What will it take for China to become a competitive force in offshore

53Analysis of the role of transaction costs in supplier selectionJournal of Information Technology (2003) 18, 53–67

Journal of Information TechnologyISSN 0268-3962 print/ISSN 1466-4437 online © 2003 The Association for Information Technology Trust

http://www.tandf.co.uk/journalsDOI: 10.1080/0268396031000077459

What will it take for China to become a competitiveforce in offshore outsourcing? An analysis of therole of transaction costs in supplier selectionZHONGHUA QU and MICHAEL BROCKLEHURSTThe Business School, Imperial College, London, South Kensington Campus, London SW7 2AZ, UK

Using transaction costs theory this paper argues that transaction costs are almost as significant as produc-tion costs when it comes to offshore outsourcing and, moreover, that it is in the field of transaction costswhere China has been unable to compete with India in the supply of information technology outsourcing.The paper outlines a framework for analysing transaction costs and uses the framework for pinpointingwhere China is unable to compete. The paper concludes with a review of the policy implications for theChinese Government.

achieved an annual growth rate as high as 62.3% for thelast 5 years. Total exports of $7.78 billion were achievedin 2001 and are expected to reach $23 billion in 2005and $50 billion in 2008 (www.nasscom.org).

The immediate question is why it should be India thathas the lion’s share of this market and not China. Afterall, in the last decade China has been hugely successfulin attracting offshore manufacturing. However, the storyis different in the IT offshore outsourcing market. In2001, Chinese export revenue in software and IT-enabledservices was only $720 million, less than one-tenth ofIndia’s (www.nasscom.org). One of the most importantfactors in the growth of offshore outsourcing in manufac-turing was the global market channel built up bycompanies and individuals from Hong Kong and Taiwan,particularly in the early stages. However, Hong Kongand Taiwan have no experience in the softwareoutsourcing market and so cannot help in this respect.

This is of concern to the Chinese Government. Incommon with other developing countries such as Malaysia(Tidd and Brocklehurst, 1999), the Chinese Governmentwants to try to move away from labour-intensive and lowvalue-added manufacturing to more highly value-addedservices which the offshore IT market provides. This willbecome essential as Chinese living standards rise and itceases to be competitive as a source of cheap manufac-turing labour. Moreover, there is a window of opportunitybased on three factors. First, it is unlikely that India willbe able to produce the qualified manpower requiredto meet burgeoning world demand sufficiently. Indiacurrently has approximately 445 000 IT workers and thisis expected to grow to 625 000 by 2005. However, thedemand for offshore IT workers will reach more than

Introduction

Information technology outsourcing is said to have origi-nated with the Kodak–IBM outsourcing agreement of1989 (Loh and Venkatraman, 1992). Yet the form andrange of IT outsourcing have undergone two key trans-formations since that date. First, it has expanded beyondjust the outsourcing of IT to encompass entire businessprocesses, which are underpinned or enabled by IT.Such business process outsourcing, such as customerinteraction centres, have grown rapidly, but the claim isthat the growth will accelerate. Thus, the Gartner groupestimate that the market grew from $100 billion in 1999to $150 billion in 2001. However, this is predicted toreach $300 billion by 2004 (Bravard, 2002). The secondtransformation is the spread from onshore to offshoreoutsourcing. This trend to offshore outsourcing is largelyserendipitous. The enormous amount of reprogrammingrequired by 2000 meant that domestic suppliers couldnot meet the demand and firms in the USA and Europehad to take a chance on overseas suppliers in spite ofconcerns about quality. However, most of these concernsproved groundless and offshore outsourcing began tomushroom.

The split between onshore and offshore outsourcing isdifficult to determine with any degree of precision.However, companies in the USA will spend more than$17.6 billion on offshore outsourcing in 2005, triplingfrom $5.5 billion in 2000 (Prencipe, 2001). Anotherapproach is to look at it from the supply side. India isknown to be the principal offshore vendor of IT services,claiming at least 80% of the world’s business. The Indiasoftware and IT-enabled services export industry has

54 Qu and Brocklehurst

1 million by 2005, as compared with 360 000 in 2001(Greenemeier, 2001). Second, putting all of youroffshore outsourcing in one country is too risky: buyersprefer to outsource to different countries in order tospread the risk. Third, military tension between Indiaand Pakistan is creating uncertainty.

This paper is organized as follows. In the next sectionthe nature of the Chinese Software Industry and currentChinese Government policy for trying to compete withIndia will be briefly outlined. The third section critiquestransaction costs theory and examines why it is of valuein this context. In the fourth section transaction costs areused for comparing production costs with transactioncosts. The fifth section develops a simple framework forenabling transaction costs for two national industries tobe compared. In the sixth section the paper turns tocomparing China and India in terms of transaction costsand the final section sets out a policy agenda for theChinese Government.

Chinese Government policy and the Chinesesoftware industry

According to the China Software Industry Association(2002), China has 5700 software companies of which70% employ less than 50 employees each and a further20% employ only 100–500 employees. Only 50 companieshave more than 1000 employees. As for revenue, most ofthese earn less than $10 million and only 18 companiesmake above $50 million. International software companiesdominate most of the China software product markets.Domestic suppliers only manage to dominate accountingapplications, anti-virus tools, Chinese platform andsolutions for some industries. In total, 250 000 profes-sionals work in the software industry. In 2001, the entiresoftware and services market was $9.6 billion, composedof $4 billion software products, $4.9 billion services andonly $700 million exports.

Chinese Government policy is detailed in its documentPolicies on Encouraging the Development of Software andIntegrated Circuit Industries, which was issued by theState Council in June 2000 (www.mii.gov.cn). Some ofthe policy initiatives that have been so successful in therealm of manufacturing have been applied to the softwareindustry. Preferential taxation and special zoningarrangements, including high-tech parks to attractdomestic and foreign investors, have sprung up. Manyregional and local government organizations have echoedthese national initiatives by providing further subsidiessuch as corporation and individual income tax deductions,low interest loans, 3 years rent-free offices in softwarescience parks and investment in the education of ITlabour. However the Chinese Government believes thereare three problems that currently hamper the software

industry and it has devised three key policy initiatives foraddressing each in turn.

First is the shortage of qualified labour. Here theresponse has been to go for expansion in education andtraining. The Chinese higher education sector hasachieved considerable growth in the last 3 years but thegrowth will accelerate dramatically. Graduates willincrease from 1.08 million in 2002 to 3.767 million in2004 (www.moe.edu.cn). There is also an expansion inIT training: recently, Microsoft, IBM and some IndianIT training firms have invested heavily in IT. Thus, thesupply of new IT professionals should cease to be anissue after 2004.

Second is the perception that China is way behindIndia in terms of quality when it comes to IT supply.China may be able to compete with India in terms ofcost, but it lags well behind India (and other high-costsuppliers such as Ireland, Singapore and Israel) when itcomes to quality (Amoribieta et al., 2001). A majorindicator of quality is whether or not a supplier hasquality certification. The government believes that thisproblem will be partly addressed by its education andtraining measures, but its major initiative is to encouragefirms to seek quality certification by means of an incentiverefunding plan. The Capability Maturity Model(CMM), a worldwide certification developed by theSoftware Engineering Institute of Carnegie MellonUniversity, is becoming the industry standard in theoffshore outsourcing market. Generally, buyers only dealwith suppliers that have a level 3 or higher CMMcertification. Compared with India, China lags farbehind on CMM certification. At June 2002, only sixChinese software companies had CMM level 3 or abovecertification and these awards were all recent. The onlylevel 5 company is the Motorola China R&D centre,which focuses exclusively on internal business anyway.Huawei Technology, a telecom equipment manufacturerand a level 4 company, actually outsources to Indiansuppliers. Thus, there are only four Chinese companiesthat have much chance of getting onto the shortlist of aprospective client. Compare this to India where 45companies have level 5, a further 28 level 4, and 16more have level 3 certification (www.sei.cmu.edu, www.nasscom.org and www.sina.com).

Third is the fragmented nature of the Chinese softwareindustry noted above. According to Orbys Consulting,the average contract size of an offshore outsourcingis $7.2 million and the average contract duration is3.3 years, which works out at $2.18 million per year(ComputerWire, 2001a). However, the average revenueof a Chinese software company is less than $600 000(China Software Industry Association, 2002). Moreover,seeking CMM certification is an expensive undertakingfor smaller vendors. It would appear that the fragmentednature of the Chinese software industry is a severe

55Analysis of the role of transaction costs in supplier selection

impediment. The government response is to encouragethe formation of ‘software export clusters’ trying to over-come the firm-size barriers in the offshore outsourcingmarket.

In order to assess the merits of this strategy requiresdetermining why outsourcing occurs in the first place. Itis argued in the next section that transaction costs theoryprovides a useful framework for answering this question,particularly in relation to offshore outsourcing.

Transaction costs theory: a critique

Hui and Beath (2002) provided a useful summary showingthe various theoretical perspectives that have beenapplied to outsourcing. They noted that, although theearly theory-based literature drew heavily on transactioncosts theory, recently there has been much more interestin applying a resource-based view or social exchangetheory to understanding outsourcing decisions andoutcomes. However, as Hui and Beath (2002) observe,much of the literature has focused on the buyers side andbeen applied at the level of the individual firm. The focusin this paper is much more at the national level andconcerned with the implications for the seller. To thisend the authors wish to reclaim transaction costs theory,as they believe it still has much to offer although theyrecognize its limitations.

Transaction cost theory, which was pioneered byCoase (1937) and developed principally by Williamson(1975, 1985a), is based on the assumption that humanbeings are utility maximizers and firms are profitmaximizers. In pursuit of these objectives, agents areboundedly rational and sometimes display opportunisticbehaviour. The paradigmatic question of transactioncosts theory is the ‘make-or-buy’ decision: should a firmcarry out an economic activity in-house or should it beoutsourced? Williamson (1985b) referred to these asmodes of governance–organizational hierarchy and themarket respectively. In making this decision firmsbalance the savings made in production costs (because asupplier can provide the goods/services more cheaply)against the transaction costs that result from outsourcing.These costs include operational costs (e.g. search costs)and contractual costs (e.g. the costs of writing, monitoringand enforcing a contract) (Gurbaxani and Whang,1991). If the savings in production costs exceed thetransaction costs then it is worth outsourcing and viceversa. A basic knowledge of transaction costs theory isassumed, as excellent guides are readily available (e.g.Douma and Schreuder, 2002).

One of the key criticisms of transaction costs theory isthat it is too stark: make or buy – organizational hierarchyor the market. However, there are intermediate governancestructures. Firms often establish long-term relationships,

which are neither one-off nor pure market in form (spotcontracting), nor do they involve purely internal hierar-chies: there are forms of long-term relationship whichoutlive the one-off buy/sell. (As noted above, the averagelength of an offshore IT outsourcing contract is 3.3 years(ComputerWire, 2001a).) Ouchi’s (1980) work on clansand, more recently, the literature on network organizations(Thompson et al., 1991) and communities of practice(Wenger, 1998) have demonstrated how nuanced therelationship between buyers and sellers can be. IndeedWilliamson (1989) himself rehearsed some of theseforms with his category of ‘relational contracting’.

A second line of attack is that almost all of the literatureon transaction costs theory relates to manufacturingrather than services and that services may be quite different.Wang’s (2002) work is one of the few exceptions (seealso Murray and Kotabe, 1999). He applied transactioncosts theory specifically to customized software asapplied to IT in the following way.

(1) Asset specificity: this refers to ‘the degree towhich an asset can be redeployed to alternativeuses and by alternative users without sacrifice ofproductive value’ (Williamson, 1989, p. 142).

Functional/Information requirements.Operating procedures.Business domain knowledge required.Training for the developers.Technical skills required.

(2) Uncertainty.Requirements specification.Delivery dates.Costs.

(3) Opportunism.The contractor ‘reinterprets’ the contract.The contractor fails to deliver on things thatare expected by the buyer, but are not in thecontract.

Using this classification his results show that ‘contractorreputation and uncertainty have the predicted effects onthe contractor’s post-contractual opportunism perceivedby the client and outsourcing success, but assetspecificity has a negative effect on post-contractualopportunism and a positive effect on the outsourcingsuccess, which are opposite to the typical predictions ofTCT’ (Wang, 2002, p. 153).

However, from this study’s perspective the mostvaluable feature of transaction costs theory is that itfocuses on the comparison between production costs andtransaction costs. To recap, if a supplier can producesomething for a buyer for less than the buyer can produceit and the difference is greater than all the costs inmanaging the transaction, then it is worth the buyeroutsourcing. However, what is the relative importance ofproduction and transaction costs in outsourcing IT?

(i)(ii)(iii)(iv)(v)

(i)(ii)(iii)

(i)(ii)


Ang and Straub (1998) made the first attempt tocompare the relative effects of production and transactioncosts on onshore outsourcing decisions in the IT context.Their study shows that information systems outsourcingin USA banks was strongly influenced by the productioncost advantages offered by vendors. Transaction costsplayed an important role in the outsourcing decision,although they were much smaller than the productioncosts. According to their model, the coefficient forproduction cost advantage is approximately six timeslarger than that of transaction costs. This suggests thatthe effect of production costs on the decision whether tooutsource or not is far greater than that of transactioncosts, even though both are significant. However, theirquestionnaire simply asked their respondents to statewhether production costs were more (or less) significantthan transaction costs. It gives only a qualitative feel forwhich is the more important. Nevertheless, the stronginference is that, when it comes to onshore outsourcing,transaction costs are relatively trivial in comparison toproduction costs.

However, this paper wishes to argue that, when itcomes to offshore outsourcing, the relative significancesof production and transaction costs are markedly different.Indeed, transaction costs are much more significant andproduction costs less so. Intuitively one would expecttransaction costs to be higher when a buyer and seller arebased in different countries. However, one would alsoexpect production costs to be much greater as that is theprincipal reason for buyers going offshore in the firstplace, namely to take advantage of wide differences inlabour costs.

In order to make the point, in the next section a simpleanalytic model for transaction costs theory is set up,which allows direct comparison between production andtransaction costs. Published data are then used forproviding some approximate weights to the two elements.

Using transaction cost theory for comparingproduction and transaction costs

Recall that firms outsource a job only if the advantagegained by lower production costs is bigger than the trans-action costs. This rule can be expressed as follows:

where Pin is the in-house production costs, Pout is theoutsourcing production costs, Tout is the transactioncosts of outsourcing and ∆ is the net gain of outsourcing.Firms will outsource only if ∆ ≥ 0.

The transaction costs of outsourcing can be analysedquantitatively, at the limit. First, transaction costs cannotbe lower than zero, but could be zero if firms madeno effort regarding the transaction. Second, since the

outsourcing production costs cannot be lower than zero,the maximum transaction costs of outsourcing cannot behigher than the in-house production costs, otherwisefirms would not outsource anything. Thus,

Equation (2) has defined the widest range of transactioncosts. It is arguable that, in a specific case, the transactioncosts might be above the production cost gain or evenhigher than the in-house production costs and theoutsourcer would therefore lose money. Although this ispossible in theory, it is unsustainable because firmswould cancel this kind of outsourcing contract as soon aspossible once they realized the loss involved.

Both in-house and outsourcing production costsshould be quantitatively measurable ex ante or ex post(that is before or after the deal is made) with thedata from historical transactions, internal budgeting,outsourcing contracts and the actual accounting records.Empirically, in each specific outsourcing case the trans-action costs could be quantitatively measured ex post.There are two ways of doing this. One is activity-basedcosting, which totals up the costs of all related activities.The other is to find the difference in the firm’s profitbefore and after outsourcing, assuming nothing haschanged except outsourcing and then compare this profitgap with the production cost gain. The difference isthe transaction costs. This method can be expressed asfollows:

where ∆profit is the profit after outsourcing minus theprofit before outsourcing.

It is more difficult to measure transaction costs ex antefor outsourcing clients. However, it is at least possible toestimatè their maximum transaction costs, which is theproduction cost gain from outsourcing: Pin – Pout. It isnot difficult to get the in-house production costs ex ante.As the IT outsourcing market is relatively mature andmany suppliers compete in it, it is easy to estimate themean outsourcing production costs as well. Now, byknowing the maximum gain (∆ = Pin – Pout whenTout = 0) and the maximum payment (Tout = Pin – Pout,when ∆ = 0), complex outsourcing decisions could besimplified by finding an acceptable balance between thebenefits and risks. The transaction costs will then bedependent on how much risk the firm is willing to take.The lower the risk the firm takes, the higher the trans-action costs the firm has to pay. (See Jurison’s (1995)model based on transaction costs theory and the capitalasset pricing model.)

The next step is to try and estimate the relative impor-tance of production costs and transaction costs and herethe paper turns to published sources of data.

T P Pout in out profit= −( ) − ∆ (4)

(2)

(3)

P T

P P Tin out

in out out

≥ ≥− ≥ ≥

0

0

(1)∆ = −( ) − × × ≥Pin out out in out out, ,P T P P T 0


Amoribieta et al. (2001) attempted a comparison ofonshore and offshore software development costs, whichis reproduced in Figure 1.

The production costs of onshore in-house developmentin the USA are expressed as 100 in Figure 1. The pro-duction costs of offshore outsourcing are expressed as 25.

Therefore the savings on production costs should be75. However, other research shows that the actual averagecost saving for US customers is approximately 25(Greenemeier, 2001). This leaves a gap of 50. Thetemptation is to say that these must all be transactioncosts. However, the figure of 50 will now be inspectedmore closely.

Almost all outsourcing contracts involve a proportionof the suppliers working at the client’s base (e.g. in theUSA). If just Indian workers are considered (recall thatIndian companies have 80% of the market), then Table 1shows the breakdown of Indian IT and service exportrevenues on-site (in the USA) and offshore (in India).The relative proportion of on-site to offshore fluctuates,but the most recent figure puts it at almost 50:50.

Let it be assumed for the moment that all Indianon-site workers are paid at the same rate as their UScolleagues. Now returning to the breakdown in costs inFigure 1, then for those Indians who work on-site in theUSA, labour costs will be 50 and additional statutorycosts (taxes and insurance) will be 15, which gives afigure of 65 for those Indians working in the USA.

However, Figure 1 shows that, for those Indians work-ing in India, the labour costs are 7 and the statutory costsare 3, which gives a total of 10 for those Indians workingin India.

Using the 50:50 split derived from Table 1 this meansthat the labour costs are on average 65 + 10 divided by2, which gives a figure of 37.5 for the offshore labourcosts as a whole. From Figure 1 the offshore mark-up(8) and the travel and other expenses (7) need to beadded in, which gives a total of 52.5. Therefore theproduction costs of offshore outsourcing are not 25 but52.5 and the gap is reduced from 50 to 22.5.

This would put transaction costs at 22.5.However, it is known that the assumption that Indian

on-site workers will be paid the same as their US coun-terparts is unrealistic. They are likely to be paid less(although not as little as their fellow offshore workersworking back in India). How much less will vary accordingto the types of work permit held (H-1B or B1), humanresource and pay policies of different US firms, etc.Table 2 shows some of the differences, but does notenable a mean figure for the differentials in wages to bespecified. All that can be said is that the transaction costsare likely to lie somewhere between 22.5 and 50. If afigure midway between these two is taken it will give afigure of 36.25 for the transaction costs.

It is known from Table 1 that, if there were notransaction costs, the difference in production costs

Figure 1 Normalized cost structure of software development. Source: McKinsey (Amoribieta et al., 2001)


would be 75 between in-house development and pureoffshore development. However, if the transaction costsare 36.25 then the real difference in productioncosts, which takes account of the realities of offshoreoutsourcing (partly at the client’s base), is 75 less 36.25,which gives a figure of 38.75. This means the increasein the transaction costs for offshore outsourcing is 36.25while the saving in production costs is 61.25.

This can be approached another way. Let the cost ofin-house production be stated as 100. According toAmoribieta et al. (2001), labour accounts for more than75% of the costs of developing software. Thus, labourcosts in-house can be expressed as 75 and other costs as25. However, it is also known that the offshore labourcost is approximately one-fifth of that of the onshorelabour cost (Heeks, 1996). This means that the offshorelabour costs can be expressed as 20% of 75, which givesa figure of 15. Add in non-labour costs (which it will beassumed are the same as for those in-house, i.e. 25) and

then the total cost of offshore production is 40, a savingin production costs of 60. This has been confirmed fromother sources: ‘there are currently hundreds of companiesin India offering these services to companies in the USand Europe for as little as 40% of the cost of going toa local system integrator or software VAR’ (ComputerWire,2001b, p. 10).

However, according to Forrest Research the meangain from offshore outsourcing is only 25% (Greenemeier,2001), not 60 as might be expected Therefore, a 35%gap that represents the increase in transaction costs forgoing offshore is found. This is close to the figure of36.25 derived from the first estimate. This paper doesnot pretend that these figures are precise and they dependon making a number of assumptions, but it can be arguedthat these assumptions are not unrealistic.

To conclude, unlike onshore outsourcing where thetransaction costs appear trivial in comparison to theproduction costs, in offshore outsourcing the transactioncosts are almost as significant as the production costs.Production costs savings appear to explain why firmsoutsource onshore in the first place (Ang and Straub,1998). They explain why a firm will decide to outsourceoffshore (the salary of an Indian programmer is approxi-mately one-fifth that of their US counterpart (Heeks,1996)). However, they do not explain why a buyer willselect one low-cost country rather than another. Forexample, an Indian company might demand $8.5 perhour and a Chinese company $7.5 per hour. There is a15% difference from the supplier’s point of view. However,from the customer’s point of view, where the labour costsonly represent approximately 10–15% of overall offshore

Table 1 The on-site and offshore revenues (Rs crore) ofIndia’s IT and services exports

1999–2000 Feb. 2000 2001–2002 est.

In 2001 US$1 million = 4.725 Indian Rs crore.Source: www.nasscom.org.

On-siteOffshoreProducts and

unclassifiedTotal

985059501350

17 150

15 90010 950

1500

28 350

17 50018 000

1500

37 000

a: India is used as the offshore country in this table; b: Hourly charge for ERP contracts (e.g. SAP, PeopleSoft, BAAN, etc.) can add100–200% to this charge. Porting and maintenance are at the low end, custom Internet, client/server contracts at the medium to highend; c: Administrative, financial, training, building, utilities and management overhead; d: B1 contractors typically have an offshoreallowance of about 20% of their hourly charge added to their overhead; e: Offshore includes additional overhead expenses for equipment,office space and supplies and management, which are covered by the client in the on-site options; f: Per diem includes lodging, board,local travel, insurance and visa-related expenses for B1 contractor near client site; g: Assumes three one-week trips to offshore location byone company employee per year. Per trip costs estimated between $2400 and $4800; h: Assumes $.70 per minute. Note that many firmsare using voice over Internet products, such as Net Meeting and Speak Freely to cut these costs.Source: Heeks (1996).

Table 2 Monthly personnel costs ($) of software development according to employee status

Cost element Domestic/H-1Bcontractor/Outsource

B1 contractor on-site Offshorea

Low Medium HighLow Medium HighLow MediumHigh

950

560032

N/A

1200600

Per contractor monthly costsWagesb

Overhead and profitc

Total man hour chargesHourly rate (175 h/month)Per diemf

Per project monthly costsTravel expenses to offshore siteg

Telephone status callsh

350035007000

40N/A

N/AN/A

460046009200

53N/A

N/AN/A

58005800

11 60066

N/A

N/AN/A

450

315018

1000

N/AN/A

700

490028

1500

N/AN/A

950

612535

2000

N/AN/A

350

262515

N/A

600200

700

437525

N/A

900400

2700d 4200d 5175d 2275e 3675e 4650e


outsourcing costs, the difference is only 1.5–2%. At thislow level of production cost difference the difference intransaction costs becomes much more important.

An immediate implication is that governments andtheir firms in countries such as China should be lessconcerned with holding down production costs by keepingwages low and more concerned with minimizing thetransaction costs which potential buyers and sellers mayincur.

The next section develops a framework that willenable China and India to be compared in terms ofpotential transaction costs.

Developing a framework for comparingtransaction costs

The first step is to classify the various factors buyersconsider when choosing a vendor. There are manydifferent versions (e.g. Terdiman, 2002). The mostsignificant factors are discussed below.

(1) Production costs differentials. These have beendiscussed above where it was noted that, whereone low-cost country is competing with another(e.g. China versus India), then these are likely tobe trivial.

(2) Language barriers. Where these are low, com-munication costs fall and there is less misunder-standing, which leads to lower uncertainty.

(3) Government support. Incentives reduce produc-tion costs and attract more investment into thesector. High-level commitment by governmentmay reduce the opportunistic behaviour of vendors.

(4) A plentiful IT professional pool and educationsystem. This guarantees the availability of humanresources, which reduces the uncertainty andavoids increases in production costs due to labourshortages.

(5) Quality. This is the basic requirement of a productor service and reduces monitoring costs.

(6) Culture fit. People prefer to work with thosewho come from the same culture for a reassuringatmosphere. It is a transaction costs barrier forothers. It is easier to communicate, understandand monitor and thus reduces contractualcosts. There is more chance of building a trustrelationship and this reduces the probability ofopportunism.

(7) Political stability. This means lower uncertainty.(8) Financial robustness. If it is unlikely or costly for

suppliers to declare bankruptcy this will preventthem appropriating the quasi-rent. Customers canavoid the shifting costs of finding new vendors aswell. Therefore, transaction costs are reduced.

(9) Process and methodology (CMM). By means ofstandardizing processes and third party monitoring,the uncertainty/complexity is reduced.

(10) Supplier reputation. Giving consideration toreputation in source selection can reduceopportunism by sellers, thereby reducing theuncertainty and thus the transaction costs forbuyers. On the supplier side, reputation buildingis an investment in some kind of asset specificitythat will increase their transaction costs. Althoughreputation has a high and durable value if thesupplier maintains it appropriately, it is alsoeasily lost if the supplier makes a mistake.

(11) On-site presentation. This could reduce thetransaction costs for buyers. However, it increasessellers’ transaction costs by higher site specificity(one kind of asset specificity).

(12) Expertise. Hardware/Software: a Windows–Intelplatform, as well as common developing tools andskills, produces lower asset specificity for suppliers.Equipment such as mainframes could be providedby clients or accessed through the Internet,thereby reducing asset specificity for suppliersas well. However, some special skills or businessknowledge required by a customer may only beuseful for that specific customer. This willincrease asset specificity on the supplier side.

(13) Commitment of outsourcing. This increases assetspecificity.

(14) Experience/Heritage. This increases human capitalspecificity for the supplier side.

(15) Proven offshore methodology. This reducesuncertainty for the client side but increases assetspecificity for the supplier side.

The above analysis indicates that, except for somefundamental requirements such as delivery capacity,quality and infrastructure, most of the selected criteriarelate to transaction costs. There are two inferences.First, clients mainly focus on reducing their transactioncosts, which, given the choice to go offshore in the firstplace, is the main theoretical principle underlying thecriteria for selecting offshore outsourcing suppliers.Second, clients tend to choose suppliers that have anasset specificity that is higher for offshore outsourcing orfor a specific customer. Both buyers and sellers willbenefit from understanding this principle. By goingthrough the activities linked with market transactioncosts buyers could have an overall view of how to chooseoffshore suppliers and then find an optimal balance ofcriteria rather than use each criterion separately. Bysimplifying the complex customer criteria into onefundamental issue, namely reducing transaction costs fortheir clients, sellers could focus their efforts on this keyconsideration. The concern in this paper is with sellers.


The second step is to examine the nature of thesetransaction costs. There are two important factors to bearin mind.

First, from the perspective of the transaction participants,transaction costs exist on both the buyer and seller sides.For example, both buyers and sellers need to pay thecosts for negotiating and writing contracts. For a one-offmarket transaction it may be true that it is only the buyerthat needs to worry about opportunism. However, for aset of transactions bound in an outsourcing contract of 3years, which is termed relational contracting in transac-tion costs theory, both the buyer and seller need to worryabout opportunism.

Second, from the perspective of cost management,transaction costs can be divided into three types.

(1) Type 1 costs, which are termed compulsory costs,are those costs that both buyers and sellers haveto pay, for example communication labour costsfor both sides, decision costs for buyers andspecial skills/knowledge-building costs for sellers(asset specificity).

(2) Type 2 costs, which are termed complementarycosts, are those costs that one side pays and theother side saves, for example searching costs: ifa seller pays for marketing and informationpublishing costs, its buyers will save their searchcosts. Although both the seller and buyer couldinvest in this, the returns are asymmetric. Theinvestment paid by clients has little scrap value forthem after they change the supplier or at the endof the contract. On the other hand, the investmentpaid by suppliers may accumulate value forthem after the end of contracts, due to enhancedreputation and awareness.

(3) Type 3 costs, which are termed win–win or lose–lose costs, are those costs that both buyers andsellers would either save or pay, for examplenegotiating and monitoring costs. If buyers andsellers trust each other both sides will save money

and, the deeper they trust each other, the morethey can save. This is the win–win case. On theother hand, if buyers and sellers suspect eachother both sides have to pay more for negotiatingand monitoring and, the more suspicious of eachother they are, the more they have to pay for this.Table 3 gives some sample items of transactioncosts using this three-fold classification.

This section has examined the various factors involvedin buyer selection of an offshore supplier and found thatthey are almost entirely related to transaction costs. Thesection then classified how these costs may differ:compulsory, complementary and win–win. The study isnow in a position to compare China and India in termsof transaction costs.

Comparing China with India

Table 4 has been compiled from a range of sources andshows how China compares with India in terms ofcompetitive advantage as offshore suppliers of IToutsourcing.

At first sight China appears to compare very favour-ably. China comes out very close to or ahead on 27 ofthe 32 factors. The five where it compares unfavourablyare highlighted and they can be reduced to two: educationand training and the legal framework for informationand communications technology (ICT) development. Ithas already been noted that education and training arebeing addressed as a top priority. What then of thelegal framework?

This involves two aspects: legal contracts and intellectualproperty rights. Legal contracts matter because, if theaverage contract length is over 3 years, then relationalcontracting is the fundamental instrument of offshoreoutsourcing and such contracting is inevitably based onthe buyer country’s, seller country’s and internationallegal systems. Both buyers and sellers try to make the

Table 3 Framework of the transaction costs involved in offshore outsourcing

Type of cost Outsourcer side Vendor side

Compulsory

Complementary

Win–Win or lose–lose

Decision processIntegration and re-engineeringContract writingCommunication–Information searchingCommunicationTransportationSuspectingMonitoringContractingRegulation

Proving its delivery capacityProving its delivery qualityContract writingCommunicationReputation buildingMarketing/AwarenessOn-site presenceTransportationProvingResponding to monitoringContractingGovernment support


deal as clear as possible by means of the outsourcingcontract. They seek to minimize uncertainty and, thus,reduce transaction costs. If a buyer has anxieties aboutthe legal system of the country of a seller then this makesit very difficult to set up a contract. For historical reasonsIndia’s legal system fits better with the Western world,where outsourcing clients come from, than does China’slegal system. There is also much concern in the Westabout intellectual property rights protection in China.This also raises transaction costs because buyers need tospend more effort in contract writing and intellectual

property rights management. However, the situation isimproving. The Chinese Government’s assignment of an$800 million procurement contract with Microsoft is amilestone in this respect. Furthermore, the challenge ofimproving the legal framework is being addressed. Since itsentry into the World Trade Organization in 2001 China hasbeen adapting its legal system to fit in with the internationalbusiness community; but there is a long way to go.

What other factors, which are not disclosed in Table4, might put China at a disadvantage in terms oftransaction costs?

Table 4 Comparison between China and India

China India

Key factsPopulation (million)Gross domestic product (US$ billion)Gross domestic product per capita at purchasing power par value (US$)Growth in real gross domestic product

Country competitiveness index ranking for 2001 (the higher the better)Overall growth competitivenessOverall current competitivenessMacroeconomic environmentInnovation capacityCountry credit ratingIT training and educationSpeed and cost of Internet accessQuality of competition in telecommunication sectorLegal framework for ICT developmentOverall infrastructure qualityIntellectual property protectionAvailability of scientists and engineers

Country business cost comparisons (Economist Intelligence Unit score) (the lower the better)Labour costsExpatriate costsInternational travel costsCorporation tax (%)Office rents (US$/m2/year)Cost of telephone callsRoad transport costsOverall score

International investment and tradingForeign investment 1996–2000 (US$ billion/year)Exports 2001 (US$ billion)Imports 2001 (US$ billion)

EducationStudents in university (1000s) 2001Graduated (1000s) 2001Graduated in computer science (1000s) 2001

ICTPersonal computers per 100 inhabitantsInternet users per 10 000 inhabitantsInternet hosts per 10 000 inhabitantsMain telephone lines per 100 inhabitantsCellular mobile subscribers per 100 inhabitants

Sources: www.un.org, www.cia.gov, www.moe.edu.cn, www.education.nic.in, www.stats.gov.cn, The Global Competitiveness Report 2001–2002 (Porter et al., 2002) and Worldwide business cost comparisons (Economist Intelligence Unit, 2001).

12731079.84

39537.1

3947

6433463585846616059

8.758.628.5

33260

26.520.5

7.7

41.2266.7243.6

75621020

62

1.6173.7

0.611.1

6.6

1029474.19

24034.7

5736453842

95441256658

4

11

36.535.7708

25.625.2

8.7

2.743.13361.015

80002000

110

0.549.4

0.43.20.4


One obvious factor lies in language and culture. Thelanguage barrier and culture fit are two of the mostserious obstacles preventing China from entering theoffshore outsourcing supplier market (Liu, 2002). Onthe other hand, language is an immense advantage forIndia. English is the official language in business andeducation in India and that is perfect for the US and UKmarkets. But what about the Japanese market? Incomparison with India, China ought to be more compatibleculturally and linguistically with the Japanese marketand, in addition, has a geographical advantage. However,it appears this is still not enough. India provided $300million worth of offshore services to Japan in 2001,which was 4% of its total revenue. At the same timeChina made approximately the same from Japan(approximately $300 million), but that represented 42%of its total revenues (China Software Industry Association,2002). Even though China has substantial advantages inculture, language and geography, it seems it still cannotbeat India in the Japanese market. This tells us twothings. First, culture fit and language barriers are indeedvery important for offshore outsourcing. Because of theseadvantages alone China has at least managed to competewith India on an equal footing in the Japanese market,even though they are not in the same league in terms ofthe global offshore outsourcing market. Second, there

must be some other drawback hindering China’sperformance, otherwise China would dominate theJapanese offshore outsourcing market in the same waythat India dominates the US and European market.

What Table 4 does not show and what is crucial is thestructure of the industry. One of the main alleged weak-nesses prevailing in China’s software industry is that thesize of most software companies is too small to winoffshore contracts, as noted above. Recall also that thelow rate of CMM certification remains an issue and thatthese two factors are linked in the eyes of the ChineseGovernment.

However, a comparison between the top 20 Chineseand Indian software companies suggests that this viewmay be mistaken. Tables 5 and 6 indicate that, in sizeterms, the top 20 Chinese and Indian software companiesare very similar. In addition, 18 of the top 20 Chinesesoftware companies are listed on the Chinese stockmarket, which guarantees them access to plentifulcapital. So, at an industry level, it cannot be said thatChina’s software companies are too small to deal withoffshore outsourcers. The top 20 companies in Chinacontribute 37% of China’s software and service revenues,whereas the top 20 in India contribute 35%.

However, the software exports data in Table 7 demandattention. India’s top 20 software export companies

Table 5 Comparison of software/service revenue between China and India’s top 20 software companies

Sources: www.nasscom.org, www.ccidnet.com and the Chinese Software Industry Association.

Huawei TechnologyZhongxin CommunicationPutain Eastern GroupDigital ChinaFounder GroupEusoft GroupCSS GroupDatang CommunicationLangchao GroupTsinghua TongfangYantai Eastern Electronics GroupZhongchuang Software LtdUfsoftUT Starcom CommunicationBodao LtdTianjin NECCGW GroupXiangji Software LtdTop GroupBeida Bird LtdMeanSubtotalPercentage of country revenueCountry total

729.52457.27293.75280.34187.97171.68160.57154.99151.45130.47113.57111.11102.88101.81

79.2770.2669.9461.9460.4754.89

177.213544.00

37.009614.00

661.29413.69390.17268.57267.07175.12148.25143.70137.35135.24120.94109.15

97.7992.4392.2171.9471.6170.3164.8859.62

179.573591.00

35.0010229.00

Tata Consultancy ServicesWipro TechnologiesInfosys Technologies LtdHCL Technologies LtdSatyam Computer Service LtdIBM India LtdCongnizant Technology SolutionsNIIT LtdSilverline Technologies LtdPenssoft Technologies LtdPentamedia Graphics LtdPatni Computer Systems LtdMahindra British Telecom LtdHCL Perot SystemsDSO Software LtdMascon Global LtdMascot Systems LtdTata Infotech LtdI-Flex Solutions LtdMphasis BFL LtdMeanSubtotalPercentage of country revenueCountry total

China Software/Servicerevenue ($ million)

India Software/Servicerevenue ($ million)


contribute 42% of India’s total software/services exportsand their mean export revenue is $166 million. China’stop 20 software export companies contribute only 13%of China’s total software/services exports and their meanexport revenue is just $4.75 million. Considering thatthey are approximately the same size this implies thatmost of the largest software firms in China have simplyneglected the export market. They have preferred to

concentrate on the very large domestic market. TheChinese software and IT services industry is onlyapproximately 5% smaller than India’s, but its exportsare as little as one-tenth of those of India (www.ccidnet.com, www.nasscom.org and www.mii.gov.cn).

Furthermore, the top three Chinese software exportcompanies in Table 7, which earn 78% of the top 10’sexport revenue and produce 15% of China’s total

Table 6 Comparison of software/service exports between China and India’s top 20 software companies

China Software/Serviceexports ($ million)

India Software/Serviceexports ($ million)

Sources: www.nasscom.org, www.ccidnet.com and the Chinese Software Industry Association.

Huawei TechnologyZhongxin CommunicationPutain Eastern GroupDigital ChinaFounder GroupEusoft GroupCSS GroupDatang CommunicationLangchao GroupTsinghua TongfangYantai Eastern Electronics GroupZhongchuang Software LtdUfsoftUT Starcom CommunicationBodao LtdTianjin NECCGW GroupXiangji Software LtdTop GroupBeida Bird LtdAverageSubtotalPercentage of country revenueCountry total

Tata Consultancy ServicesWipro TechnologiesInfosys Technologies LtdHCL Technologies LtdSatyam Computer Service LtdIBM India LtdCongnizant Technology SolutionsNIIT LtdSilverline Technologies LtdPenssoft Technologies LtdPentamedia Graphics LtdPatni Computer Systems LtdMahindra British Telecom LtdHCL Perot SystemsDSO Software LtdMascon Global LtdMascot Systems LtdTata Infotech LtdI-Flex Solutions LtdMphasis BFL LtdMeanSubtotalPercentage of country revenueCountry total

48.910.000.000.00

23.676.105.580.110.000.000.000.000.000.000.008.660.000.002.040.004.75

95.0013.00

725.00

604.01369.61389.93237.15261.20106.49147.95119.95136.25116.90115.32108.50

94.6992.4392.2171.2771.5260.6161.8159.62

165.873317.00

43.007780.00

Table 7 Comparison of China and India’s top 10 software and service export companies

Sources: www.nasscom.org and the China Software Industry Association.

China Exports 2001($ million)

India Exports 2001($ million)

604.0390.0370.0261.0237.0148.0136.0120.0117.0115.0

2498.0249.8

Huawei Technology LtdNorth China Computer System LtdFounder GroupNEC China System Integration LtdNeusoft GroupCSS GroupAsia Telecom China LtdTop Science Development LtdPFU Shanghai Computer LtdPowerise Science LtdSummaryMean

Tata Consultancy ServicesInfosys Technologies LtdWipro TechnologiesSatyam Computer Service LtdHCL Technologies LtdCongnizant Technology SolutionsSilverline Technologies LtdNIIT LtdPenssoft Technologies LtdPentamedia Graphics LtdSummaryMean

48.928.723.7

8.76.15.62.52.02.01.3

129.512.9


software/services exports, tend to sell software boundwith their hardware products rather than providingoffshore outsourcing services. From a pure offshoreoutsourcing perspective the biggest Chinese provider isthe Eusoft Group, which achieved $6.1 million in exportrevenue in 2001, which is only 1% of that of the biggestIndian provider. Although there are no detailed dataavailable on each Chinese company’s export revenue, byreferring to Table 7, where the tenth largest exporter’srevenue is just $1.3 million, it can be inferred that 87%of China’s software exports have been won by smallsoftware companies that have individual exports of belowUS$1 million.

If it is assumed that the mean annual export revenueof China’s companies is $600 000 (which is in fact themean revenue of all Chinese software companies, so theactual export figure is likely to be much lower than this)and this is compared with the $2.1 million mean offshoreoutsourcing contract (ComputerWire, 2001a), it is clearthat the transaction frequency in each outsourcingcontract of China is quite low. This means, from thefrequency perspective, that the transaction costs ofoutsourcing to China are higher than average. Engagingin many small transactions is costly: a $12 millioncontract incurs fewer transaction costs than three smallones of $4 million each. Moreover, transaction coststheory argues that trying to establish a set of independentcompanies using a common brand name – the ChineseGovernment’s ‘software export cluster’ – is flawed. Thisis because it is impossible to prevent the ‘free riderproblem’ on the brand name (Douma and Schreuder,2002). In addition, there are always problems of ensuringthe standardization of quality and the monitoring of effortwhere a number of firms work together to supply a client.

It is important to determine why the largest Chinesesoftware companies fail to win offshore outsourcing dealsin the same way that Indian companies of similar sizemanage to do. Does China’s domestic market providehigher profit margins than the offshore outsourcingmarket? This is unlikely since the margin of Indianoffshore service providers is as high as 30% and theaverage margin of China domestic software industry isonly 15% or less (China Software Industry Association,2002). The domestic market may be large, but it is notmore profitable than the export market.

There are in addition two factors that are not broughtout by the data in Table 4 and both of these put Chinaat a disadvantage.

First is the on-site presence issue. By reducing thetransaction costs for customers, on-site presence isvery important for offshore outsourcing. India made46.5% of its exports revenue from on-site delivery in2001 (Table 1). There are at least 100 000 IndianIT professionals working on customer sites, while forChina the corresponding number is negligible. Apart

from several small sales offices in the USA there isalmost no deployment of on-site delivery workforcesfrom China. In fact, most of the Chinese software exportbusiness is made up of small-size subcontracted projectsnegotiated with the middlemen, rather than real offshoreoutsourcing deals. According to Chen Yuhong, director ofCSS International, the second largest offshore outsourc-ing service provider of China, most Chinese suppliersare not even aware who the end-users are (ChinaComputer World, 2002).

Second is the issue of marketing. Marketing invest-ment, which is paid for by the suppliers, can reducetransaction costs such as searching costs for customers.However, Chinese suppliers have not done much in thisrespect. For example, at the OutsourceWorld London2002 exhibition and conference only two of the 79participating companies came from China, as opposed to26 from India, 19 from Pakistan and eight from Russia(OutsourceWorld London Yearbook, 2002). IT managersin the UK receive a deluge of selling calls from Indianand Pakistani suppliers, but rarely from Chinese suppliers.In a survey conducted by the authors among the membersof the National Outsourcing Association and IT profes-sionals in the UK, not a single respondent from 28responses knew any supplier from China. It is also verydifficult to find trustworthy information about Chinesesuppliers, particularly in English, through the Internet orother media. India has set up an efficient organization,the National Association of Software and ServicesCompanies (NASSCOM), which provides abundantquantities of reliable information, including individualsupplier profiles, through the Internet. It also buildsup a network among Indian suppliers. In contrast, theChina Software Industry Association, as a government-managed organization, provides little helpful informationfor offshore customers. This inevitably pushes up thetransaction costs for companies considering outsourcingto China.

The vendor has to be seen to have a track record in therelevant area and to have proved itself in some way.Despite this, the assessment of track records sometimesseems somewhat arbitrary and based more on anecdotalevidence and information supplied by the vendors them-selves rather than obtained independently (Michell andFitzgerald, 1997). NASSCOM has been very adept atsupplying this information. This saves transaction costsfor both customers and Indian suppliers. China shouldlearn from this and build a similar organization.

Ultimately, effective long-term networking between abuyer and vendor requires the building of trust. Trust andnetworking are effective measures for reducing transactioncosts. According to Williamson (1975), not everyonebehaves opportunistically, only someone sometimes. Ifthe buyer and seller trust each other, the transaction costsof preventing opportunism will be reduced significantly.


Trust is infectious. People tend to trust someone thatother trustworthy people trust. Networking is a good,perhaps the best, vehicle for building such mutual trust.Consequently, associations of clients, vendors or bothare a good way of reducing transaction costs.

Thirty years of isolation has meant that China has lessnetworking opportunities with the Western world thanIndia. Millions of Indians have lived in North Americaand Europe for years and many of them are successfulprofessionals, particularly in the IT industry. Chinese,from the mainland at least, have only begun to visit theUSA and Europe for lengthy periods since the 1990s.Most of them are still working in junior positions, twoor three notches lower than the well-established Indians.Thus, the Chinese network in the USA and Europe ismuch weaker than that of India and this also increases thetransaction costs for outsourcing to China.

The concluding sector considers what the policyimplications might be.

Conclusions: outlining a policy agenda

This paper has demonstrated that transaction costsassume a much greater importance relative to productioncosts for offshore outsourcing as compared to its onshorecousin. (It is not possible to be precise about the quanti-tative relationship between transaction and productioncosts – that requires further work.) Moreover, when itcomes to the choice of offshore supplier, transactioncosts are critical. Yet the difficulty remains that transactioncosts are not as transparent as production costs, nor canthey be so precisely delineated by a contract. What thispaper has accomplished is the rectification of thissituation by bringing together various sources ofpublished data to reveal where China fails to competewith India as an outsource provider.

Joint ventures are often not needed with onshoreoutsourcing because the transaction costs are so low; butwith offshore outsourcing joint ventures become moreviable. Such ventures have been hampered in Chinabecause of the legal difficulties described above. Never-theless, they are starting to grow. In fact, more than 100multinational companies are using this model in Chinaalready (Science Innovation and Made in China, 2002).Lucent has set up two research and development centresin Shanghai and Beijing hiring 500 IT professionals.SAP has set up a research and development centre inChina with approximately 150 employees. Initially thiswas just for Chinese localization of SAP R/3 for theChina enterprise resource planning (ERP) market, but ithas since become a low-cost development facility forSAP Global. IBM has set up a joint venture in Shenzhen,hiring 130 programmers. Initially this was for localizingIBM software products for the Chinese market, but now

it has become an IGS offshore outsourcing facility workingon mainframe maintenance for Hong Kong Telecom.HSBC has moved its call centre from Hong Kong toGuangzhou. Others, such as Motorola, Microsoft,NOKIA, NEC, HP, Erickson and Intel, have all set upresearch and development centres in China hiring morethan 100 professionals.

These are clearly encouraging trends for China, butwhat else should the Chinese Government do? Someof what is being done, in particular around educationand pursuing CMM certification, is along the right lines,but other measures are either irrelevant (concern overproduction costs) or counterproductive.

The first and most obvious point is to cease trying topromote software export clusters and try instead toencourage the large Chinese software companies to enterthe offshore outsourcing supplier market and allow smalloutsourcing suppliers to develop naturally. It is unrealisticto expand company size first and then hope to get morebusiness.

Second, both the Chinese Government and offshoreservice suppliers must enhance their marketing and salesforce by going abroad to customer sites. They need tomerge and acquire USA- and Europe-based outsourcingsuppliers or set up joint ventures with them or at least setup branches hiring local sales forces. The ChineseGovernment should invest in setting up an organizationsimilar to NASSCOM in order to provide free andreliable information to potential foreign customers. TheChinese Government should also invest in overseasadvertising in order to improve the international reputationof China and at least let people know more about China.The Chinese Government, as a warrantor or a trust-transferring middleman, could help Chinese suppliersbuild up their reliability and reputation.

Third, they should enhance their on-site presence. Itmay cost more for suppliers, but there is no other choice.Nearly half of Indian IT exports come from on-sitedelivery. Hiring overseas Chinese students is a possiblesolution.

Fourth, the Chinese legal system is a big concern foroffshore outsourcing clients. A reliable and efficientlegal system is fundamental for contractual businessessuch as outsourcing. It is impractical to wait for animprovement in the Chinese legal system. Registeringcompanies in the USA and Europe for dealing withcustomers is a feasible alternative.

Fifth, it is important not to lose their domesticoutsourcing market to Indian companies. The hugedomestic market is the only absolute advantage thatChinese firms possess against their Indian rivals. Bydeveloping a domestic outsourcing market, Chinesesuppliers can obtain business knowledge, gain projectmanagement experience and build reference and reputation,as well as grow their companies.


Sixth, they need to focus on special projects andregions where language or other barriers are not toohigh, such as Japan, the European continent and HongKong, where the English language is not as crucial as itis for the US market.

Seventh, Chinese suppliers should put more effort intobusiness process outsourcing businesses, where no-onehas yet to dominate, rather than IT outsourcing whereIndia is already dominant and enjoys first mover advan-tage. In particular, Chinese suppliers have the chance forproviding business process outsourcing services for thenumerous foreign investment businesses that alreadyexist in China and then to stream up to their headquartersoffshore.

Finally, now that China has entered the World TradeOrganization many multinational companies are goingto seek to do business in China. Most of them, such asinsurance, retail, telecom and bank firms, will have tonegotiate with the Chinese Government in order toobtain market entry permits. Others, such as Microsoft,IBM and GE, who want to win huge governmentpurchase contracts from China, also need to negotiatewith the Chinese Government. All of these multinationalcompanies have considerable offshore outsourcingbusiness to allocate. As a trade exchange, the ChineseGovernment could persuade them to outsource to China.For example, Microsoft has just signed an outsourcingcontract of $800 million to China for the next 5 years.This will greatly accelerate the growth of China’soffshore outsourcing service business.

There is no question that China has the potential tocompete with India and even surpass India in certainmarkets as a vendor of IT services, but there is not muchtime. Policy changes are required before this marketmatures and the window of opportunity closes.

Acknowledgement

The authors would like to thank Bob Aylott of theNational Outsourcing Association for his help in thepreparation of this article.

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Biographical notes

Zhonghua Qu is an MBA student at The BusinessSchool, Imperial College, London. He received his BScin engineering from Sichuan University and his MSc inmechanics from Peking University. Before studying atImperial College he worked in the IT industry for 13

years, including 5 years at IBM China, mainly in softwaredevelopment, ERP consulting and outsourcing services.His research interests include offshore outsourcing andthe strategic use of IT.

Michael Brocklehurst is a senior lecturer at TheBusiness School, Imperial College, London. Beforejoining Imperial College he taught at a number of highereducation institutions in the UK, Hong Kong andCanada. His PhD was in the field of new technologyhomeworking and he has published widely in this field.His current research interests are in comparative interna-tional innovation, careers and identity and long hoursworking. His most recent publications are in Organiza-tion Studies and Technological Forecasting and SocialChange.

Address for correspondence: The Business School,Imperial College, London, South Kensington Campus,London SW7 2AZ, UK.

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