Captive centre outsourcing option not so captivating

Until now, companies sending some of their IT operations offshore have generally followed two broad paths - they have either outsourced to a third party services provider overseas, or launched their own ‘captive centre’ at the offshore destination.

A captive centre is a company’s wholly-owned facility for software development, IT support, back-office data processing, call centre operations, or business process outsourcing. In this model, the activities are performed offshore, but are not outsourced to another company.

India, so far, has proved to be the most popular destination for such centres. For though North American companies have set up captive centres in China, Central Europe, and other parts of the world, India offers several advantages.

According to some experts, there are around 500 captive centres in India right now, and probably half the US companies in India in any significant way (predominantly financial services and software companies) have set up a captive centre.

India has many advantages as a sourcing destination. Fran Karamouzis, research vice-president at analyst firm, Gartner, cites some of these:

* A time-tested, proven model - Over the past five to seven years some companies sending work to India have achieved ratios of savings that average anything from 20 to 70%.

* Other factors include: the English speaking capabilities, the cost structure, the scale of the work force, the educational systems and government support in terms of special economic zones, tax havens and underlying infrastructure.

Captive centres, whether in India or elsewhere, haven’t had that great a track-record.

"Until now, there has been roughly a 50% failure of ratio after the third year," Karamouzis says. "More often than not, working with a service provider or third-party partner has been more advantageous to clients."

A report titled ‘Shattering the offshore captive centre myth’ by analyst firm Forrester Research echoes these views.

Published in April, the report reveals that more than 60% of the captive centres in India alone are struggling "as a result of the lack of management support, spiralling costs, skyrocketing attrition, and a lack of integration".

Sudan Apte, the Forrester analyst who authored the report, is based in India. He concludes that many reasons firms cite for building their own facility versus outsourcing to a third party are flawed. "Our research shows that in the majority of cases it is driven by personal reasons, such as an expatriate employee’s urge to go back to India for family reasons."

Based on how they score on Forrester’s 10-question captive centre self-test, Apte said firms have four captive exit options ranging from simply shutting down and going home to selling out to a third party.

Doubts over the viability of ‘captive centres’ surfaced again big time last month following the news that Citigroup had sold its wholly-owned offshore IT and BPO centre Citigroup Global Services, (CGS) with offices in Mumbai and Chennai, India, to outsourcer Genpact for nearly C$700m.

Following the CGS sale, there were reports of other companies with captive centres in India wondering whether it was now a good time to offload their offshore assets.

Some experts have predicted the deal would set a new trend in the market: with captives increasingly exploring joint ventures, buy-outs and third party outsourcing options.

Setting up a captive centre is undoubtedly a more difficult and daunting proposition. As Karamouzis notes, there is usually a one-year to 18-month lag time because one has to find the real estate or build it. "Then you have to contract for all the telecom components. Finally you have to hire all the people."

The main reason why many companies set up wholly owned captives offshore in the first place was because they felt it would help them gain the chief benefit of moving offshore - access to skilled but cheaper labour markets - while retaining management control.

So control is the key driver behind captive centres. In reality, though, many companies with such centres have been forced to forge alliances with third party outsourcers - and depend on them for staff augmentation. So the level of hoped-for control wasn’t achieved.

"Motorola, Texas Instruments, American Express - they all have captive centres, but they also outsource some work to Wipro and Infosys and IBM and all the big companies in India," notes Cliff Justice, head of globalisation for Houston-based outsourcing consultancy, EquaTerra.

When a company’s captive centre isn’t performing well, or meeting expectations, one option is to try and fix it - perhaps with the help of an outsourcing consultancy that specialises in these matters. (EquaTerra, for instance, has a team of consultants on the ground in India dedicated to addressing captive issues).

The more popular option these days is for companies with underperforming captive centres to outsource much of that work, or opt for a hybrid model.

One such hybrid, for instance, is the virtual captive centre, where the third-party outsourcer providers the infrastructure, people and services, but puts into place processes that mirror those of the customer, especially security and compliance processes.

Bottom line

There do not seem to be any good reasons left to perpetuate the ‘captive’ model in lieu of going with a third party provider in a country like India.

After ‘control’ (and we have seen the issues with that) the other most oft-cited reason was "the market is not mature enough".

This maturity argument just doesn’t hold true any longer in areas such as application development, IT services, analytics, and transaction processing.

But, if opting for an offshore provider, it is important to consider factors such as: the latter’s operational knowledge on the ground in places like India; the required brand that enables them to hire the best people in those locations; whether they have appropriate infrastructure capabilities in place around business continuity; and disaster recovery.