Conventional wisdom says that while China is the developing world’s manufacturing powerhouse, India is the designated software kingpin. However, China’s software industry actually generates more revenue. According to China’s Ministry of Industry and Information Technology (MIIT), China’s software industry is expected to hit US$125 billion (€83.15 billion) in revenue in 2009, more than twice as much as analysts project for India.
India’s software industry gets all the international attention because China exports almost no software outside of Asia and does not compete with India for IT outsourcing from the West. In fact, only around 2 percent of the country’s software revenue comes from outsourcing and software exports account for no more than 15-20 percent of the total industry’s value, says Shushmul Maheshwari, chief executive of Indian research firm RNCOS. In contrast, around 77 percent of India’s software industry revenue comes from exports.
But at present there is little reason for Chinese firms to risk expanding abroad. Not only do they lack expertise in foreign markets, but the domestic market is quite lucrative. RCNOS says the Chinese software sector will grow at a compound annual growth rate of 24 percent from 2009-2012, and domestic firms hold a comfortable 80 percent of the market.
In addition, Chinese clients’ demands are particular. Mainland customers tend to prefer to pay for software on an inexpensive project-by-project basis, which encourages market entry by small, nimble firms. By the end of 2007, according to the MIIT, China had 18,810 certified domestic software companies peddling 50,799 software products. Most of the companies are diminutive in scale, says Yang GenXing, secretary general of the Shanghai Software Industry Association: "Of Shanghai’s more than 1,500 software companies, there are less than 10 companies that employ more than 1,000 people, but over 1,100 that employ less than 100." The combination of Chinese firms’ ability to dominate the large and growing domestic market and a lack of consolidation has allowed Chinese companies to be complacent about the prospect of expanding internationally. This situation is not likely to change until the domestic players consolidate and scale up their skills�C or foreign firms grab a larger portion of the Chinese software market share. But given the unique nature of China’s software market, imminent foreign incursions seem unlikely.
When a Chinese firm approaches software vendors for business solutions, they usually want a customised product that takes into account their particular needs. This naturally discriminates against foreign firms and large domestic firms selling off-the-shelf solutions.
"Local application vendors have a better understanding of the local client and offer more flexible and personalised solutions for the clients," says Felix Liu, research manager at IT market intelligence firm IDC China. "Consider that SAP and Oracle have their core research and development teams in the United States or Europe, whereas Chinese companies, like market leaders Ufida and Kingdee, are solely focused on their Chinese customers." In addition, most Chinese clients have relatively low IT budgets and therefore are attracted to the low upfront investment required by local firms, adds Liu. Zeng Liang, vice president and general manager for Asia Pacific at Kingdee International Software Group, among the largest Chinese software firms, argues that even when the budget for IT is higher, the price-to-performance ratio of Chinese software vendors is still better than the foreign companies, because of their localised expertise. Thanks to this price advantage in an extremely price-sensitive market, Kingdee holds over 20 percent of the market in enterprise software for small- and medium-sized businesses, compared to only a 4.8 percent share in the total application software market, which is still led by Microsoft, according to data from IDC.
Another advantage for Chinese firms is that they can usually implement their software much more quickly than international firms. Whereas a full implementation of SAP or Oracle software can sometimes take a year or two, Chinese software companies can implement their software in a matter of months. "Chinese companies change very fast. They cannot just wait two or three years to get their Enterprise resource planning (ERP) program up and running. They hope to do it within a few months," says Zeng.
On the other hand, this cheap and quick strategy does have significant hidden costs. For one thing, custom software requires more employee training. Every time the customer hires a new employee, that employee must be trained on an unfamiliar software system. And this training is of little market value to employees; unlike knowledge of standard software packages, familiarity with a custom product is irrelevant to their next employer.
And unless the new system is exquisitely documented, it is difficult for the customer to switch platforms once they have integrated their data and operations with the new system. If the software vendor goes out of business – or if the programmer who wrote the software quits – there usually is nobody else who can provide technical support. Once a company implements a custom solution, they are effectively locked into paying the designer for technical support and service, whether they are satisfied with the product or not.
Finally, for the software firm, custom programs produce little more resellable IP than a tailored suit does.
However, it is not just a cheaper, more customised product that allows Chinese firms to dominate. Government favoritism in the software market is high. Liu at IDC estimates about 50 percent of the domestic software market is driven by sales to the government or state-owned enterprises. This part of the market is in most cases exclusively the domain of domestic software vendors.
"Since the downturn, protectionism is going on, not only in the steel or petroleum or plastics industry, [but also] in software," says Liu. "We have heard a lot of stories lately that local governments and SOEs are only purchasing software from the local vendors. If you are a foreign company, you are not even invited to bid." On top of this, local firms receive tax breaks and support from the government. In 2007, the MIIT launched an initiative with the Ministry of Commerce and State Administration of Taxation to offer a 10 percent reduction in the corporate tax rate to 152 software firms in China. In addition, the government’s 11th Five Year Plan (2006-2011) called for the establishment of "100 Digital Cities" – essentially urban areas which use software to automate certain urban planning and management functions – leading to a huge surge in demand for software products from municipalities. This surge has almost exclusively gone to domestic firms.
Not only has the central government made the development of the software industry a priority, but provincial governments have increasingly begun courting software firms. Software parks, which offer tax breaks and other forms of financial support, are popping up throughout the country. Local officials, under heavy pressure to meet GDP goals, see the fast-growing software industry as a viable alternative to the manufacturing industry, which has been hit hard by the downturn. China now has 11 national software parks and around 50 provincial-level parks. Not creative While these parks are finding tenants, they are not successfully pushing innovation. "The kind of tight-knit, self-reinforcing communities of academic institutions, established companies, entrepreneurs and investors that you see in a place like Silicon Valley aren’t fully established here yet," says Timothy Cheung, marketing director at SAP China.
Cheung believes that many of the practices that are allowing Chinese firms to dominate domestically, such as low prices, small scale, and lax IP protection, are also holding them back from becoming better companies. Indeed the reason most Chinese software companies focus on low-cost custom packages is because any standard software products they successfully sell to the wider market are likely to be ripped off.
"Until the market treasures intellectual property in the software industry, customers will not be willing to pay a premium for innovation. When the name of the game is price, it can become a vicious circle where local firms often don’t generate sufficient profit to re-invest in R&D and without R&D local firms cannot innovate," Cheung says.
Thus, Chinese software engineers lack the skills to offer new and innovative products to consumers, foreign or domestic. "The current crop of Chinese IT service providers are far behind the international leaders in terms of scale, delivery capability, service level and domain knowledge," says Maheshwari of RNCOS.
Possessing superior capabilities but nevertheless unable to compete here, international firms like SAP, Oracle and Microsoft are hoping to increase their market share in China by changing China’s software market.
SAP, for example, has set up an OEM relationship with large Chinese firms UFIDA and Neusoft. Oracle has established an extensive graduate and internship program that works with 28 universities in China to train students in cutting-edge IT technology. Finally, Microsoft is using an innovative approach to target intellectual property infringement. Not only has the company signed pacts with PC manufacturers to install licensed software, but they also made a three-year agreement with the Hangzhou government to develop the IT industry in exchange for the city cracking down on pirated Microsoft products.
But even if the industry was better suited for long-term investment and innovation, China would still have many barriers to overcome. Though it churns out large numbers of software engineers every year, most of these engineers do not have the language skills to program effectively for Western markets – or to understand and participate in the development of open-source technologies, most of which are documented in English.
"The language barrier of Chinese software engineers compared to Indian engineers, who all speak excellent English, will make it difficult to compete in the West," says Zeng at Kingdee.
As software development becomes an increasingly globalised, community-based project, therefore, Chinese software firms – and their customers – risk being left out. Their software simply doesn’t play well with anyone else’s, making tasks like integrated global supply chain management difficult. Western companies that are looking to Asia for cheaper software solutions are naturally turning instead to India, which is highly integrated into the international development system.
Zeng says Chinese firms may one day be able to compete with international players, but there is no rush. "China has such a large domestic economy, so it is smarter for us to focus on growing the domestic software industry now instead of looking internationally," says Zeng.
Cheung at SAP China believes such a narrow focus could be a mistake. "If China’s software companies are not careful, they may become too dependent on the domestic market, which will make it very challenging for them to compete outside of China. It will take a real visionary company to make the first step towards becoming truly global," he says.