Monday, September 15, 2008

Is China a threat to the Indian software industry

Other Forms for this Topic:
Is China a threat or an opportunity

As with many sectors in Indian industry, the Indian software industry too is worried over the threat from China. Yet in software and hardware, India might have an opportunity that more than makes up for any threat.
For 40 years now, since border skirmishes erupted just after some emotional posturing in 1962, Indians and Chinese have viewed each other with mutual suspicion. Over the years, although the two gigantic countries have settled some differences, they still seem to warily circle each other. In recent times, Indian industry on the receiving end of dirt-cheap Chinese imports has been at the forefront of a ‘Save Us from China’ campaign. And now even the czars of the Indian software industry are acknowledging that China poses a serious threat to India’s ambition of becoming an IT superpower. That Nasscom is finalising a white paper on the implications of the Chinese foray into software exports shows the general alarm that has set in.
There’s no doubt about China’s competitiveness in the IT sector, considering its hardware and telecom markets are much bigger than India’s. And even in software, China has a huge captive domestic market, as compared to India’s relatively tiny domestic market. There are some other alarming figures for India: the ratio of China’s IT spend to its GDP is nearly 5 times that of India’s. If India’s current growth rate in IT doubles, it would still take us 25 years to catch up with China, and that only if China’s growth rate remains stagnant.
Frankly, these numbers do seem to put a huge question mark over India’s much talked of aim of becoming an IT superpower.

Large domestic market

But, rather than throwing in the towel, there is a school of thought developing in India which believes that the Indian IT industry can convert this apparent Chinese threat into an opportunity. Nasscom president Kiran Karnik is one of the main votaries of this opinion. He believes that while China will always remain a formidable competitor, a policy of engagement rather than a policy of isolated approach would perhaps be a better strategy. First, it would give Indian companies a door to enter the Chinese domestic market which is today dominated by MNCs. Plus, Indian IT companies based in China can address other East Asian markets like Japan and Korea. This view is also endorsed by Noshir Kaka, principal, McKinsey & Co.

It is a well established fact today that Indian IT firms have an excellent opportunity waiting to be tapped in the Chinese domestic market, which is estimated to be four times the size of India’s. Also, with China becoming a part of the WTO, local banks in China will soon be forced to start upgrading their technology. As local players have not been able to provide the required expertise and technology in the domestic IT market, the Chinese market is currently dominated by MNCs. This in itself offers an excellent opportunity for Indian IT firms, whose development expertise is no way inferior to these MNCs.

Another important aspect is the growing purchasing power of the China’s 1.3 billion people which in turn is creating a strong massive base to build domestic technology companies. China is also expected to be the largest market in the world by 2004 for mobile phones and digital cameras, and the second largest for PCs after the US. A key reason why India is miles ahead of China in software exports is due to the simple fact that the efforts of Chinese software firms were spent in addressing the huge domestic market (estimated to be worth $16.2 billion).

But things are about to change, as China wants to emulate India’s success in the software sector and become a major global force. China has initiated a series of measures, which include plans to set up specialist IT training institutions on the lines of our IITs and Chinese firms are following the same strategy India’s IT majors did (bagging projects based on price) before going on to become software majors.

Yet, there is a bigger opportunity for Indian IT players in China. One, according to Infosys chairman N R Narayana Murthy, is that Chinese firms cannot meet the full demand from the Chinese domestic IT industry, resulting in the government allowing foreign firms like Microsoft, Oracle and IBM to operate through joint ventures. In addition, Kaka feels that Indian IT firms can take advantage of the fact that China offers Indian IT firms lower trade barriers, lower taxes and excellent infrastructure. No wonder Infosys is on the threshold of setting up facilities in Shanghai to tap the Chinese domestic market.

Window to Japan

The second premise for looking at China as an opportunity is that it can provide Indian companies a gateway to Japan, a market hitherto virtually untouched. This logic is significant as currently, Japan is the world’s second largest economy-estimated to be worth a gigantic 70 percent of the entire Asian market and which contributes approximately 11 percent to the total outsourcing global market. There is obviously a huge gap to be filled as only four percent of India’s software exports go to Japan.

A significant gainer in the Japanese market is China, which has been a favoured partner for Japan’s software imports. The synergy is easy to fathom. One, Japanese is the second language taught in the northeastern parts of China, where most Chinese companies are located. Also, most Chinese programmers are familiar with the double byte system used to generate Chinese and Japanese characters. Location wise also, China offers a great advantage to Japanese companies looking to outsource their projects. Due to these synergies, it comes as no surprise therefore that Japan continues to be China’s largest trading partner.

Though Indian IT firms have established bases in Japan (the list includes the likes of Wipro, Infosys and TCS and L&T Information Technology), it remains a tough market to crack. The reason primarily being that Japanese companies have traditionally resisted external help relating to their IT systems. But a gradual change is happening. The Japanese economy, which is in the throes of recession, is slowly but surely catching on the outsourcing mantra in a big way. According to industry estimates, spending on IT outsourcing is likely to exceed $15 billion in 2005. These figures are roughly one third of the market size in the US.

Since China is a natural trading partner for Japan, it makes more sense for Indian companies to set up base in China by following a strategy of partnerships with local players who have knowledge and expertise about local markets. Since the Japanese culture is not as open as US culture, tapping the Japanese market will undoubtedly require a lot of patience. But as experts say, once bonds are established they stay for a long time. Hence, it makes even more sense for Indian companies to tie up with Chinese players as China has been a long-time preferred trading partner for Japan.

Also, India’s edge over China could come from the fact that it has a good record in quality and protection of intellectual property rights. Global software majors are wary of outsourcing their projects to Chinese companies as China has a terrible record in software piracy. And on the quality front, as of December 2001, India had 36 companies at the SEI CMM Level 5 assessment out of 58 organisations worldwide, while China had none. It is thus a win-win situation for both Indian and Chinese companies as organisations who were earlier wary about Chinese firms but wanted to avail of the cultural and locational synergies, can now do so in the case of a Indo-Chinese tie-up.

The hardware angle

Even the hardware sector could gain from China’s traditional strengths in this segment. K R Naik, managing director of D-link India proposes that Indian companies should set up hardware manufacturing facilities with technology know-how from companies both in mainland China as well as Taiwan. Most of the very few manufacturing facilities in India today deal merely in assembling, and unless they replicate the Chinese model of hardware development, the MAIT-E&Y estimate of $62 billion by 2010 in hardware will only remain a pipe dream. Naik’s formula for success: Form a JV with a Chinese hardware major, procure the technology expertise, the R&D set up and then do actual manufacturing in India. “You can even supply to the Chinese market, as our labour force is not only cheaper but much more intelligent,” he adds.

The key part of the strategy for Indian IT firms is to forge partnerships with Chinese firms and participate in the country’s explosive growth. Some Indian companies have already done this. NIIT, for instance, has seen huge demand for its courses due to its unique English and Mandarin courses. As Kaka says, “Going forward, Indian software companies can outsource their work to Chinese companies to boost productivity, while maintaining a strategic relationship with the client.”

Indian software companies have an exponential opportunity to be tapped in the field of telecom software. Currently, major telecom players in China like Zhongxing and Huawei export their telecommunications equipment to India, while Indian IT firms develop the requisite software for them. That’s a great example of combining China’s strengths in hardware manufacturing with India’s strengths in software. With Infosys receiving the green signal to set up a branch in China and Satyam too likely to jump into the fray, the future seems bright for Indian IT companies in China. While it is in the best interests of Indian IT companies to view China as a formidable competitor, the opportunities far outweigh the threats. Perhaps the question should be rephrased from, ‘Is China as a threat?’ to ‘Is China as a land of opportunities?’ For India Inc’s sake, we sure hope it is.

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