Offshoring Support Services - Outsourced or Captive

8/14/2019 Offshoring Support Services - Outsourced or Captive

http://slidepdf.com/reader/full/offshoring-support-services-outsourced-or-captive 1/6

Offshoring Support Services: Outsourced or Captive?

Deloitte Consulting shows the pros and cons of two differing answers to the big

question

By: David Brainer and Peter Lowes(Issue Details:March 2007).

In the early years of offshoring support services, from roughly 2000 through

2004, many companies aggressively pursued offshore outsourcing as a means of

lowering costs. However, a number of outsourcing deals during this period were

characterized by a limited scope of services, ill-defined business cases, and, in

many instances, overambitious cost-cutting goals. In addition, many

organizations underestimated the complexity of managing the outsourcing

relationship. Problems arising from these factors led some organizations to

conclude that the hard and soft costs of offshore outsourcing, and the related

people and change challenges, could offset the financial benefit.

The good news is that the market has evolved dramatically since then, as

companies have begun to approach offshore support service delivery in a more

systematic, thoughtful manner. Many companies are now expanding their goals

for their large-scale offshoring efforts from a tight focus on cost reduction to

pursue potential benefits such as increased service quality and talent sourcing

opportunities. In addition, many companies are now taking advantage of the

benefits of offshoring by setting up wholly owned “captive” service centers in low-

cost countries, often combining the use of a captive with the services of various

outsourced service providers.

We believe that the increasing maturity of the offshore outsourcing industry, plus

the emergence of the captive offshoring model, make pursuing offshore service

delivery considerably less risky than it was just a few years ago. However,

offshore outsourcing and captive outsourcing do differ in several important

respects. Each comes with its own set of advantages and disadvantages, so it’s

important for a company to carefully consider its own current and future needs,

options, and trade-offs before deciding which route to follow for their support

service needs. The following primer, written for managers at companies that have

just begun to explore their offshoring options, discusses some of the basic

considerations that should be taken into account when pursuing offshore service

delivery.

Options for Offshoring

In a full outsourcing relationship, the vendor provides services to the client as

specified in a commercial contract. How the work is actually performed is at the

vendor’s discretion, as long as all contractual and service-level requirements are

met. In contrast, with a pure captive center, a company builds an entire service

operation from scratch, from finding the physical facilities to obtaining local

business licenses to hiring and training the people. Because they are typically

built from the ground up, pure captive centers require time and investment

before they produce the expected savings. This sweat equity can be significant

and should not be underestimated.

A third option, which might be termed a “collaborative” model, steers a middlecourse between full outsourcing and a pure captive model. In collaborative



sourcing, a company hires an outside service provider in the chosen offshore

market to help set up an offshore service center on the company’s behalf. Three

popular models are: 1) the so-called “build-operate-transfer” (BOT) model, in

which the vendor initially builds and operates the center and eventually hands

over ownership to the parent company; 2) the “assisted captive” model, where

the vendor assists the parent company to build the center but the actual work is

performed by the parent company; and 3) the “joint venture” model, in which the

service center is set up as a joint venture between the parent company and the

vendor. Although the use of these models is declining as offshore sourcing

markets mature and companies become increasingly comfortable with moving

offshore, they can still be a viable choice for companies that wish to avoid some

of the risks of building a captive center wholly on their own.

How can a company decide which option to pursue for any given set of services?

To help answer that question, here are some of the factors we believe that

companies should consider.

Scale

Scale is one of the key factors a company should keep in mind when making the

outsourced versus captive decision. In general, the less work there is to be

offshored, the more attractive outsourcing may be compared to a captive model.

Outsourcers offer their clients ready-made economies of scale because of the size

of their own operations, and for a company that wants to offshore only a few

dozen (say) full-time employees (FTEs), the outsourcer’s ability to provide the

fixed-cost infrastructure for those FTEs can be a real advantage. So if a company

doesn’t have a certain critical mass of work to be offshored – and if, importantly,

it anticipates that it will never have that scale – outsourcing may be the more

attractive choice.

On the other hand, companies that do have what they consider a critical mass of

work may find that a captive model makes good economic sense. The fixed

overhead costs of operating an offshore service center remain relatively constant

no matter how many people the center employs. Once those fixed costs are

established, a company that moves a large amount of work offshore has the

opportunity to realize considerable economies of scale.

Cost and Speed of Implementation

Very generally speaking, an outsourced offshoring arrangement can cost less up

front to set up and implement, and can be implemented more quickly, than acaptive center. A pure captive center typically requires the parent company to

make a significant up-front investment in time and money to build the

infrastructure, hire the people, and meet the requirements of the local

government. A collaborative captive model may enable a company to set up an

offshore center relatively quickly, but working with a vendor or joint venture

partner may result in substantial financial costs. Because of its potential short-

term cost and speed advantage, outsourcing can be an attractive option for

companies that are looking for more immediate cost savings and speed of

implementation.

When it comes to long-term cost savings, the difference between captives and

offshoring may not be as clear-cut. On the one hand, the greater control a parentcompany typically has over a captive can make it easier to negotiate changes to



processes, service levels, and chargebacks with a captive than with an outsourced

service provider. For example, one company that initially realized substantial

savings by its cash applications process found, after changing its cash

applications policy some time afterwards, that the policy change generated many

processing exceptions at several times the original contracted cost. Unable to

negotiate changes to the contract, the company wound up paying the outsourcer

significantly more than originally expected.

Having said that, it’s also possible for a company skilled at managing vendor

relationships and negotiating contracts to build enough flexibility into an

outsourcing agreement for changes to service levels and costs to be less

problematic. Recent outsourcing contracts, for example, often include volume

threshold flexibility clauses to avoid issues such as the one described above.

There’s also the possibility that changes to a captive center can be hampered by

internal politics and less-than-ideal governance processes.

The lesson here is not that outsourcing is necessarily more or less challenging

than a captive model with respect to flexibility and cost, but that effectivegovernance is critical to realizing ongoing value in either case. To determine the

importance of flexibility in its sourcing arrangements, whether outsourced or

captive, a company should always consider the ability of new service models and

contracts to accommodate change when deciding what model fits its needs. A

business that anticipates significant change – one that is pursuing an aggressive

merger, acquisition, and divestiture strategy, for example, or that expects to grow

or expand rapidly – should think carefully about how such events may affect its

relationship with its support service providers. The management time and

attention needed to negotiate and resolve service level changes can be

significant. In our experience, negotiations with an internal captive center can be

easier to revisit than discussions with outsourcers, which may be one reason for

companies undergoing rapid change to consider a captive model.

Presence in the Target Country

There’s no question that it’s easier to set up an offshore service center if a

company already has a presence in that country. A company without an

established brand in a particular country is likely to have difficulty recruiting

employees to work for it in that country; a company that lacks local facilities and

infrastructure will need to build them from scratch instead of being able to

leverage what’s already there; and a company that has no leadership in a country

will have a tough time finding the management talent, practical know-how, and

cultural savvy to obtain local operating licenses, negotiate economic development

incentives, and otherwise manage a captive build-out. For these reasons,

companies that have no local presence whatsoever in their country of choice may

find an outsourcing or collaborative captive model more realistic than trying to

manage the process of creating a captive wholly on their own.

An outsourcer’s or a collaborative captive vendor’s existing presence in a country

can be especially helpful when seeking a quick resolution to regulatory issues.

One company, for example, that lacked a local hiring license to set up a service

center in Panama turned to a BOT to serve as its legal agent in that country. The

vendor provided the physical space and facilities for the company’s center and

hired local staff using the vendor’s hiring license. When the company obtains its

own Panamanian hiring license, the employees will be terminated by the vendorand hired by the parent company. As an additional benefit, the BOT vendor had



considerable brand recognition in Panama while the parent had virtually none,

making it easier for the BOT to recruit and retain the center’s staff.

That’s not to say a company absolutely needs a physical presence in a country to

be able to set up a captive service center. If a company employs business leaders

in its home-country offices that are originally from the selected country, or whohave extensive experience in that country, it may be possible to assign those

leaders to oversee the development of a captive without assistance from a

vendor. This decision, of course, will depend on how much risk the company is

willing to take and the level of trust it has in the leadership team to execute.

Data Protection and Intellectual Property

A company with a high degree of concern about data security, privacy, and

intellectual property issues may be more comfortable with a pure or collaborative

captive model, in which the parent company has greater control over both the

information handled in the center and the people who do the processing than

would be the case with outsourcing. In fact, intellectual property concerns areone of the main reasons for not outsourcing any process that is strategic or “core”

to one’s own business. It can be challenging to verify that an outsourcer is

following appropriate handling procedures for intellectual property, which can

have regulatory as well as security and privacy implications. Also, unless the

contract explicitly forbids it, an outsourcer could transfer staff members from one

company’s account to that of a competitor, which can present obvious intellectual

capital risks.

Access to Talent

There are two considerations around access to talent that come into play in

evaluating outsourcing versus a captive model. The first question is whether a

company can attract enough qualified people to staff the captive center. As

discussed previously, it’s easier for a company with a recognized brand name in

the local market to recruit staff. Because these markets are typically very

dynamic, staying on top of the “war for talent” can be a daunting effort. An

outsourcer, besides having an established brand in the marketplace, may

maintain a much broader recruiting and training engine to replace open positions,

and is likely to have strong processes for recruiting, hiring, training and retaining

offshore employees. A company without a brand in the local market may need to

spend considerable time and effort to build one up before it can effectively recruit

staff, which can be one reason for such a company to consider an outsourcing or

collaborative captive model.

The second question regarding access to talent is whether the company is

interested in using a captive service center as a recruiting ground for talent to

transfer into mainstream operations. Here, we believe that the advantage clearly

lies with the pure captive model, or with a collaborative captive model in which

the service center’s staff are employees of the parent company. If the people who

work at the center are employees, a company can identify and recruit those who

contribute value or have “hot skills” important to the business. This mining of

talent would be impossible with an outsourced service provider.

Additionally, any investment a company makes in training its own offshore

employees stays within the company, at least as long as the employees remain atthe center. This is not normally true with a company’s investment in training



people employed by an outsourcer, who may be able to transfer people into and

out of a client’s account at any time without necessarily obtaining the client’s

approval (unless the contract specifies otherwise). Further, turnover among an

outsourcer’s employees cannot be directly controlled or influenced as would be

possible with a captive, which can have a large hidden cost.

Ease of Exit

Companies generally find it easier to leave an outsourcing relationship than to

close down a captive center. Leaving an outsourcing relationship is usually a

matter of executing the termination clause in the contract. Shutting down a

captive center can not only be more time-consuming than terminating an

outsourcing relationship, but also force a company to pay significant severance

and infrastructure expenses.

On the other hand, a company that leaves an outsourcing relationship will not

have a hard asset “left over” from the relationship. A company with a captive

center it no longer needs, in contrast, may have the option of selling the center toan outside party at a tidy profit. However, this is by no means a guaranteed

outcome. A company with a highly specialized service center may find it difficult

to find a buyer who needs those particular capabilities, no matter how well-run

and productive the center has been for the original parent company.

Making the Decision

The choice of sourcing model is as individual as the company that’s making the

decision. Our view is that the choice between captives and outsourcing may lie

largely in a company’s comfort level with different kinds of risk: relatively greater

execution risk with a captive center, relatively greater economic risk with

outsourcing. A company that lacks confidence in its internal capability to set up acaptive center – perhaps because it has no presence in the target country or has

a history of difficulty in implementing major organizational change – and/or views

managing vendor relationships as a strong suit may favor outsourcing or one of

the collaborative captive models. In contrast, a company with a strong presence

in the target country, that is confident in its ability to establish captive center

operations in that country, and/or that perceives the risk of having work

performed by an outside party as greater than the risks of managing a captive

center may be more likely to favor a captive approach.

A final note: a company that chooses a particular offshore sourcing model to

begin with can certainly change its approach in the future as its needs evolve.

Many companies, in fact, begin by outsourcing their offshore support services and

then move toward a captive model as they gain a more significant foothold in the

offshore market. Others draw on a mix of sourcing alternatives, running a captive

center or centers at the same time as maintaining various outsourcing

relationships – a mixed sourcing strategy that is becoming increasingly popular.

However a company chooses to obtain its offshore support services, the decision

should always be guided by a well-thought-out sourcing strategy that aims to

align the company’s overall sourcing activities with its comfort level regarding the

chosen option’s risk/reward profile as well as its overall business goals.

This article contains general information only and Deloitte Consulting LLP is not,

by means of this publication, rendering accounting, business, financial,investment, legal, tax, or other professional advice or services. This publication is



Documents

Offshoring Support Services - Outsourced or Captive