But Chinese companies need to upgrade to stay competitive

China's software outsourcing industry is expected to grow further despite climbing labor costs and increasingly intense competition from overseas.

"The software industry will play a more important role as the Internet-based services continue to expand globally," said Li Yuanming, president of Dalian Software Industry Association. "Globalization in the software-making industry could provide more clients for Chinese software companies."

In 2011, the output value of China's software and information services hit a record high of more than 383 billion yuan ($60 billion), up by nearly 40 percent year-on-year, according to an annual report issued by the electronic technology information research institute under the Ministry of Industry and Information Technology.

Meanwhile, the outsourcing sector took 20.8 percent of the entire software industry in terms of output value, shaking off years of decline since 2007.

Although Chinese-made software holds advantages in terms of price compared with overseas competitors such as Europe and India, local outsourcing providers are in urgent need of upgrading their services to protect the domestic market from incursion by overseas companies.

"We should move fast to keep the business in the country because global players, such as India, are ready to compete against their Chinese counterparts in the Chinese market," said Guo Xin, former president of IDC Greater China.

India's IT outsourcing service quickly expanded as the number of the country's talented software writers boomed.

As many as 12 Indian companies were on the list of the top 100 outsourcing companies in the world this year and three Indian firms have found a place in the top 10, data from the International Association of Outsourcing Professionals shows.

China's top-ranked company, Neusoft Corp, barely made it into the top 30.

Indian companies dominated contracts from the United States. Europe is the biggest market for Republic of Ireland companies.

Japan was the largest importer of China's software products over the past four years, followed by the United States.

China's capacity to digest overseas contracts remains weak compared with global players.

Indian companies are able to absorb a transaction value 10 times larger than their Chinese counterparts, Shenzhen-based consulting firm askci.com Group reported.

Furthermore, some analysts said that China's software companies are losing their edge in terms of labor costs, which have been growing by around 20 percent year-on-year over the past couple of years, The Wall Street Journal reported, indicating that increasing salaries were driving companies to move the labor-intensive business to cheaper areas or replace manpower with robots.

Labor costs will not be an advantage for Chinese outsourcing companies. Entrepreneurs across the industry have to find out ways to improve the added value of their products in a bid to survive as overseas outsourcing providers start to enter the Chinese market, said Guo.

But other analysts suggest the increase in salaries should be the last thing Chinese software outsourcing companies worry about.

"China's software outsourcing market is powered by rising demand. Chinese firms are likely to enjoy more orders from both domestic and overseas customers," said Ning Wright, partner-in-charge of outsourcing and shared services advisory at KPMG Advisory (China) Ltd. "Rising labor costs will have very limited effect on the industry in China."

Li from the Dalian Software Industry Association also believes that the rapid growth of labor costs will not hinder the development of the industry.

"Unlike other manufacturing businesses, software products can be copied and reused. That will help the developers to reduce massive development costs," he said.

Although the offshore demand witnessed more than 30 percent year-on-year growth over the years, the sector's share continued to decline because of faster annual growth rate in the Chinese market.

Chinese demand for software outsourcing hit 335 billion yuan last year, taking more than 87 percent of the market share.

"Domestic demand will become the major driver for the industry. The turnover of the domestic market is on a trillion-yuan scale," said Li. "The Chinese market will be one of the largest".

"China has to pay some old debts before moving forward. The country's level of informatization remains low. Unlike the Western economies, which had conducted an extensive industrial informatization renovation, Chinese companies are lagging far behind in this area," said Li.

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