Caution Marks Outsourcing in China

Lured by a skilled work force and rock-bottom wages, IT customers are eyeing Chinas outsourcers longingly, with one major misgiving: the risk of losing intellectual property.

To take advantage of the opportunity while still protecting sensitive data—customer records, proprietary business practices, patents, copyrights and trade secrets—some U.S. companies are taking a slow and careful approach to dealing with Chinese outsourcers.

The resulting rewards are modest, but the developing knowledge and trusted relationships promise bigger gains in the future.

Ozburn-Hessey Logistics, a transportation and storage management company in Nashville, Tenn., needed a labor productivity management tool for its warehouses. Six months ago, the company contracted with Chinese software developer Powerise International Software Co. Ltd. to write the software.

"Its an add-on to our warehousing software that shows individual and team productivity," said Bob Spieth, CIO at Ozburn-Hessey.

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In connecting with Powerise, personal connections between a Chinese-American Ozburn-Hessey IT staffer and Powerise personnel were key. Since the project is small and does not include trade secrets or other critical corporate data, Spieth said hes not concerned about security risks.

However, if the project is successful, Ozburn-Hessey may want to invest in more strategically significant, and potentially riskier, work.

Another executive at a U.S. cosmetics maker also vouched for the virtues of starting small and relying on personal contacts. In setting up a manufacturing facility in China, he hired a trusted individual with nine years of experience working in China and 20 years in the cosmetics business to handle his companys operations on the ground.

Powell urges China to address intellectual property violations. Read more here.

"Its difficult to sue people, to have an SLA [service-level agreement] and to enforce it. So reputation is critical, and you have to have a great relationship with the people that refer you and the people youre dealing with," said the executive, who asked not to be named. "Were not going through outsourcing companies but going into the country itself."

In another project, the executive is working through a U.S.-based Chinese national to set up an office in China to test server security. While initially small, the project could be expanded into a help desk or other IT support facility.

Chinese outsourcers know that protection of IP is perceived to be an Achilles heel of their country and their business, so they are ready with the right answers.

"Its probably the most overhyped issue. I have never had that problem, but perception is reality," said Walter Fang, vice president and chief technology officer of Neusoft Group Ltd., a software house based in Shenyang, China.

Founded in 1991, with annual revenues in 2003 of $270 million and 6,000 employees, Neusoft is among the more established Chinese software developers. Specializing in software for medical equipment such as MRI (magnetic resonance imaging), CT (computerized tomography) scan and ultrasound machines, the company has also co-developed human resources application software with Hewitt Associates LLC, of Lincolnshire, Ill.

Click here to read more about the social implications of outsourcing.

"We cannot afford to be sued. That gives us a very good motivation," said Fang. To avoid a legal confrontation, Neusoft takes copious precautions, including maintaining a geographically separate development center for each client project and welcoming on-site liaison managers from client companies.

"Only employees on a given project can go to a given center," said Fang, adding that printers and USB drives are prohibited. Employees must sign a nondisclosure agreement in order to begin work and must sign another NDA should they depart the company. Fang also pointed out that U.S. and Chinese laws govern the contracts, which typically include Singapore as a site for independent arbitration in case of disputes.

William Bierce, a partner at Bierce & Kenerson P.C., in New York, said that Sweden is also a popular destination for dispute resolution.

"The Chinese are concerned that things will be slanted toward a Western point of view. Sweden is near Russia and has historically been neutral," Bierce said. Sweden became popular as a mediation zone during the early years of détente between the United States and the former Soviet Union, noted Bierce.

Chinas history has led the country to adopt a unique outlook on business, said another attorney. "They did away with property in terms of Communist theory. Now theyre trying to establish the recognition of intangible property rights in a country that is pretty poor," said David Weild, a partner at Fross Zelnick Lehrman & Zissu PC, a New York law firm specializing in IP.

Next Page: Chinas Communist legacy affects IP laws.