Outsourcing to China

What Companies are Benefiting from Outsourcing to China   

• Microsoft, Dell, SAP, Nokia, General Electric, Alcatel-Lucent, and Unilever (UL) have meaningful engineering and IT offshoring operations in China.

• Accounting and consulting firms like Accenture (ACN), BearingPoint and Infosys Technologies (INFY) are well-positioned to benefit from China's highly-educated, lower cost workforce.

• Wal-Mart Stores (WMT) and other big box retailers benefit from low cost manufacturing in China.

• Newell Rubbermaid (NWL) and other manufacturers have shifted much of their production to China; Newell Rubbermaid outsourced 75% of its manufacturing to China in 2007. 

What Companies are Not Benefiting from Outsourcing to China?

• Lockheed Martin (LMT), Raytheon Company (RTN) are examples of prime defense contractors which would have difficulty offshoring their support or technology functions overseas.

• Pfizer (PFE) would not readily offshore production of their more profitable drugs (i.e. Viagra).

•  IP dependent industries would not likely outsource their most cutting edge R&D to China, unless their business is so capital-intensive that competitors would be hard-pressed to follow. Intel might fall into this category.

• Companies dependent on Western language customer service workers, such as telecom operators and Internet Service Providers like SBC, AOL, and Qwest are less likely to benefit from Chinese outsourcing because many workers there lack sufficient English language skills to provide real-time assistance to Western customers. 

Certain Occupations are Easier to Outsource

Engineering, finance and accounting occupations, for example, do not require much interaction with others and can often be broken down into discrete, well-defined projects and problems to be solved. This translates into more outsourcing risk for this employed in industries heavily reliant on such talents, such as software development and document processing. According to a presentation by Holly Muscolino, the Director of InfoTrends/CAP Ventures, at a meeting of the International Association of Outsourcing Professionals, Document Process Outsourcing will grow at a 17.9 percent CAGR from 2003 through 2008 – reaching a market size of more than $1.5 billion dollars in the U.S. alone. Already, Microsoft, Dell, SAP, Nokia, General Electric, Alcatel-Lucent and Unilever offshore, except perhaps the reading of x-rays and other data that can be conveyed electronically. The testing of physical samples, such as by a pathologist, by comparison, may be too time-sensitive to ship offshore for testing. 

Based on the aforementioned distinctions between occupations, it is not a surprise that outsourcing is most likely to impact information technology (IT) and routinized business processes, such as customer service. At present, China lags in these areas. In 2005, McKinsey reported that China accounted for $3.4 billion of the world’s total business process (BPO) and information technology (IT) outsourcing, a pittance compared to $8.6 billion in Ireland and $12.2 billion in India. 

Some Industries are Better Suited for Outsourcing Than Others

Service businesses with low margins are more likely to benefit from offshore outsourcing than those still commanding a high margin. Thus, a move of customer service abroad for a high-touch, high-margin business may save a few dollars, but dramatically reduce a company’s market share among competitors. By comparison, a business in a oligopolistic industry, such as utilities and telecom, can provide lower-touch customer service without dashing as many customer expectations. 

China’s poor intellectual property protection may limit its share of service outsourcing - To the extent that businesses rely on proprietary technology and processes to provide services to their customers, Western companies may shy away from locating those aspects of their business in China. While China has joined with the World Trade Organization and acceded to the related TRIPS treaty protecting intellectual property rights, in practice China’s record is still poor. Counterfeit merchandise in China abounds, reportedly accounting for 20% of all consumer products there, and the United States recently filed two intellectual property protection cases against China through the WTO dispute resolution organization. 

Government Restrictions Limit Outsourcing

For national security reasons, it is unlikely that defense contractors or even manufacturers of high-end dual use services will be able to move significant portions of their operations abroad. The May 2006 flap over the U.S. State Department’s purchase of $13 million of computers and related equipment from Chinese-owned Lenovo, despite the routing of the purchase through U.S. government contractor CDW Corp, highlights this issue. One can only guess how large of an uproar would be created by Lenovo also providing after-sales service and support… 

Other arms of the U.S. government may not restrict overseas activities, but they still regulate them. For example, the FDA must approve all drug clinical trials before such drugs can be marketed in the U.S. Trial represent a huge expense for pharmaceutical manufacturers – and perfect opportunity to lower costs by shifting overseas. On average, drug companies spend about 37% of their overall R&D budgets on clinical affairs. USA Today reports that 21% of drug industry spending for human drug testing was outside of the United States in 2004, up from 18% in 2000; however the number of U.S.-based clinical trials is not declining as "much as foreign ones are increasing." According to GlaxoSmithKline’s head of development, companies can reduce human testing costs by 10% to 50% by conducting trials in Eastern Europe, Asia, and Central and South America because clinical and hospital costs are lower outside of the United States, and patient recruitment is less time consuming. Merck concurs, as it now conducts approximately 35% of all its clinical trials overseas. 

Language

One of China’s largest impediments to success in gathering outsourcing business is its low degree of English literacy compared to other developing countries, like India and the Philippines. 

Management Skills

India has spent more than a decade developing its project management skills, as demonstrated by worldwide outsourcing players like Wipro and Infosys. By comparison, until recently, many Chinese worked for state-owned enterprises where management skills were either inessential or not well-honed. In order to scale an outsourcing business, China needs more trained managers whom foreign companies can trust from afar.