About a year ago, I had written about why offshore IT captives don’t work [link]. Now I hear that the companies that had set up captives in India are rushing to get rid of them. Except that there is a curious twist. They want to be paid to rid themselves of their mismanaged captives.
The logic works this way. Let’s say Acme Inc. set up a captive for its IT work in Bangalore 4 years back. The experiment went sour. Attrition is high even though wages keep climbing. The costs and the rupee have together blown the business case to smithereens. So now Acme wants to get rid of this white elephant. They would have laid off everyone except that the 100 odd engineers in Bangalore, actually do good work (as long as they stick around, that is). Since they support some mission critical systems, Acme can’t just shut down operations. A reverse transition to US based employees will take time and will be hugely expensive. The other problem is that some of the Indian employees carry knowledge about Acme’s business and systems in their heads that Acme would like to retain. The CIO’s ideal scenario is to find a home for these employees in one of the IT majors who will then have to deal with the employees as well as transition and knowledge retention risks.
In the eighties this was called Outsourcing. EDS and IBM built huge services businesses doing exactly this in the US. Today, the same thing in India is called an acquisition. Acme expects the Indian outsourcer to ‘acquire’ Acme’s Indian subsidiary and pay them for transferring a “stream of cashflows”.
To me this seems like an unnatural act. I can’t see how the IT services company can justify this beyond paying for the acquisition of assets. But there is obviously a way this is being justified because it is happening.
How would the IT Services company justify this ‘acquisition’:
– Growth is hard to come by. This deal will, from day one of the deal give me a revenue stream of $Xmillion.
– A deal like this will not impact margins since the acquisition cost will be a balance sheet item. ROCE has never been a problem or a key metric for IT Services. Depending upon how the amortization is set up, impact to net margins may be minimal.
– If my company doesn’t do this deal, my competitor will be happy to pay up.
– The market keeps asking us about acquisitions. Acquisitions outside India are too hard to integrate. Instead, we’ll just acquire a few captives in India.
– With this acquisition we will acquire some very important skills both technical and industry domain. This will give us a foothold in the Insurance industry or the German market or whatever.
None of these justifications work for me. They are ways to rationalize what these companies feel compelled to do to meet short-term expectations from the market. By this logic, every client outsourcing work in the US should first form a subsidiary, transfer all employees into it and then 'sell' the subsidiary.
This new game is a dangerous one. It tells a story of an industry that doesn't know how to respond to the triple whammy of costs, exchange rates and a US recession.