The real deal with offshore captives

Recently Forrester Research released a report that says that offshore captives, which have been much in vogue for the last three years, are “imploding”. A blog post here makes for interesting reading, especially the comments.

I am not surprised. Captives were gathering steam in my last year at Infosys. There was this buzz around captives that created a feeding frenzy for management consultants and research analyst firms. We knew these were bad decisions but were helpless in the face of advice from firms that had the ears of the CEO and CFOs. Plus we had a clear conflict of interest. Captives were bad for our business and so we couldn’t be relied upon for good advice.

There are two sets of reasons why making captives for enterprise IT is harder than it looks (product development has different drivers and I don’t cover it in this post). One set are structural reasons – economic, employment market etc. Another set are around how to manage distributed teams.

The market for Indian tech professionals who work on corporate IT systems is very unlike the ones you will find in developed markets. I have written about it here and here in the past. The average wages will be low but the annual growth in wages could be well over 20%. IT Services companies offer the best deal for employees – career growth, leadership opportunities, international travel and a brand name employer (yup, Infosys’ brand beats any US corporate’s in India hands down). Bottomline – the captive will have to pay much much more to keep an employee compared to an IT Services firm – and will still have to deal with higher attrition.

Most IT Services firms in India are run very efficiently. Overheads if measured by $/employee are probably among the lowest anywhere. India based costs, economies of scale and use of technology in automating business processes are like a triple whammy on costs. On top of that, real estate costs are low because facilities are typically owned and leases are negotiated with state governments at favourable terms.

If you do the math realistically, a captive’s costs are well above an IT Services company’s, even including their sales & marketing costs and margins. So there really shouldn’t be any economic reason to go build a captive.

But the reason why captives fail is actually not economic. Its not as if these captives are being closed/sold/outsourced because of a small difference in costs versus the cost of outsourcing. The real reason why captives fail is because IT organizations don’t know how to make distributed teams work. Here are a few things you will find in how IT organizations work with captives:

1. They don’t have and don’t realize the need for stronger life cycle processes for distributed development.

2. Organization models put all decision making in headquarters and none in the captive.

3. Dull, repetitive tasks like testing or support that nobody in headquarters wants to do are the first to be shipped out.

4. Average experience levels in captives will be lower. Just the nature of the Indian market. Companies won’t invest in adequate training and then arrive at incorrect conclusions that employees in the captive don’t “get” the business side of things.

5. Small things matter. Like when conference calls are scheduled. If they are always during work hours at headquarters but outside of work hours in Bangalore, there’s a sign of dysfunction right there.

6. Headcount at the captive keeps growing, but the organization model is such that headcount at headquarters never comes down. The business case goes phut.

At the end of it, you’re left with a bunch of demotivated employees looking at an endless stream of dull, routine work and a cost reduction plan that never gets off the ground.

That doesn’t mean that distributed development doesn’t exist. You have but to look at any open source project to realize how well they can work. But unfortunately, enterprise IT still, by and large, hasn’t figured out how to hack it.

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21 Responses to The real deal with offshore captives

  1. Bibin says:

    Hi Basab,

    Firstly, sorry about the long reply.

    While I think a lot of opinions that you have usually are well thought out, I think in this case, the argument you make seems to be myopic to me. I work in the captive unit of an MNC firm and I do not believe that the comments you make are completely valid.

    1. They don’t have and don’t realize the need for stronger life cycle processes for distributed development.
    – I believe each of the IT firms (the Infys and the MNCs) had to also go through this MoC/lead time to master distributed development and finally learnt the model. Given that the middle mgmt in these captives are usually sourced from the IT firms, I do not think it will be that difficult to set up processes

    2. Organization models put all decision making in headquarters and none in the captive.
    – Would agree with this one but I think India is becoming more important progressively. Again, its a matter of time but I dont see why strategic decision making should be based out of the captive. TCS does its strategy out of Bombay for any of the DC.

    3. Dull, repetitive tasks like testing or support that nobody in headquarters wants to do are the first to be shipped out.
    – Agree completely

    4. Average experience levels in captives will be lower. Just the nature of the Indian market. Companies won’t invest in adequate training and then arrive at incorrect conclusions that employees in the captive don’t “get” the business side of things.
    – I think any ODC would have gone through this learning curve and I dont see why a Captive unit would be different.In fact, I would think the Captive will get to it faster than a vendor doing it. GE has been running the business side of IT from its Bangalore center for a long time now.

    5. Small things matter. Like when conference calls are scheduled. If they are always during work hours at headquarters but outside of work hours in Bangalore, there’s a sign of dysfunction right there.
    – Absolutely no difference from a vendor…infact i would say, since you are colleagues and not ‘external vendors’, there might be a better chance of more suitable timings.

    6. Headcount at the captive keeps growing, but the organization model is such that headcount at headquarters never comes down. The business case goes phut.
    – I dont think firms have a choice other than to reduce headcount at HQ. We may be at the beginning of the curve but we are starting to see some real fundamental moves in that direction.

    Even other aspects about possible career progression etc, as an MNC, most of them have developed fairly sophisticated career frameworks which are more ‘global’ in nature. While it may take a few years to seamlessly integrate global opportunities with India, I think all the signs are there. I think you should not underestimate the possibility of creating a global career path (and also the possibility of moving to the business side of it). One other thing that you have not mentioned is, the work-life balance and culture is usually considered to be better in an MNC environment than in Indian firms and I think these are slowly becoming more important.

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  2. Basab says:

    Bibin, thanks for the detailed comment. Here is my response:

    1. Rigour in LC processes comes out of a commitment from management. Most IT organizations don’t have to and don’t. IT Services have to because this is the revenue end of things for them.
    2. IT Services decision making being India centric affects sales and marketing and perhaps client service, but not project delivery.
    3. On experience and the business side of things, I agree with your point. But IT Services project models often shield the inexperienced developers back in India. Captive project models don’t. Over long periods of time (and low attrition) it shouldn’t matter.
    4. An IT Service provider is a vendor. He will happily do conference calls at some inconvenience to himself. An employee in a captive, however, will feel like a second-class citizen if she is always at the receiving end.
    5. I agree. There may be some failures right now. But economics is a strong motivator to make it work.

    In the end, this is a management challenge. Some companies will be better at it than others. They will figure it out (some already have) and show the others the way.

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  3. Mohan says:

    A very interesting thread. The moment I saw the report, I exclaimed to myself that the sourcing vendors and consultants are going to be overly gleeful about it. On the flip side, the few captives that have enjoyed a measure of success are going to be extra diligent in defending their models.

    What most bloggers and ‘thinkers’ seem to be missing is the need to analyze the ‘long tail’ of offshoring. the ‘Big three’ or ‘big five’ of Indian sourcing account for about 9-10 billion of the 20+ B revenues last year. The rest seems to be spread among much smaller players; and captives that source a few million (or say $10 or 30 million) in in-house projects will still be a blimp when seen individually.

    As you agree in the comment: There may be some failures right now. But economics is a strong motivator to make it work.

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  4. Krishna says:

    Can’t agree entirely. So have many other buy v. build decisions as I have noticed. Look at successes like Genpact or some financial services deals. My point is it’s like saying home cooking has failed because restaurants are doing well. The 30 year history of outsourcing has been chequered, and many deals do get brought back in – in effect becoming captives. Also there are huge capital gains that seduce companies to build on their own when well run captives eventually get sold with or without the businesses that they serviced – for some in fact the build and sell is not just a one time release, it’s a continuum that fits very well as a business model in itself.

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  5. Basab says:

    Krish, Genpact was almost entirely built as an internal BPO company. GE outsourced IT to other players. In any case, I expect there to be exceptions.

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  6. Ajay says:

    Hi

    A few observations on the captives of product companies

    1. The recruitment standards of product captives is much more stringent than the companies servicing the product outsourcing market. This, along with the general manpower crunch makes it difficult for the captive to sclae. The Services companies have learned to manage with whatever resources are available. Most captives fail to meet the growth projections that are made intially. In fact, once the head of one of the biggest companies suggested that we (the services company) get into an arangement where they will reccomend a candidate who we hire and contract back to them. This was because they felt that most of the candidtes are good enough to do the project but not good enough to be recruited by them.

    2. Sometimes, in small product companies, the decision to set up a captive is made to accomadate the desire of an influential member of the product team to return back to the mother land, as opposed to a sound business strategy. While there is nothing wrong with this, a lot of the decisions made are not necessarily the best ones (where to locate the captive, what products/activities to send offshore etc.) This again results in the captive not fulfilling the original promise.

    With the kind of attrition and manpower crunch prevalent in India, it is very difficult to sustain a small captive that is an add-on to the main product team. In fact, the companies that look at the captive as the primary product team, have a better chance of succeeding.

    A few years ago when BOT clauses were becoming the norm for most procudt development outsourcing contracts, we had started tracking REVERSE BOT of failed captives as a good opportunity.

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  8. Isicamus says:

    The meaning and function of captives are changing. India has become an important market for most MNC’s. The new captives are not mere de-laminated IT functions anymore, they are adjacent either to the local business office or to business function extensions.

    The new operators are smarter, they are not there just to pick local talent and throw them between four walls. They are there to understand the IT Services players better, ensure business compliance and simply have better control. Several of the new captives require vendors to work out of them compared to their own facilities, while the larger IT Services players may cringe at the thought, the smaller local boutiques lap it up – they get a marquee client without having to sail across the oceans.

    The notion that captives end-up getting the second-grade talent and will not be able to keep them is wrong. I have several friends in the Indian IT Services industry who want to step out of the rat-race, most of them are experts in running large multi-functional IT teams. Their resumes are music to the captives ears.

    To sum it up, these successes (of captives) are no longer exceptions, and they don’t mean that the Indian IT Service providers have failed. These are signals of change and the Indian IT Service providers are smart enough to pick them up and evolve.

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  9. Raghu says:

    Interesting discussion…I just wanted to add some points and probably pose some thoughts

    I totally agree that the cost center mentality reduces incentive to be creative on cost/ processes. When “India costs” are a negligible fraction of the parent’s cost structure, Herman Miller chairs can be provided to all corporates. Likewise location/running of captive often is so arbitrary, it makes you doubt HQ oversight. Captive Product companies seem to have better work quality, hence retention is higher comapred to their captive service counterparts.

    Basab- I had a poser around whether captives make more sense for BPO/ KPO relative to technology given the IP/business linkages or is this too a transient phase?

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  10. Basab says:

    Raghu,

    Do captives have a better case outside of enterprise IT (BPO/KPO or Prod Devpmt)? I guess the answer to that is that it depends. The case for outsourcing of enterprise IT is well established. With a few exceptions, enterprise IT is better done by an external service provider. The core vs. non-core argument favours outsourcing across the board in enterprise IT.

    Outside of enterprise IT, this may not be so. You’ll have to look at it on a case-by-case basis.

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  11. Old Hand says:

    Basab, You too?

    For the last 2 years, CEOs of offshore companies (good names like WNS and eValueServe included), have been unabashedly bashing captives, to almost coerce clients into giving them business (or letting them take over captives)!

    Can we really generalize the captives the way you have done?

    Only those people who have managed a captive in senior capacity AND a 3rd party offshore in senior capacity would come close to passing a qualified opinion. Unfortunately most people maligning captives have their resumes built up only in 3rd party.

    Give us a break. Recognize the good things in captives. Acknowledge that some are very well-run.

    And by all means go buy the ones that are poorly run. White papers and blogs is not the best way to do it. Just go cut the deals.

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  12. Basab says:

    Old Hand,

    Sounds like you may be one of the smart ones (or lucky ones) that made it work, but evidence (and organizational dynamics) says that successes are and will be the exception with captives for a while.

    You raise an interesting point about the vested interest in IT/BPO companies bashing captives. I actually never did that when I was at Infosys. Instead, we formed a consulting offering to enable clients to build captives without doing a BOT (build, operate, transfer). It wasn’t a great money-spinner but at least we were able to help some of our clients to do what we we were far better at than they were and earn some brownie points.

    But now that I no longer am in the industry, I can freely speak my mind on captives. No vested interests. 🙂

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  13. Shashi says:

    This argument holds good for pure IT services (since IT is the cost side of client but revenue side of 3rd party IT service providers), the logic would be difficult to apply when it comes to emerging areas such as engineering services (which is on the business side for client as well).

    In these areas, which Indian IT companies are investing, it would become difficult to argue against captives. With India emerging as a market for many of the products such as auto, aero, engineering plants etc…..having a near shore design house is more a strategic choice for companies and i don’t see much scope for this logic to pay a part in having 3rd part vendors win against captives.

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  14. Kelpie says:

    Hi!

    Funny Basab brought this up so late in his creation (6 AM), this is something he has been intimately involved in during his INFY days and as a propagator of offshoring and GDM etc.

    Coming to the point, the primary ones by Basab and Bibin are laser like in their focus – and true too. . . I too being a part of the offshoring giant and wave have meet with many clients who happen to be the whos who of F500 list from NY to SFO and scattering in Europe – posing this “heaven and hell” question, while there are plenty of dynamics and multiple moving wheels many have forgotten the employee or the talent pool – they are the KEY, period. All others can be overcome.

    The intersection of everyones’ view above is only on the employee and that is the only thing that will make it work or not. “Shit work” shipped out to places will not be done by those who think they are as good if not better for an extended period of time, that is the only truth. Once a company realises this, it will succeed, either doing its S/W work in India, or having its chips designed in Israel, or developing algogs in Rumania, it does not matter. They will succeed once the employee comes first. Most capitves fail to recognise that and despite it being contrary to my role and sales pitch I have often told them the day you discover and practice this, you will succeed, till then leave it to the outsourcing partner. The temptation to be close to the market / client / business whatever name you wish to grant it is much more than what money can buy. . . .

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  15. Mohit Mahendra says:

    “But now that I no longer am in the industry, I can freely speak my mind on captives. No vested interests.”

    …not sure you can make that claim 100% 🙂 You’re the CEO of a company that would want to see every hedge fund let you do their number crunching rather than go build a captive team of offshore financial analysts in Mumbai! I know you’d rather sell them your platform, but tell us the split between your folks in the offshore operation between product R&D and Financial research 🙂

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  16. Basab says:

    Mohit,

    The post was about captives in enterprise IT. As per my comment above, outside of enterprise IT – prod devpmt, bpo, research – the dynamics are different.

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  17. Basab:

    Hope you are doing well. Its been a long time since we last spoke.

    On the topic of Captives, After INFY – I had the opportunity to be President & CEO of a company that helped US and European clients set-up and run captives (not BOT) in India. We took small product development companies offshore, but also took big boys like ADP offshore – we did about 40+ such projects in 4 years.

    In my experience, what you say is mostly correct for Enterprise IT. To add some more insight to your points – Our “sweet” customer was one who had spent 8-10 years with an offshore provider and was now keen to internalize the operation for a variety of reasons. These could be:

    1. Adding more types of services in India – IT, Call center, BPO and what have you. It made sense to them to have a single roof for this rather than managing a remote distributed multi-vendor operation.
    2. Adding more IP sensitive work which had not previously been done offshore and did not have the stomach to outsource – a few cases atleast
    3. And (not joking), had a high level executive of Indian Origin who wanted to return to India and the company did not want to lose him/her.

    Sorry for coming into the topic so late. Cheers

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  18. Amit` says:

    I would like to add my two cents. Basab and Bipin and Sandeep have summed up the issues totally. IMHO the difference between a successful captive and an unsucessful one is the way the employees are given responsibilities. I have had a chance to work with GE and they were dilligent in ensuring that the architects and the Business Analysts were from GE’s Indian operations. The coding and maintenance work ( typical low-end) was given to the lowest bidder. Which makes sense, get the small enhancement done at the cheapest price and keep the fundamental knowledge internal to the organization. Some companies keep a very small IT team and in turn source people from other companies.There are advantages in working for captives – better domain knowledge, better work-life balance. BUt they are offset by the limited growth opportunities and the fatigue factor.

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