Should you sell your offshore captive to an outsourcing provider - ten questions to ask yourself...

I am constantly surprised by how many times I get pulled into the "captive versus outsource" debate.  I thought this one was settled long ago, but it seems many firms are still trying to go it alone.  If you are a well-resourced firm which has a set of processes that need to be kept inhouse, or are core to your business - and you can save substantial costs by moving these processes offshore - then my advice is to maintain a captive center.  However, make sure you have the local management expertise to hire the staff you need and develop career plans to retain them.  If you are a top tier brand, you stand a good shot at running a successful captive operation, but if you are a lesser-known firm with a small global presence, you will struggle to retain and develop your staff in this intense offshore environment.  There are many firms which still persist in funneling low-value administrative processes into their captive centers, where you have to question the business case of doing so.  Utkarsh Rai, in his guest post here entitled "offshoring secrets" does an excellent job surmising how challenging and expensive it is to run your own captive operation in India.  Utkarsh has spent most of his career managing offshore operations and here are some excerpts (and these are best-practices, not warnings):

Attracting Talent: Providing an excellent work environment, a challenging work and a competitive compensation and benefits package are important in attracting the talent

Cost of operations: For the last three four years the salary raises have been given to India employees in the range of 15-20%. But this does not translate into the payroll cost. The annual payroll cost increase can be around 5% or so, depending upon the type of growth in the headcount.

If your company runs an offshore captive, ask yourself the following questions:

1) Is the work being performed in the captive truly core to our business, or could we move it over to a third party?

2) How much risk are we exposing to our business by transitioning the captive operations over to an outsourcer?  Can we work with the outsourcer to manage the transition process to ensure there is a smooth transition of people and operations?

3) By selling off our captive, how much can we save over a 5 year period?

4) What is our option-value in the future if we want to take some of these operations back in-house?

5) How severe is our attrition rate, and how does  this impact running costs and quality?

6) Is the captive truly a part of our global organization, or is it really a distant support center that doesn't play a core role in our day-to-day business operations?

7) How much management time, and how much cost, is spent flying senior executives over to offshore locations to oversee low-value processes such as accounts payable, help deck support etc.? 

8) How much experience with offshoring do our firm's senior executives currently have, or are they learning it by trial and error and substantial cost to our organization?

9) How complex is it to transfer knowledge from our parent operations over to our offshore operations?  Wouldn't it be cleaner and easier to move the work to a third party outsourcer, who will take on the work they are contracted to do?

10) Is it worth keeping our captive, but re-locating it to a more appropriate location?  And what are the costs / benefits associated with doing that?

Alternatively, look at the Aviva model, and get a third party to build your captive for you with the future option-value of selling it to a third party.  However, with the amount of captives currently operating, my prediction is that the market for selling captives will be pretty much dusted in 2 years... so is this a sensible option? 

The outsourcing providers are primed to grow through two channels:  (1) buying captives and (2) taking on business from firms with no offshore or shared services support. If you already have an established captive you have a compelling option to investigate over the next 18 months:  do you sell it to one of the ambitious outsourcing providers looking to grow their business? If you have a well established captive operation now, you are in a lucky position.  The outsourcing firms prefer to acquire captives to grow their businesses, than acquire each other (as discussed here).  With a limited number of captives currently up for sale, you will find a handful of outsourcing providers interested in your business - and you could make a tidy windfall from the sale. They will take from it what they need to run your business, and utilize some of the resources to support other clients.  They also have the advantage of running your captive virtually by integrating it into their multi-location delivery infrastructure, that can cater for multi-lingual support and a whole variety of IT and business processes that you can't often manage from a single location.  You will also minimize your business risk by having these services run by an experienced provider with a multi-location delivery strategy. 

This discussion between Genpact's European leadership and Michael Jones, editor of Finance Director Europe, raises some compelling arguments in favor of this virtual captive model that Genpact has successfully developed during its recent hyper-growth.  Other leading providers, namely Accenture, IBM, HP, ACS, Cap Gemini, Infosys, TCS and Wipro, are also extremely adept at delivering services from their multi-location infrastructures. The other major advantage of selling your existing captive is that transition is far less painful for both buyer and provider.  Retaining key staff is often less challenging, as working for a services firm, rather than a captive, can often provide a more compelling challenge for the offshore professional. 

 

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'  Have you evaluated whether you should go captive, or just sell out altogether?

Comments

[Tatyana Kanzaveli]

Hi Phil,

There is no clear-cut answer to this question: outsourcing or captive off-shore center for the company.
There are good and bad examples in both scenarios.
Companies like Google have been only using captive software development centers all over the globe with great success…and there are lots of examples of companies doing very well with their outsourcing partners and of course the combination model works as well.
There are number of things to consider when making the decision, such as company culture; company strategic international expansion plans; solid relationships at off-shore location, etc..
At a minimum what company that decided to use outsourcing offshore partner should do is to put a language in their contract that will allow them to convert/transfer project-dedicated resources to company’s captive center resources if the need arise.

Best regards,
Tatyana

[Muhammad Ali Nasim]

Another option to consider which is the middle-ground between the captive and outsourcing provider is to have captive teams (dedicated resources) contracted through an outsourcing provider. This gets closest of getting the benefits of both the worlds. With a captive team and a reasonable contract duration, 1 year plus you can negotiate a good monthly rate per resource. This relieves you from worrying about the over-head costs and local administrative issues of the offshore provider... and at the same time have stronger control and flexibility in how you would like to use the resources on multiple projects.

Further, it allows you to utilize the more dynamic delivery models such as Agile to smooth out the frictions which are caused due to change management during the delivery.

Offshore outsource provider likes this model even at a lower cost per resource, as it provides them firmer cash-flow projections... which in turn keeps them motivated to provide more flexibility to the otusourcer. Its usually always a win-win for the offshore provider and the outsourcer... Our company has experienced working in almost all the 3 models now... and we've found this captive team model which we call Power Team to be the best in terms of a good win-win balance between both the parties. For more details you can refer to the URL below.

Links:
http://www.ephlux.com/powerteam.htm

[Binesh Nambiar]

The recent trends and the way the industry shows that there is a lot of pressure building on the captives.This has led to some hiving off their units to third party providers while others following a multi -sourcing and co-existence strategy between captives and third party providers.

Cost saving comparison between captives and third party becomes questionable. In the captives fatter salaries( especially expats who form the senior management of the captives), upscale infrastructure are placing a pressure on the P&L. Also the competitive environment to drive process efficiencies and the value beyond cost story is hardly existent in the captives. Some just see it as a way to enter India and take advantage of the skilled labor( deployable labour is now becoming questionable) and the overall India story.

Captives at the same time do leverage the overall sense of control and participation in the overall organisation charter.

[Jagdeesh K]

The debate on captive versus third party is one of academic interest. In my view, they are non-issues. However, if the choice is based on an incorrect set of premises, the non-issues will become real issues.

The issue about talent retention, dollar depreciation and growing costs are certainly issues but when the decision is based on the big picture and achieving the big picture becomes relevant then these could pale into insignificance.

The reality is that with the ever changing and dynamic growth of the telecom industry delivery of service from across the globe is the only Reality. Wishing it away will not be the solution.

So the key aspect to be borne in mind is:

a. How are the operations going to be a strategic fit into the long term goals of the organization?
b. How will the operations contribute to the long term growth of the organization / development of products / reduction in time to market / improved customer experience?
c. How do we work in getting a buy-in from the senior management / existing managers in other locations to look at this paradigm shift as it will obviously mean that there will be an impact on potential job losses (though there are firms that manage this effectively as well).
d. How do we deal with cross cultural challenges and mix-n-match Global and Local (GLOCAL) realities?

If these issues are borne in mind and a solid frame built around this, then there is no reason for these to fail.

Invariably, the off-shoring / outsourcing decisions are taken because the CEO wants it to be done and hence it will be taken up or due to shore up the short term profitability (invariably the in the initial years there is high saving as the comparison to costs will be from the more expensive location). Both these have high potential of failure which will be mostly due to reasons mentioned in the question above and then once again the CEO / CFO decides that the best way to move out of this is to sell the operations!!!

[Amit Kapoor]

Phil,

I am surprised to hear that there are many organisations who set up captives & then think of selling them. I always believed that captives were made for the long haul, in a bid to avoid paying the high supplier margins & have a lot of leeway in offshoring some of your core stuff. The initial cost of setting up a captive is quite high. If I had a captive, I had rather try to make it work than look at selling it off.

Talent management (as Chethan rightly points out) is a problem for captives. But it isn't something that only the supplier industry can resolve. Any organisation in any sector needs to have a sound talent management practices & organisations setting captives can't shy from this fact just because they looked only at the economic positives of captives, when they decided to go for it on full throttle.

As you have alluded to in your post, the biggest drivers for captives are:

1. The opportunity to save on supplier margins.
2. The ability to outsource core & sensitive work.
3. At times, to counter the regulatory challenges that may impede outsourcing.

The challenges to captives are:
1. resource management (how to manage hiring, attrition, resource allocations, ramp-ups, ramp-downs & ensure utilisation).
2. talent management (i.e. how to give employees opportunities that are deemed by the workforce as at par with opportunities that might come to them had they worked for some supplier).

I think that unless the advantages are severely negated, there isn't any need to consider selling the captive. The disadvantages / challenges are at best generic & not captive-specific anyways. I am sure that captives can correct these with some more determination & resolve.

Regards,
Amit

[Michael de Zeeuw]

Also very surprised that the question keeps coming back now.

Now that the major BPO providers have significant scale, I just do not see how captives can compete with them.

Employees are better off moving to a business for which their activities are core.
BPOs can leverage their scale to invest in various technology tools that captives cannot afford: workflows, OCR, GL cockpits, service architecture, platforms, etc..
BPOs offer more flexibility in adaping to new market changes.
BPOs reduce many risks that captives have: based in few locations subject to political and currency risks, weak BCPs, incerased turnover..

Some may want to cerate a captive as a transition path towards outsourcing. It sounds a bit complicated but why not?

BPOs are now developing tools and solutions that will make it even more obvious in coming years, but those who need savings now (who does not?) should not wait!

[Jean-Paul Binot]

I think that the Captive vs BPO debate Is not quite as moot a point as it sounds to us practitioners.

We always assume that the overriding preoccupation of companies considering mutualization is to cut cost. This is naturally often the case, but not always. If a company wants the biggest bang for their buck, indeed setting up a relatively small captive SSC in a near-shore or even offshore location does not sound such a great idea.

There are companies however for which by design the benefits to be derived from a journey toward SSC is much more qualitative than cost-driven, or who simply do not want to outsource because they can afford not to do so. Or maybe they do not quite foresee the trouble that might lie ahead in terms of governance, staff retention etc. For them, a custom-made captive SSC in an expat-friendly location like Budapest or Singapore, while admittedly higher cost than would be achievable elsewhere, might be affordable still and more appealing at least in the short term. True, the day might come when they will want more from their captive SSC and at that time the initial choice of setup and location might prove limiting. The decision to go for BPO might make more sense then.

[Ed]

Phil,

I can tell you from experience that offshore captives can become a huge drain of management time and investment. Companies always end up investing far more in their captives than they originally planned or expected to. One of the chief problems for firms has been finding and retaining experienced managers for running captives. There are also far too many offshore staff who are exaggerating their management experience and failing in their jobs. Your question on companies doing this by "trial and error" is right on the money. My advice to firms looking to move work offshore, is to leave this to experienced outsourcers which have the expertise to run offshore operations. I can understand why many firms want to keep sensitive processes inhouse, but they have to consider the financial viaility of taking these processes offshore in the first place, based on the experiences of many other firms which have suffered as a result. You also have to take into account that firms moving sensitive information offshore are often exposing themselves to the same risks - whether they use an outsourcer or their captive.

Ed.

p.s. love the Clemens reference :)

[Gopal Shrikanth "GD"]

YES IF
-your offshore oversight efforts substantially impact your core business
-your ability to ramp up overnight impacts your ability to retain clients
-you need to layoff a substantial percentage of the staff
-you cannot "eventually" provide cutting edge work to the offshore team
-you are unable to attractv the best local talent
-your attrition rate is over 30%
-you cannot provide periodic / short term onsite (US/EU) opportunities
-you are a little known brand in the local job market
-your cost savings are less than 30%

No IF your offshore captive is
-actively "engaged" throughout the life-cycle of your business
-integrated with your frontline sales force
-or will soon receive "cutting edge" work
-managing to keep attrition below 10%
-producing savings of at least 20%
-focussed on new product ndevelopment rather than mere maintenance
-consistently rated amongst the top 10 best companies to work for
-providing periodic on-site (US/EU) opportunities for staff
-working on core technology that is too risky to outsource

[Phil Fersht]

Hi Sanjeev: you sum up the scenario very well in three points. Whatever the original intent was for developinhg a captive, firms need to ask themselves the 10 questions listed above to help them decide how to develop their captive strategy long-term,

Phil.

[Sanjeev Nawani]

Phil!

Let take a step back... Why was main reason to open the offshore captive unit?

1. Was Low cost aggregator a major result?
2. Was the intend to make a Global centre of excellence
or
3. Was the intend to make an innovation hub or R&D center?

Also along with this look at the support of the parent organization...

If the intent was to be a low cost aggregator and ROI is achieved and you are getting good brand value, then sell it and invest in vineyards...

But the intent was to have a global CoE or Innovation Incubator, then keep it running for some more years....

My two cents...

Cheers

[Dr Vikram Venkateswaran]

Hi Phil

The debate is not a new one and this one as you rightly pointed out does not seem to go away. Off -shore delivery is not an easy task, setting up an off-shore facility it self is difficult and getting it to perform to the expectation is a full scale challenge.

In my opinion there are only two options either allow off-shore captive to work independently that means its a separate business unit which at a later stage can look for its own business also.

the other option is to run it collaboratively with another off-shore vendor with the guidance and support with that entity.

Regards
Vikram

[Chethan D Srikant]

Hi Phil,

Being a part of the sales team of what I would consider the best offshore service provider you can brand my answer as extremely biased and vested. However I’ll wear a different hat and provide my perspective.

I will take you back to my Engineering days (long long ago) when the campus recruitment started in the sixth semester. It was a matter of pride amongst your peers if you were selected in the first few rounds. One of the top four India based offshore service providers was the first company on campus. Just before the final round of interviews I decided to pull out. I was threatened with blacklisting by my Placements coordinator. The reason I pulled out was because a few days later a major German firm was recruiting for their captive in Bangalore. I was starry eyed and wanted to stand out amongst my peers. I made it through multiple rounds and felt that I was on top of the world when I got the final offer letter. I was amongst the highest paid and working for a great brand name.

20 months later I was disillusioned. Not because the company wasn’t great nor that the work environment was a factor nor the pay nor my peers nor my boss (well, probably the boss to some extent). The real issue was that we were so far away in the company’s value chain that I had no idea how my work impacted the company’s business results. I resigned and went for my MBA.

The reason I wanted to give this background is to put in perspective the real issue in the captive vs outsourcing provider debate – talent. It is not as simple as developing a career plan. To make them feel a part of something truly revolutionary is not an easy challenge to tackle. It is so much easier for a company like TCS for which I work. The Tatas are taking India to the world in multiple areas and TCS has been a vanguard in the Tata group. So an Indian would feel truly proud to be a part of that journey. Can any captive setup in India appeal to them at the same emotional level? At best they can provide a great logo on the resume and a bigger paycheck.

I can put on my sales hat and provide you a million other reasons, true but probably clichéd, to justify why captives are not the best option. However I just wanted to bring out a more human and basic reason in this response.

Regards
Chethan