With continued improvement of the global business environment, transformation of the world economy to a service-based economy and advancement of information technology, a new round of industrial reshuffling and services outsourcing is emerging. Services outsourcing refers to the contracting out of non-core operations of a company to a third party specialising in that operation. In developed economies such as Europe, the US and Japan, the development of services outsourcing (including international or offshore services outsourcing) is fairly mature. The global software and services outsourcing market saw rapid growth in the past few years, with total value estimated to reach US$1.2 trillion in 2007. While activities in the mainland and Hong Kong services outsourcing markets have continued to increase in recent years, cooperation between players from both places has only just begun.

As the trend of global economic integration continues to gather momentum, many enterprises are increasingly outsourcing their back-office supporting functions, in particular to low-cost countries such as India and China. This not only can help reduce costs but also optimise resource allocation on a global scale, thereby enhancing corporate core competitiveness. Multinational corporations (MNCs), as the major outsourcing buyers as well as important outsourcing vendors, are the leading force behind the fast-expanding offshore services outsourcing market.

Currently, global offshore services outsourcing mainly comprises information technology and software outsourcing (ITO) and business process outsourcing (BPO). According to research institute GARTNER, the global ITO and BPO spending will increase from US$192.8 billion and US$111.3 billion respectively in 2004 to US$244.2 billion and US$157.5 billion respectively in 2008. From a global perspective, established services outsourcing vendors are mostly found in the US and India, while outsourcing buyers mainly come from the US, Western Europe and Japan. In the offshore outsourcing service supplier market, India is the most competitive, capturing over 40% of the global ITO/BPO market and accounting for seven out of the world's top 20 ITO/BPO vendors. Among the sectors covered by the world's top 100 offshore outsourcing vendors in 2006, the financial sector accounted for the largest share (69%), followed by the telecommunications (47%) and software (41%) industries.

Entering the 21st century, China's ITO industry has maintained its strong growth momentum, with an annual compound growth rate of over 50% from 2001 to 2006 and a market size of US$1.43 billion in 2006. According to CCID Consulting Company, China's ITO market is projected to reach US$4.56 billion by 2009. While ITO is currently the focus of the mainland's services outsourcing market, BPO has also embarked on a fast track of development, with an executed contract value of US$380 million in 2006, up 63.9% over the previous year.

As an outsourcing service provider, China has a number of advantages. First, China has become a world production centre. In the new round of global reshuffle of manufacturing industries, many MNCs which have established a presence in the mainland market have a strong demand for various kinds of producer services. The amount of foreign direct investment (FDI) absorbed by China in 2005, to the tune of US$72 billion, was 10 times that of India. More than 200 MNCs have set up research and development centres in China and have continued to increase their inputs in R&D. Meanwhile, as mainland government departments continue to enhance their efficiency, their demand for services outsourcing is huge.

As a major software base, China has world-class telecommunications and power infrastructures and abundant human resources. Moreover, the Chinese government offers outsourcing service vendors various preferential policies, such as tax concessions and alternative telecommunications arrangements. The great difference in cost, mainly in wage levels, between China and the outsourcing buyer countries, has also given the mainland a clear advantage in cost competitiveness. For instance, the average monthly wage of an IT engineer on the mainland is about US$500, only one-eighth of his US counterpart's or 70% of his Indian counterpart's. Also, while the supply of human resources in India has been dwindling since 2003, stable labour supply is sustained in China. In inland cities like Xian and Chengdu, human resources are rich and relatively stable, giving mainland outsourcing vendors an unrivalled advantage.

In China, a software outsourcing market comprising renowned foreign IT companies and emerging domestic professional outsourcing vendors has begun to take shape. Some famous Indian outsourcing service providers, optimistic about China's outsourcing market, have established a foothold on the mainland. While the income of an Indian outsourcing vendor could reach US$1 billion, the income of its Chinese counterpart is often much lower. Currently, among the top 10 software outsourcing service providers on the mainland, Neusoft is the only enterprise with a turnover topping US$100 million. In 2006, there were more than 8,000 ITO service providers in China. However, the combined market share of the top 10 providers amounted to 20% only. By comparison, although there are less than 3,000 ITO service providers in India, the top 10 players together account for 45% of the market.

Among the joint venture companies on the mainland, Sino-Japanese and Sino-US joint ventures account for the majority. Japan is the major market for China's offshore services outsourcing business, with software outsourcing growing at a steady pace. In 2005, the industry size of China's outsourced software and IT services reached US$970 million, of which business from Japan and the US accounted for 58.6% and 24.5% respectively, while business from Europe accounted for a mere 0.02%. In 2006, contribution from the Japanese and Korean markets reached 56%, while the contribution from the European and US markets rose 8.4 percentage points to 36%.

In terms of market structure, three regional markets in northeastern, northern and eastern China with Dalian, Beijing and Shanghai as their respective centres have emerged on the mainland. Meanwhile, outsourcing activities are also expanding to other mainland cities such as Hangzhou, Xian and Shenzhen. The cost of software talent in these cities is about 40% lower than that in major cities like Beijing, making the former cities very attractive to outsourcing enterprises. The outsourcing industry covers a broad spectrum, with BPO fast catching up with rapid development in such areas as human resources, finance and customer service.

From the perspective of national development strategy, it is of prime importance to accelerate the development and planning of the services outsourcing industry. The Outline of the Eleventh Five-Year Programme for National Economy and Social Development of the People's Republic of China states clearly that China should expedite the development of the service industry, encourage the participation of foreign investors in software development and in offshore outsourcing services, establish several outsourcing bases and take steps to capitalise on the shift of the global service industry during the 11th five-year programme period. The Outline of the Eleventh Five-Year Programme for Commercial Development emphasises the need to promote the development of trade in services, formulate policies and measures encouraging the development of trade in services, and give priority to developing international services outsourcing business and establishing regulatory and industrial systems in line with international rules. The Eleventh Five-year Programme of Rejuvenating Trade Through Science and Technology encourages the development of the software industry and provides for the policies on encouraging the export of software and IT outsourcing services. Under the Opinions of the State Council on Accelerating the Development of the Service Sector, policies supporting services outsourcing are formulated and the scope of liberalisation of the service sector is expanded in a bid to undertake international services outsourcing business. Capitalising on its advantage in human resources, efforts will be made by China to quicken its pace in nurturing a batch of outsourcing vendors with international qualifications and establishing a number of outsourcing bases. The "Thousand-Hundred-Ten" services outsourcing project launched by the Ministry of Commerce outlines a plan for establishing 10 outsourcing service bases with global competitiveness, attracting 100 world-renowned MNCs to shift their services outsourcing activities to China, and nurturing 1,000 large- and medium-sized outsourcing service providers with international qualifications in China within the 11th five-year programme period. In addition, a training programme under the "Thousand-Hundred-Ten" project aims to train 300,000 to 400,000 personnel needed by the services outsourcing industry within five years. As at the end of 2006, there were 11 state-recognised software outsourcing bases in the country, and eight of them have introduced local policies and measures encouraging the development of the services outsourcing industry. Currently, parks engaging mainly in software outsourcing are found in Zhongguancun of Beijing, Putong of Shanghai, Dalian, Shenzhen, Guangzhou and Xian.

Active development of the international offshore services outsourcing business is conducive to the further liberalisation of China's service sector and its participation in the reshuffling of the global service industry, bolstering the development of the service sector on the mainland. Presently, the challenges facing China in undertaking services outsourcing lie mainly in the inadequacies in the overall service market system, supporting policies and industry management, as well as the problem of intellectual property rights protection. Other challenges include the lack of mid-to-high-level personnel and trade associations representing enterprises in the industry, as well as weaknesses on the part of the majority of service vendors such as the lack of core competitiveness, technical strength, management skills, international recognition, ability to expand into new markets and to secure orders directly, and skills to interact with clients (including English proficiency), etc.

China presently lags behind major outsourcing service suppliers such as India and Ireland in language skills and cultural adaptation. While Japan is the major market for China's offshore outsourcing service export, most of the business is subcontracted from large Japanese enterprises. Business from the US and Europe is obtained mainly through MNCs which, having entered the mainland in the form of commercial presence, exercise direct control over both outsourcing and contracting. The lack of proficiency in English and European languages has also made it difficult for China to expand the European and US markets and secure orders directly. Other challenges include: vicious competition between different mainland provinces and cities, immature market development and management skills, immature business processes, and the lack of one-stop shop in offering information and solutions. In order to become one of the major contenders in the global outsourcing market, China must enhance its competitiveness in international outsourcing and tackle the above-mentioned challenges. Efforts must also be made to understand the specific needs of global outsourcing buyers and encourage outsourcing vendors to set up global outsourcing centres overseas.

Improvement in policy is also needed. China must increase the transparency of policies, guarantee corporate ownership, strengthen the protection of corporate intellectual property rights, and encourage outsourcing vendors to become industry leaders by obtaining international certifications, expanding through mergers (including mergers with overseas companies) and enhancing service standards. Action should also be taken by outsourcing bases and local governments to introduce differentiated incentive measures, solve the problems encountered in the development of services outsourcing enterprises on the local level, and provide policy support such as necessary funds. Local governments can also help link up domestic enterprises with multinational software companies or foreign players. Moreover, some challenges faced by mainland outsourcing service providers can be addressed through greater cooperation with Hong Kong players. In this respect, there is much room for mainland-Hong Kong cooperation.

Development, Advantages and Disadvantages of Hong Kong's Outsourcing Industry

ITO and BPO began to develop in Hong Kong in the early 1990s, with banks and telecommunications companies being the first to outsource services by means of establishing wholly-owned subsidiaries to serve as the exclusive contractors of their parent companies. Thanks to the enhanced capacity and economy of scale of these contractors, they have gradually developed into BPO/ITO service providers serving other banks and clients.

Following the economic boom in China and the region, an increasing number of MNCs have established regional headquarters or offices in Hong Kong. This, coupled with the fact that many Hong Kong companies and MNCs have entered the mainland market while mainland enterprises are expanding into overseas markets via Hong Kong, has generated a huge demand for information technology infrastructure and outsourcing services. In line with its "Digital 21 Information Technology Strategy" to position Hong Kong as a leading e-business community and digital city, the HKSAR government's demand for BPO/ITO services is expected to continue. Hong Kong's Office of the Government Chief Information Officer outsourced US$0.17 billion worth of IT-related projects in 2006/07, up 37% from the year before, making the HKSAR government the single biggest local buyer of BPO/ITO services in Hong Kong.

Over the last few years, Hong Kong has witnessed an increasing volume of activities in the areas of data centre management, application management in the financial sector, document management, and legacy system application management. Industry estimates put the value of Hong Kong's BPO/ITO at no less than US$1 billion, which has been growing annually at a double digit rate over the past few years. The ITO part is estimated to account for about two-thirds of the entire outsourcing market, or twice the size of the BPO part.

Apart from local enterprises, many of the outsourcing service providers operating in Hong Kong are MNCs, which are the branches or subsidiaries of world-renowned information technology service support and/or consultancy companies. The good international reputation, considerable scale and proven track record of these MNCs have given them an upper hand in competing with the local small- and medium-sized service vendors. This also explains the high concentration of the Hong Kong BPO/ITO market. Generally speaking, Hong Kong's outsourcing service providers, having accumulated rich experiences in dealing with MNCs, can provide clients in Hong Kong and the neighbouring regions with the best outsourcing solutions that meet international standards. However, Hong Kong has made only minor inroads into the developed markets such as Europe and the US, which only account for a small percentage of Hong Kong's outsourcing services. One of the reasons is that Hong Kong's outsourcing service providers are rather small in scale, and many European and US firms have reservations over their delivery ability.

However, as a highly popular outsourcing service delivery centre, Hong Kong has a number of advantages in providing outsourcing services. Hong Kong has world-class telecommunications and information technology infrastructures and enjoys one of the world's freest flow of information. According to the Economic Intelligence Unit's 2007 e-readiness rankings, Hong Kong ranked first in Asia and fourth in the world. With its close connectivity to the international community, Hong Kong has attracted many MNCs to establish their regional headquarters here. Alongside their capital, business operations and overseas professional staff, these MNCs are also bringing into Hong Kong their best business practices and ideas, as well as latest innovations and technologies. In return, the exposures to these international business practices and ideas not only allow Hong Kong companies and professionals to understand their foreign counterparts better, but also increase their knowledge and operational capacities to provide system design, project management and support services that meet international standards as well as excellent outsourcing solutions. According to the findings of a 2006 study by the Hong Kong Software Industry Information Centre, Hong Kong IT companies enjoy international recognition in handling outsourcing projects. The building blocks for Hong Kong as a centre of excellence in handling international projects are efficient management, top professional talent and possession of world-class certifications such as Capability Maturity Model Integration (CMMI).

Despite these advantages, Hong Kong also faces challenges such as relatively high costs and the small scale of local outsourcing service providers. With growing international competition, lowering service costs and enhancing competitiveness have become an urgent task for Hong Kong players. Given the mainland's abundant human resources and the difference in wage levels between Hong Kong and the mainland (the monthly wage of a mainland ITO company computer programmer ranges from US$385 to US$640 whereas his Hong Kong counterpart earns three to four times more), many Hong Kong outsourcing service providers have relocated part of their functions to neighbouring Guangdong province, with a view to saving costs and enhancing competitive edge. Shenzhen, Guangzhou and Zhuhai are the preferred choices of Hong Kong outsourcing vendors for conducting solutions delivery activities, mainly through their local captive investment offices or sub-contracting the work to external software service providers.

Apart from being a powerhouse in light consumables manufacturing, Guangdong is also a major player in the country's hi-tech industry, including the software sector. Meanwhile, Hong Kong enjoys worldwide recognition as a centre of excellence in handling outsourcing projects meeting stringent international requirements and has a pool of talent proficient in international market knowledge, foreign languages and technology. Through cooperation and complementing each other's functions, it is believed that Hong Kong and Guangdong's competitiveness can be further enhanced in their bid to capture global software outsourcing opportunities. Established in June 2007, the Hong Kong Software Outsourcing Alliance (HKSOA) is the counterpart of the Guangdong Software Outsourcing Council (GDSOC). Objectives of HKSOA include facilitating software outsourcing cooperation with Guangdong, improving the skills and capabilities of Hong Kong's software outsourcing industry through experience-sharing and the development of industry best practices, and promoting image building and branding. Regarding the model of cooperation between HKSOA and GDSOC, it has been tentatively agreed that HKSOA is responsible for the marketing, contract negotiation, project management, user requirement definition and system design of outsourcing projects, while GDSOC serves as a reliable "software factory" pooling the software outsourcing resources from Guangdong for system development. By leveraging on its strengths, Hong Kong can act as an interface between the back offices on the mainland and the offshore clients, as well as a quality assurance centre for clients and software factories. In addition, joint Hong Kong and Guangdong marketing and promotional activities and participation in overseas software outsourcing events will be carried out to help build the image and brand of Chinese software.

Areas for Improvement and Recommendations for HK-Mainland Cooperation in Global Outsourcing Service

While there is a strong global demand for reliable BPO/ITO services, competition among outsourcing service providers is increasingly intense. As an excellent delivery centre in the Asia-Pacific region, Hong Kong's strengths lie in such areas as good client and project management, quality assurance and timely delivery of efficient outsourcing solutions. However, lowering costs remains an issue to be addressed by Hong Kong outsourcing service vendors. By cooperating with their mainland counterparts and capitalising on the human resources and cost advantage of the mainland, Hong Kong service suppliers can create a win-win situation and enhance their competitiveness in the expanding international market. Many Hong Kong outsourcing service vendors are well aware of the benefits of this strategy and have shifted part of their outsourcing functions to neighbouring Guangdong province. As captive investment is the preferred business model, most of these Hong Kong companies set up subsidiaries in Guangdong with only a handful of them opting for outsourcing to a third-party vendor. At present, Hong Kong-mainland cooperation in international services outsourcing is still in its infancy. The lack of thorough understanding and knowledge of the development capability of their Guangdong counterparts has kept many Hong Kong outsourcing service vendors from sub-contracting projects to third-party vendors. At present, the model of cooperation between GDSOC and HKSOA is tentatively based on the concept of "shop at front, factory at the back" as in the case of product manufacturing. However, it will take time to hammer out the most practical model of cooperation in services outsourcing that would be most beneficial to both sides.

Compared with their counterparts in Guangdong, outsourcing service vendors in other regions on the mainland have less knowledge of the roles and functions of Hong Kong as a global trade and logistics centre, MNCs' most preferred regional headquarters and management hub of BPO/ITO. Also, the conditions, strengths, experiences and directions of these regions in developing outsourcing services are different from those of their counterparts in Guangdong. Therefore, the Hong Kong-Guangdong cooperation model does not necessarily apply to other mainland regions, thereby providing greater leeway or flexibility for effective cooperation between Hong Kong and the rest of the mainland. In addition to outsourcing and sub-contracting, other forms of collaboration such as strategic partnership and captive investment through merger and acquisition can also be explored. Overall, establishing industry associations at the provincial or national level is conducive to strengthening cooperation between mainland vendors and their Hong Kong counterparts. Regarding outsourcing cooperation, the mainland and Hong Kong can focus on selected areas where their partnership is most advantaged, e.g. financial, retail, telecom, logistics, and supply chain management services. As the only international financial centre of the mainland, Hong Kong is particularly strong in offering outsourcing solutions relating to financial services. Many Hong Kong vendors, be they Hong Kong-based MNCs or SMEs, have accumulated ample experiences in handling complex outsourcing projects relating to financial services.

The implementation of the Mainland and Hong Kong Closer Economic Partnership Arrangement (CEPA) has not only provided Hong Kong BPO/ITO service suppliers with an opportunity to tap into the growing mainland outsourcing market, but has also given an impetus to closer cooperation between the outsourcing players in Hong Kong and the mainland. However, cooperation between both sides is not without hurdles. While Hong Kong IT services companies that have obtained the mainland's Computer Information System Integration Qualification Certification can undertake technical projects on the mainland and handle the overall planning, design, development, implementation, maintenance and repairs of computer application system and network system projects, these companies still find themselves subject to the restrictions of a host of related rules and regulations after entering the mainland market. Although under CEPA Hong Kong professionals can sit the mainland's National Computer and Software Technology Qualifications Examination and may, upon passing the examination, render system integration-related services, in reality it is not easy for them to pass the examination and obtain the qualification to practise on the mainland. Undoubtedly, CEPA plays a very significant role in facilitating Hong Kong companies to enter the mainland. As such, fine-tuning the implementation rules of CEPA, optimising supporting policies, and accelerating mutual recognition of professional qualifications between the mainland and Hong Kong will greatly help strengthen cooperation between the outsourcing companies in both places.

In short, through teaming up with mainland outsourcing service vendors, Hong Kong players can expand their operation scale and put themselves in a better position in winning international outsourcing contracts. On the part of mainland vendors, with Hong Kong vendors as their partners, they can acquire more business knowledge and experiences in international projects. This, coupled with the mainland's sustained supply of human resources (an advantage over India), will enhance the competitiveness of mainland outsourcing service providers in the global market. Looking to the future, the positioning of Hong Kong in the mainland outsourcing service sector includes: to act as an interface between the back offices on the mainland and the offshore clients; a quality assurance centre for clients and software factories; a contracting centre and outsourcing contract management centre for offshore outsourcing clients and service contractors; a training centre providing mainland talent with training in business, language, information technology, project management and solutions delivery related to outsourcing services; an effective business platform for mainland enterprises ready to undertake international services outsourcing projects (by making good use of Hong Kong's financing platform to raise funds, enhancing international profile, and building brand image); and a platform for mainland outsourcing service vendors to participate in exhibitions and trade promotion activities abroad.