BEIJING - Bangalore used to be the preferred Asian destination for international companies looking to outsource software development, data processing or even debt collection. But Last July, IDC (International Data Corporation) introduced a new indicator called GDI (Global Delivery Index), and compared and contrasted 35 cities in 18 countries in the Asia Pacific region which have the potential to be global delivery destinations. Surprisingly, Dalian beat first-tier cities like Beijing and Shanghai, and even managed to rank fifth overall. IDC also predicted that by 2011, Chinese cities like Dalian would outstrip Indian cities and become the most suitable global delivery locations in the world.

In his book The World is Flat, Thomas L. Friedman wrote about his amazement at the development of software outsourcing in Dalian, apart from China's software and service industries. Business Week has even called this small scenic city "the Bangalore of China".

In 1998, the total sales revenue of Dalian's software industry was a mere RMB200 million (US$29 million), and the software export turnover was less than US$10 million. Ten years later, in 2007, the sales revenue of its software industry rocketed to RMB21.5 billion (US$3.1 billion), and the software export turnover reached US$720 million. And the rapid growth continues. It is estimated that the city's total sales revenue in the software industry will exceed RMB30 billion (US$4.3 billlion) and the software export turnover will exceed US$1 billion by the end of this year. In fact, in 2006, Dalian's software export turnover had already surpassed that of Beijing.

Dalian people have their eyes on the future and they want to be the leader in global outsourcing for software and services. The city is now aiming for RMB90 billion (US$13 billion) in the software industry and US$ 4.5billion in software exports by 2012. By 2017, the size of its software industry and services will be able to match the global market leaders. Outstripping Bangalore will no longer be a dream by then....

From dawn to dusk, overseas visitors wander through a curved grey office building at the No. 1 Digital Square, Dalian Software Park. As they study the spectacular diorama of the Software Garden in the hall, they often ask the same question: how did Dalian accomplish all this in just ten years?

Rewards for Persistent Efforts

Jin Guowei joined the Dalian Bureau of the Information Industry ten years ago. Since Dalian was the first city to establish such a bureau in China, Jin used to have trouble finding his counterparts in other cities when he travelled out of Dalian on business trips. Now, he is the vice-director of the bureau.

Gao Wei, the president of the Dalian Software Park Co., Ltd. (DLSP), is an authoritative figure in the software park. When he left Yida Group, the main shareholder of DLSP, and took up his current position ten years ago, there was actually nothing on the site where the software park is now located. They started the business by setting up a sign outside their office building that read "Northeast Asia Outsourcing Centre". That office building was actually a renovated guesthouse of a machine tools factory. Over the next ten years DLSP gradually earned a nationwide reputation and Gao intends to continue his career at the software park.

The software industry in Dalian owes a lot to consistent government support over the last ten years. "In China, the government still has a critical role to play in the development of an industry," says Jin.

Bo Xilai, the gutsy mayor who initiated the software strategy, helped lay a solid foundation for the development of the software industry in Dalian. In 2001, Bo was transferred to Liaoning province and Li Yongjin took over his position. As soon as he started his new job, Li led a delegation to Japan in a bid to attract overseas business for software and outsourcing services. It was the first time that Dalian companies had approached Japan for business opportunities. During his first month in the Mayor's office, Li also held a general meeting with the heads of bureaus such as water, electricity, police and municipality management. The gathering identified all the issues, challenges and difficulties and solutions were worked out on the spot. Shortly after the meeting, a memo was released as a guideline for future problem solving.

Xia Deren was the vice mayor responsible for science and technology when Bo Xilai was still mayor of Dalian, so it was natural for him to continue government support for the software industry after he succeeded Li Yongjin.

Once the strategy was established, choosing which way to proceed was critical. Instead of producing products similar to those of Microsoft, Dalian chose software outsourcing and services as its breakthroughs. And instead of the larger European and American markets, Dalian chose to focus on the nearby Japanese market.

It turned out to be a wise decision. After 2002, the growth in the Chinese software industry shifted from software products to software services, and Dalian subsequently gained a leading advantage thanks to its early entry into the market. In addition, although the outsourcing demands in the European and American markets have been growing fast in recent years, Chinese software outsourcing service providers only get about 25% of the orders from these markets. In contrast, they get about 60% of the orders from Japan. Dalian has gained a virtual monopoly on outsourcing orders from Japan.

The booming software industry in Dalian relies on some committed entrepreneurs. Li Yuanming, the ex-chairman of HiSoft Technology International Ltd., left the company this past May and started his own business, which is also a software outsourcing service provider. "I believe this industry has great potential, and there are abundant opportunities to provide outsourcing services to the Japanese market."

There are plenty of software outsourcing service providers in Dalian, including star companies like Neusoft Corporation, Dalian Hi-Think Computer Technology, Corp. (DHC) and HiSoft Technology International Ltd., the top three software exporters in China. The competition and cooperation between these domestic software outsourcing powerhouses and international giants like GE, Dell and HP, have shaped Dalian's prosperous software industry landscape.

The Advantages of Mechanisms

DLSP has played a vital role in Dalian's software industry. Among the 60,000 IT staff in the industry, 40,000 work for various software companies inside DLSP.

Surprisingly, a private company is running DLSP Phase I, which occupies a three-square-kilometre piece of land. The phenomenon is unique to Dalian. In other Chinese cities, software parks are usually managed by enterprises controlled by local governments.

There are distinct advantages of getting government support while being run like a private company. Such a company can maintain practical and ambitious spirit, but still secure strong policy support from the government. In contrast to the inefficiency of many poorly managed government-run software parks, Dalian Software Park strives to be proactive by taking the initiative and cooperating to solve problems as effectively as possible.

DLSP prepared a tailor-made solution for GE, the first of the Fortune 500 companies to take up residence at the Dalian Software Park. Under a long-term lease agreement between the two parties, the office buildings and the affiliated facilities were to be constructed by DLSP according to GE's standards.

Gao Wei was stretched to the limit for the project. The dictated standards by GE were previously unheard by DLSP. Mountains of documents on technological standards stipulated everything from power distribution, heating and ventilation to the installation of leisure zones, ATM and coffee machines, and even the specifications of toilet seats. Many of GE's requirements actually exceeded the national standards at the time, but Gao was determined to deliver a quality project on time because he knew it would eventually pay off. Knowing that those office buildings were constructed to GE standards helped convince IBM Japan to move into the software park.

The greatest advantage of a private business is its close relationship with clients and its willingness to serve. DLSP, for example, set up a Human Resource Service Centre to address the talent shortage problem for companies inside the software park. The centre can be commissioned by enterprises to conduct HR training and recruitment for new employees in its "practice training base". It does recruitment drives in major cities both inside and outside China each year. As well, after finding that many companies in the park had to go through several different departments to solve even trivial problems, DLSP established an Infrastructure Service Centre. It consolidates services like merchandising, leasing, property management, and engineering. This makes things much more convenient for enterprises. More than 30 Fortune 500 companies have now set up facilities at Dalian Software Park.

Expansion is also a major focus for the company. In addition to the original park in Dalian, it now has three new software parks located in Wuhan, Tianjin and Suzhou. They were created in cooperation with the local governments. "We must follow customer demand," intones Gao Wei. Faced with rising labour costs in Dalian, some DLSP's clients hope to move their mid-range and lower-end business to these second-tier cities where labour costs are relatively low. For these clients, DLSP offers a series of professional services such as choosing locations, building construction, recruitment and training. DLSP recommended Wuhan Park to EDS, the second largest IT service company in the world, when it was looking for a delivery location in China. More companies followed. Soon, its 150,000-square-metre office buildings in Wuhan Phase I were completely sold or fully leased.

"This won't jeopardize the status of Dalian as an outsourcing centre. Instead, it will encourage Dalian to further improve its capabilities and provide more value-added services," assures Gao. "Furthermore, our business expansion will also attract talent from the second-tier cities to work in Dalian."

The Dalian government plans to continue offering support to privately-run operations. Since 2003, a growing number of Chinese and overseas business groups, including Neusoft Corporation, Ascendas Group from Singapore, and Shui On Group from Hong Kong, have set up in Dalian. They will develop their own software parks, which will constitute part of the software industry belt along Lvshun South Road.

Challenges in Future

"We are under a lot more pressure than we were ten years ago," admits Jin Guowei. "It was not a big deal to double RMB200 million (US$29 million), but it will be very difficult to double RMB20 billion (US$2.9 billion)." Having witnessed the success of the software industry in Dalian, a couple dozen more Chinese cities are now preparing to turn their software businesses into pillar industries. Many of them have set software revenue goals of at lest RMB100 billion (US$14 billion).

Now the question is: Will Dalian be able to maintain its market leader position in the future? The answer depends on how effectively it can upgrade itself.

In fact, the industrial positioning of the Dalian government has been undergoing some subtle changes. Dalian's future goals are to become the R&D centre for Chinese software, the production base for high-end outsourcing services, and the transfer centre for domestic outsourcing services.

After accumulating plenty of know-how in the outsourcing business, Dalian began encouraging its own outsourcing service providers to grow by innovating and developing outsourcing services. Some of them have done well. In November 2005, DHC outbid Deloitte from the US and SAP from Germany for the US$2 million national railway financial system project in Uzbekistan. It was the first time that Chinese software products had penetrated the international market. In 2007, DHC's software products cracked markets in Bangladesh and Nigeria.

Dalian Huachang Electronics & Communication Technology Co., Ltd. has also innovated and developed its outsourcing services. In addition to helping develop application software for Japanese firms, it developed the WCDMA 3GPP Protocol Stack, which has since been exported to Japan. This small company earns big profits by charging licensing fees for every mobile phone or chip. These success stories challenge the notion that outsourcing lacks technologies and innovations. Innovations take time and can only be achieved after foundations are built on the basis of replication and imitation.

Based on its experience in the lower-end to mid-range outsourcing services field, Dalian can now move towards the higher-end market. Last year, Intel set up its first Asian chip factory in Dalian. It not only attracted the integrated circuit (IC) industry, but also some IC design companies as well. They are exactly the kind of high-end software businesses that Dalian has been dreaming about. IBM also donated a mainframe to Dalian and set up a training base there. This gesture will be appeal to other mainframe software companies as well. Forte (Group) International Inc., the largest fund management company in the world, already has an outsourcing centre in Dalian, and is planning to introduce high-end outsourcing services like financial analysis to Dalian.

As costs continue to rise in Dalian, some mid- and lower-end outsourcing services like testing and data input will inevitably move elsewhere. It is therefore imperative for Dalian to speed up the development of high-end services like embedded software, software design, business consultation, and process re-engineering in order to maintain its market-leading position.

The Dalian government is now encouraging software enterprises to think about the capital markets. Vice Mayor, Dai Yulin believes that activating the capital market is the next stage in the development of that city's software industry. 

In fact, it's the biggest challenge that Dalian is facing. Unlike mega cities like Beijing and Shanghai where financial institutions are highly concentrated, Dalian has been dogged by capital shortages and sluggish venture capital investment. Apart from the imported Neusoft Corporation, there are not many listed local software companies in Dalian. The government has launched a project to encourage enterprises to go public in the hope that ten or so companies will be listed on the stock exchange in two to three years.

Jin still regrets the fact that DHC failed a China Securities Regulatory Commission evaluation for an A-share listing in China. "It is a loss for the Chinese stock market, because DHC is an unusually good software business in China." He hasn't given up however. "In addition to encouraging companies to go public, we are also promoting mergers and acquisitions between enterprises, in an effort to further boost their business performance. After all, venture capitals cannot be attracted simply by granting favourable policies."

Ten years ago, Dalian had a forced take-off with limited resources. Ten years later, it continues a steady ascent with higher goals.

Previously on Zhongnanhai:

• Dalian: China's Outsourcing Capital and a Pretty Nice Town to Boot
• China's Seattle Kicks It Into High Gear