Captive is basically a service model (a type of Business
Process Outsourcing) where an organization invests and develops its own
subsidiary rather than investing in a Third Party vendor. The benefit of such
an arrangement is that organizations are able to leverage the cost savings of
offshore resources, while having complete authority over the center. It also
allows them to build domain/knowledge capital over time. However, running a
captive data center involves huge infrastructure cost in terms of land, buildings,
servers and networking equipment, security personal, power and generators cost,
electronic surveillance. Apart from these, complexity costs like installation,
maintenance and monitoring requires highly skilled technical professionals,
data protection and software experts, data warehouse and storage experts,
etc. On the other hand you have Third
party vendors who have all the infrastructure set up and can provide you the
required service efficiently at a much lower cost. Citigroup, Unilever, Deutsche
Bank, Dell etc. are few of the Fortune 500 companies who have shut down their
captives in recent years. Some 60 per cent of all such captives fail to meet
expectations. Third party offshore outsourcing industry, particularly in India,
has reached a maturity level that one wonders why a company would take the
hassle of setting up their own shop abroad.
And yet the Captive Center lives on. According to NASSCOM
there are more than 750 multi-national companies with captive centers in India.
The captive centre market has grown to $11.1 billion in annual revenue, which
represents a 300% plus growth since 2003. According to international Data
Corporation (IDC) India, Captive Centers are expected to grow at CAGR 16% in next
two years. MNCs like MetLife Inc. started its captive center in India three
years back and currently employs close to 2500 employees. Indian banks like SBI,
ICICI Bank, PSB and Bank of Baroda have their own data centers. BSNL, Bharti
Airtel, Reliance Communications and Tata Communications are the leading telecom
operators that have captive data centers. How have the captive centers managed
to survive when it makes absolutely no business sense to invest in one? What
are the driving forces that make a company opt for a captive delivery center
rather than outsourcing?
Captive Model
Drivers:
Control over operations
Companies prefer to keep a very tight control over the
sensitive matters of their business, like new product launches, product costing
data, engineering data, etc. Since captive center model enables them to have
complete operational control and transparency, it is preferred over other
models.
Reduce Cost
When companies have ambitious and aggressive plans for
offshoring and would like to do it on a large scale, they would like to retain
the 'economies of scale' and set up their own centers. Companies already having
an existing set up in the low cost region would prefer to extend these centers
to support engineering activities as well.
Knowledge Transfer and Retention
Some companies believe that best knowledge repositories are
their own people who have worked in the organization for several years and have
been part of multiple product launches. So companies prefer captive centres where they can leverage the knowledge of their employees to train new employees
and thus retain the knowledgw within their organization.
Strengthen their presence in local market
Companies want to establish a strong foothold in emerging
markets like that of China and India. local presence will enable these
companies to understand customer prefernces well and they can leverage the
local resources to bring products faster and cheaper to the market.
Data Security
Insurance and banking companies are extremely sensitive
about customer data. These companies deal with account details, social security
numbers etc. of their customers which if leaked can result in severe penalties
and lawsuits. Naturally, companies would prefer having their own captive
centers.
Challenges:
Lack of Scale
Scale of operations is the most important parameter
determining the success of the company.
Higher than anticipated costs
Many companies don't pay premium salaries to attract top
talent in their captive units.Desperate to scale up, captives often pay well
above market rates throwing the entire cost model out of order. This is a
serious demerit of the captive model especially hurting the start-up units
which operate on a shoe-string budget.
High Attrition
High attrition is a major deterrent which kills productivity
and at the same time destroys morale of the resources. Industry statistics show
attrition at captive centers is almost twice as high as the average rate for
the third-part providers. There are several factors that drive attrition.
There is sense of lacking as far as career path opportunity
is concerned, especially at smaller captives
Second-class-citizen status
In many cases off-shore teams
at the captives are considered as second class employees doing uninteresting
work that is not important to the main function of the organization
Managing Attention Wanes
The management team is initially excited about the captives.
But it is generally observed that the management support and the enthusiasm are
very short-lived. It is highly essential for the captive model to be experts in
managing their operations without diverting attention from the core focus of
the company.
Poor Development Process and Integration
Many captives face a lot of difficulty in establishing
strong development processes. Ability to integrate rigorous procedures like
CMMi, Six Sigma and other measures into practice are seldom found in the
captives. Further they often lack proven processes for knowledge transfer and
collaboration.
Perception Change
Due to heavy startup costsand the lead-times involved in
showing the ROI and tangible results, captive centres develop an image of a
cost center in an organization. To change perception within the parent
organization from being a 'Cost center' to a 'Profit center' would be a
challenge.
Key Reasons for failure:
- Lack of vision and focus from the parent company
- Thrust on short term goals and to show quick benefits
- Inability to attract, develop and retain talent in local markets
- Trying to maximize benefits from labour arbitrage rather than focus on building a value chain in these centres.
Outsourcing Model
Drivers:
Shorter lead time to get started and to get results
Since vendors have an established setup they can provide a
quick start and have the ability to ramp up operations quickly
Companies have the option of doing a pilot execution before
any large scale operation
Upon successful piloting, companies can choose to strengthen
the vendor-partner relationship to support the large scale operation or set
their own captive operations
No large upfront investments required
No wind-up hassles/costs involved
Challenges:
Domain Skills and Knowledge Transfer
For engineering companies finding vendors with core domain
and technical expertise is very difficult. under such circumstances, companies
would have to invest a lot of time and money to ramp up the knowledge levels of
their vendor partner
IP Protection
Companies believe that it is risky to carryout core
engineering activities with vendor partners due to fear of losing IP.
Data Security
Companies in insurance and banking sector are very sensitive
about their customer's data. Any misuse of such data can lead to heavy
penalties and lawsuits.
Having seen the drivers and challenges of both service
models, a company should choose the model that fits their short-term and
long-term plan best. The decision to select an off-shore model should be based
on the Total Cost of Ownership. If a company is opting for Captive Service
Model, it should assess its strengths and weaknesses w.r.t. the country where
it is planning to establish the center. Management support, Infrastructural facilities,
Government policies etc. are some of the key points to be taken note of.
On the other hand if a company is opting for a Third Party
Vendor, it needs to assess its partner from various perspectives and narrow
down to the best choice. However, going ahead I believe that a blend of these
two service models is what will suit the business best - a hybrid model where
service providers complement the operations of the company. For example, a
service provider can help in setting up the captive center initially using its
own resources. Once it is setup, the service provider along with the parent
company can start recruiting talent and train them. Once the processes are
established and the center is stable, ownership can be transferred to the
parent organization. The service provider can take the role of a consulting
partner after transfer of ownership. There can also be a scenario where a
company opts for a service provider and within the Third party's premises sets
up its own personal space to handle sensitive data and key processes. In fact
this is something that is already in practice e.g. Microsoft has Offshore
Development Centers (ODCs) within Infosys premises. The costs of operating the
ODC like electricity, maintenance, employees etc. is borne by Microsoft.
According to Eric Simonson, managing principal of the
Everest Research Institute, an independent research and analysis organization
on taking 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.
(you can read the complete interview at
http://www.itbusinessedge.com/cm/community/features/interviews/blog/captives-vs-outsourcing-combining-approaches-may-be-best-answer/?cs=22760)
References:
Offshore Models for Engineering Product Development: Captive
Center vs Vendor Partner - Vijay Machigad, KNS Acharya (White Paper)
-Rahul Mukherjee
MDI 2011-13
