Over the past three years, multinational companies’ (MNCs’) approach to outsourcing in China has steadily matured as they seek to leverage broader outsourcing models and source from a combination of global providers and local Chinese providers.

In my latest report, Lessons Learned From Outsourcing In China: Part 2, I analyze the key outsourcing trends and approaches to help sourcing and vendor management (SVM) professionals at MNCs select the right local outsourcing suppliers. As part of this analysis, I’ve highlighted the main service capabilities of local Chinese vendors broken down by service model and profile the different types of service providers that currently operate in China.

Key findings from the report include:

• MNCs are adopting sophisticated outsourcing approaches in China. Many MNCs are shifting away from a pure global service provider approach to a broader shortlist that also includes Chinese providers. SVM professionals at MNCs appreciate local providers’ broader geographic coverage, lower outsourcing cost and more flexible service deliverables.
• MNCs are also diversifying their outsourcing requirements. After signing the first wave of outsourcing contracts in the past five to 10 years, MNCs are becoming increasingly comfortable considering more sophisticated outsourcing contracts, such as best-of-breed selection, vertical outsourcing, etc.
• Local outsourcing service providers are continually improving their capabilities. To approach more MNC clients in China, local providers have enhanced their geographic coverage in remote cities, accelerated consolidations, recruited senior talent for improved depth at key positions and aggressively recruited fresh graduates to manage costs.

Gene Cao, Frederic Giron, Michael Barnes

On August 10, rival IT outsourcers hiSoft and VanceInfo announced their intention to merge. The resulting entity will comprise a much bigger organization, with more than 20,000 employees mainly located in China, making it one of the largest IT services vendors in the country. In another recent example of market consolidation, BeyondSoft announced on August 18 that it would acquire six Chinese and Japanese subsidiaries of Achievo, a US-based offshore IT services provider.

Over the next 18 months, we believe that IT services vendors in China will face increasing price and margin pressure driven by rapidly increasing local labor costs. The days of relying on low labor costs to drive business in the US, Europe, and Japan are numbered. Chinese IT services vendors are being forced to evolve from a cost-based to a business value-based approach. As a result, we expect the Chinese IT services market to consolidate over the next 18 to 24 months as vendors seek ways to improve their organizational and operational maturity.

The challenges hiSoft and VanceInfo will face after the merger are indicative of broader market pressures, including:

• An increased capacity to better compete in large deals. As separate entities, hiSoft and VanceInfo both faced significant challenges when bidding on large-scale outsourcing projects with a total contract value of more than $50 million. With this merger, we expect the newly formed organization to gain better access to these deals as they become more visible to MNCs. However, the new company will still be small by Indian offshore standards.