Will China ever take India’s offshore top spot?

India’s dominance of the offshore outsourcing market is indisputable despite issues in recent years over skills shortages, rising costs, security and increasing competition from other countries and regions. The big one, of course, is China. For as long as I can remember people have been predicting China will eventually knock India off the top spot. But it’s never quite happened that way.

A new report out this week by respected consultancy McKinsey & Co sheds some more light and says while China’s offshore outsourcing industry has expanded rapidly in recent years, it isn’t growing quickly enough to achieve its aspiration of becoming the leading global offshoring and outsourcing destination.

McKinsey’s study shows that China currently accounts for less than 10 per cent of the global $60bn market for offshoring and outsourcing of IT services. The figures paint a worrying picture for China - four of the top offshoring providers in the country have grown by 15 to 20 per cent annually over the past five years. Impressive double digit growth by any normal business standards but way behind the 30 to 40 per cent annual rate seen among India’s top four offshore outsourcers.

McKinsey says: “According to more conservative estimates, the total global market for offshoring and outsourcing could exceed $160 billion by 2012. If China aspires to be a clear number two player by then, it will need about 20 per cent market share, or roughly $30 billion in industry revenues. Reaching this level would require growing the industry more than five-fold over the next four years.”

If anything the gap between India and China is widening.

So what are the obstacles hindering this Chinese offshore outsourcing growth? McKinsey points to a highly fragmented Chinese IT services industry; the lack of a single domestic player of any significant scale or market presence (can you name one Chinese outsourcer with the international brand reputation and market share of the likes of a TCS, Infosys or Wipro?); the perception still of China as a manufacturing centre than services; continuing concerns about intellectual property protection; and a shortage of qualified managers to run offshoring and outsourcing businesses.

But it’s not game over for China. Indeed there’s still a world of opportunity there for the country to achieve its top dog of offshore outsourcing goal. McKinsey says China’s domestic providers need to substantially increase their scale by moving into higher value added services, such as R&D, and expanding global footprint through M&A. There are also opportunities for global service providers to ramp up their presence in China.

Beijing-based Alex Peng, partner at McKinsey, concludes in the report (entitled Destination: China, A Perspective on the Offshoring and Outsourcing Industry): “China is at a critical juncture in the development of its offshoring and outsourcing industry. A number of obstacles still stand in the path of China’s efforts to build a globally competitive industry. However, with concerted action by domestic and global service providers, supported by government policies and initiatives, China could emerge as one of the world’s leading offshoring and outsourcing destinations.”