By Dian Schaffhauser
When Freeborders announced in September 2005 that it was receiving an infusion of $20 million from existing and new investors, it was a hefty endorsement of that company’s business model and track record as a US-China IT service provider.
Funding came from existing investors TAL Investments, a division of TAL Group, one of the largest apparel manufacturers in the world, and Internet Capital Group, a venture fund that targets B2B e-commerce companies, as well as new investor FTVentures, a consortium of financial services firms.
Sourcingmag.com recently spoke with co-CEO John Cestar to learn how the company intends to use the money and just what the business model is. Along the way, he explained the nuances of delivering services to the retail and financial industries and how the company will grow to a thousand people by the end of 2006.
Can you explain what this latest investment is about?
John Cestar:
We were founded on the premise that we could build software in China for delivery to major industries here in the US. The economics for doing that are extremely attractive for clients. At the time -- in 2000 -- you couldn’t get a financial services firm to do that. They were too nervous about China. India at that time was extremely cost effective and successful. So most financial services firms were not interested [in China].
The industry that was interested was retail. It kind of makes sense. Retailers have been working in China for decades. Many of them have infrastructure in China. They’ve been getting their core products from China. China’s no big mystery to most big global retailers. They felt comfortable having their software products built and delivered from China as well...
Our initial investment went to building out the retail vertical of the business. So we invested in hiring retail experts here in the US, because it’s not enough to have engineers in China to build software. If you do that, you’re just a commodity. You have to really have industry-specific business process experts here in the US to drive strong results.
We did that and gained process maturity.
In what kinds of projects?
At that time, most custom non-packaged software the retailers were consuming was and continues to be on the supply chain side of the business. Retailers will buy a package to manage retail point of sale, for example, or buy a package to manage CRM -- customer-facing software.
Retail supply chains are extremely complicated, and retailers typically build large custom systems around categories like PLM, which we specialize in -- product lifecycle management -- around workflow and other supply chain management applications, plus applications that touch logistics and integrate into ERP systems...
Retailers see that as strategic to their businesses. We’ve got 30 retail clients in this business. They all approach it differently. They all have some twist on it that they see as competitively important. Which is why vendors have not succeeded at selling fixed packages on the supply side to retail.
Is that retail vertical business coming from the US or China reps?
[TAL Apparel Group] is an investor. They are part of this $20 million expansion round. TAL is one of the largest retail products manufacturers in the world. [Major customers include Brooks Brothers, L.L. Bean, J.C. Penney, Giordano, Land’s End, Liz Claiborne., Nautica and Tommy Hilfiger.] They’re a private company. They are extremely profitable and strategic to retailers.
Fountain Set is another one. Fountain Set produces 50% of the Gap’s knit fabric. It’s the largest fabric supplier in the world. They’re a shareholder in the company.
What’s going on in retail is a concentration of strategic work with highly technology-enabled partners. It’s kind of the opposite of what went on [in retail] in the early ’80s -- which was, just find more sources of supply, cheaply.
So we were...able to attack the market with a deep knowledge of how key strategic suppliers need to communicate with retailers here in the US.
How do you make the leap to providing services for financial services firms then?
The core strategic value that we have developed is the ability to build complex software products from scratch in China for delivery to the US. That requires a huge degree of process maturity. We work differently today than we did five years ago. Five years ago in China our infrastructure wasn’t as automated as it is now. We were much more focused on heavy lifting -- everybody jump on a new project and do it to perfection. Now we’ve got serious process maturity and repeatability...
Those processes do migrate to other industries well. We’ve completed major work for financial services firms, and the key is bringing on front end talent here in the US -- but using the same processes for defining requirements, getting technical specs to China, communicating well in a formal process with the engineers in China, then delivering back and implementing in the US... It’s all around process maturity.
We’re in the final evaluation for [Capability Maturity Model Integration (CMMI)] level 5. We should have it in December... We’ve had our auditors living with us for two years. And the audit firm is from India because CMMI -- as a value -- was really developed and proven by the major outsourcing firms in India. We realized we didn’t want to have an auditor from China who was basically looking for us to get to Level 5 as a marketing matter.
Why are financial services so important to your company?
FTVentures [is] a special kind of firm. [Their] limited partners -- people who gave them the capital to invest -- are the 33 largest financial services firm in the world -- everybody from Citigroup to UBS to Deutsche Bank to JP Morgan. They really are a consortium of financial services firms with a mission of giving companies expansion capital to deliver services to financial services.
Delivering technologies to financial services requires the same degree of industry knowledge as delivering in retail. If you’re going to work on a supply chain in retail, you’re going to have to know how the retail supply chain really works. If you’re going to work on a core banking system, a trading system, a cash management system -- whatever in financial services -- you really need to have the industry expertise to have credibility.
We were interested in their partnership, in their ability to recruit top talent, in their track record in building outsourcing services firms. You can see on their Web site, they’ve built some successful firms in India that deliver services to Wall Street firms.
The reason [the financial services firms] invested in FTVentures was to turn around and be the client for the firms that FT [funds]. It’s a virtuous circle. It’s really the bank’s money. The banks give it to FT to decide where to place it, and then the banks become customers of the companies that FT invests in.
We’re not exclusive to financial services. But in our business, you say, “Hey, let’s not reinvent the business model. India did it.” ...The top Indian firms work in multiple verticals, not just one. Of the top five Indian firms, financial services is the largest vertical. The reason is, there’s huge profit. Financial services firms dedicate a large percent of their budgets to IT and outsourcing.
I think last year, there was about $12 billion that went from the US to the firms in India... Half of it was from Wall Street.
Most major Wall Street firms decide, we are going to outsource. Then it’s a question of, what are we outsourcing? What are we keeping in-house? How strategic do we get with our outsourcing firms? Do we throw projects over the wall? Or do we actually bring them inside our firewall? So from China, they’re inside our firewall in NY and can do large-scale maintenance and integration work. It’s really a co-sourcing or co-location model. That’s where you get groups like Infosys inside Merrill Lynch. Merrill Lynch has got 2,000 people at Infosys.
Who’s your competition?
If you go in the Internet and put in “China software outsourcing” or “China solutions outsourcing,” you’ll see a bunch of entrepreneurs from China who have no understanding of how major global companies consume services... Lots of companies that are working in the China market are not sophisticated enough in terms of their process, in terms of their English language, in terms of their business knowledge [or] knowledge of how major western clients work, to deliver to them.
[So the competition] really is the guys from India.
Now, China has an advantage over India that’s significant. We’re not saying that all the business in the world is going to move from India to China. But China is more cost effective than India, significantly. And part of that is what I call “the disease of success.” India has been so successful, it’s gone haywire. So many firms are out there now, and there’s been wage inflation. There’s been a lot of turnover at the firms. And the clients feel this. India firms are passing on price increases to clients, because their own wage bases have gone up 60% in the last 18 months.
That’s driving people to look at China for the first time.
Also, more importantly, in the financial services world, there’s the sense that major firms got overcommitted to India. Just as a matter of risk mitigation and diversification -- they are bankers after all -- they need to send 5%, 15%, half of it, whatever the number, to China. They have to diversify away from India a bit.
The only place where you can get the kind of scale that you can get in India is China.
What are your goals?
We have 400 [people] now in China. We plan to be at a thousand in 12 months. We’re hiring between 30 and 50 people a month. And we’re being selective in hiring. The good news is the talent pool is huge and well qualified. The education system is producing results. More importantly, multi-nationals are training good technologists in China.
So IBM has huge facilities in China. Microsoft has huge facilities in China. What they’re doing is not what we’re doing, which is offering talent from China to the rest of the world. They’re taking Microsoft products from the US and using teams from China to localize that product for the China market.
Since we started four years ago, what’s gone on in China is a dramatic shift in multi-nationals going to China. There’s not an industry in the US today that has not identified China as their number one growth story. Four years ago, Microsoft had 50 people in China. Now it’s 5,000.
It’s enabled us to tap into that. It’s great training. We’ve hired many people from multi-nationals.
They know as technologists that their careers become valuable if two things happen: One, if they work in an English-speaking environment. So if you’re localizing an IBM product for China, you’re speaking Chinese, you’re delivering a product for the Chinese market that’s Chinese-based. English is important. The other is the opportunity to work for multiple western-based clients outside of China. You know if you’re delivering to a major bank in NY and you succeed, that is a major accomplishment and career builder.
What is recruiting like in China vs. the US?
...The key to success in operating in China is not having expatriates run the technology facilities. Expatriates meaning Americans, Indians, anybody outside of China.
What’s lacking in China -- which is true of many developing economies, but particularly in China -- there are outstanding technologists -- world-class. We have many clients who will attest to that. The challenge is identifying and recruiting good senior managers, who know what it means to be good custodians over someone else’s assets, not theirs.
Part of it is the history of the country. There are many bureaucrats in that economy... In the US, on the left hand side [of a bell curve], there are relatively few bureaucrats in our economy as a percent of the working population. Relatively few people work in government. Most people work in the middle, and professional management. And we have relatively few entrepreneurs on the right hand side as a percent of the working population. China is the exact reverse of that curve. There’s a huge group of bureaucrats who are well trained technologists, who work for state-owned industries. And they want to make the leap to a private company. But if you hire those guys, nothing gets done. They just don’t know how to deliver the quality. On the right hand side of the curve, there’s a huge group of entrepreneurs in China, but if you’re going to rest your company’s fortunes on that group, it’s a big risk. You’re not really sure what they’re up to. In the middle of the curve, there’s a tiny group of professional managers.
We spend all of our effort, identifying, recruiting, training and retaining those people. Initially we recruited at the top -- 20 people from the US who were Chinese citizens, who were from the US or Canada or Europe who were on H-1 visas or some kind of visas and working for western software companies... They had a taste for how western clients consumed technology services.
So we were able to populate our initial management ranks in China with those people.
Then [those management groups] spend a great deal of effort identifying and recruiting in China.
We’re well known in China. Where we are in Shenzhen -- in southern China, fairly close to Hong Kong -- [there’s a] national draw. If you go around the facility and ask people where they’re from, nobody’s from Shenzhen. But they all go there because of the opportunity and because major firms like IBM and Microsoft are set up there.
We recruit through our network in China. We use Web sites. We use job fairs. We do use recruiters as well...
Last year, we went through 20,000 applications and invited 3,400 for first-round interviews and testing. We invited 800 back for second round interviews and further testing. We gave 200 offers and 170 accepted.
What we were recruiting for last year, we definitely emphasized English language. People must speak English as well as being strong technologists. We tie our comp plan to demonstrating increasingly proficient English skills. You can be a great technologist, but if you can’t pass a level 2 English exam that’s online, then you don’t get your comp.
...We do a lot of training around how to speak with clients. What clients are concerned about, how to ask questions, how to listen. These things are not obvious to people who are good technologists in China but haven’t worked with Western clients...
What are the US-based folks doing?
We’re working in three distinct industries: financial services, retail and high tech. The main expert [for retail, for example,] used to run the women’s business at Levi Strauss & Co. She has a couple of decades in retail. All of our retail team has great degree of retail credibility and business credibility. So what they do is initiate discussions with the client. Clients typically are very vague in the beginning: “We need a system to coordinate with 10 suppliers.” It’s the CIO’s job and his or her team’s job to translate that mandate into a technology project that meets the needs of the end users and that works and that is cost effective.
The industry experts on the front end will work with the business users to really flesh out what the use of this product is, will define the high-level requirements, will drive those high-level requirements into detailed use cases and detailed functional specs.
Ultimately those specifications are transferred in standardized documents we’ve developed over the years to a team lead in China...someone with eight to 12 years of experience in application development and in running teams. That team lead will take the hand-off.
And we have deployed in China solutions managers who will get assigned to the project as well, who will clarify any questions on the spot in China about requirements, will build a sizing plan and execute against the documentation.
Sizing?
Sizing is the key to the whole thing. It’s the key to setting the project delivery schedule, setting customer expectations, it’s the key to pricing. And we are very highly productive in China. Yet we don’t push people 80 hours a day. It’s important to setting client expectations.
Most of the clients take our deliverables and use them in their business. If we slip on timelines, it’s very painful for them. We’ve gotten sophisticated about understanding, “OK, in a product cycle in this retailer, they need this system in place by June 1st, in order to hit a Jan. 1 set of deliveries that need to be in stores by May 15th.” The implications of our delivery slipping is major for their business because we understand how that retailer deploys software. We understand that retailer’s own merchandising calendar.
One of the reasons our growth has been so swift is that we are close to the client, and we make decisions close to the client. We push decision authority in this organization down to client partners who live with our clients.
We’re doing the same with financial services. We’ve been building HR systems for financial services most recently. And the whole compliance area in financial services is a very big growth area. [Sarbanes-Oxley] is a subset of that.
Like retailers, financial services firms are global. They work in many different geographies and legal environments.
We’re working on a number of systems that give early warnings to managers back in the US if managers in a different country are out of compliance, either with specifics of regulations in that country or with the global regulations internally at the bank. So it’s these training systems that will ask critical questions of key managers every week. [As a manager] you’re able to understand pretty quickly if their understanding of regulations is sufficient. And if not, you get them additional training.
What systems are you using?
We’re heavy users of Skype. We’re heavy users of formalized process. If you start talking informally on the phone -- you can do that to clarify specific issues, but if that’s the process, there will be communication error. If we’re ever off a 10th of a degree in a delivery, it’s because of communication errors. You want to squeeze out all communication error. So we have documentation and processes around issue resolution, around decision checkpoints, around escalation procedures. We constantly train on and reinforce process. You cannot work in an ad hoc way.
We’ve invested in systems to do it, very sophisticated software systems from companies like [IBM Rational Software] and others that help to put a workflow process around issue resolution.
Talk about intellectual property. I can see it be important to financial services, but retail?
I think the whole category needs to be taken very, very seriously. I wouldn’t want to distinguish between industries. It is true, if you build a complex back end system [for retail], there’s no commercial value to anybody. You’re not going to sell that thing on the streets of Shenzhen. But at the same time, these systems are delivering competitive advantage to the client. They don’t want any of that knowledge going anywhere else.
It’s important that we have security inside our facility... When you come to our facility, it looks like it’s in San Jose CA. It happens to be in China. It happens to enjoy the world’s most cost-effective environment for doing this kind of work. The teams are dedicated and the infrastructure is secure. And there’s no chance that work from one client is suddenly going to show up in the environment of another client. We encourage our clients to visit us. This is a big reason we’ve grown so swiftly. When people do come to visit, they say, “Wow, this place does look like it could be in California.”
For example, there is no paper. You will not see a scrap of paper. No one can bring anything in, no one can bring anything out. Everyone is searched on the way in and on the way out. We have no USB ports. They’re all blocked out. You can’t email, except for dedicated people in dedicated rooms.
...It looks almost like we’ve gone too far. The people in China weren’t used to that. [They’d say,] “What are we building in this place?” It looks like a government lockdown.
Now it’s clear, you’re working on important work. This work you’re doing is for the world’s largest companies. And it’s strategic and competitive to them. It actually adds seriousness to the environment. It’s like if you wear a suit to work, you probably act more serious than if you wear jeans.
So what is the dress code?
...We don’t require people to wear coat and tie, but everybody has to wear a collared shirt with slacks. No short skirts.
At first, people said, “Wait a minute. We’re executing over here. We can’t be marketing.” And we said, “No, no. You may not be explicitly marketing, but this facility is a big part of our company’s presentation, because people want to come see it.”
We want to squeeze out the whole thing that this is a college all-nighter. It’s not a college all-nighter. It’s a professional environment. We’re going to do all we can to eliminate all the heavy lifting. We want to run a facility that’s highly automated. The work is very professional, but well meted out, well planned. We’re not having a lot of crisis. It’s not a success in my view if we have to get our best people around a problem, stay up all night for three days, to deliver to the client, even if the client is happy. That’s too much heavy lifting.
Useful Links:
Freeborders
www.freeborders.com/
An interview with Freeborders' other co-CEO, Ramsey Walker
www.sourcingmag.com/Home/home.aspx?i=02_12/12/2005_plink_895_1
How To Start Working with China (18 Practical Tips)
www.sourcingmag.com/home/home.aspx?i=02_12/...5_cn_740_5_00_00
TAL Group
www.talgroup.com/eng/home.html
FTVentures
www.ftventures.com/
Internet Capital Group
www.internetcapital.com
About the Author:
Dian Schaffhauser is the editor and publisher of Sourcingmag.com. Contact Dian at dian (at) sourcingmag.com.
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