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China’s IT Services Industry Challenges India in Outsourcing

India’s information technology outsourcing companies have taken over everywhere.

Everywhere, that is, except for one of the most promising markets in the world: China. India’s software executives recognize their neighboring country as one of the hardest markets to crack.

Language issues prove one problem. So does the difference between Indian entrepreneurship and China’s more complicated, personal network-driven approach.

And Indian companies are used to dealing with private sector companies, not the state-driven enterprises that China runs.

Still, most Indian outsourcing companies have set up operations in China. Tata Consultancy Services, India’s largest IT outsourcing company, plans to double the number of employees there from 1,100 to 2,200 over 2011.

Pramod Bhasin, the CEO of India’s largest business processing company Genpact (NYSE: G), may have put it best: “In China, we are Chinese.”

Indian outsourcing companies took a while though in creating that identity. In fact, they may have already missed their chance…

China’s IT Outsourcing Industry

Out of seemingly nowhere, Chinese IT outsourcing companies have appeared to challenge India’s dominance. According to the accounting firm Deliotte, those Chinese companies grew their revenues to $26 billion last year.

And according to Edigio Zarrella, a partner at KPMG, “The Chinese outsourcing sector is bound to see the same curve the Indian industry had before – they are in for incredible growth.”

India is well aware of the doors such growth opens up. Its own outsourcers remember all too well how they rolled up western markets in just a few years’ time. Now, they fear China will do the same to them. And the Chinese government seems to be betting on that possibility as well.

Authorities there have offered strong support to such local companies. This includes incentive packages and paying no business tax on offshore contracts until 2014.

It hopes to create millions of jobs in the industry, along with 10 internationally competitive outsourcing hubs. It also wants to encourage 100 multinational companies to outsource to China and develop 1,000 Chinese outsourcing services vendors that can serve the global market.

As a result, the Chinese are now increasingly picking up orders in the U.S. and Europe… both traditional strongholds for Indian companies.

Last year, those areas brought in sharp revenue rises for all top 10 Chinese outsourcing service vendors. In some cases, the revenues outgrew those from Japan and South Korea, where Chinese companies first started offering their services.

The Nay-Sayers Have Nothing

Those who doubt China’s IT services point out how exports last year amounted to only $9.6 billion. India, on the other hand, made $49.7 billion.

However, those figures don’t factor in the huge domestic market that China can rely on. And that can make a huge difference…

IT services currently account for only 13.8% of China’s total IT market, compared with a 30.3% share for the Asia-Pacific region in general, according to research firm IDC.

Expect that to increase as government efficiency requirements push local groups to step up outsourcing… something that’s already happening.

At $8.1 billion last year, China’s domestic IT services market was bigger than India’s $5.8 billion.

The Emerging Chinese IT Services Industry

The emerging Chinese IT services industry opens a true growth opportunity for investors. And better yet, a few of the biggest businesses in that group are listed on U.S. exchanges.

China’s second largest IT services company, VanceInfo ADR (NYSE: VIT), has fed off of the domestic market. In 2006, it only represented 5% of the company’s revenues. But in the second quarter of this year, that number soared to 45%.

The third largest Chinese offshore IT vendor, HiSoft ADR (Nasdaq: HSFT), went public in June. Its clients now include Microsoft (Nasdaq: MSFT). It has seen domestic business soar over the past six quarters and expects China will account for 10% of its revenues by the end of this year. By 2012, that number should rise to 40%.

With China’s IT services industry still in its infancy, investing in these companies should prove very profitable over the next several years.

Good investing,

Tony D’Altorio

*The views and opinions expressed in this article are those of the author and do not necessarily reflect the official position of Wall Street analysts.

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