The Captive Comeback

In its latest quarterly research report on outsourcing deals, outsourcing consulting and research firm, Everest Group (see page 81 for extracts from the report) points out that the death of the captive model that has by now become a popular notion is nothing more than a myth. It has pointed out that in the last two quarters, AMJ and JAS 2010, there has been as many as 63 new captive operations that have been announced. Out of that, 31 have already been operational. In this period, the firm says that there has been just one captive divesture. The research firm concludes that the activities in the captive market remains high.

This is something that Dataquest had pointed out in its annual issue DQ Top20. In its analysis on BPO exports, Dataquest had observed that for the first time in many years, there are some positive activities on the captive side. However, while the conclusions are similar, the Everest report has pointed to announcement of new captives while what Dataquest referred to was the captive work that happens but never gets announced. Typically, these are the corporate shared services work which are co-located with the offshore development centers/engineering design centers of IT companies/engineering companies. The actual revival of captive activities is on account of both these.

I would tend to believe that the recession was one of the reasons that was responsible for driving this phenomenon. A slowdown is a time when people take decisions that pay off quickly. Outsourcingespecially of business services and R&D servicesfor textbook reasons of creating long-term efficiency, has a longer execution cycle because of the legalities involved and longer process transition time. On the other hand, setting up a captive in a low cost locationwithout any change (and often improvement) in processmay not be more efficient in the long run, but is a quicker way of getting cost savings. What has changed in the last few years is the location risk. With a very strong established model, there are few unknowns about running an operation in India. I believe this is a short-cut that many have taken. The ones that grow beyond a scale may have to reevaluate later if they can continue as captives but for most who plan to run less than 1,000 people operations, captives are a good option.

Also, with the offshore model now strongly proven, many companies are realizing that they end up doing outsourcing because they want to do offshoring. This is especially true of BPO and engineering/R&D, as compared to IT, because IT is typically a non-core function as are some of the horizontal BPO services. It is not surprising that the Everest research finds that while only 10-15% of the total offshored IT work to India (by value) is executed through the captives, in BPO, that percentage is close to 25-30% and in engineering services/R&D, it is as much as 50-55%. The Everest research also points to another phenomenon: the emergence of engineering services opportunity. Between 2008-10, the firm says, as much as 56% of new captives announced were in engineering services/R&D.

There is no doubt that for high volume, low value work, outsourcing is a better model than captive. And I believe that in the long run, outsourcing would surely take away some work that is being performed by the captives, as they get more and more commoditized. But just as consolidation in an industry does not mean the industry would not have new start-ups, more and more outsourcing work moving out of captives would not mean a decline of offshore captives. What must stop is choosing outsourcing for wrong reasons: to minimize location risk. India is a well-established location now. Those companies that want to take the India advantage but are not ready for outsourcing, should explore captives and not go to a third party just because he knows India better.