A former colleague called my attention to a sea change in the Chinese software outsourcing industry that’s going on as I write this.  I’ve seen a couple of key shifts over the past several years.  Now we’re seeing the third big transition.

The Early Days

Prior to about 2004, most of the Chinese software outsourcing companies either did business domestically, or in Japan.  The few companies that succeeded in winning western business tended to have strong founders with deep western experience and contacts.  Not to diminish their accomplishments, but their success came largely from the direct and indirect contacts of the founders.  Most of these companies invested little, or nothing, in marketing and were very conservative in their direct sales force.  During this stage, some companies became leaders, including Achievo, Augmentum (Cadence & IBM heritage), Huatek (HP heritage) and Symbio (IBM heritage), but no companies really emerged as a dominant player.

The biggest challenge for prospective buyers was simple awareness.  Most western prospects couldn’t even get a useful list of the Chinese vendors.  Direct competition between the vendors was limited because most prospects weren’t aware of the competitive vendors.  You could win just by making the contact and speaking English.

Chinese Software Outsourcing Starts to turn Heads

The next stage was short, and disruptive.  From about 2004 to mid-2007, some of the companies began to understand the value of marketing and PR.  This awareness coincided with an influx of private equity.  Some of the leading companies assembled pretty tidy war chests (see also: “What Will They Do with the Money?” and “hiSoft Announces Completion of Largest Investment in IT Outsourcing Space” [$30M Series B on top of a $20M Series A]).

Among other things, they listened to their investors and made investments in marketing.  They also started to build U.S. based direct sales teams.  In a case of perfect timing, this is the period when China really exploded onto the world stage.  As a result of both the newfound attention, and the early investments in marketing, western prospects were starting to hear about a few of the leading companies.  Some analysts began to cover China and there was enough media coverage that pretty much anyone with an interest could come up with a list of vendors.

As this stage wrapped up, competition was becoming more real.  Clients understood that they had alternatives, and they had access to a body of third party analysis to help them identify the stronger players.  Competition was somewhat increased, but you could still win by telling a good story, because it has been difficult to objectively compare vendors.  Some companies that emerged as leaders from this stage include Worksoft, hiSoft and BeyondSoft.

We Join the Big Leagues

The stage that we’re entering now is interesting for a number of reasons.  Foremost among them is that the industry is maturing and becoming a “real” business.  Investors are backing Chinese outsourcing companies with significant financial resources and are expecting them to win.  We’re also seeing a wave of very skilled managers moving into senior level positions in the industry.  They are generally, either Chinese returnees with very strong western experience, or aggressive managers that learned their lessons at some of the leading companies in the earlier stages.

Any client with the slightest level of interest can find a list of vendors and details about their offerings.  A large, and growing, group of sharp analysts is covering the Chinese software outsourcing space and they are actually traveling to China to gain an understanding of the vendors.  The mainstream media runs several stories on Chinese outsourcing and the companies involved every day.

Competition is fierce and winners need to be hitting on all cylinders.  Execution really matters.  Delivery has to be world class, as does both sales and marketing.  The competitors have the resources, and are increasingly willing to spend money on infrastructure, training, recruiting and external messaging in order to gain market share.  Vendors have to offer services that clients want, with good quality at competitive prices.  Beyond that, they have to achieve a scale, in terms of both revenue and delivery team size that allows them to be taken seriously in the global outsourcing industry.

Will A Dominant Player Emerge?

This new phase is really gaining momentum in the second half of 2007.  I expect that we’ll see at least a couple more Chinese software outsourcing companies gaining access to the public markets before the end of Q1 2008.  I also expect that the stronger companies will continue to pursue acquisitions to accelerate their growth.  I’ll go out on a limb, and predict that at least one, and maybe two, organizations will emerge as the clearly dominant companies by the middle of 2008.

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