Captives: Does India Still Captivate?

Captiveslike GE, BA, SwissAir, and American Expresswere
the harbingers of what is today called offshore BPO in India. At one time, they
accounted for the lions share of business services exports from India.

They no longer do. That is an extremely simple statement many
would not be able to digest. If we give some numbers heresay their revenue
share in the overall exports has gone down to 45% or 42%that will probably be
headline stuff.

Unfortunately, we are not confident enough to give that big
number. The reason is not difficult to imagine for anyone who knows this
segment. Unlike the third partiessome of who shout from the rooftops on their
growthcaptives are secretive about sharing any number, primarily because of
fear of backlash, as most of them are consumer-facing companies. Some of them go
out of their way to ensure that the numbers are not leaked by employees,
partners, or suppliers. In the absence of any such data, we had to manage with
the best we could do.

And, that does not give us a big number to share with you. But,
what we can tell you with a lot of confidence is that they no longer export more
than the third parties.

The reason why big numbers are quoted is because at one time,
they did dominate the business services export. And, despite the fact that many
of them have ceased to growsome have in fact gone down on their headcountthe
myth lives on: that captives are big. The absence of data only intensifies the
myth.

The Changing Equation

The captives versus the third party BPO debate continues to simmer globallywith
the epicenter of that debate in India. While the news of offshore captive
centers opening are still common, a slightly discerning look would reveal that
many of the new captives are small IT design/development centers, and not large
scale processing centers like those of HSBC or Standard Chartered.

If anything, some of these are turning third party. Till three
years back, Genpact was a captive. Its changing from a captive to third party
model sent two messages: it is not possible to continue as captives and still
keep growing; and that large, trend-setting companies like GE are now quite
confident about outsourcing. For the analysts, however, that means the
captive-third party balance changed drastically, with a big chunk now being
classified under third party. WNS, which had taken that route earlier, may have
been a pioneer, but its numbers did not have that kind of impact on the balance.

Since then, Unilever has sold stake in its third party to
Capgemini. Now, with the 8,000 people Citigroup Global Services up for sale,
that equation may change even more in favor of third parties. There is also the
likelihood of Scope (captive arm of Stanchart) and JP Morgan, two other major
players, transforming themselves into third parties. There are rumors in the
market that the Prudential captive (PPMS) operations was being eyed by a few
companies including UKs Capita Group.

With other big captive players like Dell (probably the largest)
and Aviva following a hybrid model of outsourcing to third-parties, there are
possibilities of the club further dwindling in FY 08. And, imagine if one of
the largest players, HSBC Electronic Data Processing, too changes colors, the
Indian offshore BPO story would no doubt cease to be captivating. Though there
would still be enough captive operations left, the fact is that unlike
third-parties, these take much longer to scale and, hence, could easily lose out
if one or two established players switch allegiance.

With scaling up obviously being a harder option, the only way
this apparently irreversible momentum of dwindling captive numbers could be
arrested and even overturned is by more players entering the space. And, just
looking statistically, that would be possible even if a few of the technology
and telecom MNCs who have started captive R&D and IT operations here in the
last 18-24 months also take up BPO. Most of them do have small voice kind of
operations, and even some sort of scale up could again tilt the scale in favor
of captives.

Blame it on Cost

Forrester predicts that by 2009, more and more companies will move out their
captive BPO operations to rely more on third-parties for services like customer
support and maybe even receivables management.

A Forrester report titled "Shattering the Offshore Captive
Center Myth" tries to substantiate the cost factor with some interesting
numbers. Instead of saving money, the cost of operating a captive center is
typically higher than using third-party providers, it says. The cost per person,
per month of a captive center is $4,944, compared to $4,231 for a third-party
supplier. And, over three years, the costs of a 150-person captive center are
$29,453,799, compared to $21,723,299 for using a third-party supplier. The
report concludes that more than 60% of the current captive BPOs are not in a
healthy shape.

According to analysts, Citigroup too would become one of the
high-profile victims of spiraling costs in managing captive BPOs in India.
Apparently, Citi is putting its BPO on the block after finding it difficult to
keep its costs down, especially after recruiting thousands of employees on the
companys rolls. Citigroup Global Services (in its eServe avatar) had spent a
huge amount of money in advertising that included hoardings, which third-party
competitors reckon goes against the industrys practice of keeping costs low.

Too Many Hurdles

It would be unfair to blame only spiraling costs for the current predicament
of captive BPOs in India. It is more often than not a combination of factors
including skyrocketing attrition, lack of management support, and a lack of
integration that has started spelling the doom for captives. And, therefore,
while costs are still most important, there are other factors that force a
rethink amongst the MNCs. Most of the captives serve the parent companys
global operations and, over a period of time, these captive units do not get the
cost arbitrage factor because they do not match the growth of third-parties.

Analysts say that Indias high rate of attrition, coupled with
low productivity levels could also spell the end of the captive honeymoon. A
recent Nasscom study found that the annual attrition rate is as high as 30% and
industry experts point out that attrition rates in MNC-owned captive centers are
higher at 30-40%. This makes it more expensive for MNCs as they have to either
keep a huge bench (a waiting pool) or consistently hire HR consultants to hire
new sets of employees.

Productivity too is low in Indian units, when compared to
nations where the MNCs are headquartered. According to Zinnov, a research firm,
staff productivity at offshore centers like in India is 50-60% lower than that
at the onsite units located in parent countries. For many firms, this creates a
severe mismatch in the productivity between their Indian and US teams. Experts
add that captive units are further burdened with a poor delivery record,
operational problems, a lack of scale, and poor morale.

Add to this the Forrester contention that despite lofty claims
most of the reasons firms cite for building their own facility versus
outsourcing to a third party are flawed. According to Forrester research, in the
majority of cases, the need to set up a captive is driven by personal reasons
such as an expatriate employees urge to go back to India for family reasons.
Not all captive baiters too are willing to, however, buy this argument: if
personal reasons could dictate such key strategic decisions the business anyway
is doomed, they feel.

Even if the GE, SwissAir, and British Airways transformations
are looked as past aberrations, Unilever belled the cat this year. Its
arrangement with Capgemini involves a seven-year agreement to deliver the full
range of BPO F&A services to all the Unilever companies, which Indigo used
to serve. It seemed that Lever must have realized sustaining a captive BPO
center may not be the best option available in front of it, when looked from an
expertise, economics, or scaling up perspective. Levers approach is likely to
be emulated by other MNCs: unlock the value and renounce management control
where the operational challenges cannot be managed with its existing core
competency.

Captive Support

Captives still do have their die-hard supporters who argue that
notwithstanding higher costs, what makes them a strategic choice still is that
most captives follow practices set by the parent company, which means better
operational excellence. This translates into better customer satisfaction. The
naysayers immediately counter that the captives can also fall into the trap of
slackening their practices since there are no clients per se to keep a
check on the quality of their operations.

The key business reasons and priorities underpinning the
decision to go captive in the first place include, among others, the carrot of
saving money, protecting intellectual property, and more tightly controlling
processes. Some captive evangelists do not buy the arguments on productivity
concerns, as that cannot exclusively impact only captive operations; rather, the
focus needs to be on the cultural synthesis within the global organization to
facilitate the evolution of the captive beyond an arbitrage player.

And while only the Citi/Unilver/British Airways kind of stories
are cited by third-party advocates, the captive votaries like to talk about how
FirstSource (then in its ICICI OneSource avatar) piloted the development of
Prudentials captive unit before handing over the reins, or how currently
Aviva operates with 24/7 Customer on a BOT model whereby it starts the BPO
operations for Aviva and after successful running of the center transfers the
job back.

According to Everest Research, the growth of Indian captives
continues to spread across industry verticals, functions, size of the parent
companies, and geographies. Existing captive operations are evolving from being
lost-cost providers into strategic entities by aligning themselves with their
parent companies, managing more end-to-end strategic processes and driving
innovation and profit impact. Dell International Services, Dells service and
sales support arm, concurs that for its business model, captive BPO is the key
to growth.

Middle Path or Disaster

And though the arguments against captives look potent, the trend probably is
more towards what some analysts call an "externally co-managed
captive" model. What this would entail is more creative thinking by global
enterprises to consider a global service delivery model. Captives can then be
structured so that an external service provider manages service levels. Such
structures can go in and out of pure captive mode, depending on transformation
needs. This would take care of captives lack of ability to add resources in
cases of spikes in demand unless they subcontract to outsourcers and at the same
time helping it in control of data, human capital, true branding, and other
management goals.

The trend, going forward, is definitely toward this kind of
hybrid model, where organizations may look at going for both captive and third
party players addressing separate business needs.

The prognosis of the Forrester report is, however, much more
alarming, and predicts a difficult future. Over the next three years, at least
40-60% of the current captives would have embarked on some exit strategies, and
for the next year, the number of new centers would gradually taper off as the
news about struggling existing centers gets around. More precisely, the report
predicts that in the near future 10% of the MNCs captive units will shut
down, 20% will adopt a hybrid approach by using third parties for less critical
work and outsource strategic work to their Indian campuses, 10% will sell out
and completely give out work to third parties, and almost 50% were likely to
follow a termite strategy of going slow on their plans and gradually exiting.

Rajneesh De

rajneeshd@cybermedia.co.in