Business Process Outsourcing – Captive service or third party vendors?

Which is a more viable option – captive providers or third party vendors? This has been a question plaguing the outsourcing industry since the BPO (Business Process Outsourcing) boom in the 90s. For many global players, offshoring is not so much the issue as the choice between opting to set up a captive unit or outsourcing to a third party service provider.

Background

Realizing the potential of countries like India in terms of cost saving and brain power, many Fortune 500 companies opted to outsource none-core processes in the 80s. GE and British Airways led the path for captive services by setting up wholly owned subsidiaries in India. Local players also realized the scope of this budding industry and offered services, with the backing of established players or venture capitalists. The industry soon realized the advantages of outsourcing to third party service providers (TPSP) instead of investing in captive units in terms of responsibility and cost savings.

Why captives at all?

• Compulsion to keep absolute control over processes
• Fear of intellectual property being compromised
• Inclination to keep critical activities within the organization

According to Ravindra Datar of Gartner India, "Some companies in the US are convinced about the benefits of going offshore and of using India as a base for global requirements, but are not comfortable outsourcing to external service providers. These companies prefer to set up their own captive units to gain from the benefits of offshoring."

In terms of cost, captives stand 30 percent higher than third party players. So what is it that prompts companies to invest in captive offshoring arms? According to Noshir Kaka of Mackinsey & Company, “What makes them a strategic choice still is that most captives follow the practices set by the parent company, which means better operational excellence." So better customer satisfaction can often be guaranteed. However, there is always the danger of diminished accountability among captives since there are no "clients" as such to keep tabs on operations. "In fact, third party service providers can outperform captives since they need to keep a reality check all the time to attract more customers," adds Kaka. According to the Everest Research report, for captives to deliver strategic value to their parent companies the BPOs "must operate differently and integrate better with their parent companies, create alignment on the definition of value between parent and captive stakeholders, help cultural change within their global organizations to facilitate the evolution of the captive beyond an arbitrage player; and design and implement governance mechanisms to integrate better."

Current scenario

The debate on the offshoring operational model can be viewed in perspective by basing it on the Indian scenario. Analyst firm Forrester Research maintains that more than 60% of current captive BPOs are not in a healthy shape and that by 2009, more and more companies will shelve their captive business in favor of third party players, especially in the fields of customer support and product development. Aviva Global Services (AGS), the outsourcing division of insurance major Aviva Plc, is supposedly considering the sale of its (BPO) units in India. This is in tandem with two high profile sales of their BPO arms by GE and Citigroup in recent times. Indigenous companies like TCS, Firstsource and Infosys are taking over the captive businesses of their clients both in India and abroad. Sudin Apte, Country Head, Forrester Research India, states in his report Shattering the Offshore Captive Center Myth, "In the majority of cases, setting up of captives is driven by personal reasons such as an expatriate employee's urge to go back to India for family reasons. As a result of the lack of management support, spiraling costs, skyrocketing attrition, and a lack of integration, more than 60% of the captive centres in India alone are struggling."

On the other hand, according to the Everest Research Institute, in spite of market perceptions to the contrary, the captives in India are all set to grow at a rapid pace. The Indian captives market amounts to around US $9 billion, employs about 200,000 full-time employees and accounts for 30% of the Indian offshore services market. In fact, current captive players like Dell International Services are expected to expand their headcount, with the company affirming that it has no plans to wrap up its captive services. The Fortune 2000 companies continue to initiate new operations, with over 50 operations added in the last three years and existing captive operations intending to double their capacities in the next two years. Captive revenues have increased from $5.2 billion in 2004 to $6.9 billion in 2005 and to $9 billion in 2006, according to estimates by the Everest Research Group. It is also interesting that while many captive units have surrendered to third-party outsourcers or sold their facilities to third parties, a few others like Barclays Plc have left third-party outsourcers and have set up their own units. Even Aviva had initially moved some of its contracts to its own captive from third party players. According to Milan Sheth of Ernst & Young, "Ultimately, it is a question of what role the organization sees for the captive. In some cases, although firms may want to outsource, third-party outsourcers may not have that capability, so they have to go the captive route."

Each unto its own!

All said and done, what India is witnessing is a dynamic coexistence of both models depending on individual business process needs. As Don Ganguly of Equinox points out, "The trend is moving towards a hybrid model, where customers may look at going for both captive and third party players addressing separate business needs." Financial entities like banks opt for captive facilities, while many IT companies that began as captives have moved on to become third party players. There are also companies that use third party vendors to initiate BPO services and then recall operations once business stabilizes.

Whichever way the outsourcing industry is headed, it cannot be refuted that augmented services and unquestionable quality will have the final say. As the Nasscom/McKinsey report points out, companies will need to fortify their best practices and promote operational excellence to remain competitive. Noshir Kaka aptly sums up, "It is time that the BPOs looked at improving and standardising their processes and practices to remain in business. It applies to both captives and non captives."

Vidhu Panicker
Outsourcenews.com network