IT doesn't make sense for a foreign company to manufacture in China.

This bit of well-intentioned 'counsel' has been dispensed so often that if you haven't yet heard it, you're probably in the minority.

The refrain goes like this: Yes, labour is cheap in China but skilled workers and senior executives are hard to come by; office and industrial space is becoming more expensive; transportation costs to export markets are high; intellectual property is inadequately protected; the yuan is rising too quickly; and official red tape is a horrendous tangle. And, worst of all, goods made in China are of inferior quality.

These arguments should rightly concern investors - if they were true for all industries. The reality is they really only apply more to manufacturers of low-margin, high-volume consumer goods destined for foreign markets. For makers of IT products, an increasing number of which are made in China, the story is dramatically different.

There are several reasons for this.

'Open arms' welcome

To start with, China's tax policies have favoured foreign IT manufacturers more than they have, say, makers of apparel or household appliances. For many companies in the IT industry, with its high level of competition, this 'open arms' welcome alone is incentive enough to establish new production facilities in the country, or transplant existing ones from higher-cost locations.

But investments by IT companies in China do not necessarily have to be direct in nature. Some choose to outsource production to contract manufacturers operating in the country, or form joint ventures with Chinese manufacturers who have established themselves in the domestic and export markets, or acquire local producers.

Whatever the corporate vehicle, the systems, disciplines and processes used by established sister or stepsister plants located outside China end up being adopted in these new company-owned or partner facilities. The result: products of a quality as good as anywhere else in the world.

However, IT companies do not invest in China just because production costs are lower there. For many, their investments extend beyond physical plant and local partners. Direct, active participation in the burgeoning domestic market for IT products is one big pull factor. IDC forecasts that in 2007, the Chinese IT market will be worth US$42.09 billion, a 13.6 per cent increase compared to 2006; and the Internet service provider (ISP) market will be worth US$86.17 billion, a 7 per cent rise over 2006.

Another magnet is the proximity to component suppliers that can offer better prices because they operate on a lower cost basis than those located elsewhere and who can help shorten the overall design-to-delivery cycle.

A significant proportion of IT companies operating in the Middle Kingdom also leverage on a large and growing number of skilled local engineers, to conduct R&D and localisation work in collaboration with their peers spread across the world. Many of them received training and IT industry work experience in the US and other technologically advanced countries.

And where these local talents are organised as external independent IT start-ups with promising technologies/products and entrepreneurial spunk, they offer opportunities for IT players wanting to acquire new capabilities, business areas or product lines.

Chance to consolidate

Besides being a viable location for IT manufacturing, China also offers ample opportunity for IT companies to consolidate non-manufacturing activities that are spread out across geographies and time zones. These candidates for hubbing include data centres, customer service and support facilities, supply chains, and R&D. Together with local production facilities, these hubs enable IT companies to bring solutions to market faster - and support customers better - than others whose functions are more far-flung.

The phenomenon of IT manufacturers investing in lower-cost locations is not a new one. The last three decades saw heavy investments by technology companies in manufacturing capacity in North Asia (Japan, Korea and Taiwan), South-east Asia, and Mexico (remember Nafta?). Like China, each had its detractors. Each presented its own set of challenges, certainly, but the fact remains that investors and their customers benefited from the arrangements, and that each country moved up the value chain.

Well, now it's China's turn. And while similarities can be found, the 'China as IT factory' story that is still playing out is a unique one: the stage (market) is wider and deeper, the backdrop (investment landscape) is bigger, locals form a large part of the audience (customer base), and the antagonists (competitors) are fleeter of foot. Got your front-row season ticket yet?

The writer is VP and GM, 3Com Asia Pacific.