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Analysis: Failing Captive Centers

Posted by Girish Krishnan on August 1, 2006

Recent news on Apple closing its development centre in India due to cost pressures prompted me to think about the reasons that cause captives to fail in our country. If at all this is a trend staring at us, we should be aware of the opportunities for External Service Providers (ESPs) to leverage the same. I am sharing a summary of my research and analysis below.

While the Indian IT and ITES industry is still under the boom phase, there is a significant trend indicating that the Captive centers are increasingly facing pressure due to a variety of reasons. Some of them (like Genpact) are growing bigger and even becoming service providers by diversifying into other areas, while others (like Apple) are forced to close shop. This opens up a big opportunity for the External Service Providers (ESPs) to cash out by adapting themselves to suit the drivers of this trend.

I shall quickly try to establish that captive offshoring can lead to a negative ROI for companies in quite a lot of cases and also assess if outsourcing to partners instead of starting a captive center can be made a more viable option to companies.

If we track back the history of captives in India, we could observe that majority of captives started as subsidiaries. Infosys research reveals that this number could be as high as 56% while joint ventures help fuel around 13% of the captive centers. The early captive centers (like Oracle, SAP AG etc set up in the 90’s) were more IT (technology) focused than the recent ones which handle low end work like BPO. If you look at the split across industries, its an obvious fact that financial services dominate this market contributing around 50% of captive offshoring.

The primary motivation behind outsourcing or offshoring are Cost savings, Improvement in Quality or strategic imperatives (where the vision is to leverage the capacity to fuel the organization’s growth in different directions). Once this thought barrier is crossed with a positive binary result, the motive is to choose either a captive way or to outsource work to ESPs.

The two main reasons to go the captive way would be to safeguard the company’s competence and/or of course a vision to transitioning the imperative from tactical to strategic. The plan to go captive demands that you have sufficient size and scale that is sustainable in the long term, and in a way have the ability to compete with the outsourcing providers (by the comparative advantage theory). Also, essential are the capability to integrate with the new outsourcing location in terms of setting up infrastructure, hiring staff, managing remotely etc.

On observing many of the captive centers that have failed recently, one can observe three reasons that cover the entire gamut of failure cases; Cost Overruns, “Time” frame issues and quality issues..

Cost Overruns: This can be attributed to high fixed costs, bad planning that ignored the industry dynamics and miscalculated the sustainability in terms of size and scale, and most importantly undermined the Captive Critical Mass (CCM). The CCM is an interesting phenomenon which decides the ramping up speed and also the steady state load of the captive center. Gartner says that for a captive center in India to reach its desired CCM steady state within 18 months, it needs:
• 500 people for a general IT operation focusing on generic application development and
maintenance.
• 250 to 300 people for a business process outsourcing (BPO) operation, not including call-center-related activity.

It is probably obvious that the CCM varies with the type of the job performed and companies should try to minimize the impact of CCM if they want to maintain profitable captive centers. There are many factors that affect the CCM from being at the optimum – including the work complexity, retention issues, resource availability, Hiring/Firing HR costs, job perceptions, brand value, compensation etc.

Time Frame Reasons: These issues are connected to CCM- Inexperienced managers and cross cultural issues could be major reasons for captive center to fail.

Quality Issues: Pertain to customer dissatisfaction caused due to security breaches, bad service etc

In the recent past, the Indian outsourcing industry has become extra efficient and their brand value sucks most good resources available in the market. Infrastructure cost is shooting up like anything in India and it appears quite unlikely that these rapid market dynamics featured in the original business plans which paved the way for captive centers in India.To give you a sense, the cost of commercial office space in Bangalore has quadrupled within the last 4 years (2002-2006)!! Lack of experience handling these situations in India is proving fatal to most of the existing captive centers.

Given the trend where in captive centers are failing, outsourcing partners need to think on how they can leverage this situation to their advantage. This is a big opportunity for them to get work which could have gone to a captive center if not for the stumbling blocks we discussed a while ago.

Broadly, I believe that there are two major areas which would give maximum marginal utility towards this goal. One could leverage the flexibility possible with the current delivery models and also consider improving the safeguards offered to the client. Hybrid models like BOT (Build-Operate-Transfer) give more flexibility to the client in terms of deciding the extent of his control and at the same time bring in the advantages of having an established partner to setup the center.

ESPs need to have stricter security norms in place – internationally recognized practices like BS7799 really help boosting the customer’s confidence. (It may be noted that Europeans have higher risk appetite in starting captives than the US companies that show more outsourcing willingness. BS7799 comes from UK reaffirming that part of the world’s extra sensitiveness in security issues)

ESPs in India should send out right signals to the clients by ensuring secure transactions, investing on a continuous effort to safeguard IP and provide data protection through the enforcement of appropriate policies, procedures and work culture.Security breaches should not be taken lightly and immediate action need to be taken to rectify the damage and also to mitigate the root causes.

Tech Tags: Captives, Outsourcing,ESP, Offshoring, BOT, Critical Mass

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6 Responses to “Analysis: Failing Captive Centers”

  1. Satish Raman said

    Hi

    Good Analysis. So how do these ESP get a piece of this big pie? What tactics do they use to identify and finally convert. Do you have inputs on this?

  2. Nandani said

    Overseas companies hired a lot of people who had no experience in running captive nor did they had any exposure of running an organisation in a cost effective way. The main reason of some of the companies failing had been purely bad management and lack of support from their parent companies. It has also been a fact that all big IT companies who have been earning huge money from the same overseas organisations have drummed up failures of few captive setups to discourage their customers going captive way. If you take statistics, almost all big captive setups are doing well and are growing. Small setups have mostly been in trouble as in several of them the reason to start captive was not cost saving but for some Indians to come back to India and try their luck. Corporate sponsorship had lacked in most of the cases. Small captives also have problems of scales and looking at small returns, parent companies loose interest. In a few cases poor quality of delivery too had been the reason, mainly in call center BPO. However in all, the trend has been in favor of captive in India.
    In order to prove the study done, I urge author to show statistics along with the source of them. Several such studies have been circulation sponsored by IT service providers who fear business loss if captives grow.
    Indian growth story and increase in real estate and unreasonable increase in salaries indeed have dented the cost advantage and if Indian companies and youth have to remain competitive, they have to leave high expectations else perish in long run. They will face the same fate as auto giants of US but without any bailout.

  3. Rama said

    Hi,

    Its been a long pending aspect to Indian outsourcing or Offshoring industry.

    There are two factors that have complemented this as a highlighted issue.

    1. The increase in the cost of operations in India abroptly.
    2. The availability of cheaper resources and willingness of these to accept any kind of work (Thanks to the so called Recession).

    Its high time that India should look beyond dependency of external agencies to offshore the left outs. We should create our own Knowledge oriented resource based industry that can cater value to the industry. This is only possible by supporting R&D and good collaboration of Industry with Educational institutions.

  4. Here’s a site similar to elance.com but aimed at multi-year ouitsourcing contracts. OutsourcerMasrketplace.com

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