Captives vs. Outsourcing: Combining Approaches May Be Best Answer

Ann All

Ann All spoke with Eric Simonson, managing principal of the Everest Research Institute, an independent research and analysis organization founded by Everest Group to serve as a central source of strategic intelligence, analysis and insight for buyers, suppliers and investors in the IT and BPO marketplace.


All: Everest Research found that while third-party outsourcing suppliers typically cost five percent to 15 percent less than captives in terms of total cost of operations, best-in-class captives can operate at similar or even lower costs than third-party providers. What are some of the features/characteristics of these "best-in-class" captives?
Simonson: The first thing that we see is scale - not being 200 or 300 people but perhaps 2,000 or 3,000 or even 5,000 people. Beyond scale, another thing that can make a difference is being a little less selective about recruitment policy with front-line staff. Often captives skew toward a higher emphasis on soft skills, which has to do with their initially trying to find people that understand the parent company. Cultural differences often cause them to seek similar soft skills, which command a premium in the market. The other thing is being able to pay lower salaries and also have non-monetary incentives, like job rotations, transfer programs to parent companies, other incentives that help staff view the value proposition of working for the company as being about more than direct compensation. To the extent the parent company has a local office in the country, it should leverage that office for senior management talent to initiate and manage the captive, as opposed to paying for expats.


The last one is having more cost-effective policies around certain expenses - travel and entertainment, training. If you are a big offshore supplier vs. a company wanting to establish a presence, you can do your training in the country vs. pulling people and sending them to the parent for training. These strategies are not accessible to every company; they are best done by companies with pretty deep experience in the market. Much of it comes down to, on the cost-risk profile, being willing to exploit items that are less costly but carry higher risk.


All: There appears to be a trend lately of companies selling their captives, to earn revenue from a sale but also to pursue lower-cost outsourcing models. Conventional wisdom seems to be that captives are generally too expensive. Is this a shortsighted view? Your research seems to indicate that some companies could suffer from a long-term loss of business value by opting for a third party vs. a captive outsourcing model.
Simonson: There is a lot of buzz about this. But taking the buzz head-on, if you take a sample of captives, you might find that a fairly high number are struggling. But if you weight it and look at the larger and more mature organizations, the number that are struggling is dramatically less. Many of them that are struggling are less experienced companies that have come to the market more recently. So some are in the early stages and experiencing growing pains, others might have been late adopters to begin with and maybe not as adept in understanding offshoring or the culture in which they are operating. So yes, it's right that a fair number of captives are struggling. But if you look at where the work is occurring, the mass will tell you a different story.


My strong experience has been that a company that is not a provider of services, but is trying to figure out how to leverage offshore, they at most levels of the company undervalue the benefits of outsourcing and overvalue the benefits of retaining control, and therefore of having a captive. Outsourcing suppliers have the opposite dynamic. So each of them tends to miss out on the value of the other approach.


With the sales activity, it's important to note that there's a lot more talk than action. You ask yourself why, as the market matures, would people buy captives? If I am a leading offshore supplier, I might buy a captive a time or two for capability to expand my footprint or to attain an anchor client or to attain domain expertise - however, I don't do that 10 times. If I do it 10 times, I am doing it because I get a good price. I am helping someone who has a problem and I am relieving them of the problem and fixing a mistake.


All: What are the key factors companies should consider when deciding whether a captive or third-party outsourcing model will best suit their business needs?
Simonson: Does it have the scale and the natural inclination to operate in that geography? Or is there some reason why (the company) may need to understand that geography? If they pass those tests, it comes down primarily to what kind of value they are trying to attain. If the objectives are primarily about cost savings, then a heavy consideration of outsourcing is appropriate, particularly as you think about business support services that may be fairly standard in the market and not containing what I would describe as "secret sauce."


If a "secret sauce" is involved - you are a software company and you want to localize your software program into Hindi and you want to be able to invest in more versions of your application and you see this as a business enablement of that - then yes, a captive can make a lot of sense. Target and Tesco have captives in India. They see it as a way to attract talent and at the same time, to learn the market. So those are some pretty hefty business objectives, and it makes a lot of sense for them to consider a captive. If you are not framing it as a business-oriented objective - it's more about cost per transaction or cost per FTE (full-time equivalent) - then I think outsourcing makes more sense.


Unless you know you are going to be big in a captive, it's probably easier to start with outsourcing, and as you mature in the market, build a captive later to take back the work or add the work you want. The people that are best able to describe this are the senior management of the mature captives. They see where they have limits. They don't necessarily feel threatened by the cost-based outsourcing model, and they say, "How can I leverage different types of sourcing for different types of things?" So there may be some things they do themselves. There may be others they do themselves but also outsource pieces of it. They are more equipped to deal with the gray.

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Apr 21, 2010 2:58 AM Naveen Naveen  says:

Much appreciated. Responses to queries were put in very practical manner.


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