The Realities of Outsourcing

The CEO of the company, Lan Haiwen, and [COO] Wu Jun were executives at Ubisoft China. Three years ago they decided to strike out on their own and get into the development and outsourcing business.

It's a model in China that's happening every day. Once people get the expertise in core business...I mean, it's very entrepreneurial. People are really taking big risks and starting companies.

Basically, in the three years since they started with next to nothing, today we have four studios with over 300 people. We work with some of the largest names in North America as well as Europe and Asia. We've really segmented what we do.

I think the old model in outsourcing or third world development was to be very, very specific in terms of art assets, backbone, or something where the larger publishers could say: "We need you to make cars. We need you to make backgrounds. We need you to set up an Internet site." Whatever it was. And the companies really specialised in that.

We have found to be competitive we've had to break up what we do and have individual studios really focus on it.

So, we have one studio in Beijing that is 100 per cent dedicated to mobile gaming. And we do a catalog of about 300 games. We make anywhere from 4 to 8 new games every month. We have a large contract with China Mobile. We're doing a little bit now in terms of coming to North America, but that team...That's there expertise and that's what they do.

We have a large studio, over 100 people, in Shanghai that is 100 per cent dedicated to game development. So, we have the programmers, the producers - all the technical expertise. We make games for the Asian market. We actually work on turnkey games for the North America market, especially on the Flash side. So, that group, that's what they do. They make complete game projects.

Also in Shanghai we have a new state-of-the-art facility that we just opened up in October that has over 130 people. And that's our art center. It is totally dedicated to art creation. There are about 80 or 90 people on the 3D side. And there are another 40 on the 2D side, which is the largest, I think, 2D studio in China, in game development, for concept art, casual gaming, etc. The general manager there just came over to us in December from EA Shanghai.

And the fourth studio we have is, at this point, dedicated to handheld gaming and, in fact, will be releasing our first Xbox Live game through Microsoft in about two months.

MS has a major initiative in China right now in gaming. About a year ago, they decided to open up what they call an incubation center - which is a fully-staffed, stocked studio for game development. And then they invited developers from all over Asia to submit concepts for Xbox Live games. They got over 200 submissions. They cut that down to 6 studios - we were one of them and then about 10-11 months ago they made the decision. They chose us and our game design, which is called Crazy Mouse - a multiple player, arcade, kind of semi-Pac-Man style game.

By winning the bid, we sent our team to the incubation center where Microsoft has basically revved us up to be a full developer.

The game, Crazy Mouse, is 100 per cent our development. But it is being created for and released by Microsoft first party - not just for China, for worldwide. That will come out in, I think, the June time frame.

The issue in gaming right now is 100 per cent capacity.

You take the Indian market, the Eastern European market and the Chinese market - which I think are the three keys for outsourcing for gaming - and you know what? All the good studios are almost at 100 per cent capacity.

There are definitely games and projects in North America that are sitting there waiting for some of this capacity to open up so that these games can go into full production.

It's created a domino effect in terms of production and teams and whether large studios are trying to acquire and buy outsourcing companies or whether they want to have long-term contracts and how many they choose.

Some literally have one key outsourcing partner, and I know others that have over twenty. Some North American companies have a 100 per cent dedicated division that does nothing but qualify, test and organise projects for outsourcing. And there are still other companies - not tiny, but certainly not huge - that are very well known literally are still trying to feel their way around because of the perceived prejudice that if you go outside of the US or outside North America you are going to get an inferior product.

The people who use it as a pipeline tool know that's not the case. But I think there are still some people out there who are doing it for the first time, and the reason they are is because, in large part, with the current economy in gaming, where you don't have - with the exception of the Nintendo DS - a system that has a 60-80 million installed base like we had with PlayStation 2 and Nintendo years before that.

The trouble is, is still costs what it costs to make a game - 5, 10, 20 million dollars - but you just don't have that many customers. So they have to bring the costs down. And yet the customers demand that the quality is transparent. It forces the entire industry to say either outsourcing of entire games, of parts of games, of art...it literally is a requirement at this point to start production on probably more than 90 per cent of all games.

What we find - and obviously it has to be anecdotal, as there is not scientific evidence - we work with dozens of companies that literally would not be in business, would not have art directors, would not have concept artists - if it wasn't for outsourcing. Because they could not afford either the manpower or the down time between projects that would be required to be competitive.

I think that the economic imperatives that you talk about are 100 per cent real. You have a lot of outsourcers who are making a lot less money because of the change in the dollar. I don't know, universally, whether prices have started to rise yet or they are just absorbing it.

Certainly we are pretty close to a tipping point where a continued weakened dollar would have to mean increased prices. And again, I'm not talking about Ultizen specifically, but just for the industry.

But one issue is the delta between domestic pricing and international pricing. It is very, very significant - much more so than the 10 per cent devaluation since the first of the year. So, it makes the prices closer, but on a dollar for dollar standpoint, not necessarily competitive.

There are definitely two schools of thought. One is that it is pure economics, and you go for the lowest price for the best quality you can for your project, and that's where you make your decision.

But a lot of the larger companies - because they have to put a lot of the infrastructure in place to monitor, Q&A, manage, etc. the external pipeline - they would tell you that cost is not the reason they participate. It is all about capacity. They simply don't have the internal capacity to crank out the amount of assets that they can get and manage by using external partners.

You always have individual companies in any given day who make a one on one decision of "No, we are going to keep this project in house..." because of any of the reasons that you just mentioned. But I would say, as a percentage, it is really not that high.

The reason for that is...Look at a company like Ultizen who, if you take management out of it, has 100 or 110 artists on staff or whatever it is. It is not that easy to go out for a project and hire 100 experienced artists. And then to train them, manage them, to do all of that.

And then let's just say that you could ramp for six months, seven months, eight months - whatever it would require to get that much additional capacity. Let's say the project runs for nine months. Then after the completion of that project, your next round doesn't start for three or four months - you're paying for down time for three or four months.

So, the combination of the lead time to create a large staff, which can be really long - certainly more than three to six months - plus the potential down time of having a very large staff that's generating no assets because the company doesn't currently have the right project...That gets added to the cost factor and to the management factor and to the projects. And, for the larger companies, it's a part of doing business - they don't really make a decision.

And you also have to understand...Just because a company decides to outsource, let's say, art assets - because that's what everybody seems to understand - that doesn't mean they don't have an internal art team. That doesn't mean that they're not doing the concept art, that they are not doing primary characters, that they are not having artists who are having to manage the asset project.

There is no situation I'm aware of where an outsourcing company is not dealing directly with the art staff on the other side. It's just a function of...If you need 30 additional artists for a four month period, what is the most practical solution? Outsourcing is really not even an argument - it is a reality. Outsourcing seems to be the way that the majority of the industry looks at it currently.

You've kind of hit the nail on the head as to one of the two major issues in international outsourcing.

The gaming world has become a worldwide stage, but there is definitely significant regional flavour and differences. There is a lot of training time involved and ramping time involved - whether its Eastern European or Indian or Chinese teams - to get the right look, get the right feel. To learn how, operationally, North American teams work. To be able to be integrated. To be seamless. There are significant issues.

In most of these situations you have to have key members of the teams that have superior language skills. And you have to make sure that both sides are managing the process so that everybody is clear on the communication. It is really not, in most instances, as simple as getting parameters for the assets and going ahead and creating them. It is a lot more detailed than that.

The companies that don't pay attention to that management structure and don't work hard - on both ends, the domestic team and the international team - if they're not working hard on that communication, there absolutely can be issues. And those issues can dictate whether the conclusion of the project is seen as universally successful or not.

Style-wise, each region definitely has nuances. But, typically, if you have a good and broad art team - if they communicate well and understand direction well - its very achievable for them to obtain any look that is necessary. Same thing for a domestic art team. It's really about understanding what the task is.

Management.

I won't speak for all the companies, but what we have learned is, to work with the larger companies and to be successful...We constantly look for team members that have western game management experience.

It is very hard to be successful in these projects if you do everything by email. It's a learning curve. The closer you get as a company to filling up your capacity - in other words, the more dishes you're spinning - the more your ability to communicate and really manage the process becomes key.

In that way, it is no different than handling a domestic team.

The US companies that don't understand that, and that simply want to buy assets cheap, don't usually have the outcome that they expected. And the companies that do put a lot of work into it, into developing the foreign teams into becoming an integral part of the process - they're almost universally successful.

They do the due diligence. They look at the portfolios, they talk to management, they visit the studios to make sure that everything that is being said is actually true - and they usually get exactly what they think they are going to get. And it does take time. And it does take money. And it does take resources. But, at the end of the day, they get that increased capacity. And that does seem to be the driver in the market right now - that additional capacity.

I know what you are saying. I think it parallels the basics of economy. As regions become more mature, and their economies become more mature, what happens is that they can pay more and become competitive for the same capacity that the North American and European developers are currently looking at.

Ultizen does a lot of inter-Asia business. We're actually profitable in our business just within our Asian market. It is more lucrative for us to go with the long-term contracts that our North American and European partners can offer, but as the economy improves in China - just like anywhere else in the world - it means that they will pay more for those same services and eventually...It's not even a question of if, it's a question of when...They'll become more competitive for that same capacity. That just means that you'll have to go someplace else.

I think, though, the thing that separates the games industry and other software-related industries from just simple manufacturing is that there has to be a relatively high quality of education. You have to have a good university system. You have to have a real focus on technology for those regions to pop out the kind of people that are qualified and trained to do this kind of work.

Certainly in Asia right now, and specifically in Shanghai, there is almost a hiring war going on for the new guys coming out and for the people that want to move up. They've hired almost everybody they can, and they're looking for the new guys graduating college and they're looking for the people that want to step up.

I can't speak for India or Eastern Europe, but in China there is definitely a scarcity of resources that doesn't match the current capacity requirements. And that's why you have studios in North America scrambling not just to find partners but to secure capacity.

And you do see this round of larger US companies buying international outsourcers/developers. It's a mixed bag - you get that 100 per cent capacity commitment because it's now your team, but there are all sorts of cultural and management issues that extend way beyond China and North America.

It's very hard to have a management team from one culture trying to manage an actual studio from another culture. So that's become an issue.

Some people are very, very aggressive on buying the outsourcing studios right now, and others really aren't. The jury is out on what the best way is, but it is definitely a trend.