Captive Sourcing : Can you have your cake and eat it too?





Data Source: WSJ.com article

For some CIOs/sourcing decision makers the risks of traditional outsourcing outweigh the rewards.   They are either too wary of changing the status quo (having an in-house IT) and giving up the proven way of doing business, or have already tried outsourcing and feel that it promises more than it delivers. This is where captive sourcing comes in.

Captive sourcing, or having a fully owned subsidiary where your outsourcing vendor would operate, seems to be the silver bullet that provides the cost advantages without sacrificing control. Many firms have tried captive outsourcing. Have they succeeded? Hit the jump to find out.

   

Many companies such as Citibank, BNY Mellon, Motorola and Texas Instruments have/had established their own IT/ITES operations in foreign countries, specially India. This is perceived as a way to reap the benefits of low cost operations (labor arbitrage) and yet having the tight integration and controllership as an in-house operation.

Why do some firms seeking to outsource go the captive route?


As a highly placed official in BNY Mellon said to me recently, the costs of using an offshore IT vendor is not really as low as it “seems at first”, (she was likely referring to the pure offshore billing rate). Another procurement manager at a New York based global leader in management consulting said he was concerned about the escalating “Total Cost of Ownership”. It is true that the traditional IT vendors use a mix of cheaper offshore and more expensive onshore (usually on-site) personnel (a key operating ratio known as the “offshore leverage” which usually ranges from 50% to 90%) that leads to an adjusted blended rate much higher than the pure offshore rates. How high? Well it could range from 40% to 100% higher than the pure offshore billing rate depending on the leverage factor and the actual billing rates in question. The providers obviously feel it is necessary to maintain a smooth operation. There are also phenomena such as job rotation, transition, shifting junior/senior ratios etc. some of which are incidental and some by design that impact the fully loaded billing rate one way or the other and make matters more complex. It is safe to presume that the firms that open foreign captive units feel that they can do a better/cheaper job than the local players.

Where do they go wrong?
  

To begin with, offshore captive units are not easy to set up with no prior expertise and no brand image in the space. In fact, some firms use a BOT (build-operate-transfer) type contracts to hire a local vendor to set it up, operate for a certain duration and transfer ownership back to them). However sustaining a captive unit is a challenge for a foreign firm with no credibility in the in the operating country. So when a JP Morgan opens an IT shop in India, they usually have to provide higher local salaries than the local big players (such as the Tata Consultancy Services, Infosys and Wipro in India), and often a much less attractive career path. By design, there is little or no possibility for the employees of stints abroad, first hand client interactions that enrich their business and social skills. Also in an effort to do one thing very well, they have limited or no freedom to move between technology areas, work for different clients within the industry and even across industries over time. In the absence of these “perks”, the only retaining factor for the employee becomes the salary. And with many “me too” captive wannabes, there is no dearth of employers offering a slightly higher salary to lure them away. This usually leads to either escalating labor costs (a higher effective billing rate that they were trying to beat in the first place) or a high turnover/ attrition situation which soon spirals out of control from an operational standpoint .



Amazon Book Review



Dr. Ilan Oshri explores captive outsourcing in his new book “Offshoring Strategies: Evolving Captive Center Models”.  According to him, captive operations end up in one of these states:

• they outsource part of their services to a local vendor (Hybrid)
• attract external clients in addition to their parent (Shared)
• divest to a local vendor or spinoff (example Citigroup selloff of its BPO for over $500 million to TCS in 2008), or 
• are terminated

 

The diagram at the beginning of this post is from a study published in May 2008 in WSJ.com by Dr. Ilan Oshri, Julia Kotlarsky and Chun-Ming Liew which provides this interesting finding. Of 150 of the largest global companies studied, 80 have,  or had, captive centers in India. Of those 80 companies, 30% changed their strategy for managing their captive centers in the past six years, some more than once. He goes on to observe that of those 80 companies 12.5% went to a hybrid mode (that is performs core business processes for the parent and outsources non-core work locally), 11% attracted external clients, 6.3% divested to local vendors and another 8.8% terminated operations.

  

So we see, captive sourcing by itself is no silver bullet. When done in a hurry and with the short term focus on direct labor costs, can cause more problems than it solves and even leave a big hole in the corporate pocket. However there is yet another sourcing strategy that takes a best of both worlds approach. We will explore this in a later post.