July, 2002

 

1. Introduction

 

Purpose

 

The primary incentive to offshore software development from US to China is cost advantage. As a preliminary study, this report analyzes the recurring cost of operating a software development firm in Shanghai, China. Startup cost or any other one-time charge is not covered in this study.

 

Scenario

 

One US company opens a branch office in Shanghai, China. The office hires 17 local employees: 15 software developers, one office manager, and one IT administrator. The branch office rents 4,000 square feet office space: 100 square feet per person, 1,300 square feet for lab and office equipments, and 1,000 square feet for conference, kitchen and open areas.

 

Notes

 

All currency related numbers in this report are expressed in US dollars. The currency exchange rate between Chinese RMB and US dollar is around 8.28.

 

2. Executive Summary

 

Even though a recent national survey states that the average annual salary for “computer related” jobs in Shanghai, China, is around $6,000, this study shows that it costs $11,500 per employee per year on cash compensation to operate a high-quality software development firm in Shanghai, China. After including employee benefits, the total capital cost for each employee is $16,000 per year. Since the burst of Internet bubble around the world, China sees larger number of experienced software engineers look for jobs. That may lower the capital cost for software engineers to certain degree.

 

This study shows that renting 4,000 square feet “international standardized” office space in Shanghai, China, costs $96,000 per year, that is about $2.00 per square foot per month, comparable to the Bay Area in California. If including asset management fee, utility charge and Internet access charge, the total infrastructure related cost is $141,000 per year.

 

This study finds that other than the cost mentioned above, there is no other significant “hidden” cost to operate a foreign business in Shanghai, China. Considering that Shanghai has been consistently among the top four most expensive cities in China, numbers shown above are close to the top in overall China.

 

Business taxation varies based on the products, location and ownership of the business. The majority part of business tax is business income tax, which is normally levied at 30%. For foreign owned, hi-tech, export-oriented companies, the income tax would be 15%. If the company is located at so-called “development areas”, the company can have 100% exempts for the first two years and 50% exempts for the next three years from income tax, starting from the year when the company becomes profitable. Note that business income tax only applies to companies that have sales income inside China.

 

3. Detailed Descriptions

 

Employee Profiles

 

All software developers hired in China shall have at least the Bachelor’s Degrees in computer science or related areas. For the purpose of cost saving, high productivity and sufficient training, software developers shall be hired from three different tiers based on qualifications and experience. Table One lists the three tiers and describes their characteristics.

 

Table One - Description of Three Tiers of Software Developers

 

Rank	Years of Experience	Qualifications	Qualified Positions
1st Tier Engineers	5 or more	Expert in OOA/OOD/C++ Fluent in System Level Design Fluent in Development Process Leadership and Communication Skills Managed one or two cycles before	Architect Team Lead Project Manager System Analyst
2nd Tier Engineers	3 and 4	Fluent in OOA/OOD/C++ Understand Development Process Been through one or two cycles	Life-cycle Object-Oriented Development (from analysis to testing)
3rd Tier Engineers	1 and 2	Fluent in C++/Java Understand OOA/OOD	C++/Java coding Testing

 

The characteristics drawn here are based on author’s general understanding of the level of skills and experiences of software engineers in China. Author’s understanding comes from tracking publications in China and interviewing IT professionals in China.

 

Office Manager is responsible for human resources, accounting activities and other daily works. He or she shall be well connected in the local city so that the office can run smoothly with minimal interruptions. Ideally, he or she shall have human resource background.

 

IT administrator handles all the IT issues such as software upgrade and network administration. He or she will not be responsible for the software build system or SQA.

 

 

Capital Cost

 

In China capital cost for employee consists of two parts: cash compensation and employee benefits. Cash compensation includes salary, bonus and allowance. Employee benefits, which are required by State Labor Law, cover medical insurance and social benefits. Employee benefits are normally in the range of 30% to 42% of cash compensation (40% is used in this study). Table Two illustrates the projected capital cost of local employees of different positions. As shown in the table, the total cash compensation per year is $194,400 for 17 employees, or $11,435 per employee. After including the employee benefits, the total capital cost per year is $272,160 for 17 employees, or $16,009 per employee.

 

Table Two - Projected Capital Cost

 

Position	Monthly Compensation Per Person	Annual Compensation Per Person	Annual Benefits Per Person	Annual Cost Per Person	No. Of People	Monthly Compensation for the Group	Annual Compensation for the Group	Annual Benefits for the Group	Annual Cost For the Group
1st Tier(s)	$2,500	$30,000	$12,000	$42,000	3	$7,500	$90,000	$36,000	$126,000
2nd Tier(s)	$800	$9,600	$3,840	$13,440	6	$4,800	$57,600	$23,040	$80,640
3rd Tier(s)	$400	$4,800	$1,920	$6,720	6	$2,400	$28,800	$11,520	$40,320
Manager	$1,000	$12,000	$4,800	$16,800	1	$1,000	$12,000	$4,800	$16,800
IT Admin	$500	$6,000	$2,400	$8,400	1	$500	$6,000	$2,400	$8,400
All		$11,435	$4,574	$16,009	17	$16,200	$194,400	$77,760	$272,160

 

Information used in the projection comes from the interview with the CEO of one successful e-commerce company in Shanghai, who has been in the position for five years. The range of ratio of employee benefits to cash compensation, 30% to 42%, is from the accounting practice and shall be reasonably accurate. The projected cash compensation per employee per year ($11,435), though, doubles the average cash compensation (between $5,600 and $6,000) for IT jobs in Shanghai, based on a recent national survey. There can be several explanations for this divergence. First, software engineers with five years or more solid experience are still scarce in China therefore carry high price tags. Salaries for software engineers with ten years or more experience in China are estimated to be in the range of $60,000 to $100,000 per year. Second, the interviewee is very successful in recruiting and maintaining a top-notch IT team by offering the competitive compensations. Therefore even though the number projected here may seem high compared with the survey results; it is actually close to what a high quality firm would encounter.

 

 

Infrastructure Cost

 

Infrastructure cost as used here refers to the cost of office space, Internet access and telecommunications. It does not include the IT cost. The personnel part of IT cost has been included in the capital cost (see the previous section). The equipment part of IT cost varies depending on the business activity and requirements. The branch office in Shanghai, China shall use the same types of equipments and tools as the main office in US. In which case, the equipment part of IT cost would be very close.

 

During the past several years, China invested heavily in business infrastructure, especially in the areas of business offices, telecommunications and transportations. Shanghai has been one of the cities that got top government and foreign funding for development. Today the functions of hi-tech infrastructure in Shanghai are comparable to those in US, even though the reliability still needs some improvement. Table Three describes the projected infrastructure cost for a 4,000-square foot, 17-employee branch office in Shanghai, China. As shown in the table, the total cost is $141,000 per year, of which $96,000 is rental charge.

 

Table Three - Projected Infrastructure Cost

 

Item	Cost per Sq Ft per Month	Other Unit Cost	Cost per Month	Cost per Year	Normal Range	Note
Office Space	$2.00		$8,000	$96,000	$1.66 ~ $3.30 per sq ft per month	Office built based on international standard
Management	$0.30		$1,200	$14,400	$0.20 ~ $0.35 per sq ft per month	Including cleaning and security
Parking		$100/car	$200	$2,400	$75 ~ $150 per car per month	Based on two cars
ADSL		$150/line	$300	$3,600		Dynamic IP, 512 KB
DDN		$350/line	$700	$8,400		Dedicated Data Network (kind of VPN), 128 KB
Utility			$350	$4,200		Electricity and water
Telephone		$50/line	$1,000	$12,000		Based on 20 lines
Total			$11,750	$141,000

 

Information used in this projection comes from the published materials in China and on the Web. Most of the numbers are confirmed with the IT managers in China.