How China-Based Vanceinfo Grows Big Faster

CASE: HR-34 DATE: 01/23/09 SCALING: HOW CHINA-BASED VANCEINFO GROWS BIG FAST Our biggest challenge is that the company is growing very fast and we’re not sure that our systems can withstand such growth. 1 ? Chris Chen, Chairman and CEO, VanceInfo Technologies When Chris Chen founded VanceInfo Technologies in Beijing in 1995, the company had 25 employees and one low-end IT services outsourcing project for a U. S. multinational.

By August 2008, through a combination of organic growth and acquisitions, VanceInfo employed more than 4,800 people, had numerous Fortune 100 clients, and enjoyed revenues exceeding $80 million over the preceding 12 months. It had attracted big-name venture capital partners and listed shares in 2007 on the New York Stock Exchange. Although small compared to more sophisticated Indian rivals, VanceInfo was well placed to capture an expected explosion in demand for Chinabased offshore IT services. At the same time, rapid growth was straining the firm’s management personnel, systems, and resources.

Headcount was slated to quintuple to 20,000 in four to five years’ time to keep pace with aggressive revenue targets. Old ad-hoc ways of doing things no longer could accommodate current or future needs. To succeed, management had to implement new financial, operational, and internal management systems, especially in the critical area of human resources where VanceInfo faced some of its greatest challenges. These included introducing effective processes for rapidly expanding, training, managing, and retaining its workforce in a fast-growth economy characterized by job hopping and a dearth of management talent.

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Moreover, in its quest to grow its workforce to 20,000 within five years, move into higher-margin business lines requiring new expertise, and beat out domestic and international rivals, management had to strike a balance between quick gains via acquisitions and potentially slower growth through organic expansion. 1 Interview with Chris Chen, Chairman and CEO, VanceInfo Technologies, August 18, 2008. Subsequent quotations are from the author’s interviews unless otherwise noted.

Pamela Yatsko prepared this case under the supervision of Professor Hayagreeva Rao as the basis for class discussion rather than to illustrate either effective or ineffective handling of an administrative situation. Copyright © 2009 by the Board of Trustees of the Leland Stanford Junior University. All rights reserved. To order copies or request permission to reproduce materials, e-mail the Case Writing Office at: cwo@gsb. stanford. edu or write: Case Writing Office, Stanford Graduate School of Business, 518 Memorial Way, Stanford University, Stanford, CA 94305-5015.

No part of this publication may be reproduced, stored in a retrieval system, used in a spreadsheet, or transmitted in any form or by any means –– electronic, mechanical, photocopying, recording, or otherwise –– without the permission of the Stanford Graduate School of Business. Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 2 THE OFFSHORE IT SERVICES OUTSOURCING INDUSTRY In the offshore IT services outsourcing industry, a company in one country exported IT-related work to a firm in a second country, normally to take advantage of lower labor costs.

The industry’s growth took off in the late 1990s when global communications infrastructure became increasingly inexpensive and reliable. With a large pool of low-wage, English speaking, technologically savvy workers at their disposal, Indian companies were preferred suppliers. Valued at $17. 3 billion by 2006, the global offshore IT services industry was expected to grow at a CAGR of 17. 1 percent between 2006 and 2011 compared to a CAGR of 7. 4 percent for the $674 billion global IT services industry (Exhibit 1). 2 Five of the world’s top 15 IT services firms in 2006 hailed from India, thanks to their outsourcing prowess (Exhibit 2). China in 2004 ranked second to India in attractiveness as an offshore location, according to management consulting firm A. T Kearny. 4 Albeit from a low base of $1. 4 billion in 2006, China’s offshore IT services industry was expected to expand even faster than the global industry as a whole, some 38 percent annually between 2006-2011 as U. S. , European, and Japanese clients looked to diversify away from India and gain a foothold for their products in China (Exhibit 3). 5 China also offered 30 percent cost savings over India and more than 700,000 engineering graduates annually. Potential brakes on growth included economic downturn in client markets and concerns that offshore outsourcing was stealing domestic jobs. Compared to their Indian rivals, Chinese vendors primarily offered IT outsourcing services to the China-based operations of multinational firms under the category of R&D Services (RDS). Although technically challenging, these RDS activities typically required less English than higher-end IT outsourcing services, making them a good fit for Chinese engineers, who for historical reasons were weaker in English than their Indian counterparts.

RDS included localization and globalization services, in which vendors translated clients’ software products into Chinese and adapted them for the Chinese market. RDS also included software testing and development for clients’ products. In 2007, some 60 percent of international clients hailed from Japan and South Korea, while U. S. firms accounted for 20 percent. 7 Whereas clients generally paid vendors of higher-end, competency-driven IT services on a project basis, R&D services were usually billed on a less risky time and material basis (known as a resource or time model), under which vendors billed clients for their engineers’ time.

The more people the service provider put to work for a client, the more revenue it made. Some Chinese vendors had started moving up the value chain to work on clients’ internal IT systems, offering Application Development & Maintenance (ADM), Application Testing and Quality Assurance, and Enterprise Solutions. Chinese vendors offering Enterprise Solutions 2 “Introduction to VanceInfo Technologies,” VanceInfo Technologies, Q2 2008, p. 21. Ibid. , p. 23. 4 Ibid. , p. 26. 5 Ibid. , p. 21 6 Ibid. , p. 25. 7 “CBR Project Watch-Chinese Outsourcing on the Rise,” Computer Business Review, April 2, 2007, http://www. bronline. com/article_cbr_asp? guid+ED23811B-B0B2-a65B-BD99-78AD9C0A889E, (October 10, 2008). 3 Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 3 might customize and implement a U. S. software firm’s enterprise resource planning (ERP) software at a U. S. manufacturer’s China operations. These higher-end, more knowledge-based IT services (ITS) required expertise in the client’s industry. Despite the doubling of Chinese engineering graduates each year, Chinese vendors had trouble hiring enough qualified resources.

Some firms were also setting their sights on scaling the top of the ITS value ladder to offer solutions to clients based on intellectual property created by their own engineers. Indian competitors had joined western counterparts in this more lucrative business. Success in the industry depended largely on management’s ability to attract, hire, train, and retain enough skilled workers to meet growing demand, rapid technological change, evolving industry standards, and changing customer preferences.

And with labor costs accounting for roughly two-thirds of Chinese vendors’ total costs, finding ways to keep labor costs down was another key to competitiveness. Vendors made the most money by increasing efficiency and by predicting accurately market demand for specific skill sets and hiring/training for those skill sets. If they predicted incorrectly, they ended up paying for underutilized people. COMPETITIVE LANDSCAPE VanceInfo competed for business with a dozen Chinese players. Much larger Neusoft, which built its business serving the Chinese and Japanese markets, led the domestic pack by a wide margin with total offshore revenues of $145 illion in 2007 (Exhibit 4). 8 VanceInfo, which did $55 million in offshore revenues that year, ranked sixth in the industry domestically. Whereas many local rivals focused on China- and Japan-based clients, VanceInfo developed a niche as a “go-to” Chinese vendor for U. S. and European multinationals with a significant presence in the Asia/Pacific region. With $49. 5 million in North American/EU revenue, it was the top Chinabased outsourcing vendor in those markets in 2007. That said, ChinaSoft, with $45. million and HiSoft with $42 million, were not far behind (Exhibit 5). 9 Analysts expected the field to dwindle in the future as a need for scale encouraged companies to consolidate. 10 Besides domestic players, VanceInfo competed with large Indian outsourcing firms, such as Wipro, Infosys, TCS, HCL, Satyam, and Cognizant. New vendors were also emerging in Southeast Asia, Eastern Europe, and Latin America. Some international firms were establishing operations in China, driving up demand for IT service professionals and exacerbating employee turnover at Chinese providers.

Although wage costs for skilled staff were lower in China than in India and western countries, these developments were putting pressure on wages in China. VANCEINFO MILESTONES Chris Chen, VanceInfo’s CEO, chairman, and founder, stood out from an early age. Born in 1963, he was the first person from his town in Jiangxi province to attend prestigious Tsinghua University in Beijing. He went on to work for state-owned Great Wall Computer, which in 1991 transferred him to Los Angeles. China’s economic reforms at the time were still in their infancy 8 “Introduction to VanceInfo Technologies,” op. it. , p. 19. Ibid. , p. 19. 10 “CBR Project Watch-Chinese Outsourcing on the Rise,” loc. cit. 9 Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 4 and the experience exposed Chen early to U. S. business practices. Two years later, Great Wall assigned him to help spearhead a major project in China for U. S. technology firm IBM. The Early Days of VanceInfo When IBM in 1995 approached Chen to start a software localization and testing company, he and two cofounders jumped on the opportunity. “IBM explained to me India’s success in IT service outsourcing,” he said.

With IBM as the start up’s first customer, Chen secured a 300,000-yuan loan (US$1:RMB6. 8) from a friend. In 1997, VanceInfo, which originally went by the English name of Worksoft, started doing testing for Microsoft. It opened branches in Shanghai in 1999 and in Japan in 2001, taking on Fuji Xerox as a client. Growth in offshore IT services was steady, but slow. The firm grew to 80 employees in 1998 and 200 in 2001. Lack of access to financing was a problem: China’s state banks did not want to lend to private firms; venture capital was scarce; and the government did not let private companies go public.

With company profits its only funding source, VanceInfo, for instance, could not afford in 1997 to pay US$1 million to send 30 engineers to Singapore for training in order to win an important IBM project related to Y2K conversion for the European banking industry. The project instead went to India, Chen recalled. The firm also had trouble attracting talent, since Chinese engineers looked down on IT services outsourcing firms for not creating their own intellectual property. Moreover, the family members whom Chen relied on to help build his business, like most Chinese entrepreneurs those days, lacked professional management know-how.

Realizing that VanceInfo’s family-run structure was hindering growth, Chen in 2001 instigated a management shake-up. He asked family members to leave and tried to attract professional talent locally and overseas. He hooked up with David Chen (no relation), who had worked for a number of technology companies in Silicon Valley and was itching to do something entrepreneurial in China. Together, the two Chens hatched an idea to provide high-end IT consulting services for domestic clients along with outsourcing services for overseas clients.

They succeeded in attracting financing from local investors, but the new business did not succeed as expected. “Profits from IT consulting services were terrible,” said David Chen, “We spent a lot of money and time preaching those ideas [ERP and BPO] to Chinese companies. I think at that time we were too ambitious and too stretched, and that was a hard lesson to learn. As a small start-up we should have stayed very focused. ” They sold off the consulting division in 2004 to focus solely on offshore IT services outsourcing. Meanwhile, the business climate for offshore IT services outsourcing in China by 2004 had improved.

With China’s economy booming, Fortune 1000 firms started doing more outsourcing in China. VanceInfo gained a number of important international clients, such as PeopleSoft (later bought by Oracle) and Citibank, for whom VanceInfo established offshore development centers (ODCs) in China to do RDS and core banking system application testing respectively. 11 Under the ODC model, VanceInfo operated facilities and project teams dedicated solely to clients. It coveted these arrangements, in which both client and vendor invested in building the ODC, encouraging long-term client-vendor relationships.

With clients continually creating new 11 In China, offshore development centers (ODCs), are sometimes referred to as CDCs (China Development Centers) due to political sensitivities over offshoring in client countries. Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 5 software versions and ODC staff building up experience that clients did not want to lose, the work tended to be ongoing. Clients, who were extremely wary of intellectual property theft in China, favored the greater IP protection that ODC arrangements offered. Building Staff VanceInfo’s headcount by the end of 2004 jumped to 650 (Exhibit 6). 2 The industry had started gaining in prestige, making it somewhat easier to attract Chinese engineers. At the same time, VanceInfo was tidying house internally. Besides re-focusing management energy on offshore IT service outsourcing, Chris Chen believed the firm could not succeed without becoming international. To do this, he needed to hire more returnees with greater expertise in western business practices and more fluency in English than he himself possessed. Before hiring more returnees, however, he needed to resolve festering conflict over U.

S. versus Chinese business practices between the several returnees already on board and the company’s local management team. He achieved this, he said, by clearly defining the responsibilities of all executives; making each responsible for their business units management, with a direct reporting line to the CEO; and by explaining the value that each side brought to the table. International teams would work on the front lines with international clients, while local teams would focus on dealing with local governments and controlling costs.

To attract more returnees, Chen took advantage of new rules in China allowing VanceInfo to become an offshore Cayman Islands company, which in turn entitled it to offer stock options to employees. The re-domiciling also allowed VanceInfo to seek international venture capital. The firm in 2005 received funding from Silicon Valley VC Doll Capital Management (DCM) and local VC Legend Capital, with another Silicon Valley firm, Sequoia Capital, joining a second round in 2006. The VCs helped VanceInfo hone its governance structures, focus systematically on strategic and technical planning, and impose quarterly reviews. Between 2001 and 2004, we knew about all that, but we only did it in increments,” President David Chen recalled. Rapid Growth With the groundwork thus set, growth took off. Between 2005 and 2007, VanceInfo acquired seven companies and set up or acquired seven new offices in China, three in the U. S. , and one in Japan and Hong Kong (Exhibits 7 and 8). It expanded into higher-end IT outsourcing services, and added a slew of international clients and two new ODCs (Exhibit 9). Net revenues in 2007 reached $62. 7 million and net income $9. 6 million, up from $29. 1 million and $4. 4 million in 2006 respectively (Exhibit 10). 3 Headcount surged to more than 3,600 by the end of that year (Exhibit 6). 14 Although most employees were Chinese nationals, VanceInfo’s workforce boasted 25 nationalities. The company’s leaders at the level of executive vice president and above were in some cases American citizens, but all of Chinese ethnicity. They were trying to attract nonethnic Chinese managers, such as Technical Marketing Director Ken Schulz, a Caucasian 12 “Introduction to VanceInfo Technologies,” op. cit. , p. 6. VanceInfo Technologies, Form 20-F, June 27, 2008, p. 4. 14 Ibid. , p. 6. 13 Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 6

American, and the Shanghai director of VanceInfo’s Microsoft practice Hajime Hirose, a Japanese American. VanceInfo was particularly proud of its leading position among Chinese vendors in North America and Europe. But with technology and telecommunications clients in those regions accounting for the vast majority of VanceInfo’s revenues in 2007, management knew the company was vulnerable to an economic downturn in those geographies and sectors (Exhibits 11 and 12). Although VanceInfo boasted a large number of international clients, its top two clients, IBM and Microsoft, each accounted for over 10 percent of net revenues. 5 Becoming a Public Company The company in 2007 set its sights on becoming the first pure-play IT services outsourcing firm to list on the New York Stock Exchange. When the offering price for the December 2007 IPO fell far below the original petitioned price, senior management discussed whether or not to call it off. They ultimately decided to forge ahead, deeming more important the company’s goal of raising brand awareness in its most important market. The decision, said David Chen, seemed the right one given that the company “signed a lot of contracts” following the IPO, which still raised $75 million.

Rather than bristle under public scrutiny, management welcomed the discipline it forced. “We think it is a great way to help us become more process-oriented in terms of financial reporting,” he said. Prior to going public, the firm changed its name from WorkSoft to VanceInfo Technologies. While it did so mainly to avoid trademark conflict with another WorkSoft in Texas, the choice of VanceInfo reflected the company’s focus on advancing customer and employee potential as well as its desire to shift away from a purely labor-intensive model toward a more innovation-driven future.

Company executives in 2008 expected brisk growth to continue, with revenues up some 40 percent annually over the next five years and headcount hitting 20,000. To balance the rapid growth of VanceInfo’s present and future customer base with the internal changes that needed to take place to accommodate that growth, VanceInfo redistributed responsibilities among its leadership in early 2008. David Chen, who had been chief operating officer, became president. In this role, the fluent English speaker became VanceInfo’s public face to the international community and could focus more energy on the booming sales area.

In addition to his CFO responsibilities, Sidney Huang was made COO to oversee the company-wide systematization of internal business processes across the firm’s business units (Exhibit 13). GROWTH STRATEGY VanceInfo’s growth strategy historically and going forward has involved winning new clients and expanding service lines, both organically and through strategic acquisitions. 15 Ibid. , p. 6. Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 7 Service Line Expansion Labor-intensive R&D Services contributed the majority of VanceInfo’s revenues, some 63 percent in 2007 (Exhibits 14 and 15). 16 The handful of

ODCs that VanceInfo operated for clients did mostly RDS work. VanceInfo typically started out doing a small RDS project for clients, proving itself on that project, and then winning more technically and/or geographically complex projects from them. Although ITS outsourcing accounted for 37 percent of revenues in 2007, VanceInfo wanted it to make up 50 percent in the future (Exhibits 14 and 15). 17 While profit margins were comparable for RDS and ITS, ITS was a larger market and presented stronger long-term growth potential for the company. In 2008, VanceInfo’s profit margin hovered around 15 percent? ealthy for China where companies were often willing to do business for less—but not good compared to American and Indian IT services companies, which enjoyed profit margins above 20 percent. “So our profit margins would be flat,” said Schulz, “We’d probably be able to maintain rapid growth rates, but just not as rapid as if we were able to move into the IT services space as well. ” Plus, the potential client base for RDS was limited to customers who developed their own software products. In ITS, VanceInfo could potentially serve any firm with an IT system.

Explaining the firm’s decision in 2007 to invest more in IT services, James Xi, VP, General Industries Solutions, at VanceInfo in Shanghai, said: “Most of the revenue of Indian companies like Wipro comes from the financial services and manufacturing industries. We had to have a similar business model. ” VanceInfo expected strong demand for ITS in China as multinationals expanded their presence in China and the Asia-Pacific region and needed to develop their IT systems. Xi believed VanceInfo’s knowledge of the China market gave it a competitive advantage over its larger Indian rivals.

VanceInfo hoped to parlay its experience in ITS outsourcing into even higher-end Process Driven Services like Business Process Outsourcing (BPO), in which clients outsourced “non-core” functions, such as accounting, payroll, and customer service activities (Exhibit 15). Multi-year contracts, sometimes worth hundreds of millions of dollars, made BPO both highly attractive and competitive: Infosys, Wipro, Capgemini, Accenture, and IBM were among the players in BPO that VanceInfo would have to face. 18 The firm eventually planned to follow Indian and western rivals in providing solutions for clients based on its own intellectual property.

The first step for VanceInfo in climbing up the ITS value ladder was strengthening its industry knowledge in targeted sectors: telecommunications; banking, financial services, and insurance; manufacturing and retail & distribution; and technology. That meant finding enough skilled talent with domain knowledge in those industries. Because engineers needed to act as consultants as well as developers in ITS outsourcing, they had to understand their client’s business, whether it consisted of supply chains for manufacturing clients or capital markets for financial service firms.

Knowledge of business processes in China was low owing to the country’s recent transition from a socialist to a market economy and the continued existence of many state-owned enterprises. As a result, VanceInfo had to tap overseas markets in addition to the domestic 16 “Introduction to VanceInfo Technologies,” op. cit. , p. 5. Ibid. , p. 5. 18 “BPO – What Is Business Process Outsourcing? ” SOURCINGmag. com, http://www. sourcingmag. com/content/what_is_bpo. asp , September 26, 2008. 17 Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 8 market for ITS talent.

Xi, who was one of the executives leading VanceInfo’s charge into ITS outsourcing, for example, spent 15 years in the U. S. working for Lehman Brothers, Bank of New York, Deloitte Consulting, and Bearing Point before joining VanceInfo in 2006. Besides hiring talent, VanceInfo was acquiring domain expertise. In August 2008, for instance, the firm announced the purchase of a 33 percent stake in an ITS outsourcing firm serving multinational financial institutions. It had an option to buy the remaining shares, depending on the acquired company’s performance.

COO/CFO Huang explained VanceInfo’s strategy for building teams in targeted sectors: “You hire the leaders first—people within the industry—and have those people recruit and train more. For most of our critical verticals, we already have a team, so if the project expands, the team can recruit and train more people. The beauty of our business when it comes to business growth is we rarely get big projects up front; we almost always start with small projects. ” Once VanceInfo built up sufficient domain knowledge, it would be in a position to develop its own IT solutions and software products for those industries.

As of 2008, innovation at VanceInfo was limited to customization of other companies’ software for individual clients. It did not have an internal R&D budget: Instead clients paid for R&D that its engineers performed on their behalf. Investing in R&D was still a challenge for VanceInfo since the engineering hours spent on developing its own intellectual property were not billable. VanceInfo was therefore proceeding cautiously, focusing on its advance into higher-end IT services and strengthening industry knowledge on the grounds that its engineers could not develop their own IP for an industry without that knowledge.

At the same time, management would start thinking about how to create its own IP. “When we build the ITS business, we should keep in mind to put an emphasis on innovation and solutions building. We need to cooperate more with research organizations and try to get some more ideas. And we should also empower our employees to come up with more innovative stuff. We no longer need to be heavily dependent on just the time model,” said David Chen. The company had already hired some highly educated engineers with multinational experience for the ITS business and was encouraging them to keep an eye out for ways to make VanceInfo more innovative.

The company eventually hoped to hire a corporate CTO. “A traditional service company does not have a CTO, but to become very innovative, you need a CTO to be responsible for long-range innovations, not short-term numbers,” he said. Besides winning more technically complex projects, VanceInfo planned to increase revenues by winning more global ITS outsourcing projects. As of 2008, it mainly acted as clients’ China or Asia/Pacific (APAC) vendor, but had won a large U. S. manufacturer’s confidence to become its global provider for two major e-business projects.

Xi explained: “We started with one IT services project and then they said, ‘Great job, I will give you five more projects, 10 more projects’ until they made us their exclusive APAC vendor. Then [in July 2008] they invited our team to their headquarters to discuss global projects. We met with 40 to 50 managers including their CIO and Global VP. They said, ‘Great. China can do this, not just India. ’ ” This success was particularly sweet given the competition VanceInfo faced in global ITS markets from Infosys, Wipro, and other Indian rivals, which were well-known brand names in

Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 9 U. S. industry circles and had bases there. VanceInfo in comparison enjoyed little U. S. presence or brand name recognition. “We have sales offices in New York, Silicon Valley, and Seattle, but we don’t have any real engagement team in the U. S. ,” Xi said (Exhibit 8). And while VanceInfo’s Chinese engineers could generally read and write English, they typically could not speak it as well as Indian engineers. They subsequently had difficulty participating effectively in conference calls with clients in the U. S. who often had to explain project requirements over the phone with VanceInfo’s team in China. Xi’s preferred solution was to hire returnees fluent in English and American culture to take senior management positions which required them to handle contacts with U. S. clients. Organic Growth vs. Acquisition By 2008, most of VanceInfo’s growth had been organic, with some selective strategic acquisitions (Exhibit 16). Although it made four acquisitions in 2007, Huang insisted the buying spree did not indicate a change in strategy, pointing out that only one-third of revenue growth came from M&A that year.

He explained: “This is a fragmented industry so M&A should be part of our growth strategy. If there’s a perfect target we’ll jump on it. It’s just that there’s a tendency for CEOs to grow their companies through M&A because it’s easier than organic growth. They tend to ignore the danger in M&A. ” M&A was ostensibly easier, he said, because VanceInfo gained a proven team with a manager rather than having to build a team one employee at a time. It also obtained the acquired company’s knowledge and customers, accelerating expansion into desired business lines, lumping revenues, and quickly gaining scale. VanceInfo could also leverage its larger platform to make the acquired company grow faster than it could on its own. The danger of M&A in IT services outsourcing? where a company’s assets were its people? was the possibility of acquiring a team that did not integrate well, resulting in the departure of the acquired firm’s core management team and customers. VanceInfo also had to make sure it did deals at a reasonable valuation. In its experience, entrepreneurs often had unrealistic price expectations, making it difficult to close the deal.

Huang commented: “So it’s not that we don’t like M&A, we just fully recognize the challenges. This is such a great industry that even without M&A we could grow. We’ve proved it to the market in the past three quarters. Growth was purely organic. So why should we ruin this great growth story with some imprudent M&A activity? ” Whether VanceInfo grew through acquisition or organically, Huang emphasized the importance of finding the “right people. ” Executives stressed “cultural fit” between the candidate’s top management and VanceInfo’s.

They determined cultural fit a number of ways, first starting with CEO-to-CEO discussions. When CEO Chris Chen met with the CEO of Beijing-based ITC, for instance, they enjoyed a meeting of the minds. “I think they have a lot of similar characteristics: very aggressive, very good salesmen, very inspiring, very charming,” said VanceInfo’s Regional Human Resources Director Wendy Xia, who originally worked for the smaller company and deemed its 2007 acquisition and integration into VanceInfo very successful.

VanceInfo then structured deals to detect signs that the cultural fit was not as good as it seemed. Huang, for instance, informed acquisition targets that VanceInfo would divide payment into three tranches, paying the first tranche at the time of the purchase and tying the remaining payments to post-merger performance. This focus on contract details was different from Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 10 traditional practices in China, where parties often signed contracts and hashed out the specifics later.

According to Huang, the method allowed VanceInfo to find out how the candidate really perceived their future business prospects and whether the CEO and top management planned to stick around. “Sometimes everything seemed good. CEO-to-CEO, they were very happy. But when I lay out terms, the CEO backs off. That sends us a signal that they may just want to get out,” he explained. The less than stellar performance of a small acquisition made in 2005 in a “handshake type of deal” helped underscore for VanceInfo the importance of cultural fit, CEO commitment, and rigorous vetting.

The CEO of the acquired company believed his team’s performance as part of VanceInfo warranted a greater reward than management believed he deserved. He eventually quit. “He did not integrate into our culture,” Huang said. And although his team stayed, it never performed as well as VanceInfo had hoped. Huang estimated that for every completed acquisition, a chastened VanceInfo vetted 10 companies. To be successful, the acquisition also had to be a win-win situation for both sides. For example, although ITC had some Chinese clients, its biggest customer was a major European telecom company, which accounted for 70 percent of its revenue.

The European company wanted to use fewer outsourcing vendors and had voiced concerns to ITC about the firm’s ability to handle growing demand given its small size and lack of access to financing. After VanceInfo’s purchase of ITC, the European company was reassured: It became just one of five top VanceInfo clients and VanceInfo became one of the European company’s key mobile telecom vendors under development. Moreover, the ITC team started winning business from other multinationals in the same industry—business that it never would have won on its own.

Former ITC employees were enthusiastic about the purchase. “I think this is a very good opportunity for me and ITC,” said William Wei, who two months after the acquisition was promoted from running sales and marketing for VanceInfo’s ITC sub-business unit to doing the same for the entire RDS division. VanceInfo’s efforts to integrate its acquisitions through cross-staffing new managers like Wei helped ensure that the initial enthusiasm for the acquisition did not wane and that VanceInfo got the most out of its new mployees. ITC founder Howard Yu, for instance, went from running a 251-person team at ITC in 2007 to heading up VanceInfo’s RDS Mobile business unit, under which the ITC sub-business unit grew to 450 people by mid-2008, and the RDS mobile unit as a whole grew to some 800 employees. Returnee Junbo Liu managed 45 employees for SureKam when VanceInfo bought the international business unit of the IT outsourcing firm in 2005. By 2008, he managed more than 2,000 staff as the head of VanceInfo’s RDS business unit.

According to Huang, cross-staffing provided promising managers room to develop within a large organization and helped them understand VanceInfo’s culture and management approach. It also broke up the acquired firm’s tight group, mitigating turf-protection and other problems. Chris Chen also made sure to talk on a regular basis after the acquisition to the former CEOs, to understand their thinking and how VanceInfo could support them. VanceInfo was working as well on integrating acquired companies’ financial, accounting, human resource, and other systems with its own.

For instance, VanceInfo tracked acquired companies’ monthly financial activity, sending them financial reports and talking to them about their performance. Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 11 MANAGING GROWTH Company executives across the board underscored the importance of skillful management of human resources to VanceInfo’s past and future success. “We’re a service firm, but if you were to compare us to a manufacturer, our products and parts are our engineers and their skills,” explained Schulz.

When trying to figure out how best to manage its growing staff of engineers, VanceInfo’s leaders did not have any real role models in China. The most successful Chinese technology companies were focused on manufacturing and sales & marketing—not services. VanceInfo instead looked to IBM, which organized human resource management into three centers: HR function, HR services, and HR solutions. China’s labor market posed a number of challenges owing to the country’s socialist past, doubledigit growth rates from 2002 to 2007, and potential as the world’s greatest market with more than 1. 4 billion consumers.

China’s potential and its growth story inspired foreigners to pour $1. 8 trillion cumulatively in direct foreign investment into China by mid-2008, making it arguably the most competitive place to do business in the world. These factors created an “opportunity extravaganza” for engineering and managerial talent in China. The phenomenon affected attrition, retention, recruitment, and training at VanceInfo and complicated its goal of increasing its workforce to 20,000 in five years. VanceInfo Human Resource Director Kevin Liu commented: “The employees we recruit are not worried about having to find a job.

Skilled labor has high expectations. If we do not provide them attractive conditions, it’s hard for us to retain them. ” Xi compared expectations in China to those he encountered in the U. S. , where he recalled working with a 64-year-old database administrator: “His whole career was engineering. In China you can’t imagine this. When engineers here reach age 30, they want to become a manager or a salesperson. ” Recruiting Because headcount determined business volume in the labor-intensive IT outsourcing industry, recruiting at VanceInfo was an extremely important function.

Despite China churning out some 5 million university graduates in 2007, of which 700,000 had engineering degrees and 3,000 had PhDs in computer science, “We see a continued challenge recruiting the best, most suitable employees for openings to keep up with the current pace of growth,” Huang said. 19 Indeed, one VanceInfo business unit offering higher-end IT services outsourcing reported having to put three projects on hold for a key client because it did not have enough qualified staff. Another unit doing RDS work for a major U. S. irm needed to fill 43 job openings and expected any day to have another 50 to fill. Campus Recruiting Campus recruiting accounted for approximately 25 percent of net hiring at VanceInfo, although percentages varied by business unit. VanceInfo’s Shanghai branch, which did higher-end IT services outsourcing, only recruited 10-15 percent of its employees from university because it required more experienced labor. Corporate HR handled campus recruiting for the business units. 19 “Introduction to VanceInfo Technologies,” op. cit. , p. 25.

Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 12 Its team in Shanghai, for instance, visited 30 to 60 universities in Eastern China from February to May each year. In some cases, its recruiters first met with project managers in specific business units to find out the skill sets required. If they found suitable candidates at the universities, they asked the candidates to take a test. If the candidates passed, the recruiters referred them to business units to work as interns prior to graduation, after which they ideally became VanceInfo employees.

In other cases, recruiters used general criteria to scout for university students to attend special training courses, known as “VanceInfo University,” during their senior year or immediately after graduation. They sought candidates who were quick learners and not afraid to take on challenges. Candidates who successfully completed VanceInfo University were referred to specific business units. Shanghai branch head Gerry Lu estimated that 60 percent of the branch’s college hires came from the intern program and the remainder from VanceInfo University.

The branch probably recruited 100 college graduates through the two programs in 2008, up from 70 to 80 in 2007, and hoped to recruit even more in the future. (See Training for more on VanceInfo University and the intern program. ) In response to complaints from business unit heads, the firm was trying to determine best practices for campus recruiting to improve its integration with business requirements, David Chen said. Recruiting Lateral Hires The majority of new junior engineering staff at VanceInfo were lateral hires, enerally people who had worked in another firm’s IT department for two to three years, ideally not a competitor’s to avoid poaching wars. In response to the job-hopping plaguing the industry and the company’s rising headcount needs, VanceInfo employed a low-efficiency recruitment strategy: Instead of employing 5 recruiters to recruit 30 engineers per month, for instance, it might employ 8 recruiters to hire 40 engineers a month. “This is more expensive, but it’s more suitable for us,” Liu said.

VanceInfo recruited more than 800 entry-level workers in 2007, many via the Internet. Recruiters at the corporate and business unit level mostly tapped Chinese corporate recruiting websites to post job listings and scour resumes, in order to find junior staff with at least a year’s work experience. Take VanceInfo’s localization sub-business unit. It dedicated one recruiter to search sites for suitable resumes according to a set of criteria provided by project managers. The recruiter then called candidates to ask them to come in for a job interview.

Some business units compensated employees for referring candidates. Lateral hires, though more experienced than college graduates, were also more expensive: The starting salary for entry-level staff straight from college was 3,000 yuan per month and at least 4,000 yuan per month for workers with a year’s experience. Junior wages were rising some 6 percent annually. VanceInfo hoped to cut costs by hiring fewer junior people laterally and more from university. Recruiting Mid-Level Managers

Although young engineers often wanted to become managers, finding mid-level managers who understood how to manage engineers in a service business in China was a challenge, owing to China’s long manufacturing tradition, said David Chen. VanceInfo’s acquisitions accounted for nearly half of mid-level hires in 2006 and 2007, but company executives expected this Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 13 proportion to decline given the company’s selective acquisition strategy. Other key avenues for recruiting managers were through websites and by grooming internally.

VanceInfo’s corporate HR department did not yet have a centralized program for grooming managers from its engineering ranks, but rather left promotion and training tasks to individual business units. According to Chen, a key challenge going forward was for VanceInfo to figure out how to identify potential leadership candidates from middle management and turn them into top-line leaders (see Retaining Middle Management under Attrition and Retention for more on management grooming). This was particularly important given the shortage of senior managerial talent in China. It is hard to recruit suitable senior people in China. If you lose them, it’s difficult to back up the position,” Liu commented. VanceInfo senior executives with overseas experience often looked for recruits among other returnees—ones they met while overseas themselves or those referred by the firm’s VC partners. They looked for candidates, either in China or abroad, who felt they had reached a ceiling at their multinational corporation (MNC) employer and were interested in doing something more entrepreneurial.

Hajime Hirose had considered starting an IT services outsourcing company after working for Microsoft in the U. S. for eight years, when the head of VanceInfo’s Microsoft practice, Jeff Wu, offered him the chance to run the Shanghai region’s practice. Hirose, who joined VanceInfo in January 2008, commented: “Microsoft is a great company, but it’s already established. This company is growing. They don’t have many processes, which is bad, but it excites me because that means we have a lot of room to improve.

I figured that with my Microsoft and international experience I could make a difference here. ” General Industries Solutions VP Xi estimated that for every 50 resumes he received, only two returnees were a match, of whom only one accepted. Not only did candidates need to have the right skills, want to return to China, and wish to join the ITS outsourcing industry, but their families had to want to move to China as well, which was tricky if their children were in school in North America and did not speak Chinese. Moreover, they had to have realistic compensation expectations.

Xi recalled how one candidate seemed perfect until he demanded a salary similar to what he earned in North America: US$150,000 a year. When Xi could not meet it, the candidate requested an unrealistic number of stock options in the then pre-IPO company. “Everything has to be perfect,” Xi lamented. As a result, returnees accounted for only 5 percent of his staff. Given how critical a strong team of senior managers was to VanceInfo’s success, a question facing the company was whether to offer more competitive pay packages to lure high-level managers from multinational corporations.

If so, it would need to reduce costs elsewhere. Its present cost control strategy emphasized opportunity over salary when recruiting/retaining all levels of workers. One sub-business unit head doing RDS business proposed that VanceInfo deflect the costs of offering MNC-comparable wages to senior employees by putting one senior manager in charge of many new graduates, thereby reducing the need for as many mid-level managers. In mid-2008, less than 10 percent of staff were senior, 30 percent middle, and 60 percent junior. “If we had more senior people, we could grow a lot faster,” he commented.

Hiring Outside vs. Growth from Within The company’s leadership was also mulling over the best ratio of external professionals to homegrown talent for VanceInfo management. Despite the firm’s efforts to attract external Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 14 professionals, most managers to date either came up through the ranks or its acquisitions. Those who came through acquisitions were normally entrepreneurs themselves, able to fit easily into VanceInfo’s collegial culture. “Our competitors hire professionals.

Within our company, except for the finance organization, we don’t have a lot of professionals in the business operations,” David Chen explained. But VanceInfo’s goal was to become a world-class company, he said, and it could not achieve that without hiring more professionals. Homegrown talent often did not have the breadth of experience and skill sets necessary to manage global activities at a world-class level, like VanceInfo’s global sales organization. On the other hand, professionals from multinational corporations sometimes had trouble working effectively in a fast-growing start-up. For one, they ere used to a large support infrastructure to help them perform their jobs, which did not and could not exist at VanceInfo. This meant they had to do more on their own and that the solutions to certain problems at their former employer might not be suitable for VanceInfo. “If we copied everything their multinational had today, we’d lose money,” Chen said. External professionals often came with unrealistic expectations as well as large egos that clashed with VanceInfo’s collegial culture. Plus, hiring them in large numbers would be discouraging to homegrown staff, leading to greater attrition. We want to be a world-class company. At the same time, we’re very entrepreneurial. How then do we strike the right balance between a professionally run organization and our passion and entrepreneurial spirit? ” Chen asked. He believed the ideal scenario was to groom 70-80 percent of senior managers internally and to hire the rest externally to keep management’s thinking fresh. To reach this ratio, VanceInfo would need to beef up its programs for developing homegrown talent (see Retaining Middle Management under Attrition and Retention for more on management grooming). Current vs. Future Skill Needs

Management also had to strike the right balance between current business needs and its goal of expanding into increasingly complex business lines that required employees with more advanced skills than those currently in place. To do so, VanceInfo wanted to become less dependent on the time model that typified the RDS business in favor of the competency-driven model practiced by more sophisticated Indian and western IT service companies. “I think we need to look at the marketplace two years from today, determine the skill set required and then build those competencies,” Chen explained.

That said, the company at present did not plan to make big investments in building these advanced skill sets without clear indication of business demand. Instead, it planned to “invest gradually with an eye always on demand,” said Huang. Central vs. Branch Office Recruiting Management was also trying to determine how much to centralize its recruiting efforts. The Shanghai branch’s experience underscored the complexities of finding the right balance at a quickly growing operation. Recruiting at the ranch before 2006 was left to individual business units, since each had different HR requirements owing to their clients’ different technical needs. The branch had maybe 100 employees and two to three business units, with unit managers handling recruiting. The downside of decentralization was that VanceInfo had no systematic way to track recruiter performance or offer recruiters a career path toward becoming a well-rounded HR professional. Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 15 In 2006, the branch, which had grown to almost 500 employees, centralized recruiting.

Centralization worked at that relatively small size, said Shanghai Branch head Gerry Lu: The account manager in each business unit could easily communicate the unit’s human resource needs to four or five recruiters based in Shanghai’s corporate HR department, who in turn could respond effectively to overnight changes in clients’ requirements. By 2007, however, the branch had mushroomed to over 1,000 employees spread across five business units with multiple account managers handling an ever-growing number of projects.

The centralized recruitment team could not always react quickly enough to satisfy clients, who expected seamless communication and understanding. Lu reorganized recruiting again, decentralizing it somewhat. Rather then clump all recruiters together in the corporate HR department, he put two to three recruiters back in each business unit to liaise between account managers and the centralized recruiting team. The four to five member centralized team hired the unit-level recruiters (with unit head approval), performed their performance evaluations, and provided them a career track.

According to David Chen, management had not yet settled on the proper level of centralization for the company as a whole. Attrition and Retention VanceInfo’s attrition rate hovered around 25 percent annually, which was average for the industry. Attrition varied, however, according to employee level. For project managers and above, who made up roughly 15 percent of the workforce and received stock-based compensation, the attrition rate rested in the single digits, Huang said. For the remainder, junior employees generally experienced the highest attrition rates, but numbers varied by business line.

Attrition rates were below average in VanceInfo’s ODCs, mainly because employees felt they had a career ladder to climb. Attrition rates were higher in sub-business units focused on testing and lower-level activities, where little technical level differentiation existed. Many junior employees subsequently chose to leave after three years. Some went to work for VanceInfo’s multinational clients, which normally offered higher salaries, more prestige, and more professional training programs. “People leaving the company in some cases thought our training program was not comprehensive enough,” said Liu.

Attrition rates were not formal criteria by which managers were evaluated, but according to company executives, managers knew they were very important. Retaining Senior Management VanceInfo executives attributed the company’s success thus far to stable and collaborative top management. They credited this situation to Chris Chen’s open-mindedness and his willingness to give managers enough opportunity and leeway to lead their teams. “If you look at our competitors, if there are any issues at this stage it’s internal management issues, meaning that people can’t work together.

And when you have a defection at management level, it’s very disruptive,” Huang said. This fact, and the scarcity of senior managers in China, made retaining senior managers critical. Attracting and retaining senior managers, who at VanceInfo were aged 35 to 45, was tricky because the company could not afford to pay as much as multinational corporations in China— let alone as much as returnees earned in North America. Shanghai Branch head Lu estimated that Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 16

VanceInfo paid senior employees between 12,000 yuan and 30,000 yuan per month, making it competitive with local rivals. It then had to contend with 10-15 percent annual wage inflation to keep up. Tony Zhang, for instance, who joined VanceInfo in 2005, said he earned only oneeighth the amount he had made in the U. S. working in the e-commerce department of a major American insurance provider. Why then did someone like Zhang not jump to a higher-paying position at an MNC? One reason was that VanceInfo sweetened its compensation packages for the top 15 percent of its employees with stock options.

It also often supported returnees with trip allowances to visit families in North America, with help renting an apartment in China, and through assistance with visa issues and other personal matters. Most important, according to executives, was that VanceInfo used its high-growth status to provide senior staff with plenty of opportunities to continue developing their careers— opportunities that would be harder to come by at an MNC. These included giving senior managers autonomy to run their own business units and making them responsible for their unit’s profit and loss, which was uncommon in China. This company offers an open platform. So even though a returnee like me has no affiliation with its founders, I am able to utilize this platform to run my own show,” commented Executive VP Jeff Wu, who headed up VanceInfo’s Enterprise Solutions Practice and its Microsoft practice, overseeing some 900 employees, approximately 850 more than when he started working for VanceInfo in 2004. He did not believe he would have had the same opportunity to grow had he taken a position with an MNC upon his return to China after almost 10 years in the United States. Retaining Middle Management

VanceInfo also sought to retain middle managers, normally aged 27 to 35, with opportunities for career development rather than increases in wages, which were comparable to local competitors’ and ranged from 7,000 yuan to 15,000 yuan, growing at an annual rate of 10 percent. The firm’s rapid growth allowed management to offer mid-level employees ever-greater responsibilities. The team they managed might grow as the client needed more work, or VanceInfo might win a new project or new client, in which case a superior could promote a manager to take on more responsibility there.

VanceInfo’s corporate HR department did not yet have a centralized program for grooming managers from engineering ranks, but rather left promotion and training tasks to individual business units, whose programs differed. Promotions and movement between business units was also organized among business units, rather than centrally through Corporate HR. Likewise, business units had different systems for evaluating and rewarding employees. Corporate HR simply offered general guidelines.

The Microsoft business unit pioneered a differentiated title system, under which its employees received a VanceInfo title in addition to their client-supplied title. For example, employees could be a ‘software test engineer’ as far as Microsoft was concerned, yet also be classified as an ‘associate manager’ internally at VanceInfo. According to Wu, the system, which was devised internally, worked well to motivate and develop the unit’s employees. “We have throughout the years promoted so many engineers to important positions—development leads, technical leads— and many of them became associate managers and managers.

By leveraging a good title system we’ve been able to provide a clear pathway to get them moving up,” he said. Corporate HR tried Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 17 to implement a similar company-wide program in 2007, but the project stalled when the newly hired HR executive championing it left the company. The Microsoft business unit also introduced a “two-track” career path for engineers to overcome the problem of losing talented engineers to management—a common approach at high-tech companies. In China, people perceived a promotion into management as the sign of career advancement and the route to higher pay.

They therefore did not want to remain engineers even if that was where their talent lay. The Microsoft business unit offered engineers a chance to stay on the technical path, receiving promotions, titles, and pay equal to those on the management path. “We just have to communicate to people that they do not need to be a manager to move up the ladder,” said Hirose. As part of this program, the Microsoft unit offered stock options to 15-20 percent of engineers, in addition to the company-wide practice of offering them to executives at the director level and above.

For Wu, steps like these were necessary to empower employees and middle managers in particular to take initiative and come up with solutions rather than relying on business unit heads, who had an increasing amount on their plates as a result of VanceInfo’s rapid growth. In addition to overseeing hundreds of projects for MNC clients, business unit directors had to meet P&L numbers to satisfy Wall Street, win more business, and hire and retain the right staff. “We need to have infrastructure in place so that normal people can do a fabulous job,” Wu commented.

Rather than groom from within, business units that did ITS work preferred to hire senior managers externally. But Xi realized that doing so exclusively was demoralizing for internal staff, who needed promotion opportunities to stay motivated. “That’s the challenge I’m facing right now,” he said. He recently hired a native English speaker to train talented engineers, promising them a promotion if they improved their English in six months. Retaining Junior Employees Retaining junior employees was tricky in a fast-growth economy like China’s.

According to Liu, young workers had high expectations for quick promotions and salary hikes. With multinationals again offering higher salaries than VanceInfo could afford, the company emphasized opportunity and training over wages. Junior employees seemed satisfied with their VanceInfo salaries compared to those of peers in the same industry, but they stressed the importance of opportunity as part of their job satisfaction and their belief that VanceInfo, as a fast-growing company in a fast-growing industry, offered them that opportunity. If it did not, said one, “I will look for another job. VanceInfo found that retention was generally better among junior employees who attended VanceInfo University and/or worked as interns at VanceInfo before being hired full-time. That said, VanceInfo expected worse retention rates for junior staff, as employees unsuited for promotion or in low-end, non career-track jobs inevitably decided to pursue opportunities elsewhere. “If they leave after three, four, or five years, it’s okay,” said Lu. General Industries Solutions head Xi estimated that his business unit focused on providing a clear career path for its top 20 percent of employees only.

Scaling: How China-Based VanceInfo Grows Big Fast HR-34 p. 18 Training VanceInfo’s focus on keeping labor costs down, and its perpetual need for bodies to fill large numbers of entry-level jobs, made hiring a greater proportion of VanceInfo engineers straight from university an important goal, particularly if the firm wanted to expand its workforce to 20,000 in five years. However, fresh engineering graduates in China were not well prepared to jump into VanceInfo projects; their university training was very theoretical.

Recent graduate He Xiangao explained: “We always learned a lot of theory, but lacked practical experience. ” Both to overcome those deficiencies and as a recruiting tool, VanceInfo’s corporate HR department designed a co-op program with 14 universities in China. These were not the country’s most prestigious colleges, but rather quality tier-two schools that graduated smart students willing to consider employment at a relatively unknown Chinese company rather than at multinational firms paying better wages. VanceInfo University VanceInfo’s co-op program had two components.

The first was called “VanceInfo University,” in which students selected by VanceInfo recruiters attended the firm’s training classes for one to three months. At present, VanceInfo University was a more virtual concept than a physical one, with courses taking place at VanceInfo offices in Beijing, Shanghai, Wuhan, Dalian, Xi’an and a new dedicated training center in Tianjin. VanceInfo’s Beijing headquarters used to have a separate area for the classes, but the company needed that space to accommodate business growth and so courses there, as of August 2008, took place in conference rooms.

While at VanceInfo University, students attended classes in common software development languages like C++, basic software testing, and other technical areas, plus English. VanceInfo then tested the students and recommended them to different business units, providing the units information on the training they received and their English language level. Business units then sent project managers to interview the candidates. The project manager might choose, say, three out of eight candidates. Those who weren’t selected received more training.

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