Q U I C K TA K E

February 1, 2007

Includes Business Technographics data

Japans Oshore Evolution: Baby Steps Toward China And India

Japanese IT Must Improve Processes And Adapt Culturally To Benet
by Jonathan Browne and John C. McCarthy with Sudin Apte and Francesca Bartolomey

EXECUT I V E S U M MA RY
Japanese companies are increasingly interested in oshore outsourcing, but they remain limited in their utilization, given their poorly developed IT processes. Theyre motivated to work with oshore partners not only by a desire to reduce cost but also to gain access to technology skills and process knowledge that are scarce domestically. China for reasons of cost, geographical proximity, and language capabilities is often touted as Japans ideal outsourcing partner, but Chinas oshore players lack the necessary skills and maturity. To fully leverage oshoring, Japanese rms need to improve their internal governance and project management capabilities. In order to mitigate their risk and acquire the process knowledge they require, they should hedge their China bets by working with more mature vendors in India. TARGET AUDIENCE Sourcing and vendor management professional JAPANS INTEREST IN OFFSHORING IS ON THE RISE Japanese companies face the two-headed beast of reducing costs and nding skilled IT personnel to meet the increased demand for the renewal of legacy applications and compliance with new regulations.1 The oshore imperative has become an increasingly compelling solution as Japan wakes up to the inadequacy of its current IT labor force. At the recent ASOCIO conference in Tokyo, a speaker from Japans Ministry of Economy, Trade and Industry (METI) said, There is a lack of skilled IT engineers, in terms of both quality and quantity.2 As Japanese rms increasingly consider oshoring, vendors are boosting their eorts to bring oshore capabilities to bear on the local market.

IT-intensive verticals like nancial services look oshore. Japanese companies show a high level Japanese systems vendors have increased their investments across Asia. To date, most of the

of interest in oshoring, with 16% of respondents currently using oshore IT providers for software services at a steady or increasing rate (see Figure 1).

activity has been in China, followed by India, and then by other Asian countries. For example, Hitachi currently has 2,000 IT engineers in China, 200 in India, and 100 in Vietnam.3 NEC has a similar distribution, with ve development centers in China. Fujitsu has a larger footprint in India, having obtained facilities there in February 2006 as part of the acquisition of US rm Rapidigm.
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Quick Take | Japans Oshore Evolution: Baby Steps Toward China And India

Figure 1 Oshore Activities

Which of the following statements best describes your companys approach to oshore IT services providers for software services?
Japan
65% 64% 67% 43%

Australia/New Zealand

North America*

Europe

15%

8% 9% 10%

16% 3%

12%

8%

14%

9% 11% 9%

Dont use and have no plans to

Dont use, but are considering using

Currently using at a steady rate

Currently using and expanding our use

Base: 808 software decision-makers at Japanese, Australian, New Zealand, North American, and European enterprises Source: Business Technographics August 2006 Asia Pacic Enterprise Technology Adoption And Governance Survey *Source: Business Technographics November 2005 North American And European Enterprise Software And Services Survey
41162 Source: Forrester Research, Inc.

Oshore vendors pay more attention to Japan. An estimated 60% of the export work from

Chinese software outsourcers like Neusoft and China National Software & Service (CS&S) is for Japanese clients. And recently, Indian vendors have augmented their capabilities in Japan: In October 2006, Tata Consultancy Services (TCS) announced the creation of an oshore development center (ODC) in Kolkata, housing 1,200 consultants focused on serving Japanese clients, and KPIT Cummins signed a deal with Renesas Technology to create a 500-person product development center in Bangalore. In addition, Vietnam has made a particular eort to win Japanese contracts. For example, FPT Software, Vietnams largest software outsourcer, opened a school in Vietnam in December to train university graduates in IT skills and Japanese.

JAPANS OFFSHORE EVOLUTION AT THE BYSTANDER AND EXPERIMENTER STAGE At rst glance, Japans oshoring activity appears similar to that of Europe. But a closer examination reveals that Japanese companies are at a relatively early stage in their oshore development and utilization:4

Bystanders comprise about 69% of the Japanese market. Fifty-eight percent of respondents

to Business Technographics August 2006 Asia Pacic Enterprise Technology Adoption And Governance Survey reported no oshore activity at this time, and 11% responded dont know. Surprisingly, only 43% of companies rule oshore out of their plans completely. This compares
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Quick Take | Japans Oshore Evolution: Baby Steps Toward China And India

with 64% of North American companies that do not use oshore and have no plans to. Sixteen percent of Japanese respondents claimed to be interested in oshore in the future. But when faced with a real decision, some of this enthusiasm will surely evaporate.

Experimenters comprise 14% to 28% of the market. Forresters data shows that 14% of

companies are increasing their oshore activities, but an equal number report cutting back. This points to a trial and error phase of oshore experimentation, with many instances of burnt ngers initiatives that fail to meet expectations as companies struggle to manage projects with oshore partners.

Committed companies have just begun to emerge. Most of the activity at this level centers on

the local IT services companies bolstering their oshore focus and commitment. In discussions with second-tier systems integrators in Japan, Forrester found that they are winnowing down their number of oshore partners from as many as 30 to three, while taking steps to improve governance. Top-tier companies such as NEC have also announced steps in this direction too, reducing partners in China from 120 rms down to 30.5 This winnowing down of suppliers will continue as rms deepen their focus on India and China.

Forrester rarely sees full exploiters. Very few companies have reached this level of utilization.

One notable company at this level is Shinsei Bank. Rescued from bankruptcy by foreign equity rms, the new leadership at the bank aggressively leveraged oshore providers to build modern IT systems, which now play a central role in the dierentiation of Shinseis products.

WHILE JAPAN AND CHINA ARE A MATCH ON PAPER, REAL CHALLENGES REMAIN China has long been touted as Japans logical oshore IT partner, given its natural advantages in language, proximity, and infrastructure. But during the past year, Japanese companies have gained a more realistic view of the benets and risks of using China as a sole oshore location. Theyve found that several issues on both the Chinese supplier side and the Japanese client side obstruct building a successful partnership. For example:

Poor project management skills hamper measurable success. Oshore vendors complain of

poorly dened projects, which result in unnecessary rework and cost overruns. In the case of China, this results from immature processes on the client side and with many of the small and midtier suppliers.

Political tensions between China and Japan make Japanese executives hesitate. A wave of

anti-Japanese demonstrations in several Chinese cities in April 2005 provided a rude reminder that Japanese companies should diversify their investments in more than one country. Although relations between the two countries appear to have been more cordial in recent months, the possibility of another manifestation of anti-Japanese sentiment remains embedded in the minds
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Quick Take | Japans Oshore Evolution: Baby Steps Toward China And India

of executives. Indian vendors comment that their Japanese clients are shying away from putting all their eggs into one basket.

Employee turnover disrupts operations. High attrition rates are a commonly cited problem

of Japanese employers in China. The situation is exacerbated by gaps between the expectations of employers and employees. Japanese companies exhibit typical experimenter behavior by treating their oshore centers as low-cost body shops rather than strategic partners. This deprives oshore employees of stimulating projects and the chance to develop new skills. In addition, career progression in Japanese companies often depends on length of employment rather than meritocratic principles, which provide quicker career advancement in US and European rms. M.B.A. students at Peking University recently told Forrester: Why would I want to study Japanese? It limits me to working with only Japanese companies, which have a glass ceiling for foreigners so you cant go far in your career.

R E C O M M E N D AT I O N S

JAPANS OFFSHORE SUCCESS REQUIRES A MULTI-TIERED STRATEGY

As Japanese companies move toward fully exploiting oshore capabilities to meet their cost reduction and skill requirements, they should:

Include India in their oshore mix. To hedge risks and pick up best practices from processoriented Indian companies, Japan should seek partners in India while using a low-cost center in China or Vietnam.

Invest resources to upgrade their internal software development processes. Japanese

rms need to adopt disciplined project scoping and project management processes to accelerate their oshore evolution and achieve improvements in the quality and exibility of their systems.

Provide clear career progression paths and stimulating work to combat high attrition
rates. To compete with European and American companies in attracting, and then holding onto, the top ight of Chinese graduates, IT divisions need to lead their companies in adjusting the business culture to show oshore employees they have a chance to develop valuable skills and advance their careers.

Focus their oshore eorts with a smaller pool of suppliers. Oshore partnerships will
bear fruit when the scale of oshore activity increases and the necessary skills are fully exploited. A simple body-shopping strategy yields much lower returns in quality or cost savings. To build trust and process cohesiveness, as well as implement consistent governance, Japanese companies should focus their eorts by using only two or three vendors.

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Quick Take | Japans Oshore Evolution: Baby Steps Toward China And India

W H AT I T M E A N S

THE MOVE OFFSHORE WILL IMPACT DOMESTIC AND FOREIGN IT SERVICES FIRMS IN JAPAN
Despite the inevitable need to seek skilled help from oshore vendors, Japanese companies will make slow and timid progress toward oshoring. Local companies long-standing preferences for custom applications and extensive customization of packaged applications will die hard. Furthermore, it will take time for vendors to build up a large number of suciently bilingual sta members to take on increasing volumes of work from Japan. However, Japans oshore evolution will be driven to a tipping point by developments such as the following:

Indian vendors will acquire Japans second-tier systems integration rms. To gain a
foothold in key industries, TCS, Infosys Technologies, or Wipro Technologies will follow the lead of Electronic Data Systems (EDS) which bought Japan Systems and buy out local companies. One potential pairing could be HCL and Exa a result of their existing partnership. The selection criteria will be whether or not the Japanese integrator has strong relationships in a specic industry. Japanese IT services rms with existing subsidiaries in China will also be acquisition targets as the Indian vendors build capabilities in China and Japan to optimize their global delivery models. The Indians need to avoid purchasing a vendor that is tied to a single keiretsu.

Indian vendors promote a study-in-India program with Japanese schools. They should
promote one-year India-based IT internships. Young Japanese students who take a year out from school to experience an Indian IT campus will ag themselves as having the right mindset to become facilitators for business between Japan and India. Simultaneously, such a program will boost Indias brand as a country with knowledge and skills that Japan needs.

Japans major domestic vendors lose control. The overwhelming market share currently
held by Japans IT giants will erode as Japanese user companies gradually wean themselves away from proprietary code and begin using packaged applications implemented by oshore rms with a depth of skills the giants cant match. Furthermore, Japans major vendors will nd it harder to compete with oshore players who bring process excellence to their clients.

Half measures will not save Japanese suppliers. Vendors who treat oshore partners as
body shops and take a scattershot approach will increase their own pain. They should focus their eorts on one to three oshore partners, make eorts to improve IT processes, and outsource higher-level work to their suppliers.

Companies with global ambition will adopt oshore aggressively to compete

internationally. Banks, auto manufacturers, and consumer electronics will increase their oshore reliance as the software value of their product rises. In particular, Japans banks are nally free of their bad debt problems and will seek new revenue through business

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Quick Take | Japans Oshore Evolution: Baby Steps Toward China And India

expansion in Asia. The exposure to international competition through experienced oshore practitioners such as Citibank will require Japans banks to become oshore experts. Similarly, Japans auto and consumer electronics companies will beat a path to Chinese and Indian developers who can provide the embedded software, an essential element of new product innovation in those industries.6

ENDNOTES
1

In August 2006, Forrester released its Business Technographics August 2006 Asia Pacic Enterprise Technology Adoption And Governance Survey, which received responses from 205 IT decision-makers in Japan. Fifty-ve percent of Japanese respondents said that reducing software costs in any way was a priority or critical priority for their organization. At the same time, the pressure to upgrade systems to comply with new regulations was evident from the high levels of interest in technologies for data protection, leak prevention, and so on. See the February 1, 2007, Data Overview Japan Technology Investments And Priorities. The speaker was Katsuhiko Kaji, director, Information Service Industry Division, Commerce & Information Policy Bureau, METI. Source: Speech, ASOCIO ICT Summit 2006; Tokyo, Japan; November 16, 2006. Source: Speech by Junzo Nakajima, vice president and executive ocer, Hitachi Ltd. ASOCIO ICT Summit 2006; Tokyo, Japan; November 16, 2006. In 2003, Forrester analyzed the progression of companies seeking to use oshore capabilities and outlined a four-stage migration through which companies progress over a period of 24 to 60 or more months (with less than 5% of the Fortune 1,000 having matured to the full exploiter stage at the time of Forresters original analysis). See the December 4, 2003, Brief Users Oshore Evolution And Its Governance Impact. NEC trimmed its expanse of partners in China down to 30 from 120 rms. In compensation, the company is oering software development tools that help automate program writing. In July, NEC mapped out a policy to dispatch workers as needed to help develop software personnel in China. See Nikkei Online, November 6, 2006, Software Jobs Shifting From Japan. http://www.nni.nikkei.co.jp/AC/TNW/Search/ Nni20061106AP9CHIN1.htm In industries such as automotive, telecom, and consumer electronics, the role of software and embedded intelligence as a way to add value continues to expand. For example, the percentage of a cars value that comes from software/electronics will increase from 10% to 25% over the next three years. See the August 3, 2006, Market Overview Oshore Product Development Has Arrived.

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