OffShoring Engineering

Jobs to China and India

By : Abe De Ramos

In the beginning, outsourcing jobs to China and India was all about driving efficiencies in IT services. Now the eastward drift is going beyond technology into core areas such as R&D. By Abe De Ramos

Cost cutting is the new religion for Alcatel, but the road to enlightenment has been a rocky one. Following heavy losses in the two years following the bursting of the technology bubble in 2000, the €16.5 billion French network-builder adopted a strict regime of attrition. The cuts had to be deep, and they were—by the middle of 2003 management had reduced headcount by around 6,000, improving the firm’s gross margin as a percentage of sales by 6% to 31%.

But it is within the realm of outsourcing that the company has acted most effectively. Alcatel devoted the relatively meagre sum of €100m to build a brand new R&D centre this year, employing 2,000 engineers. The move has saved money while simultaneously bolstering quality in one of the firm’s core activities. If that sounds like a lot of bang for the buck, it is—and that’s because the R&D centre is based in China.
Eastern promise

CFOs still wondering whether or not to send back-office functions offshore are already far behind the outsourcing vanguard. Increasingly, technology R&D is migrating overseas. US chip maker Intel, for example, is developing Banias, a new mobile processor, in Israel; and Canada’s Nortel Networks is developing wireless internet infrastructure in India.

Cost advantage and a vast talent pool are driving the trend. India is the overall outsourcing leader, followed by Ireland and the Philippines. But China is rapidly gaining ground (see box). In general, the movement of high-end jobs offshore can only accelerate, says Partha Iyengar, an analyst at Connecticut-based consulting firm Gartner.

But the eastward trend is not restricted to large companies. California-based E.piphany, a US$83m provider of customer relationship management software, currently outsources around 20% of its R&D workforce to iNova, based in Bangalore. It expects to bring this to 50% by the end of 2004, possibly split between India and China. “What really led us there initially was our desire to have the most cost-efficient, quality R&D organisation we can have,” says CFO Kevin Yeaman.

For other firms, arriving in China is not solely driven by cost and efficiency gains. US-based UTStarcom, which currently has more than 1,400 engineers in China and India, for example, shipped out with the aim of getting a foothold in the Chinese market, using an R&D centre as a springboard. The telecoms equipment company has 400 engineers in the US, who divide development work with Chinese and Indian counterparts. CFO Mike Sophie says there are no plans to reduce the US headcount, but there are no plans to increase it, either. “We want to drive the growth of our engineering in China and India,” he says, adding that plans are already afoot to further increase investments there.

But in the meantime, it’s all for the good of UTStarcom’s P&L. Sophie says the firm’s R&D cost offshore is about 25% of what he would have spent in the US. This brings his R&D cost down to just 10% of sales. “If we were to assume that all those engineers were domiciled in the US, our R&D would be well over 15% of revenues,” he notes.

Similarly, E.piphany’s Yeaman has no qualms about outsourcing R&D jobs overseas. “I can’t tell you what might take the place of the development jobs that are going to be transferred offshore,” he says. “But I can tell you that we need to do what’s best for shareholders, and that is to have the most efficient development organisation while maintaining the quality it takes to be an innovator in the industry.”
Offshoring vs outsourcing

The inevitable difficulties involved with management of outsourcing relationships have led some companies to choose the “offshoring” model of outsourcing R&D, in which companies establish their own subsidiaries rather than farm out the work to third parties. UTStarcom took this path last year when it hired 25 engineers for its initial R&D investment in India. This year it acquired an Indian facility that was controlled by CommWorks, a division inside 3Com that is focused on telecommunications.

Larger companies also prefer full ownership to ease the risk of infringement of intellectual property rights (IPR). In China, multinationals formerly did much R&D in joint ventures with Chinese firms or universities, says Kathleen Walsh, a senior associate at the Henry L Stimson Center, a Washington, DC-based think-tank. Now they are abandoning this model in favour of wholly owned enterprises, “to make sure anything they develop in the R&D centres is their own property.”

In third-party outsourcing arrangements, companies ultimately have little power over IPR protection, although Yeaman says that generally, outsourcing providers like Innova have “tight” protection procedures. Meanwhile, E.piphany is exploring the possibility of full ownership. The company is now analysing whether to continue the fully outsourced set-up, establish its own presence in India or China, or pursue a combination of both.

The CFO is studying the implications of each option, and expects to have a final decision by early 2004. But whatever E.piphany finally decides, Yeaman is confident the cost advantage will be substantial. In the year to September 2003, E.piphany’s R&D costs accounted for 35% of revenues, compared with over 40% in 2002. Ultimately, Yeaman expects to spend “around 15%” on R&D.

Given such promise, it’s easy to predict that offshoring of R&D could only grow. Gartner’s Iyengar says the next wave of outsourcing could be for big pharma companies in the US and Europe to choose India as an offshore location for downstream drug-discovery efforts. In June 2003, for example, AstraZeneca, the Anglo-Swedish pharma, announced plans to quadruple its $10m investment to date in India, for the development of new treatments for tuberculosis. “This is a very expensive process for these companies, and heavily dependent on high-quality PhDs, which are in abundance in India,” Iyengar says.

To Yeaman, it all makes economic sense. “If you’re going to have the most cost-efficient structure,” he says, “you need today to have an offshore presence.”

China wants your IT jobs too

As if manufacturing jobs weren't enough, China is grabbing IT jobs too. Between 2004 and 2007, China and India will receive almost the same amount of foreign direct investment—each around US$30 billion—from IT outsourcing, according to research firm Gartner.

The lure for US and European companies to outsource IT jobs to China is obvious: cheap labour costs. "China is about 40% cheaper than India right now, and I think that gap will widen over time," says Gordon Brooks, CEO of Waltham, Massachusetts-based E5 Systems, which runs IT outsourcing facilities in Beijing and Bangalore.

A testament to China's growing role in the industry is the influx of Indian IT services companies. Well-known providers such as Tata, Wipro and Infosys have quietly set up shops in the mainland in the past year. "Most of the Indian firms are outsourcing to China; they're just not telling their customers they're doing it," says Brooks. "I don't think Indian firms want people to understand that China is ready, for the benefit of preserving their margins."

Nevertheless, China is ready. Already, IBM, Microsoft, Hewlett-Packard and other multinationals are running IT services support in cities like Shanghai, Wuhan and Dalian. Skills-wise, China's strength is in programming, and less so in systems integration and project management, says Rajesh Rao, COO of Bamboo Networks, a Hong Kong-based provider with outsourcing centres on the mainland. As a result, any CFO attracted by the potential cost savings in China would be wise to consider what applications he or she is planning to outsource. "If you're going to outsource a relatively recent package like Siebel, I would do that in India, but if I was going to outsource C++ or Java, I'd do that in China," says Brooks of E5 Systems.

As for business-process outsourcing, such as running call centres, processing invoices and human resources, China remains far behind India. The reasons go beyond the limited use of the English language. "Processing invoices and handling human resources, legal matters and insurance are very different in China," says Alex Lam, Toronto-based COO for Asia of US consulting firm The Outsourcing Institute. Also, despite reform efforts, China still has major obstacles with its banking system, wherein the central government keeps a very tight lid on the movement of foreign exchange. "Because of all these things, the mindset of the Chinese in terms of business processes is not as advanced as that in the West," says Lam.