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Updated: 2007-06-19 11:08

When Legend Capital made a decision to invest in Beijing-based SinoCom Software Group Ltd in 2003, few people knew the deal would trigger an investment in China's outsourcing sector two years later.

Most multinationals at that time saw China as a location to outsource manufacturing. The 500-person SinoCom was about one-twentieth of size of India's info-tech giants, able only to deal with small-scale software development tasks for Japanese clients.

"It was a risky bet at that time," says Li Jiaqing, executive director of Legend Capital. "Before us, no venture firms had invested in Chinese outsourcing companies."

However, the risky bet turned out to be one of Legend Capital's most successful investments. In 2004, Sinocom made its debut in Hong Kong Stock Exchange, becoming the first listed Chinese software exporter. By developing software for Japanese companies, including NEC, SinoCom's revenue almost quadrupled over the past five years and brought a seven-fold return to Legend Capital.

Reassured by SinoCom's success, Legend Capital then invested in Worksoft Creative Software Technology Ltd in 2004. By providing services to United States tech giants Microsoft and IBM, the Beijing-based company rapidly expanded into a workforce of about 3,000 people by the end of 2006 and with its rapid growth attracted Silicon Valley-based investors Sequoia Capital and DCM.

Over the past two years, software outsourcing has become one of the hot spots for venture capitalists in China, attracting about $100 million in investment from heavyweights such as Intel Capital and Sequoia. Hefty returns seem well on their way as a range of Chinese outsourcing companies, including WorkSoft, are preparing for share offerings in the NASDAQ this year.

Li Jiaqing, who managed Legend Capital's investment into SinoCom and WorkSoft, talks with China Business Weekly reporter Wang Xu about the growth of China's software outsourcing firms.

Q: How did Legend Capital identify the opportunity in the software outsourcing sector?

A: Part of the inspiration came from our partner General Atlantic, a US-based buyout firm. The company made a series of successful investments into Indian outsourcing firms such as 24x7bpo, a business process outsourcing (BPO) service provider and the world's largest BPO service provider Genpact. Their experience showed outsourcing was becoming a global trend. And we felt that's also going to happen in China, given the nation's affordable and enormous labor force. Moreover, we were looking for opportunities in the software sector for a while and our research showed outsourcing is the only segment that could have explosive growth and wouldn't be affected by piracy.

Q: How did you then find SinoCom ?

A: We actually talked to all the major outsourcing firms before we made the investment. At that time, local outsourcing companies focusing on the US market were still too small to invest in. SinoCom, specializing in the Japanese market, was the largest outsourcing company in China at time. And Japan was an easier market than the US and Europe for Chinese companies, as there was no competition from Indian companies, largely due to the language obstacle.

Q: SinoCom was the largest outsourcing company in China in 2004. But its growth seems to have slowed in recent years compared with some other companies, such as Worksoft. What do you think of the phenomenon?

A: SinoCom has actually been growing pretty well. However, it has now come across a growth bottleneck faced by all outsourcing companies focusing on the Japanese market. It's difficult for an outsourcing company to become a global player if it only focuses on the Japanese market. First, Japanese companies are more conservative compared with US and European firms. Most of the time, they only outsource low-end coding and testing jobs. This gives little room for their vendors to improve capacity and tap into high-end markets such as consulting and software architecture. Moreover, the value of such contracts is usually small compared with those in the US, making it difficult for outsourcing companies to expand.

Q: Is that why you chose to invest in WorkSoft later?

A: Yes. When SinoCom went public, we felt more confident that China's software outsourcing sector would take off. Due to the bottleneck of the Japanese market, we then set out to find a company focusing on the US market. WorkSoft came into our sights then as it was one of the leading firms involved in US market.

Q: What are the major challenges for Chinese software outsourcing companies?

A: People are still the greatest challenge. There is a serious shortage of middle and high-level management talent with international experience. For entry-level engineers, it's OK, with the huge supply of computer graduates each year. But as Chinese companies are trying to deal with more sophisticated projects, more experienced engineers and managers are needed. Now, the salary for experienced engineers and management talent in China is much higher than in India.

Q: Do you think China's outsourcing sector could repeat the success of India?

A: Why bother to do so? The Indian model is very simple - serving multinational clients abroad, which we call offshore. One reason is that India's domestic IT services market is very small, providing limited business opportunity locally.

But it's a different scene for Chinese companies. A major advantage is that we have a booming domestic IT service market, probably the second-largest by 2009. Multinationals in China and domestic companies are now outsourcing their software projects locally. So an important part of the Chinese model is delivering software services to domestic clients - multinationals and homegrown companies. This allows Chinese companies to achieve a certain scale just by catering to domestic demand. Beside that, we also could compete for offshore business, but that takes a long time.

Q: Do you see any upcoming Chinese outsourcing giants like Infosys?

A: Not in five or 10 years. Chinese companies are still quite small. It took Infosys 30 years to accumulate the experience and human resources for global expansion. If we could achieve a similar scale in 20 years, it would be very good.