source of cheap manufacturing labour. Moreover, there is a window of opportunity
based on three factors. First, it is unlikely that India will
be able to produce the qualified manpower required
to meet burgeoning world demand sufficiently. India
currently has approximately 445 000 IT workers and this
is expected to grow to 625 000 by 2005. However, the
demand for offshore IT workers will reach more than
Journal of Information Technology
ISSN 0268-3962 print/ISSN 1466-4437 online © 2003 The Association for Information Technology Trust
http://www.tandf.co.uk/journals
DOI: 10.1080/0268396031000077459
54
1 million by 2005, as compared with 360 000 in 2001
(Greenemeier, 2001). Second, putting all of your
offshore outsourcing in one country is too risky: buyers
prefer to outsource to different countries in order to
spread the risk. Third, military tension between India
and Pakistan is creating uncertainty.
This paper is organized as follows. In the next section
the nature of the Chinese Software Industry and current
Chinese Government policy for trying to compete with
India will be briefly outlined. The third section critiques
transaction costs theory and examines why it is of value
in this context. In the fourth section transaction costs are
used for comparing production costs with transaction
costs. The fifth section develops a simple framework for
enabling transaction costs for two national industries to
be compared. In the sixth section the paper turns to
comparing China and India in terms of transaction costs
and the final section sets out a policy agenda for the
Chinese Government.
Chinese Government policy and the Chinese
software industry
According to the China Software Industry Association
(2002), China has 5700 software companies of which
70% employ less than 50 employees each and a further
20% employ only 100–500 employees. Only 50 companies
have more than 1000 employees. As for revenue, most of
these earn less than $10 million and only 18 companies
make above $50 million. International software companies
dominate most of the China software product markets.
Domestic suppliers only manage to dominate accounting
applications, anti-virus tools, Chinese platform and
solutions for some industries. In total, 250 000 professionals work in the software industry. In 2001, the entire
software and services market was $9.6 billion, composed
of $4 billion software products, $4.9 billion services and
only $700 million exports.
Chinese Government policy is detailed in its document
Policies on Encouraging the Development of Software and
Integrated Circuit Industries, which was issued by the
State Council in June 2000 (www.mii.gov.cn). Some of
the policy initiatives that have been so successful in the
realm of manufacturing have been applied to the software
industry. Preferential taxation and special zoning
arrangements, including high-tech parks to attract
domestic and foreign investors, have sprung up. Many
regional and local government organizations have echoed
these national initiatives by providing further subsidies
such as corporation and individual income tax deductions,
low interest loans, 3 years rent-free offices in software
science parks and investment in the education of IT
labour. However the Chinese Government believes there
are three problems that currently hamper the software
Qu and Brocklehurst
industry and it has devised three key policy initiatives for
addressing each in turn.
First is the shortage of qualified labour. Here the
response has been to go for expansion in education and
training. The Chinese higher education sector has
achieved considerable growth in the last 3 years but the
growth will accelerate dramatically. Graduates will
increase from 1.08 million in 2002 to 3.767 million in
2004 (www.moe.edu.cn). There is also an expansion in
IT training: recently, Microsoft, IBM and some Indian
IT training firms have invested heavily in IT. Thus, the
supply of new IT professionals should cease to be an
issue after 2004.
Second is the perception that China is way behind
India in terms of quality when it comes to IT supply.
China may be able to compete with India in terms of
cost, but it lags well behind India (and other high-cost
suppliers such as Ireland, Singapore and Israel) when it
comes to quality (Amoribieta et al., 2001). A major
indicator of quality is whether or not a supplier has
quality certification. The government believes that this
problem will be partly addressed by its education and
training measures, but its major initiative is to encourage
firms to seek quality certification by means of an incentive
refunding plan. The Capability Maturity Model
(CMM), a worldwide certification developed by the
Software Engineering Institute of Carnegie Mellon
University, is becoming the industry standard in the
offshore outsourcing market. Generally, buyers only deal
with suppliers that have a level 3 or higher CMM
certification. Compared with India, China lags far
behind on CMM certification. At June 2002, only six
Chinese software companies had CMM level 3 or above
certification and these awards were all recent. The only
level 5 company is the Motorola China R&D centre,
which focuses exclusively on internal business anyway.
Huawei Technology, a telecom equipment manufacturer
and a level 4 company, actually outsources to Indian
suppliers. Thus, there are only four Chinese companies
that have much chance of getting onto the shortlist of a
prospective client. Compare this to India where 45
companies have level 5, a further 28 level 4, and 16
more have level 3 certification (www.sei.cmu.edu, www.
nasscom.org and www.sina.com).
Third is the fragmented nature of the Chinese software
industry noted above. According to Orbys Consulting,
the average contract size of an offshore outsourcing
is $7.2 million and the average contract duration is
3.3 years, which works out at $2.18 million per year
(ComputerWire, 2001a). However, the average revenue
of a Chinese software company is less than $600 000
(China Software Industry Association, 2002). Moreover,
seeking CMM certification is an expensive undertaking
for smaller vendors. It would appear that the fragmented
nature of the Chinese software industry is a severe
Analysis of the role of transaction costs in supplier selection
impediment. The government response is to encourage
the formation of ‘software export clusters’ trying to overcome the firm-size barriers in the offshore outsourcing
market.
In order to assess the merits of this strategy requires
determining why outsourcing occurs in the first place. It
is argued in the next section that transaction costs theory
provides a useful framework for answering this question,
particularly in relation to offshore outsourcing.
Transaction costs theory: a critique
Hui and Beath (2002) provided a useful summary showing
the various theoretical perspectives that have been
applied to outsourcing. They noted that, although the
early theory-based literature drew heavily on transaction
costs theory, recently there has been much more interest
in applying a resource-based view or social exchange
theory to understanding outsourcing decisions and
outcomes. However, as Hui and Beath (2002) observe,
much of the literature has focused on the buyers side and
been applied at the level of the individual firm. The focus
in this paper is much more at the national level and
concerned with the implications for the seller. To this
end the authors wish to reclaim transaction costs theory,
as they believe it still has much to offer although they
recognize its limitations.
Transaction cost theory, which was pioneered by
Coase (1937) and developed principally by Williamson
(1975, 1985a), is based on the assumption that human
beings are utility maximizers and firms are profit
maximizers. In pursuit of these objectives, agents are
boundedly rational and sometimes display opportunistic
behaviour. The paradigmatic question of transaction
costs theory is the ‘make-or-buy’ decision: should a firm
carry out an economic activity in-house or should it be
outsourced? Williamson (1985b) referred to these as
modes of governance–organizational hierarchy and the
market respectively. In making this decision firms
balance the savings made in production costs (because a
supplier can provide the goods/services more cheaply)
against the transaction costs that result from outsourcing.
These costs include operational costs (e.g. search costs)
and contractual costs (e.g. the costs of writing, monitoring
and enforcing a contract) (Gurbaxani and Whang,
1991). If the savings in production costs exceed the
transaction costs then it is worth outsourcing and vice
versa. A basic knowledge of transaction costs theory is
assumed, as excellent guides are readily available (e.g.
Douma and Schreuder, 2002).
One of the key criticisms of transaction costs theory is
that it is too stark: make or buy – organizational hierarchy
or the market. However, there are intermediate governance
structures. Firms often establish long-term relationships,
55
which are neither one-off nor pure market in form (spot
contracting), nor do they involve purely internal hierarchies: there are forms of long-term relationship which
outlive the one-off buy/sell. (As noted above, the average
length of an offshore IT outsourcing contract is 3.3 years
(ComputerWire, 2001a).) Ouchi’s (1980) work on clans
and, more recently, the literature on network organizations
(Thompson et al., 1991) and communities of practice
(Wenger, 1998) have demonstrated how nuanced the
relationship between buyers and sellers can be. Indeed
Williamson (1989) himself rehearsed some of these
forms with his category of ‘relational contracting’.
A second line of attack is that almost all of the literature
on transaction costs theory relates to manufacturing
rather than services and that services may be quite different.
Wang’s (2002) work is one of the few exceptions (see
also Murray and Kotabe, 1999). He applied transaction
costs theory specifically to customized software as
applied to IT in the following way.
(1) Asset specificity: this refers to ‘the degree to
which an asset can be redeployed to alternative
uses and by alternative users without sacrifice of
productive value’ (Williamson, 1989, p. 142).
(i) Functional/Information requirements.
(ii) Operating procedures.
(iii) Business domain knowledge required.
(iv) Training for the developers.
(v) Technical skills required.
(2) Uncertainty.
(i) Requirements specification.
(ii) Delivery dates.
(iii) Costs.
(3) Opportunism.
(i) The contractor ‘reinterprets’ the contract.
(ii) The contractor fails to deliver on things that
are expected by the buyer, but are not in the
contract.
Using this classification his results show that ‘contractor
reputation and uncertainty have the predicted effects on
the contractor’s post-contractual opportunism perceived
by the client and outsourcing success, but asset
specificity has a negative effect on post-contractual
opportunism and a positive effect on the outsourcing
success, which are opposite to the typical predictions of
TCT’ (Wang, 2002, p. 153).
However, from this study’s perspective the most
valuable feature of transaction costs theory is that it
focuses on the comparison between production costs and
transaction costs. To recap, if a supplier can produce
something for a buyer for less than the buyer can produce
it and the difference is greater than all the costs in
managing the transaction, then it is worth the buyer
outsourcing. However, what is the relative importance of
production and transaction costs in outsourcing IT?
Qu and Brocklehurst
56
Ang and Straub (1998) made the first attempt to
compare the relative effects of production and transaction
costs on onshore outsourcing decisions in the IT context.
Their study shows that information systems outsourcing
in USA banks was strongly influenced by the production
cost advantages offered by vendors. Transaction costs
played an important role in the outsourcing decision,
although they were much smaller than the production
costs. According to their model, the coefficient for
production cost advantage is approximately six times
larger than that of transaction costs. This suggests that
the effect of production costs on the decision whether to
outsource or not is far greater than that of transaction
costs, even though both are significant. However, their
questionnaire simply asked their respondents to state
whether production costs were more (or less) significant
than transaction costs. It gives only a qualitative feel for
which is the more important. Nevertheless, the strong
inference is that, when it comes to onshore outsourcing,
transaction costs are relatively trivial in comparison to
production costs.
However, this paper wishes to argue that, when it
comes to offshore outsourcing, the relative significances
of production and transaction costs are markedly different.
Indeed, transaction costs are much more significant and
production costs less so. Intuitively one would expect
transaction costs to be higher when a buyer and seller are
based in different countries. However, one would also
expect production costs to be much greater as that is the
principal reason for buyers going offshore in the first
place, namely to take advantage of wide differences in
labour costs.
In order to make the point, in the next section a simple
analytic model for transaction costs theory is set up,
which allows direct comparison between production and
transaction costs. Published data are then used for
providing some approximate weights to the two elements.
Using transaction cost theory for comparing
production and transaction costs
Recall that firms outsource a job only if the advantage
gained by lower production costs is bigger than the transaction costs. This rule can be expressed as follows:
∆ = ( Pin − Pout ) − Tout × Pin , Pout , × Tout ≥ 0
(1)
where Pin is the in-house production costs, Pout is the
outsourcing production costs, Tout is the transaction
costs of outsourcing and ∆ is the net gain of outsourcing.
Firms will outsource only if ∆ ≥ 0.
The transaction costs of outsourcing can be analysed
quantitatively, at the limit. First, transaction costs cannot
be lower than zero, but could be zero if firms made
no effort regarding the transaction. Second, since the
outsourcing production costs cannot be lower than zero,
the maximum transaction costs of outsourcing cannot be
higher than the in-house production costs, otherwise
firms would not outsource anything. Thus,
Pin ≥ Tout ≥ 0
(2)
Pin − Pout ≥ Tout ≥ 0
(3)
Equation (2) has defined the widest range of transaction
costs. It is arguable that, in a specific case, the transaction
costs might be above the production cost gain or even
higher than the in-house production costs and the
outsourcer would therefore lose money. Although this is
possible in theory, it is unsustainable because firms
would cancel this kind of outsourcing contract as soon as
possible once they realized the loss involved.
Both in-house and outsourcing production costs
should be quantitatively measurable ex ante or ex post
(that is before or after the deal is made) with the
data from historical transactions, internal budgeting,
outsourcing contracts and the actual accounting records.
Empirically, in each specific outsourcing case the transaction costs could be quantitatively measured ex post.
There are two ways of doing this. One is activity-based
costing, which totals up the costs of all related activities.
The other is to find the difference in the firm’s profit
before and after outsourcing, assuming nothing has
changed except outsourcing and then compare this profit
gap with the production cost gain. The difference is
the transaction costs. This method can be expressed as
follows:
Tout = ( Pin − Pout ) − ∆ profit
(4)
where ∆profit is the profit after outsourcing minus the
profit before outsourcing.
It is more difficult to measure transaction costs ex ante
for outsourcing clients. However, it is at least possible to
estimatè their maximum transaction costs, which is the
production cost gain from outsourcing: Pin – Pout. It is
not difficult to get the in-house production costs ex ante.
As the IT outsourcing market is relatively mature and
many suppliers compete in it, it is easy to estimate the
mean outsourcing production costs as well. Now, by
knowing the maximum gain (∆ = Pin – Pout when
Tout = 0) and the maximum payment (Tout = Pin – Pout,
when ∆ = 0), complex outsourcing decisions could be
simplified by finding an acceptable balance between the
benefits and risks. The transaction costs will then be
dependent on how much risk the firm is willing to take.
The lower the risk the firm takes, the higher the transaction costs the firm has to pay. (See Jurison’s (1995)
model based on transaction costs theory and the capital
asset pricing model.)
The next step is to try and estimate the relative importance of production costs and transaction costs and here
the paper turns to published sources of data.
Analysis of the role of transaction costs in supplier selection
Amoribieta et al. (2001) attempted a comparison of
onshore and offshore software development costs, which
is reproduced in Figure 1.
The production costs of onshore in-house development
in the USA are expressed as 100 in Figure 1. The production costs of offshore outsourcing are expressed as 25.
Therefore the savings on production costs should be
75. However, other research shows that the actual average
cost saving for US customers is approximately 25
(Greenemeier, 2001). This leaves a gap of 50. The
temptation is to say that these must all be transaction
costs. However, the figure of 50 will now be inspected
more closely.
Almost all outsourcing contracts involve a proportion
of the suppliers working at the client’s base (e.g. in the
USA). If just Indian workers are considered (recall that
Indian companies have 80% of the market), then Table 1
shows the breakdown of Indian IT and service export
revenues on-site (in the USA) and offshore (in India).
The relative proportion of on-site to offshore fluctuates,
but the most recent figure puts it at almost 50:50.
Let it be assumed for the moment that all Indian
on-site workers are paid at the same rate as their US
colleagues. Now returning to the breakdown in costs in
Figure 1, then for those Indians who work on-site in the
USA, labour costs will be 50 and additional statutory
costs (taxes and insurance) will be 15, which gives a
figure of 65 for those Indians working in the USA.
57
However, Figure 1 shows that, for those Indians working in India, the labour costs are 7 and the statutory costs
are 3, which gives a total of 10 for those Indians working
in India.
Using the 50:50 split derived from Table 1 this means
that the labour costs are on average 65 + 10 divided by
2, which gives a figure of 37.5 for the offshore labour
costs as a whole. From Figure 1 the offshore mark-up
(8) and the travel and other expenses (7) need to be
added in, which gives a total of 52.5. Therefore the
production costs of offshore outsourcing are not 25 but
52.5 and the gap is reduced from 50 to 22.5.
This would put transaction costs at 22.5.
However, it is known that the assumption that Indian
on-site workers will be paid the same as their US counterparts is unrealistic. They are likely to be paid less
(although not as little as their fellow offshore workers
working back in India). How much less will vary according
to the types of work permit held (H-1B or B1), human
resource and pay policies of different US firms, etc.
Table 2 shows some of the differences, but does not
enable a mean figure for the differentials in wages to be
specified. All that can be said is that the transaction costs
are likely to lie somewhere between 22.5 and 50. If a
figure midway between these two is taken it will give a
figure of 36.25 for the transaction costs.
It is known from Table 1 that, if there were no
transaction costs, the difference in production costs
Figure 1 Normalized cost structure of software development. Source: McKinsey (Amoribieta et al., 2001)
Qu and Brocklehurst
58
Table 1 The on-site and offshore revenues (Rs crore) of
India’s IT and services exports
1999–2000
On-site
9850
Offshore
5950
Products and
1350
unclassified
Total
17 150
Feb. 2000
2001–2002 est.
15 900
10 950
1500
17 500
18 000
1500
28 350
37 000
In 2001 US$1 million = 4.725 Indian Rs crore.
Source: www.nasscom.org.
would be 75 between in-house development and pure
offshore development. However, if the transaction costs
are 36.25 then the real difference in production
costs, which takes account of the realities of offshore
outsourcing (partly at the client’s base), is 75 less 36.25,
which gives a figure of 38.75. This means the increase
in the transaction costs for offshore outsourcing is 36.25
while the saving in production costs is 61.25.
This can be approached another way. Let the cost of
in-house production be stated as 100. According to
Amoribieta et al. (2001), labour accounts for more than
75% of the costs of developing software. Thus, labour
costs in-house can be expressed as 75 and other costs as
25. However, it is also known that the offshore labour
cost is approximately one-fifth of that of the onshore
labour cost (Heeks, 1996). This means that the offshore
labour costs can be expressed as 20% of 75, which gives
a figure of 15. Add in non-labour costs (which it will be
assumed are the same as for those in-house, i.e. 25) and
then the total cost of offshore production is 40, a saving
in production costs of 60. This has been confirmed from
other sources: ‘there are currently hundreds of companies
in India offering these services to companies in the US
and Europe for as little as 40% of the cost of going to
a local system integrator or software VAR’ (ComputerWire,
2001b, p. 10).
However, according to Forrest Research the mean
gain from offshore outsourcing is only 25% (Greenemeier,
2001), not 60 as might be expected Therefore, a 35%
gap that represents the increase in transaction costs for
going offshore is found. This is close to the figure of
36.25 derived from the first estimate. This paper does
not pretend that these figures are precise and they depend
on making a number of assumptions, but it can be argued
that these assumptions are not unrealistic.
To conclude, unlike onshore outsourcing where the
transaction costs appear trivial in comparison to the
production costs, in offshore outsourcing the transaction
costs are almost as significant as the production costs.
Production costs savings appear to explain why firms
outsource onshore in the first place (Ang and Straub,
1998). They explain why a firm will decide to outsource
offshore (the salary of an Indian programmer is approximately one-fifth that of their US counterpart (Heeks,
1996)). However, they do not explain why a buyer will
select one low-cost country rather than another. For
example, an Indian company might demand $8.5 per
hour and a Chinese company $7.5 per hour. There is a
15% difference from the supplier’s point of view. However,
from the customer’s point of view, where the labour costs
only represent approximately 10–15% of overall offshore
Table 2 Monthly personnel costs ($) of software development according to employee status
Cost element
Per contractor monthly costs
Wagesb
Overhead and profitc
Total man hour charges
Hourly rate (175 h/month)
Per diemf
Per project monthly costs
Travel expenses to offshore siteg
Telephone status callsh
Domestic/H-1B
contractor/Outsource
Offshore a
B1 contractor on-site
Low
Medium
High
Low
Medium High
5800
5800
11 600
66
N/A
450
2700 d
3150
18
1000
700
4200 d
4900
28
1500
950
5175 d
6125
35
2000
350
2275e
2625
15
N/A
700
3675 e
4375
25
N/A
950
4650 e
5600
32
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
N/A
600
200
900
400
1200
600
Low
Medium
High
3500
3500
7000
40
N/A
4600
4600
9200
53
N/A
N/A
N/A
N/A
N/A
a: India is used as the offshore country in this table; b: Hourly charge for ERP contracts (e.g. SAP, PeopleSoft, BAAN, etc.) can add
100–200% to this charge. Porting and maintenance are at the low end, custom Internet, client/server contracts at the medium to high
end; c: Administrative, financial, training, building, utilities and management overhead; d: B1 contractors typically have an offshore
allowance of about 20% of their hourly charge added to their overhead; e: Offshore includes additional overhead expenses for equipment,
office space and supplies and management, which are covered by the client in the on-site options; f: Per diem includes lodging, board,
local travel, insurance and visa-related expenses for B1 contractor near client site; g: Assumes three one-week trips to offshore location by
one company employee per year. Per trip costs estimated between $2400 and $4800; h: Assumes $.70 per minute. Note that many firms
are using voice over Internet products, such as Net Meeting and Speak Freely to cut these costs.
Source: Heeks (1996).
Analysis of the role of transaction costs in supplier selection
outsourcing costs, the difference is only 1.5–2%. At this
low level of production cost difference the difference in
transaction costs becomes much more important.
An immediate implication is that governments and
their firms in countries such as China should be less
concerned with holding down production costs by keeping
wages low and more concerned with minimizing the
transaction costs which potential buyers and sellers may
incur.
The next section develops a framework that will
enable China and India to be compared in terms of
potential transaction costs.
Developing a framework for comparing
transaction costs
The first step is to classify the various factors buyers
consider when choosing a vendor. There are many
different versions (e.g. Terdiman, 2002). The most
significant factors are discussed below.
(1) Production costs differentials. These have been
discussed above where it was noted that, where
one low-cost country is competing with another
(e.g. China versus India), then these are likely to
be trivial.
(2) Language barriers. Where these are low, communication costs fall and there is less misunderstanding, which leads to lower uncertainty.
(3) Government support. Incentives reduce production costs and attract more investment into the
sector. High-level commitment by government
may reduce the opportunistic behaviour of vendors.
(4) A plentiful IT professional pool and education
system. This guarantees the availability of human
resources, which reduces the uncertainty and
avoids increases in production costs due to labour
shortages.
(5) Quality. This is the basic requirement of a product
or service and reduces monitoring costs.
(6) Culture fit. People prefer to work with those
who come from the same culture for a reassuring
atmosphere. It is a transaction costs barrier for
others. It is easier to communicate, understand
and monitor and thus reduces contractual
costs. There is more chance of building a trust
relationship and this reduces the probability of
opportunism.
(7) Political stability. This means lower uncertainty.
(8) Financial robustness. If it is unlikely or costly for
suppliers to declare bankruptcy this will prevent
them appropriating the quasi-rent. Customers can
avoid the shifting costs of finding new vendors as
well. Therefore, transaction costs are reduced.
59
(9) Process and methodology (CMM). By means of
standardizing processes and third party monitoring,
the uncertainty/complexity is reduced.
(10) Supplier reputation. Giving consideration to
reputation in source selection can reduce
opportunism by sellers, thereby reducing the
uncertainty and thus the transaction costs for
buyers. On the supplier side, reputation building
is an investment in some kind of asset specificity
that will increase their transaction costs. Although
reputation has a high and durable value if the
supplier maintains it appropriately, it is also
easily lost if the supplier makes a mistake.
(11) On-site presentation. This could reduce the
transaction costs for buyers. However, it increases
sellers’ transaction costs by higher site specificity
(one kind of asset specificity).
(12) Expertise. Hardware/Software: a Windows–Intel
platform, as well as common developing tools and
skills, produces lower asset specificity for suppliers.
Equipment such as mainframes could be provided
by clients or accessed through the Internet,
thereby reducing asset specificity for suppliers
as well. However, some special skills or business
knowledge required by a customer may only be
useful for that specific customer. This will
increase asset specificity on the supplier side.
(13) Commitment of outsourcing. This increases asset
specificity.
(14) Experience/Heritage. This increases human capital
specificity for the supplier side.
(15) Proven offshore methodology. This reduces
uncertainty for the client side but increases asset
specificity for the supplier side.
The above analysis indicates that, except for some
fundamental requirements such as delivery capacity,
quality and infrastructure, most of the selected criteria
relate to transaction costs. There are two inferences.
First, clients mainly focus on reducing their transaction
costs, which, given the choice to go offshore in the first
place, is the main theoretical principle underlying the
criteria for selecting offshore outsourcing suppliers.
Second, clients tend to choose suppliers that have an
asset specificity that is higher for offshore outsourcing or
for a specific customer. Both buyers and sellers will
benefit from understanding this principle. By going
through the activities linked with market transaction
costs buyers could have an overall view of how to choose
offshore suppliers and then find an optimal balance of
criteria rather than use each criterion separately. By
simplifying the complex customer criteria into one
fundamental issue, namely reducing transaction costs for
their clients, sellers could focus their efforts on this key
consideration. The concern in this paper is with sellers.
Qu and Brocklehurst
60
The second step is to examine the nature of these
transaction costs. There are two important factors to bear
in mind.
First, from the perspective of the transaction participants,
transaction costs exist on both the buyer and seller sides.
For example, both buyers and sellers need to pay the
costs for negotiating and writing contracts. For a one-off
market transaction it may be true that it is only the buyer
that needs to worry about opportunism. However, for a
set of transactions bound in an outsourcing contract of 3
years, which is termed relational contracting in transaction costs theory, both the buyer and seller need to worry
about opportunism.
Second, from the perspective of cost management,
transaction costs can be divided into three types.
(1) Type 1 costs, which are termed compulsory costs,
are those costs that both buyers and sellers have
to pay, for example communication labour costs
for both sides, decision costs for buyers and
special skills/knowledge-building costs for sellers
(asset specificity).
(2) Type 2 costs, which are termed complementary
costs, are those costs that one side pays and the
other side saves, for example searching costs: if
a seller pays for marketing and information
publishing costs, its buyers will save their search
costs. Although both the seller and buyer could
invest in this, the returns are asymmetric. The
investment paid by clients has little scrap value for
them after they change the supplier or at the end
of the contract. On the other hand, the investment
paid by suppliers may accumulate value for
them after the end of contracts, due to enhanced
reputation and awareness.
(3) Type 3 costs, which are termed win–win or lose–
lose costs, are those costs that both buyers and
sellers would either save or pay, for example
negotiating and monitoring costs. If buyers and
sellers trust each other both sides will save money
Table 3
and, the deeper they trust each other, the more
they can save. This is the win–win case. On the
other hand, if buyers and sellers suspect each
other both sides have to pay more for negotiating
and monitoring and, the more suspicious of each
other they are, the more they have to pay for this.
Table 3 gives some sample items of transaction
costs using this three-fold classification.
This section has examined the various factors involved
in buyer selection of an offshore supplier and found that
they are almost entirely related to transaction costs. The
section then classified how these costs may differ:
compulsory, complementary and win–win. The study is
now in a position to compare China and India in terms
of transaction costs.
Comparing China with India
Table 4 has been compiled from a range of sources and
shows how China compares with India in terms of
competitive advantage as offshore suppliers of IT
outsourcing.
At first sight China appears to compare very favourably. China comes out very close to or ahead on 27 of
the 32 factors. The five where it compares unfavourably
are highlighted and they can be reduced to two: education
and training and the legal framework for information
and communications technology (ICT) development. It
has already been noted that education and training are
being addressed as a top priority. What then of the
legal framework?
This involves two aspects: legal contracts and intellectual
property rights. Legal contracts matter because, if the
average contract length is over 3 years, then relational
contracting is the fundamental instrument of offshore
outsourcing and such contracting is inevitably based on
the buyer country’s, seller country’s and international
legal systems. Both buyers and sellers try to make the
Framework of the transaction costs involved in offshore outsourcing
Type of cost
Outsourcer side
Vendor side
Compulsory
Decision process
Integration and re-engineering
Contract writing
Communication
–
Information searching
Communication
Transportation
Suspecting
Monitoring
Contracting
Regulation
Proving its delivery capacity
Proving its delivery quality
Contract writing
Communication
Reputation building
Marketing/Awareness
On-site presence
Transportation
Proving
Responding to monitoring
Contracting
Government support
Complementary
Win–Win or lose–lose
Analysis of the role of transaction costs in supplier selection
61
Table 4 Comparison between China and India
China
Key facts
Population (million)
1273
Gross domestic product (US$ billion)
1079.84
Gross domestic product per capita at purchasing power par value (US$)
3953
Growth in real gross domestic product
7.1
Country competitiveness index ranking for 2001 (the higher the better)
39
Overall growth competitiveness
47
Overall current competitiveness
6
Macroeconomic environment
43
Innovation capacity
34
Country credit rating
63
IT training and education
58
Speed and cost of Internet access
58
Quality of competition in telecommunication sector
46
Legal framework for ICT development
61
Overall infrastructure quality
60
Intellectual property protection
59
Availability of scientists and engineers
Country business cost comparisons (Economist Intelligence Unit score) (the lower the better)
8.7
Labour costs
58.6
Expatriate costs
28.5
International travel costs
33
Corporation tax (%)
260
Office rents (US$/m2/year)
Cost of telephone calls
26.5
Road transport costs
20.5
Overall score
7.7
International investment and trading
Foreign investment 1996–2000 (US$ billion/year)
41.2
Exports 2001 (US$ billion)
266.7
Imports 2001 (US$ billion)
243.6
Education
Students in university (1000s) 2001
7562
Graduated (1000s) 2001
1020
Graduated in computer science (1000s) 2001
62
ICT
Personal computers per 100 inhabitants
1.6
Internet users per 10 000 inhabitants
173.7
Internet hosts per 10 000 inhabitants
0.6
Main telephone lines per 100 inhabitants
11.1
Cellular mobile subscribers per 100 inhabitants
6.6
India
1029
474.19
2403
4.7
57
36
45
38
42
9
54
41
25
66
58
4
1
1
36.5
35.7
708
25.6
25.2
8.7
2.7
43.133
61.015
8000
2000
110
0.5
49.4
0.4
3.2
0.4
Sources: www.un.org, www.cia.gov, www.moe.edu.cn, www.education.nic.in, www.stats.gov.cn, The Global Competitiveness Report 2001–
2002 (Porter et al., 2002) and Worldwide business cost comparisons (Economist Intelligence Unit, 2001).
deal as clear as possible by means of the outsourcing
contract. They seek to minimize uncertainty and, thus,
reduce transaction costs. If a buyer has anxieties about
the legal system of the country of a seller then this makes
it very difficult to set up a contract. For historical reasons
India’s legal system fits better with the Western world,
where outsourcing clients come from, than does China’s
legal system. There is also much concern in the West
about intellectual property rights protection in China.
This also raises transaction costs because buyers need to
spend more effort in contract writing and intellectual
property rights management. However, the situation is
improving. The Chinese Government’s assignment of an
$800 million procurement contract with Microsoft is a
milestone in this respect. Furthermore, the challenge of
improving the legal framework is being addressed. Since its
entry into the World Trade Organization in 2001 China has
been adapting its legal system to fit in with the international
business community; but there is a long way to go.
What other factors, which are not disclosed in Table
4, might put China at a disadvantage in terms of
transaction costs?
Qu and Brocklehurst
62
One obvious factor lies in language and culture. The
language barrier and culture fit are two of the most
serious obstacles preventing China from entering the
offshore outsourcing supplier market (Liu, 2002). On
the other hand, language is an immense advantage for
India. English is the official language in business and
education in India and that is perfect for the US and UK
markets. But what about the Japanese market? In
comparison with India, China ought to be more compatible
culturally and linguistically with the Japanese market
and, in addition, has a geographical advantage. However,
it appears this is still not enough. India provided $300
million worth of offshore services to Japan in 2001,
which was 4% of its total revenue. At the same time
China made approximately the same from Japan
(approximately $300 million), but that represented 42%
of its total revenues (China Software Industry Association,
2002). Even though China has substantial advantages in
culture, language and geography, it seems it still cannot
beat India in the Japanese market. This tells us two
things. First, culture fit and language barriers are indeed
very important for offshore outsourcing. Because of these
advantages alone China has at least managed to compete
with India on an equal footing in the Japanese market,
even though they are not in the same league in terms of
the global offshore outsourcing market. Second, there
Table 5
must be some other drawback hindering China’s
performance, otherwise China would dominate the
Japanese offshore outsourcing market in the same way
that India dominates the US and European market.
What Table 4 does not show and what is crucial is the
structure of the industry. One of the main alleged weaknesses prevailing in China’s software industry is that the
size of most software companies is too small to win
offshore contracts, as noted above. Recall also that the
low rate of CMM certification remains an issue and that
these two factors are linked in the eyes of the Chinese
Government.
However, a comparison between the top 20 Chinese
and Indian software companies suggests that this view
may be mistaken. Tables 5 and 6 indicate that, in size
terms, the top 20 Chinese and Indian software companies
are very similar. In addition, 18 of the top 20 Chinese
software companies are listed on the Chinese stock
market, which guarantees them access to plentiful
capital. So, at an industry level, it cannot be said that
China’s software companies are too small to deal with
offshore outsourcers. The top 20 companies in China
contribute 37% of China’s software and service revenues,
whereas the top 20 in India contribute 35%.
However, the software exports data in Table 7 demand
attention. India’s top 20 software export companies
Comparison of software/service revenue between China and India’s top 20 software companies
China
Software/Service
revenue ($ million)
India
Software/Service
revenue ($ million)
Huawei Technology
Zhongxin Communication
Putain Eastern Group
Digital China
Founder Group
Eusoft Group
CSS Group
Datang Communication
Langchao Group
Tsinghua Tongfang
Yantai Eastern Electronics Group
Zhongchuang Software Ltd
Ufsoft
UT Starcom Communication
Bodao Ltd
Tianjin NEC
CGW Group
Xiangji Software Ltd
Top Group
Beida Bird Ltd
Mean
Subtotal
Percentage of country revenue
Country total
729.52
457.27
293.75
280.34
187.97
171.68
160.57
154.99
151.45
130.47
113.57
111.11
102.88
101.81
79.27
70.26
69.94
61.94
60.47
54.89
177.21
3544.00
37.00
9614.00
Tata Consultancy Services
Wipro Technologies
Infosys Technologies Ltd
HCL Technologies Ltd
Satyam Computer Service Ltd
IBM India Ltd
Congnizant Technology Solutions
NIIT Ltd
Silverline Technologies Ltd
Penssoft Technologies Ltd
Pentamedia Graphics Ltd
Patni Computer Systems Ltd
Mahindra British Telecom Ltd
HCL Perot Systems
DSO Software Ltd
Mascon Global Ltd
Mascot Systems Ltd
Tata Infotech Ltd
I-Flex Solutions Ltd
Mphasis BFL Ltd
Mean
Subtotal
Percentage of country revenue
Country total
661.29
413.69
390.17
268.57
267.07
175.12
148.25
143.70
137.35
135.24
120.94
109.15
97.79
92.43
92.21
71.94
71.61
70.31
64.88
59.62
179.57
3591.00
35.00
10229.00
Sources: www.nasscom.org, www.ccidnet.com and the Chinese Software Industry Association.
Analysis of the role of transaction costs in supplier selection
Table 6
63
Comparison of software/service exports between China and India’s top 20 software companies
China
Software/Service
exports ($ million)
India
Software/Service
exports ($ million)
Huawei Technology
Zhongxin Communication
Putain Eastern Group
Digital China
Founder Group
Eusoft Group
CSS Group
Datang Communication
Langchao Group
Tsinghua Tongfang
Yantai Eastern Electronics Group
Zhongchuang Software Ltd
Ufsoft
UT Starcom Communication
Bodao Ltd
Tianjin NEC
CGW Group
Xiangji Software Ltd
Top Group
Beida Bird Ltd
Average
Subtotal
Percentage of country revenue
Country total
48.91
0.00
0.00
0.00
23.67
6.10
5.58
0.11
0.00
0.00
0.00
0.00
0.00
0.00
0.00
8.66
0.00
0.00
2.04
0.00
4.75
95.00
13.00
725.00
Tata Consultancy Services
Wipro Technologies
Infosys Technologies Ltd
HCL Technologies Ltd
Satyam Computer Service Ltd
IBM India Ltd
Congnizant Technology Solutions
NIIT Ltd
Silverline Technologies Ltd
Penssoft Technologies Ltd
Pentamedia Graphics Ltd
Patni Computer Systems Ltd
Mahindra British Telecom Ltd
HCL Perot Systems
DSO Software Ltd
Mascon Global Ltd
Mascot Systems Ltd
Tata Infotech Ltd
I-Flex Solutions Ltd
Mphasis BFL Ltd
Mean
Subtotal
Percentage of country revenue
Country total
604.01
369.61
389.93
237.15
261.20
106.49
147.95
119.95
136.25
116.90
115.32
108.50
94.69
92.43
92.21
71.27
71.52
60.61
61.81
59.62
165.87
3317.00
43.00
7780.00
Sources: www.nasscom.org, www.ccidnet.com and the Chinese Software Industry Association.
Table 7
Comparison of China and India’s top 10 software and service export companies
China
Exports 2001
($ million)
India
Exports 2001
($ million)
Huawei Technology Ltd
North China Computer System Ltd
Founder Group
NEC China System Integration Ltd
Neusoft Group
CSS Group
Asia Telecom China Ltd
Top Science Development Ltd
PFU Shanghai Computer Ltd
Powerise Science Ltd
Summary
Mean
48.9
28.7
23.7
8.7
6.1
5.6
2.5
2.0
2.0
1.3
129.5
12.9
Tata Consultancy Services
Infosys Technologies Ltd
Wipro Technologies
Satyam Computer Service Ltd
HCL Technologies Ltd
Congnizant Technology Solutions
Silverline Technologies Ltd
NIIT Ltd
Penssoft Technologies Ltd
Pentamedia Graphics Ltd
Summary
Mean
604.0
390.0
370.0
261.0
237.0
148.0
136.0
120.0
117.0
115.0
2498.0
249.8
Sources: www.nasscom.org and the China Software Industry Association.
contribute 42% of India’s total software/services exports
and their mean export revenue is $166 million. China’s
top 20 software export companies contribute only 13%
of China’s total software/services exports and their mean
export revenue is just $4.75 million. Considering that
they are approximately the same size this implies that
most of the largest software firms in China have simply
neglected the export market. They have preferred to
concentrate on the very large domestic market. The
Chinese software and IT services industry is only
approximately 5% smaller than India’s, but its exports
are as little as one-tenth of those of India (www.ccidnet.
com, www.nasscom.org and www.mii.gov.cn).
Furthermore, the top three Chinese software export
companies in Table 7, which earn 78% of the top 10’s
export revenue and produce 15% of China’s total
64
software/services exports, tend to sell software bound
with their hardware products rather than providing
offshore outsourcing services. From a pure offshore
outsourcing perspective the biggest Chinese provider is
the Eusoft Group, which achieved $6.1 million in export
revenue in 2001, which is only 1% of that of the biggest
Indian provider. Although there are no detailed data
available on each Chinese company’s export revenue, by
referring to Table 7, where the tenth largest exporter’s
revenue is just $1.3 million, it can be inferred that 87%
of China’s software exports have been won by small
software companies that have individual exports of below
US$1 million.
If it is assumed that the mean annual export revenue
of China’s companies is $600 000 (which is in fact the
mean revenue of all Chinese software companies, so the
actual export figure is likely to be much lower than this)
and this is compared with the $2.1 million mean offshore
outsourcing contract (ComputerWire, 2001a), it is clear
that the transaction frequency in each outsourcing
contract of China is quite low. This means, from the
frequency perspective, that the transaction costs of
outsourcing to China are higher than average. Engaging
in many small transactions is costly: a $12 million
contract incurs fewer transaction costs than three small
ones of $4 million each. Moreover, transaction costs
theory argues that trying to establish a set of independent
companies using a common brand name – the Chinese
Government’s ‘software export cluster’ – is flawed. This
is because it is impossible to prevent the ‘free rider
problem’ on the brand name (Douma and Schreuder,
2002). In addition, there are always problems of ensuring
the standardization of quality and the monitoring of effort
where a number of firms work together to supply a client.
It is important to determine why the largest Chinese
software companies fail to win offshore outsourcing deals
in the same way that Indian companies of similar size
manage to do. Does China’s domestic market provide
higher profit margins than the offshore outsourcing
market? This is unlikely since the margin of Indian
offshore service providers is as high as 30% and the
average margin of China domestic software industry is
only 15% or less (China Software Industry Association,
2002). The domestic market may be large, but it is not
more profitable than the export market.
There are in addition two factors that are not brought
out by the data in Table 4 and both of these put China
at a disadvantage.
First is the on-site presence issue. By reducing the
transaction costs for customers, on-site presence is
very important for offshore outsourcing. India made
46.5% of its exports revenue from on-site delivery in
2001 (Table 1). There are at least 100 000 Indian
IT professionals working on customer sites, while for
China the corresponding number is negligible. Apart
Qu and Brocklehurst
from several small sales offices in the USA there is
almost no deployment of on-site delivery workforces
from China. In fact, most of the Chinese software export
business is made up of small-size subcontracted projects
negotiated with the middlemen, rather than real offshore
outsourcing deals. According to Chen Yuhong, director of
CSS International, the second largest offshore outsourcing service provider of China, most Chinese suppliers
are not even aware who the end-users are (China
Computer World, 2002).
Second is the issue of marketing. Marketing investment, which is paid for by the suppliers, can reduce
transaction costs such as searching costs for customers.
However, Chinese suppliers have not done much in this
respect. For example, at the OutsourceWorld London
2002 exhibition and conference only two of the 79
participating companies came from China, as opposed to
26 from India, 19 from Pakistan and eight from Russia
(OutsourceWorld London Yearbook, 2002). IT managers
in the UK receive a deluge of selling calls from Indian
and Pakistani suppliers, but rarely from Chinese suppliers.
In a survey conducted by the authors among the members
of the National Outsourcing Association and IT professionals in the UK, not a single respondent from 28
responses knew any supplier from China. It is also very
difficult to find trustworthy information about Chinese
suppliers, particularly in English, through the Internet or
other media. India has set up an efficient organization,
the National Association of Software and Services
Companies (NASSCOM), which provides abundant
quantities of reliable information, including individual
supplier profiles, through the Internet. It also builds
up a network among Indian suppliers. In contrast, the
China Software Industry Association, as a governmentmanaged organization, provides little helpful information
for offshore customers. This inevitably pushes up the
transaction costs for companies considering outsourcing
to China.
The vendor has to be seen to have a track record in the
relevant area and to have proved itself in some way.
Despite this, the assessment of track records sometimes
seems somewhat arbitrary and based more on anecdotal
evidence and information supplied by the vendors themselves rather than obtained independently (Michell and
Fitzgerald, 1997). NASSCOM has been very adept at
supplying this information. This saves transaction costs
for both customers and Indian suppliers. China should
learn from this and build a similar organization.
Ultimately, effective long-term networking between a
buyer and vendor requires the building of trust. Trust and
networking are effective measures for reducing transaction
costs. According to Williamson (1975), not everyone
behaves opportunistically, only someone sometimes. If
the buyer and seller trust each other, the transaction costs
of preventing opportunism will be reduced significantly.
Analysis of the role of transaction costs in supplier selection
Trust is infectious. People tend to trust someone that
other trustworthy people trust. Networking is a good,
perhaps the best, vehicle for building such mutual trust.
Consequently, associations of clients, vendors or both
are a good way of reducing transaction costs.
Thirty years of isolation has meant that China has less
networking opportunities with the Western world than
India. Millions of Indians have lived in North America
and Europe for years and many of them are successful
professionals, particularly in the IT industry. Chinese,
from the mainland at least, have only begun to visit the
USA and Europe for lengthy periods since the 1990s.
Most of them are still working in junior positions, two
or three notches lower than the well-established Indians.
Thus, the Chinese network in the USA and Europe is
much weaker than that of India and this also increases the
transaction costs for outsourcing to China.
The concluding sector considers what the policy
implications might be.
Conclusions: outlining a policy agenda
This paper has demonstrated that transaction costs
assume a much greater importance relative to production
costs for offshore outsourcing as compared to its onshore
cousin. (It is not possible to be precise about the quantitative relationship between transaction and production
costs – that requires further work.) Moreover, when it
comes to the choice of offshore supplier, transaction
costs are critical. Yet the difficulty remains that transaction
costs are not as transparent as production costs, nor can
they be so precisely delineated by a contract. What this
paper has accomplished is the rectification of this
situation by bringing together various sources of
published data to reveal where China fails to compete
with India as an outsource provider.
Joint ventures are often not needed with onshore
outsourcing because the transaction costs are so low; but
with offshore outsourcing joint ventures become more
viable. Such ventures have been hampered in China
because of the legal difficulties described above. Nevertheless, they are starting to grow. In fact, more than 100
multinational companies are using this model in China
already (Science Innovation and Made in China, 2002).
Lucent has set up two research and development centres
in Shanghai and Beijing hiring 500 IT professionals.
SAP has set up a research and development centre in
China with approximately 150 employees. Initially this
was just for Chinese localization of SAP R/3 for the
China enterprise resource planning (ERP) market, but it
has since become a low-cost development facility for
SAP Global. IBM has set up a joint venture in Shenzhen,
hiring 130 programmers. Initially this was for localizing
IBM software products for the Chinese market, but now
65
it has become an IGS offshore outsourcing facility working
on mainframe maintenance for Hong Kong Telecom.
HSBC has moved its call centre from Hong Kong to
Guangzhou. Others, such as Motorola, Microsoft,
NOKIA, NEC, HP, Erickson and Intel, have all set up
research and development centres in China hiring more
than 100 professionals.
These are clearly encouraging trends for China, but
what else should the Chinese Government do? Some
of what is being done, in particular around education
and pursuing CMM certification, is along the right lines,
but other measures are either irrelevant (concern over
production costs) or counterproductive.
The first and most obvious point is to cease trying to
promote software export clusters and try instead to
encourage the large Chinese software companies to enter
the offshore outsourcing supplier market and allow small
outsourcing suppliers to develop naturally. It is unrealistic
to expand company size first and then hope to get more
business.
Second, both the Chinese Government and offshore
service suppliers must enhance their marketing and sales
force by going abroad to customer sites. They need to
merge and acquire USA- and Europe-based outsourcing
suppliers or set up joint ventures with them or at least set
up branches hiring local sales forces. The Chinese
Government should invest in setting up an organization
similar to NASSCOM in order to provide free and
reliable information to potential foreign customers. The
Chinese Government should also invest in overseas
advertising in order to improve the international reputation
of China and at least let people know more about China.
The Chinese Government, as a warrantor or a trusttransferring middleman, could help Chinese suppliers
build up their reliability and reputation.
Third, they should enhance their on-site presence. It
may cost more for suppliers, but there is no other choice.
Nearly half of Indian IT exports come from on-site
delivery. Hiring overseas Chinese students is a possible
solution.
Fourth, the Chinese legal system is a big concern for
offshore outsourcing clients. A reliable and efficient
legal system is fundamental for contractual businesses
such as outsourcing. It is impractical to wait for an
improvement in the Chinese legal system. Registering
companies in the USA and Europe for dealing with
customers is a feasible alternative.
Fifth, it is important not to lose their domestic
outsourcing market to Indian companies. The huge
domestic market is the only absolute advantage that
Chinese firms possess against their Indian rivals. By
developing a domestic outsourcing market, Chinese
suppliers can obtain business knowledge, gain project
management experience and build reference and reputation,
as well as grow their companies.
66
Sixth, they need to focus on special projects and
regions where language or other barriers are not too
high, such as Japan, the European continent and Hong
Kong, where the English language is not as crucial as it
is for the US market.
Seventh, Chinese suppliers should put more effort into
business process outsourcing businesses, where no-one
has yet to dominate, rather than IT outsourcing where
India is already dominant and enjoys first mover advantage. In particular, Chinese suppliers have the chance for
providing business process outsourcing services for the
numerous foreign investment businesses that already
exist in China and then to stream up to their headquarters
offshore.
Finally, now that China has entered the World Trade
Organization many multinational companies are going
to seek to do business in China. Most of them, such as
insurance, retail, telecom and bank firms, will have to
negotiate with the Chinese Government in order to
obtain market entry permits. Others, such as Microsoft,
IBM and GE, who want to win huge government
purchase contracts from China, also need to negotiate
with the Chinese Government. All of these multinational
companies have considerable offshore outsourcing
business to allocate. As a trade exchange, the Chinese
Government could persuade them to outsource to China.
For example, Microsoft has just signed an outsourcing
contract of $800 million to China for the next 5 years.
This will greatly accelerate the growth of China’s
offshore outsourcing service business.
There is no question that China has the potential to
compete with India and even surpass India in certain
markets as a vendor of IT services, but there is not much
time. Policy changes are required before this market
matures and the window of opportunity closes.
Acknowledgement
The authors would like to thank Bob Aylott of the
National Outsourcing Association for his help in the
preparation of this article.
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Biographical notes
Zhonghua Qu is an MBA student at The Business
School, Imperial College, London. He received his BSc
in engineering from Sichuan University and his MSc in
mechanics from Peking University. Before studying at
Imperial College he worked in the IT industry for 13
67
years, including 5 years at IBM China, mainly in software
development, ERP consulting and outsourcing services.
His research interests include offshore outsourcing and
the strategic use of IT.
Michael Brocklehurst is a senior lecturer at The
Business School, Imperial College, London. Before
joining Imperial College he taught at a number of higher
education institutions in the UK, Hong Kong and
Canada. His PhD was in the field of new technology
homeworking and he has published widely in this field.
His current research interests are in comparative international innovation, careers and identity and long hours
working. His most recent publications are in Organization Studies and Technological Forecasting and Social
Change.
Address for correspondence: The Business School,
Imperial College, London, South Kensington Campus,
London SW7 2AZ, UK.