Devott Insight: Huawei Taps into Service Outsourcing Domain, China’s Outsourcing Market Emerges a New Trend
Source:  View: 2428 Date: 2012-03-08

written by Sherry Sha

traslated by Ryan Zhang

Even though it has been for some time that the outsourcer to participate shares or even control shares of the contractor, the cooperation between Huawei and CS&S (HKSE.354) undoubtedly produces more extensive and far-reaching impact as several Chinese outsourcing giants are involved with. It may change the market structure of China’s service outsourcing industry in the near future.

——Devott Service Outsourcing Research Center Deputy Director — Sherry Sha

Back in November 2009, Chen Yuhong, CEO of ChinaSoft International (CS&S), said on Chinese IT conference that the international software services industry has shown a trend of software outsourcing transfer from India to China and expected to emerge some new companies as successful as Huawei in China’s software industry. It seems to have indicated the cooperation two years later.

On 12th January 2012, CS&S announced an establishment of IT outsourcing-focused company jointly ventured with Huawei. CS&S and Huawei each take 60% and 40% of shareholding ratio respectively and 3 seats of Board of Directors for CS&S and 2 for Huawei. The joint venture is dedicated to integrating years of outsourcing experience of CS&S with mature quality, delivery management, and HR management practice of Huawei, and strive to become the industry-leading software outsourcing company.

Even though it has been for some time that the outsourcer to participate shares or even control shares of the contractor, the cooperation between Huawei and CS&S undoubtedly produces more extensive and far-reaching impact as several Chinese outsourcing giants are involved with. It may change the market structure of China’s service outsourcing industry in the near future.

The mix of software and hardware intensifies service-oriented trend for IT enterprises

Devott forecasted in “Report on ‘the Twelfth-Year Plan’ Outlook” that Chinese IT enterprises would gradually achieve the transition to service-oriented development mode. The cooperation between CS&S and Huawei confirmed this forecast. Meanwhile it shows an unstoppable trend that global IT enterprises are becoming more service-oriented. A large number of solutions have shifted focus on enterprise software outsourcing. The boundary between hardware, software and outsourcing services will become more and more ambiguous. The software-hardware mixture or software replacing hardware has become the industrial development trend at present.

Win-win cooperation makes it bittersweet

As all well known, any cooperative agreement between two companies is based on “win-win” status for both parties. CS&S’ joint venture with Huawei has proved this.

As the leading global ICT solutions provider, Huawei’s contract amount keeps increasing annually. The cooperation helps to strengthen the management to its software outsourcing providers as well as improving the quality of project. Moreover, Huawei enables to recover around 40% of profits through cooperating with CS&S. More importantly, Huawei could attempt to engage in software outsourcing that lays a good foundation for the company’s strategic decision-making to enter service field.

Establishing a joint venture with Huawei is a strategic choice for CS&S. Through the establishment of strategic partnership with world-class leader, 1) it helps to further strengthen the business relationship with Huawei and even get more new business opportunities through Huawei; 2) it can effectively improve CS&S R&D quality, project quality, human resource management capability, service quality and delivery capability, and expand the outsourcing service scale and scope on Huawei, become the core software outsourcing supplier of Huawei; 3) cooperating with world giant helps to expand overseas outsourcing market and accelerate to enhance the international core competencies.

However, the cooperation model indicates Huawei will share the profits of joint venture, which objectively decrease the net profit of CS&S by 3% to 5%. The small and declining profit margins will make software outsourcing companies confront with heavier business pressure if the profits are further squeezed. In addition, since cooperated with Huawei, in the light of industry rules and security issues, it is predicted that the outsourcing contract received from other telecommunication fields will be affected dramatically except for from Huawei. Due to the advantages and abundant resources in other industries, CS&S may develop a new situation.

As the national largest outsourcer, Huawei is estimated to have 3 billion Yuan of contract amount in 2012 and to increase by 15% above of growth rate per year that mainly generated by domestic leading IT providers like CS&S, Vance and ISoftStone. CS&S will undoubtedly monopolize the software outsourcing business from Huawei progressively. For instance, Huawei contributes 10% above business revenue to Vance and ISoftStone per year. At present, there are more than 700 billion Yuan of outsourcing contract for Vance from Huawei as well as almost 600 billion for ISoftStone. From revenue ratio perspective, both two companies are heavily dependent on Huawei. Once the order reduces, both of them will definitely experience a decrease in contract amount, which result in a reduction of business revenue or even profit rate.

New phase of software outsourcing market confronts with great impact and transformation

From the software outsourcing industry level, the cooperation between Huawei and CS&S is bound to have a huge impact on China’s software outsourcing industry pattern and facilitate the industry to show a variety of characteristics and trend.

In terms of Huawei’s corporate culture and usual way of doing things, it is not difficult to predict their intention of entering IT service field or the possibility of fully acquiring CS&S or other IT outsourcing leading companies. With its strong economic strength and industrial influence, there is no doubt that Huawei will become the giant in Chinese IT outsourcing field, dramatically seize the market shares of other service providers, thereby cause a direct impact on the entire industry and market structure.

Secondly, the service-based trend of IT companies and the leading companies’ influences will facilitate more industrial giants to get involved in software outsourcing field to stimulate the competition more intensified within the industry. Although merge & acquisition, joint venture or restructuring enables to create a number of advantageous enterprises with high added value, large market share, core competency and R&D capabilities, the joint venture model between IT outsourcer and contractor will lead IT contractors to be in the low end of the industrial chain. The less accumulation of profits fails IT contractors to move to high end and the low-end business cannot produce high profits, which lead to a vicious circle and difficulties in specialization and meticulous division of labor, eventually result Chinese software outsourcing industry in turning back to non-service-based development cycle. Especially for SMEs, most of them as the driving force have a lot of issues such as less fixed assets, small staff size, and low-end contracting business. Alliance between giants will further reduce the possibility for small and medium service providers to obtain the opportunities to do business with leading outsourcers, compress the business volume, squeeze the living space of low-end companies, and even go bankruptcy.

From China’s software outsourcing perspective, the small profit margins of the majority of software outsourcing enterprises, rising labor costs and appreciation of Chinese currency lead to the continuous fall of net profit in software outsourcing enterprises in recent year. If the joint venture is established, the outsourcer will seize the certain percentage of contractor’s profits. Therefore, Devott deems that the joint-venture model between software outsourcer and contractor would not to be followed by many other companies.

In conclusion, as the IT outsourcing keeps developing rapidly in China, in order to win competition in the intensified international market, Chinese IT outsourcing industry and its practitioners must focus on 1) industrial resource integration; 2) encourage leading companies to play their exemplary role; 3) form a group of scale corporations in the basis of industrial advantages; 4) economies of scale and brand image; 5) achieve the operational and human resource centralization, so as to stimulate the development of the whole industrial chain. We must admit that the strategic cooperation between CS&S and Huawei will accelerate the rise of national brands of IT services. Devott will continue to focus on the effects carried by the cooperation.

About CS&S

ChinaSoft International Limited, “CSI” (354.HK), is a global Information technology service company rooted in China with end to end service capability. The major verticals we cover are: Government and Manufacturing, Finance and Banking, Telecommunications and High-Tech. The Services we offer include: IT consulting, IT technical service solution and IT outsourcing service.

CSI has reached annual revenue about 1.5 billion RMB with more than 10,000 employees located worldwide, including 25 cities in China, Princeton, NJ and Seattle, WA in the US, as well as Tokyo in Japan and London in England. CSI has achieved 57% service revenue CARG in the past eight years.

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About Huawei

Huawei is a leading global information and communications technology (ICT) solutions provider. Through our dedication to customer-centric innovation and strong partnerships, we have established end-to-end advantages in telecom networks, devices and cloud computing. We are committed to creating maximum value for telecom operators, enterprises and consumers by providing competitive solutions and services. Our products and solutions have been deployed in over 140 countries, serving more than one third of the world’s population.

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