The Real Threat From China

Over the past decade, people have often asked me the question – where is the next India? A question relating to the next major IT off-shoring destination. The general sense in India is that this is largely a settled question and there is no major emerging competitor to India. While India has some huge advantages over other countries, I believe there is a real threat to India’s dominance in IT, and it comes from a not so distant neighbor – China. Here are the reasons why:

There are three factors that intersect to create large IT off shoring destinations–labor supply, quality and cost. Let us compare China and India on each factor:

Labor Supply: Major off-shoring hubs require huge talent pools. The problem with locations that have limited talent pools is that capacity quickly gets overtaken by demand and wages rise rapidly. Simply observe what happened in Ireland in the late 1990’s and the Chezk Republic earlier this decade. Companies were attracted to the highly skilled, lower cost talent in these countries, but saw wages increase sharply in a matter of years as there was not a large and growing pool of talent. In countries with huge IT talent pools, the supply of talent keeps wage inflation at bay. India and China are the only two competitive countries concerning this factor. And today China is producing more IT graduates each year than India. Essentially, Advantage China.

Labor Quality: This is where the general consensus is India has an unbeatable advantage. Especially when it comes to English speakers. India does have a strong advantage here, but you cannot count out the Chinese. They have made fundamental changes to their education system, making English language studies compulsory starting at the elementary school level. I was in China recently and met with many university students. I noticed a dramatic improvement in their English communication from just a few years ago.

There is also another critical issue. Many outsourcing companies are talking about diversifying their businesses away from the US to Europe and Asia. If a shift in this direction occurs, English dominance will become less relevant. In fact when it comes to competing for outsourcing work in Asia (Japan, Korea, Taiwan)China actually has a language advantage over India. So, when it comes to labor quality, today India has the advantage, but we need to keep a close watch for potential changes.

Cost: Most cost comparisons to-date revolve around wages – where India has historically held an advantage. However, the wage gap between India and China has been dwindling because of massive wage inflation in India. But experienced outsourcing companies are beginning to look at other major costs, such as infrastructure and taxes in addition to wages. The Indian government has fueled the growth in the IT industry by providing all IT companies with a tax holiday for the past ten years. This is now expiring. Interestingly, at the same time, local provincial governments in China are expanding their tax benefit programs for companies setting up large outsourcing centers.

The other major cost is infrastructure. Here, China has a huge advantage. The infrastructure costs in India are large – both monetarily and operationally. As an example, companies have to provide transportation to employees because public transportation is not available. IT companies are running huge transportation businesses instead of focusing on their core business. Sohistorically India has held the advantage on cost, but China is slowly gaining the upper hand.

So what does all this mean? I believe China will most likely emerge as a major IT outsourcing hub. I also believe the overall growth in the industry can support the development of another major off-shoring hub. Further more, this can be an opportunity for Indian companies to embrace China, diversify their own operations, and expand their presence in China.

There is a historical context here. The US lost the manufacturing market because they failed to take the threat from Japan and other low cost countries seriously. When it came to IT off-shoring the major US companies were much more nimble –embracing off-shoring and India. Just look at how quickly companies like Accenture and IBM have developed their global sourcing capabilities.

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