Discussion Paper No.331
Business Creation and Transformation Processes inFour Software Companies in Dalian, China:
Commonalities and Differences
Yan Zhang and Nozomu Kawabata

March 2015

TOHOKU ECONOMICS RESEARCH GROUPGRADUATE SCHOOL OF ECONOMICS AND
MANAGEMENT TOHOKU UNIVERSITY
27-1 KAWAUCHI, AOBA-KU, SENDAI,
980-8576 JAPAN1

TERG Discussion Paper No.331
Business Creation and Transformation
Processes in Four Software Companies in
Dalian, China: Commonalities andDifferences
Yan Zhangi and Nozomu Kawabataii
March 2015

TERG Discussion Paper, No. 331, Graduate School of Economics and Management,
Tohoku University.

Graduate School of Ecnomics and Management, Tohoku University, 27-1, Kawauchi,
Aoba-Ku, Sendai 980-8576, Japan, E-mail: yan_zhang315@yahoo.co.jp
ii Graduate School of Ecnomics and Management, Tohoku University, 27-1, Kawauchi,
Aoba-Ku, Sendai 980-8576, Japan, E-mail: kawabata@econ.tohoku.ac.jp
i

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Business Creation and Transformation Processes in Four Software
Companies in Dalian, China: Commonalities and Differences
Yan Zhang & Nozomu Kawabata

Abstract
This study aims to determine the nature of entrepreneur behavior, business creation, andtransformation of software companies in Dalian City through case studies.
Four companies that were launched in the 2000s were studied. These companies' businesses
initially involved labor-intensive processes of offshore software development for the Japanesemarket. However, they were confronted with the challenge of business transformation after the
global financial crisis. Their set agenda included forays into high-grade processes, diversification of
products and services, and exploitation of the Chinese market.
All four companies tried to transform themselves by creating a unique advantage. The
development of such an advantage was a focal point for the software companies to transform theirbusiness structure that relied heavily on labor-intensive offshore development. The acquisition ofhigh-grade human resources was an important factor for gaining this advantage.
In the field of offshore development for the Japanese market, cross-border cooperation acrossprocesses was necessary to advance into high-grade processes. The “on/off-site” hypothesis wasvalid, while having a Bridge System Engineer (BSE) in the company was not a prerequisite.
Differences were observed across the four case studies. In China, Japanese-affiliated companies
approached other Japanese-affiliated companies, while Chinese companies approached other
Chinese companies. Moreover, the disparity of resource availability for transformation was large
between big companies and small- and medium-sized companies. As a result, a difference wasobserved in the strategy employed by the companies for transformation, especially in personnel
management in the face of high liquidity in the labor market in China.

1. Introduction(1) Issues and Perspective
In a previous paper, the authors presented an explanation of how the software and information
services industry in Dalian, China was built. The industry formation was actualized through theexecution of the local government’s industrial policies, the entrepreneurial formation of local
companies through various routes, including brain circulation, and the foreign companies’ expansion
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into China. All factors operated in coordination with one another (Zhang & Kawabata, 2012).
However, concerning the specific processes involved in local company formation, the authors wereable to study only the three largest local companies. Further, regarding the entry of foreigncompanies into the market, they were able to provide just a broad outline of offshore ordering by
Japanese companies and their entry into the Dalian market.
As of 2011, there were 1,200 software and information services companies in Dalian.1 Amongthem, there were only 13 companies (1.1%) with 1,000 or more employees, 68 (5.7%) with 300-999
employees, 324 (27%) with 100-299, and 759 (66.3%) with fewer than 100. The average number of
employees per company was 104. Considering the sales figures, while only 77 companies (6.4%)
generated yearly sales revenue of 100 million yuan or more, 488 companies (40.7%) had sales
income of less than 1 million yuan, with the average annual income being 5.88 million yuan. A pointof interest is that while 78% of all software companies in the city exhibited commercial profitability,
only 36% of those earning less than 1 million yuan were profitable, suggesting that differences incompany size may merit focus.
Regarding investor types, the 307 foreign companies (excluding those from Hong Kong, Macao,
and Taiwan) that represent 25.6% of Dalian’s software companies recorded higher rates of
profitability and export competitiveness than other companies did. They account for 48.6% of sales,
88.2% of exports, and 32.6% of sales profits.
The topic for discussion in this study, which uses a case study methodology, is how the different
types of companies constituting the Dalian software and information services industry acted
entrepreneurially to create new business and to cope with any problems related to business
transformation as they grew. Through this discussion, the formation, development, and process ofchange in this industry may appear more palpable. With regard to the industry in Dalian havinggrown as a base for offshore software development services for the Japanese market, this study
focuses on how a system to manage offshore software development might be organized when stagesof the development process are split between Japan and China. The study also assesses how thebusiness of those companies might diversify away from its dependence on offshore softwaredevelopment for the Japanese market. In so doing, we will evaluate the commonalities anddifferences in business creation and transformation processes by differentiating the companies
according to their scale, that is, whether the company is large or small-/medium-sized, and byinvestor type, that is, whether the company is local or foreign.
In this study, the facts of each case are derived primarily from the records of interview surveys
that took place in August 2010 (the E Company) and August 2011 (the XA, BD, C, and E
Companies), and these data were supplemented with publicly available information about eachcompany. The names of the companies have been, and will be kept anonymous, and the findings,
including any possible misrepresentations, are entirely the responsibility of the authors.
4(2) Literature review
This section reviews case studies from previous research, a method commonly employed by someindustry researchers in Japan, on offshore software development in Dalian as well as across China.
The results of all the studies of Chinese offshore software development companies since the latter
half of the 2000s indicate that Chinese companies are advancing beyond labor-intensive coding andunit testing into highly skilled areas of the development process, such as requirements definition andoutline design (JILPT, 2006; Takahashi, 2009; Umezawa 2005, 2007, 2011; Xu, 2006). Consequently,
almost all the research correspondingly highlights the importance of human resource management insecuring highly skilled talent.2
Takashi Umezawa was the first researcher to perform a series of studies and propose a perspective.
According to Umezawa (2007), when a software company in China receives a Japanese order foroffshore development, it requires “on/off-site development”; that is, a part of the work has to be
performed in Japan with the Japanese customer, rather than the entire work being completed in
China. Further to the detailed design stage, even offshore development requires that some work bedone in Japan and information, like dealing with specification changes and answering questions, beexchanged with stakeholders in Japan. Moreover, if the company participates in upstream phases likerequirements definition or preliminary design, a systems engineer from the company or its Japan
branch may be stationed at the client’s office, or the development may take place at its Japan branch.
Thus, a combined on/off-site approach to development becomes necessary. Furuya (2008) adopted avery similar perspective to the one Umezawa developed from his case study findings. He has
identified the key challenge in offshore development management on how to minimize the cost ofcommunicating design information alternating between Japan and China. The current study
continues this line of investigation.
It is, however, important to note that as his research advanced, Umezawa’s opinions changed
regarding the role of the bridge system engineer (BSE), a person who coordinates the onsite andoffshore development. In his 2005 study, Umezawa distinctly proposed that international travel wasessential for a BSE; however, since his 2011 research, he no longer sees international travel asnecessary, or the role of BSE as vital. This has led to the unresolved problem of how an argument for
the “on/off-site development” model can remain valid when the arguments for the BSE role havebeen challenged.
Studies of companies in Dalian can be split into two groups. One investigated whether the Daliancompanies entered into the more technically sophisticated stage of software development operations(Gao, 2010; Habuchi, 2010; JILPT, 2006). The other emphasized the differences in strategies
adopted by companies according to their scale (Organization for Small & Medium Enterprises andRegional Innovation, Management Support Information Center, 2007). According to the results of5this latter research, which are important to this study, companies with 100 or fewer employees
specialized in uncomplicated tasks like coding, as subcontractors to Japanese companies. As thecompanies expanded, they oriented themselves toward proprietary software package development,
IT outsourcing for the Japanese-affiliated subsidiaries in China, and technically advanced stages ofthe development process. The view that strategy differs with company scale provides a basis for partof this study’s investigation.
Case studies of IT technical expert hiring practices are quite limited. Among them, Mizuki
Kobayashi observed from a study of 3 companies in Shenyang and Dalian that, characteristically, all
the companies “deploy more internally developed personnel in the operations of Japanese companies
that give importance to developing staff internally and deploy more externally hired personnel in theoperations of European, American, and Chinese companies, which assign significance to softwaredevelopment results” (Kobayashi, 2012, p. 172). However, this finding does not eliminate thepossibility that other factors may influence personnel policy. Building on previous research, we
decided to focus on how volatility in the Chinese labor market, company scale, and investor typemay influence personnel policy.

2. Case Studies(1) The XA Company: A large local company3
1) Company overview
The XA Company is a local entity capitalized with 100 million yuan, and 100% owned by the X
Group. As of 2012, the company has more than 2,000 employees (XA website). The X Group is amajor private real estate company in Dalian and is the parent company of Software Park (SP), whichmakes up the center of the Dalian Hi-tech Zone. In Dalian in 2011, the XA Company was among the
top 20 exporters of software, and among the top 10 in sales of software products, data processing
and administration services, and software services outsourcing (Dalian Institute of Software &Service Outsourcing, 2012, pp. 152-157). It is a CMMI (Capability Maturity Model Integration®)
Level 3 certified organization.

2) Founding and growth process
The XA Company was originally SP’s IT Business Department, established in 2003. SP’s IT
Business Department developed technical experts and deployed them as programmers and engineers
at SP tenant companies, as part of SP’s strategy to increase its market predominance. After a defined
period, these consultant programmers and engineers were transferred to the tenant companies as
full-time employees. The IT Business Department expanded substantially; and, because it grew to bevery different from SP’s other departments and businesses, it was spun-off in 2006 as an independent6

entity called the SPA Company. It started retaining its employees, who began providing services onbehalf of the new company. At the time of going independent, along with the IT Business
Department with a few hundred employees, SPA acquired SP’s Outsourcing Solutions Center (OSC)and its subsidiary in Japan. The role of the OSC department was to manage requirements between
new SP tenant companies and customers. The number of these OSC employees was small, but they
all possessed Japanese language ability and 2-3 years of IT experience. SP remained embedded in
the SPA Company name until 2009 after which it became completely independent, changing its
name to the XA Company.
The XA Company, in order to secure technology and personnel for its growth, engaged inacquisitions. First, it acquired a company in Chengdu that possessed a mobile communications
protocol that, it believed, could spread in China in the future. It also acquired two Japanesecompanies. One was acquired to assimilate its personnel who could speak both Japanese andChinese. Its employees included 40 BSEs. The other was acquired for its visible light
communications technology apart from its personnel. In addition, XA also acquired a local
embedded software company.

3) Changes in the business structure
SP’s IT Business Department engaged mainly in subcontracted application development and in
business process outsourcing (BPO), but it began to strengthen its consulting capabilities with an eye
on participating in more advanced phases of the development process. When the company changed
its name from SPA to XA, it added technology design and consulting to its historical businessdomain that had been limited to outsourcing services. With regard to classification of business,
information technology outsourcing (ITO) had decreased to less than half, while BPO had increased.
It also began marketing services to domestic Chinese, European, and American companies in
addition to its historical targeting of the Japanese market. At the time of this study, however, Japan
still accounted for 70% of its operations.
Among Company XA’s operations, the services for Japan are divided into 5 groups: onsite andoffshore application development and maintenance (ADM), as per the services explained above;
information management services (IMS); embedded software development (EBD); BPO operations;andproduct

engineering

services(PES)

focusedoncomputer-aided-design/computer-aided-manufacturing (CAD/CAM). These services had originallybeen conducted in parallel with each other, but because of the reduction in application developmentin the wake of the 2008 financial crisis, the BPO and IMS businesses have received a relatively
higher priority since 2011. The BPO business has expanded, for example, with staffing forsubscription processing services for Japanese mobile phones reaching a scale of about 650 jobs. At
XA Company, IMS, as BPO requiring IT knowledge, includes technical support/help desks and7system operation monitoring. Taking advantage of its extensive experience in ITO, the company
makes effective proposals in BPO. In the company’s opinion, conducting BPO operations in China
not only reduces unit prices but also increases efficiency.

4) The management of offshore software development
When orders are received from Japan for offshore development, the requirements definition andpreliminary design are usually conducted in Japan, and detailed design, coding, and unit testing takeplace in Dalian. However, Company XA participates in the requirements definition and preliminary
design phases in Japan, and partners with the client to create the technical specification. When suchwork takes place in Japan, various models are possible, such as XA sending an SE to work at theclient site or working on the design at XA’s Japan subsidiary, XAJ. The purpose is to reassure theclient, as is XAJ’s hiring of Japanese technical experts; and, some clients want their contracts to bewith the Japanese branch. XAJ is entrusted with the responsibility of consulting, sales, andtemporary provision of onsite technicians to clients. Project leaders (PLs) and SEs sent by XA or
XAJ to the Japanese client subsequently move to Dalian after the upstream phases. In Dalian, theysupervise the offshore development team. Although at XA, the people performing this role are called
BSEs, they are not merely mediators of information.

5) Strengthening research and development, and hiring and retaining personnel
XA has a research institute inside the company. This institute has laboratories to facilitate researchin embedded applications, cloud computing, and mobile technology. Besides, it promotes researchand development in partnership with Chinese research institutes and universities.
XA recruits and hires talent from all over China and Japan. In addition to the Chinese employee
turnover rate being high, it has become even more difficult to retain talent because the New Labor
Law of 2008 made it possible for individuals to quit companies freely. XA focuses on thedevelopment of its personnel and also employs external recruiters to identify high-level talent.
Believing that employees are not interested only in money, but also in feeling motivated, having
future opportunities, and finding the work worthwhile, XA also tries to improve retention through,for example, new employee training and project training.

(2) The BD Company: A major Japanese electronics company’s software subsidiary4
1) Company overview
The BD Company, a 100% owned subsidiary of the B Company, a major Japanese electronics
manufacturer, was established in 2004 in Dalian Software Park in the Dalian Hi-tech Zone. It has acapital of US$ 2.38 million and engages 320 full-time employees. In addition, there are about 100
people on assignment from B’s business partner companies. In Dalian in 2011, BD ranked among the
top 20 companies for software exports, in the top 10 for software product sales, and in the top 20 for8sales of software service outsourcing (Dalian Institute of Software & Service Outsourcing, 2012, pp.
152, 153, 157). The three reasons the company preferred to operate in Dalian were its geographicalproximity to Japan, the availability of high-quality Japanese-speaking personnel for hire, and its
system of preferential tax treatment.

2) Business structure
The company’s primary business is the development of embedded software for B’s products: B
brand digital TVs, audio equipment, DVD players, telephones, etc. In addition, it develops software
for loading into semiconductors, for lighting systems at Olympic venues, for municipal energy
management solutions, and for B’s internal administrative applications. More than 90% of its work is
outsourced from the B Company in Japan, and the remaining 10% is from B’s business units in
China. While BD generally does its own development, it also outsources some development to local
companies.

3) The management of offshore software development
While creating a requirements definition is essentially the client’s responsibility, staff areoccasionally deputed to the client site, and sometimes the client travels to Dalian to conclude theactivity. System design, programming, and testing take place at BD’s office in Dalian.
Communication during those stages of the process takes place mainly via video conference andemail, with occasional trips to each other’s offices. At BD, project leaders are referred to as BSEs.
They are not only capable of communicating in both Chinese and Japanese, but they lead daily
progress reviews and software development as engineers capable of advanced design. When thecompany was first founded, BD was only able to contribute in simple tasks like unit testing.
However, now experienced engineers are enabling its engagement in design work.
Generally, BD always conforms to its committed deadlines; and, since 2010, its softwaredevelopment productivity (software development efficiency per engineer person-month) has been
above the average for the Japanese domestic software companies that are vendors to B, and it isaiming to surpass that average by 20% in 2011. Furthermore, the development cost efficiency
relative to Japan, that is, the relative rate of the cost of developing the same software completely inJapan to BD’s cost of development, has currently reached 180%, and BD is working toward raising it
to 200% at the earliest. In other words, even with the overhead costs associated with offshoredevelopment, BD is still trying to be able to develop software at half the cost of developing it inJapan. To offset rising labor costs in Dalian, the company will increase development productivity
and outsource work to other places in China with cheaper labor costs.

4) New business development
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The company’s medium term plan includes three objectives: to expand its businesses in China,
strengthen its software development process, and to put into practice a quality management system(QMS).
First, BD has a plan to raise the percentage of sales for China-related business. It is currently 50%,
but it is targeting 65% in 2013, and 75% in 2015. It is aiming to expand in growing business fields
by collaborating with the Dalian municipal government. In addition, the growing Chinese market is
an attractive target for new products for which BD is aiming to develop software, primarily in theareas of energy management solutions, digital broadcasting and communication services, automotive
systems, healthcare, as well as related internal administration systems for the B Company. The B
Company also sells semiconductors with embedded software developed by BD even to the Chinese
home appliance manufacturers to increase the sales.
Next, there are several reasons that require the development process to be strengthened. Unless the
product meets the Chinese specified standards and regulations, it cannot be sold in China. To avoid
this problem, the headquarters of the B Company in Japan needs to cooperate not only with BD, butalso with other subsidiaries in China. Furthermore, given the difficulty in understanding Chinese
customer preferences in detail, completion of requirements definition phase in Japan is becoming
irrational. It illustrates the need of collaboration between B and BD.
Finally, improvement of quality management is necessary to expand BD’s business in the Chinese
market. BD is attempting to obtain a CMMI Level-4 certification for the entire company. Moreover,
it is putting PDCA (the plan-do-check-act cycle for continuous improvement) into practice, based on
key performance indicators.

5) Recruitment and development of human resources
BD offers an annual technical training class for around 30 students each at three Chinese
universities: Northeastern University, Jilin University, and the Dalian University of Technology. New
graduates from those universities occupy 70% of BD’s new fresh recruit. The two-month duration
classes are scheduled from May to July on workday evenings or Saturdays, and they facilitate
discussion on a problem posed by the Japanese company for which the technical training isorganized. In 2011, the challenge was to develop a music player for Android, and the solutions of all
the teams were of such high quality that it was difficult for BD’s general director to believe they
were created by third-year college students in just 2 months. BD advocates that its development
productivity surpasses that of Japan because of the excellent quality of the university students it
hires.
In the 7 years since its inception, the development of technical experts at BD has primarily been
led by people assigned from Japan providing on-the-job training (OJT). Additionally, as an incentive,
team leaders and project leaders are frequently sent to Japan, an assignment for which being selected10

is a matter of pride. The results of this approach are discernible in the growth of the first- andsecond-year student hires. In addition, BD hires experienced persons, both in Japan and locally in
China.
BD recommends the employees to pass level 1 of the Japanese-Language Proficiency Test after
four years of graduate hiring, because they have to communicate with clients in Japan directly using
the Japanese language. This employee group shows relatively high attrition rate because of thehis/her inability to attain such level of proficiency. Additionally, there are personal reasons such as
looking for a marriage partner in their hometown. However, as long as resignations are limited to afew employees leaving after working for three or four years, BD does not get perturbed because theirwork can be subcontracted. The employees with more than four years’ experience do not resign as
they adapt to the B Group’s corporate philosophy. It means they are not attracted to other companies
with slightly higher salaries.

(3) The C Company: A local small-sized company5
1) Company overview
The C Company is a local company founded in 2004 with 100 million yen in capital and has 180
employees. A Japanese IT vendor invested 2.5% of the capital, and employees hold 10% stake in thecompany. The headquarters are located in Dalian Software Park in the Dalian Hi-tech Zone, andthere is a branch office, the CJ Company, in Yokohama, Japan.
The founder, Mr. H, is a graduate from the Dalian University of Technology. He spent 2 years inJapan as an IT trainee and after returning to China, worked in the IT industry. Later, he co-founded
this company with five others. All six founders were computer experts with training experience inJapan. The company started out with a little over 10 employees.

2) Business structure
The C Company is mainly engaged in offshore IT services for Japan and provides IT services toChinese companies. Japan accounts for 80% of sales. The IT services for Japan, in addition to
offshore software development, include the provision of services such as Chinese localization ofJapanese software products and Chinese marketing support. Regarding IT services for China, thecompany provides comprehensive service packages from consulting to system design, coding, andsystem implementation management. In addition, they develop software products and provide BPO
services, albeit only five employees are devoted to BPO.
The development projects vary in scale from 2 to 200 person-months. C has a CMMI Level-3
certification and an independently developed form of PDCA quality management methodology.
Specifically, the PDCA cycle has been thoroughly implemented through analyzing quality trends andtheir causes, based on charts about person in charge, difficulty, workload, and test results in each11

function of projects.

3) The management of offshore software development
Most project orders are received through 5-6 primary vendors with whom C has well-establishedrelationships. Japanese customers like to contract with the Japanese branch so that any potential
problems could be resolved locally.
C employs three patterns for its offshore software development business. Pattern 1 consists of
only coding, unit testing, and troubleshooting; hence, for the Japanese customer, the cost savings are
small, but implementation is easy and low-risk. In Pattern 2, the preliminary design, detailed design,coding, unit testing, integration testing, and troubleshooting take place in China. For the Japanesecustomer, the cost savings are good, but because this pattern requires extensive knowledge of thebusiness and design ability, it involves a high degree of difficulty for the Chinese side. In this pattern,coordination between C Company and the customer is extremely important. Pattern 3 represents akind of contract for a dedicated offshore development team, in which, upon receiving a request fromthe Japanese customer, a dedicated Chinese team manages the research, design, coding, and testing.
Trust between the companies is a premise for this pattern, which can also be said to be an extensionof Pattern 2. Quality and productivity are high, and cost effectiveness is extremely good, but the
Chinese team must be knowledgeable about the business and possess excellent design capability. C
considers that communication problems, and not just the technological or business challenges, areoften the cause for offshore development failures. To manage this risk, they regard communication
between the Japanese and Chinese project managers (PMs) to be very important.
In addition to Patterns 1 and 2, there are many intermediate variations of C’s offshoredevelopment for Japan. C attempts to expand its participation into the more advanced stages of thedevelopment process. However, as the company receives its orders through primary vendors, there
are few opportunities for it to contribute in requirements definition.
C copes with fluctuations in work volumes by sharing staff with its three partner companies,
which implies that, in total, it has access to 300 technical personnel.
CJ, the country branch and the base of operations in Japan, collects information, conducts sales
activities, prepares contracts, and provides IT services to Japanese customers. All of CJ’s 30
employees are called BSEs, mostly assigned from Dalian, with five people having being hired inJapan. When a project includes preliminary design, it is primarily managed by CJ’s BSEs at thecustomers’ offices, but an additional scenario is that some employees from the main office may be
deputed to Japan on a short-term assignment. Subsequently, the software is developed offshore in
Dalian after which a BSE from CJ supervises the acceptability checks, release, troubleshooting, ifany, and on-going maintenance, etc. As a result, the company specifies the desired personality andlanguage skills as mandatory criteria to becoming a successful BSE in Japan. Additionally, technical12

ability and business knowledge are considered necessary. Understandably, in many cases, a BSE
deputed to Japan may know nothing about the customer’s business, and needs to gain thatperspective onsite.

4) In-house product development
C is investing in efforts toward in-house development and offers products such as corporate
information management systems, sales management systems, and sales support tools. The
information management systems are products based on management systems for use within acompany. Japanese companies are the target customers. Sales management systems target Chinesecompanies with the selling points of price and usability. C’s sales support tools are designed for theiPhone, and they enable the consolidated management of client data, the support of daily sales
activities, and the sharing of personal contacts. A characteristic of these tools is that all information
is maintained on a server, and none is stored on the phone itself.

5) Business changes and diversification
C envisages growth in the IT services in China. It forecasts the future business framework to beequally constituted of Japanese and Chinese, and plans for both the Japanese and Chinese businesses
to expand rather than for the Japanese business to shrink.

6) Recruitment and development of human resources
C hires many more graduates from university than experienced professionals because graduates
are easier to train. However, as people with special knowledge or technical skills are also needed, thehiring of such persons is increasing. In order to retain employees, C creates a supportive corporate
climate. Individual development plans are made with each employee. Japanese language instructionused to be provided internally, but for the last 2 years, instructors from the Dalian University ofForeign Languages have been invited. The instructors teach lower competency level employees 3
times a week and intermediate and advanced level employees twice a week. Employees currently
hold 10% of the company’s stock, but C is trying to increase that to 30%. Its retention policy has
enabled C to restrict employee turnover at 7-8%.

(4) The E Company: A small-sized Japanese-owned company6
1) Company overview
The E Company was founded in October 2003 in Dalian Overseas Student Pioneer Park with acapital of US$ 226,000, and it has 45 employees (as of August 2011). It is a Japanese company
having a Chinese board chairperson, Mr. K, and a Japanese general manager, Mr. L. In order to saveon remittance fees, a Japanese branch was formed in August 2008.
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2) The company’s inception
Mr. K, the board chairperson, lived in Japan for over 20 years because his father was employed
there. Mr. K originally worked at a trading company specializing in foodstuffs, and as he was
responsible for purchasing imports for Japan, he gained experience in various operational functions
such as production management and customs clearance. He founded the E Company on his father’s
recommendation. Since his university major was in the liberal arts, he had no skills related tosoftware and learned the business on the job. When he founded the company, the demand in thisindustry was strong, but because Mr. K had no personal networks in the software field, he was facedwith challenges in securing business. The general manager, Mr. L, was originally employed at amajor Japanese manufacturer of electronics, where he was responsible for mechanical design. In
1994, he was assigned to the development department at the Dalian branch, where he was in chargeof the motor business. In 2002, he took up permanent residence in Dalian. His venture into the IT
world was facilitated by a friend he had met while working in Japan. Hailing from the Dalian
University of Technology, that friend founded a company in Dalian in 2002, and Mr. L went to work
there. Subsequently, in 2003, he co-founded a different company with his friend to conduct offshore
software development for Japanese companies. However, he quit in 2007 and joined E.

3) The management of offshore software development
Until 2008, E’s main line of business was typical offshore software development, for which
secondary IT vendors in Japan provided it the orders for part of the software development process.
In the main pattern of E’s offshore development, the technically advanced stages of requirements
definition and preliminary design, as well as system development and maintenance, are effected bysenior vendors in Japan, while coding and unit testing are conducted by E in China. When orders arereceived from Japan for offshore development, a non-disclosure agreement is first signed with thecustomer. Because Japanese customers often change the technical specifications midway through the
project, the E Company tries to set higher quoted price to cover that cost; subsequently, E negotiateswith the customer as to who should bear the cost of specification changes to prevent losses.
It used to be that the Japanese-speaking BSEs at the E Company, who were responsible foroverseas sales, played the role of mediator between the customer and E. However, now that E’s PMs
and PLs are able to speak Japanese, BSEs are no longer required, and the usage of that term has been
discontinued. E emphasizes that the SEs have to rely on them even though BSEs do not understandthe technology. the role of BSE carries no responsibility What makes it worse, the role of BSE
carries no responsibility. Consequently, it is unclear who will take the ownership for mistakes.

4) Business transformation and in-house product development
14

The E Company believed that it was difficult to be profitable by only doing offshore development
for its Japanese client, and its personnel were not gaining in expertise. Hence, when orders dropped
suddenly during the 2008 financial crisis and the company started to lose money, it changed
direction and started to pour efforts into selling software packages developed in-house. Further, it
entered and then exited the BPO business, because being a secondary or tertiary subcontractor was
not very profitable.
E started focusing on in-house development, capitalizing on the Japanese language skills acquired
during offshore development for Japanese companies and on the expertise Mr. L had in
manufacturing and production management. First, it sold production management packages and thendiversified into products for personnel evaluation and for managing purchases of equipment andtools. E accorded special attention to sales because, in contrast to software development
subcontracting, in the packaged software business, once the development is completed, revenues andprofits grow with increase in numbers of customers. Their target customer base is mainly small- andmedium-sized enterprises (SMEs) in the Dalian Development Area (DDA) and in regions that aretrying to attract Japanese companies, like Qingdao and Tianjin. Sales approaches include accessing
directories from the chambers of commerce and industry to make cold calls to potential clients, andto request acquaintances from other companies for introductions. In 2010, the cost of labor at allcompanies soared because of strikes targeting the Japanese companies in DDA, which affected E’srevenues as well. Meanwhile, sales to local Chinese companies are difficult for theJapanese-affiliated SMEs like E because of factors including collection of account receivables andconflict management.

5) Recruitment and development of human resources
Because E cannot compete with large companies in the scale of funding, organization, or sales
networks, it is trying to overcome these challenges by providing employees with business education,using component-based development, and hiring excellent sales people. In particular, E is paying
attention to hiring and developing personnel. Among its 45 employees, 40 are responsible fordevelopment and 5 for business operations support. This workforce strength is the result of distilling
down what was once a staff of 100 to the more capable employees. The average employee age is
29.8 years with 6.1 being the average years of experience.
The E Company hires only experienced professionals. This is because new graduates hire need to
be trained for a year before being able to assemble a program for a customer, and it is a major
setback to the company when they resign after training. In order to cope with the volatility in thelabor market and employee turnover, E focuses on the employees’ futures for retention of personnel.
In addition to offering various compensation incentives, such as salary increases and bonuses, E
invests in developing all employees so they can excel in their field of work. Mr. L requires that they15

study technology and management and emphasizes that “They could all be future company
presidents.” After joining the company, they are trained in business etiquettes followed by a new
employee orientation and education in sales, support functions, leadership, project management, etc.
Employees whose roles are restricted to only coding and unit testing for offshore development willlearn nothing about the end user and never be able to write a technical specification. For that reason,
the business transformation to development of software packages was an opportunity for employee
growth while also being a challenge. By the time they started developing software packages, Mr. L
provided basic instruction to the PLs for 2 hours every day for 3 months; and, all the PLs, in turn,
passed that knowledge on to their staff.7

3. Discussion(1) Commonalities and differences
We have observed from the case studies of these four Dalian software companies that as theytransformed their businesses, there were some commonalities as well as some differences related tocompany scale and investor type. We believe this study makes the following contributions to theresearch literature.
All four companies presented in this study initially engaged in offshore software development for
the Japanese market, providing labor-intensive components of the process like coding and unit
testing. Until 2011, when the interviews were conducted, they were dealing with structural changes
to their businesses as they pursued growth by advancing into more technically sophisticated levels,
expanding their services and product offerings, and diversifying their target markets, in particular, bycultivating the Chinese domestic market. Moreover, at XA and E, the need to raise the level ofcompanies’ technical skills as a catalyst for change was reinforced by the external stimulus of thefinancial crisis.
All the four companies were attempting to achieve transformation by leveraging their uniquestrengths. XA and BD were trying to achieve levels of productivity in their Dalian operations that
could surpass that of Japan; C was laying emphasis on communication and quality; and E was trying
to integrate lower production costs with its business management expertise. For Dalian software
companies, the achieving of predominance over other companies is an issue of transforming acompany’s business model away from offshore development dependent on low labor costs.
Moreover, the strategy for recruitment and development of human resources to cope with thevolatility in the labor market is the key to maintaining and expanding this market dominance.
When upgrading the offshore software development business for Japanese market, a company’sbase in Japan plays an important role: BD, fortunately, had its parent company and customer, the B
Company, in Japan, and XA and C found it necessary to establish Japanese subsidiaries. This kind of16

transnational division of labor, both within the company and in the stages of the development
process with the customer, is inevitable given that some parts of the business, such as sales, contracts,
requirements definitions, and preliminary designs are performed in Japan, where the customers arelocated. Coordination between a company in Dalian and its base in Japan is, therefore, important.
These findings support Umezawa’s (2007, 2011) “on/off-site development” perspective.
Regarding who should be responsible for this coordination, the results suggest that the PM or PLof the development team and each level of engineer should assume direct ownership for
communication in Japanese. In practice, these people are sometimes called BSEs. However, at othertimes, this reference is avoided. In the one case where a specialist position called the BSE wasestablished to mediate in communication, it was viewed as an immature and problematic approach.
In other words, while transnational coordination across stages of the development process isessential, the position or title of BSE is not. Sorting out this issue may make the “on/off-site
development” perspective more consistently applicable.
The study also observed the different approaches of the four companies. First, Japanese-owned
companies and local companies differed in their methods of expanding their businesses into theChinese market. While BD and E assumed that the Japanese-affiliated companies in China would betheir customers, XA and C assumed that their customers would be the local Chinese companies. It
appears that Japanese-owned companies may perceive the existence of certain barriers in directly
approaching local Chinese companies.
Another difference was the large gap in the scale of people and resources that could be mobilized
for business transformation. XA grew multi-dimensionally through the effective means of acquiring
companies for their technologies and personnel, while BD was able to capitalize on B Group’s
overall resources for the development it had perceived for the Chinese market. Only a large company
and its overseas subsidiaries could do these things. Meanwhile, business diversification for the C and
E Companies was concentrated on the in-house development of software packages. This was a
feasible strategy for these SMEs because while business knowledge is important for software
package development, a huge investment of resources is not necessarily needed to raise thecompany’s skill level. However, access to end users becomes important for the sales activities forthese packaged offerings as opposed to subcontracting for parts of offshore software development
projects. As C and E were secondary or tertiary vendors in offshore software development forJapanese companies, they did not have access to the end users and did not gain any sales experience.
It was important to overcome this challenge, especially for E that had ventured into packaged
software as its new main business. Hence, improving the skills of its sales staff became a focus. The
analysis of these cases shows that companies adopt different strategies according to their sizes,
which confirms the findings of the Organization for Small & Medium Enterprises and Regional
Innovation, Management Support Information Center (2007).
17

In the recruitment and development of human resources, all four companies shared theunderstanding that in this highly volatile labor market, improving skills leads to changing jobs.
However, based on their respective sizes, there was a large gap in how the companies responded tothis challenge. BD was resilient to resignations and hired highly skilled new graduates, even getting
involved in the administration of university classes. In contrast, E could not afford to spend a year on
training any new graduates considering the risk of turnover. The SMEs, C and E, tried to compensate
for their disadvantageous salary levels by focusing on human resource development as a strategic
issue. Company scale has emerged as a factor explaining the differences in the human resource
policies as response to the shared environmental threat of the volatile labor market. This provides anunderstanding of a different aspect of IT expert hiring practices to add to Kobayashi’s (2012)
comparison of resource hiring and deployment practices at three large companies.

(2) Future research topics: The international division of labor and business upgrades
This study has generated two issues for future research. The first concerns understanding how thebusiness transformation at individual companies influences the international division of labor in thesoftware and information services industry. We need to acquire a better understanding of thecharacteristics of Dalian’s international position. Moreover, it is necessary to investigate how theposition may change in relation to other offshore development bases such as India and large markets
such as Japan and America. The second issue arising from this study is the need to improve ourunderstanding of the industry level mechanisms that provide opportunities for individual companies
to upgrade their businesses, and to develop the relevant skills. Specifically, in Dalian, software andinformation services companies are clustered together, and the importance of the cluster is growing
in the international division of labor in the software development process. How do both the local
system and international system of collaboration and division of labor act as catalysts to promote orconstrain a business upgrade or determine its direction? These are the subjects of our next study.
※ This study was funded by the Japan Society for the Promotion of Science Grants-in-Aid (Basic
research programs B: 22330108 and C: 24530449).

18

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No. 28, p. 73–85.

1

The statistics in this paragraph are from the Dalian Institute of Software & Service Outsourcing(2012).
2
In addition to the references cited, the record of a large-scale field study by Chuo University’s
Software Offshoring Joint Research Team have been published in the journal Chuugoku Keizai[China’s Economy] of the Japan External Trade Organization (JETRO). Unfortunately, however, the20research team did not provide its views or evaluation of the data.
3
This section, unless otherwise mentioned, is based on data from an interview with Mr. F, Directorof Japan Sales and Marketing for the XA Company, on August 23, 2011.
4This section, unless otherwise mentioned, is based on data from an interview with Mr. G, General
Manager of the BD Company on August 24, 2011.
5This section, unless otherwise mentioned, is based on data from interviews with Mr. I, Director of
Human Resources at the C Company and with Mr. J, Senior Manager of Systems Development for
the Japan Branch of the C Company on August 24, 2011.
6This section, unless otherwise mentioned, is based on data from interviews with Mr. K, Chairmanof the Board of the E Company on August 26, 2010 and with Mr. L, General Manager of the E
Company on August 23, 2011.
7
Further, at the time of this survey in August 2011, Mr.L emphasized E’s funding constraints, but inthe fall of 2011, the company had a funding crisis, which led to the company’s liquidation at the endof the year. However, Mr. L, aiming to continue the development of software packages founded a
new company and is trying to revive the business alongwith the former employees of E.

21