Stroll along the aptly named Japanese First Street in downtown Dalian, and it's easy to forget you're in northeastern China. With its faux rice-paper lamps and shoji sliding doors, the street could easily pass for a tidy neighborhood in Tokyo. There are restaurants with names such as Fuji and Fukuhana, and signs on storefronts are all in Japanese. Kimono-clad women stand outside sushi bars and karaoke joints, beckoning salarymen to come inside. JCB credit cards -- or, even better, Japanese yen -- are accepted everywhere.
Why the Japanophilia? In part, it's history. Dalian -- the port city of Manchuria -- was occupied by the Japanese from 1905 to 1945. Although few recall those years of brutal colonial rule fondly, the worst memories of that era have faded, while a strong cultural affinity with Japan remains. There are an estimated 100,000 Japanese-speakers in Dalian, and with Tokyo just a three-hour flight away, Japanese tourists flock to Dalian on weekends to stroll the tree-lined streets, play golf at courses along the rocky coastline, and dine on bargain-priced seafood. "Most Japanese feel very welcome in Dalian," says Takashi Ota, a Tokyo-based senior manager at NEC Soft Ltd.
That friendly atmosphere attracts more than golfers and sushi fans. In recent years, Dalian has drawn dozens of Japanese multinationals looking to outsource their technology development and back-office operations. Hitachi, Matsushita, NEC (NIPNY), NTT Data, and Sony (SNE) have call centers or software development operations in Dalian. And it's not just the Japanese. Dell (DELL), GE Capital (GE), and IBM have set up customer-support offices in Dalian to serve their Japanese operations, while accenture (ACN), BearingPoint (BE), and Hewlett-Packard (HPQ) are providing software to Japanese customers such as big telcos and industrial companies. The trend is in the early stages: Japanese outsourcing to Dalian reached $375 million in 2004. But that's double the level from 2002, according to city officials. "Dalian is becoming to Japan what Bangalore is to the U.S.," says Chen Ying Sheng, Managing Director of BearingPoint China Global Development Center.
Just as in Bangalore, cultural ties are important, but low costs seal the deal. Software engineers start at about $300 a month, about a tenth of what their Japanese counterparts might earn. What's more, land in Dalian is cheaper than in Beijing, Shanghai, and Guangzhou -- not to mention Tokyo or Osaka. All told, companies can cut costs in half on service jobs outsourced to China, BearingPoint estimates.
A skilled workforce is the second part of the equation. Dalian has roughly 26,000 experienced software engineers, and its 22 universities and technical institutes churn out 3,800 software engineering grads annually. An additional 8,600 students with reasonable Japanese-language skills hit the job market each year. "Dalian has really geared itself up to produce the kind of people with the right skills," says Luke J. Yang, practice leader for the financial institutions group at consulting firm A.T. Kearney Greater China (EDS) in Shanghai.
Dalian's probusiness attitude helps, too. The local government offers generous incentives, including a two-year tax holiday on profits and an 80% reduction in value-added taxes. And Dalian has spruced up telecommunications and roads, and in 2000 opened the Dalian Software Park, now home to more than 50 foreign companies. The 3 sq.-kilometer facility houses the Neusoft Institute of Information Technology, a school focusing on IT skills and Japanese language. Accenture, HP, and Sony have set up centers to develop application software serving mainly clients and affiliates in Japan. GE Capital has 1,100 employees, 80% of them Japanese speakers, providing back-office support for more than 20 GE companies in Japan, including accounting services, customer-support call centers, and data processing for credit cards. Dell Inc.'s 400 call-center operators provide tech support and process orders from Japan and Korea.
Dalian's success, though, could be its undoing. As more multinationals set up back-office support for their Japanese operations, good employees are increasingly getting poached. Furthermore, salaries are rising -- about 25% in the past year for some jobs. Japanese-speaking call-center operators today earn up to 40% more than entry-level software writers, the opposite of the situation in Bangalore and most other outsourcing centers. The labor market "is very cutthroat at the moment, and many vendors complain that as soon as they train someone, someone else steals them," says Dion Wiggins, vice-president at researcher Gartner Asia Pacific (IT) in Hong Kong.
Despite the legions of Japanese-speaking grads, some companies warn that they already face a shortage of new hires. So BearingPoint has started recruiting Chinese living in Japan. And Dalian Hi-Think Computer Technology Co., a local software-outsourcing company with clients including Hitachi, NTT Data, and Nomura Research Institute, would like to expand beyond its current 1,700 employees but is having trouble finding the right people. "Software engineers and programmers are easy to recruit, but it's difficult to find project managers and leaders," says Zhang Limin, chief technology officer of Hi-Think.
Dalian, meanwhile, has a long way to go before closing the gap on Bangalore. India's outsourcers brought in some $17 billion in revenues last year. China's outsourcing revenues, by contrast, amounted to just $600 million last year, according to researcher IDC (IDC). But that number is growing rapidly. Outsourcing to the mainland grew by 50% in 2004 and could reach $4.7 billion by 2009, IDC figures. And Japanese demand is bound to increase. "Because of the sharp drop in the birthrate, we have to think of another way to secure good engineers," says Ota of NEC Soft, which has 60 outsourcing operations in China. Dalian isn't Bangalore yet, but the hunger to create a new Bangalore is there.
By Frederik Balfour in Dalian, with Hiroko Tashiro in Tokyo