Strategic Challenges Facing Captive Centres 2009
Strategic Challenges Facing Captive Centres 2009
Strategic Challenges Facing Captive Centres 2009
RSM Case Development Centre have prepared this case to provide material for class discussion rather than to illustrate
either effective or ineffective handling of a management situation. The author may have disguised identifying information to
protect confidentiality.
Synopsis
Firms such as General Electric, Texas Instruments and Motorola that established captive
centres1 in India in the mid-1990s had formerly kept most of their offshored tasks in-house.
Since then, however, the Indian IT service sector has grown and developed abilities to carry
out both simple and complex IT maintenance and development, often more cheaply than their
western competitors. This development has made western multinationals consider how to
better utilize their offshore assets. For example, in 2006 SAP Hosting Services in Bangalore
outsourced several hosting services to Tata Consultancy Services (TCS), also based in
Bangalore. Other companies, such as Standard Chartered and Hewlett Packard (HP), have
followed a different approach in which their captive centres have provided services to both
parent company and external service providers. British Airways, on the other hand, sold a
majority stake of its captive centre to the private equity firm Warburg Pincus in 2002. Apple
Inc went even further and closed down its development centre in India in 2006. Clearly, such
changes suggest that the basic concept of the captive centre is being transformed
A captive centre is a wholly-owned-subsidiary located offshore that performs various tasks ranging from the development
of software applications to providing customer support for the parent company. (Oshri et al. 2008)
Offshoring work is not exempt from challenges and risks. Therefore, firms have traditionally
considered three options in this context: (i) to contract work out to a service provider located
offshore, (ii) to set up a joint venture with an offshore company, or (iii) to set up a whollyowned captive centre to carry out work at an offshore location.
Offshore Outsourcing
Offshore outsourcing is defined as a contracting activity with a third service provider that is
located offshore for the completion of a certain amount of work, for a specified length of
time, cost and level of service.
Offshore outsourcing was first adopted by healthcare, telecommunication and technology
industries in the late 1980s. Back then, industries in the US and other Western countries
suffered from labour shortages. The demand for cheap, low-level data-entry personnel who
were proficient in English led to offshore outsourcing in India and the Philippines. During the
technology boom of the mid-1990s, offshore outsourcing was driven by the need to gain
access to talented developers.
When choosing an offshore service provider, cost, quality, security and proximity are the
main considerations. While such factors for successful offshore outsourcing have been
known for some time, there have been quite a few examples in which offshore outsourcing
projects have failed.
Joint Ventures with Offshore Service Providers
Joint ventures between a parent company and an offshore service provider have taken place
since the 1980s. The main purpose of the joint venture is to reduce the risk of offshore
outsourcing by gaining more control over intellectual properties, quality and costs.
Companies that had no presence or limited developed infrastructure in a remote region often
prefer to form a partnership through a joint venture with a local vendor over the
establishment of a captive centre or contracting out work to an offshore vendor. For example,
an insurance firm or a retail bank would buy a company based offshore and run it jointly with
the previous owner for a while in order to learn and understand local market conditions and
gradually shape work routines according to their philosophy. When ready, the new owner
would complete the takeover and assume full responsibility of the venture.
There are still significant risks in setting up a joint venture with an offshore service provider.
Though the parent company may gain control over processes and critical knowledge, and
could share know-how with its local partner, there could still be intellectual property
breaches and mistrust between the partners.
Captive Centres
While companies have steadily increased the volume of work outsourced to offshore service
providers, many have also set up offshore captive centres, the number of which is steadily
growing.
Most captive centres are set up for one of the following reasons: to acquire skilled and
motivated personnel or to expand and enter new markets2. Reducing costs, though perceived
2
The following reading provides more information about these aspects: E. Carmel and P. Tjia, Offshoring Information
Technology (Cambridge University Press, Cambridge, UK, 2005)
to be one of the rationales, is in fact not so (see Table 1 in Appendix A). The cost-base of a
captive centre in India, for example, is about 15% more than the cost-base of a local service
provider. Some of the benefits associated with setting up a captive centre include the ability
to secure intellectual properties and the more limited exposure of core competencies
(Subramanian and Atri, 2006).
Captive centres, however, have been struggling with ever-increasing costs, high employee
attrition levels and the lack of integration with the firms global strategy, and at times a lack
of headquarters support. The size of a captive centre is an imperative factor that could affect
its success rate. Small captive centres are often hard to maintain, as these cannot build up
large-scale operations and also can offer little long-term career growth to their employees,
often resulting in a high level of attrition.
The consultancy firm A.T. Kearney publishes the Global Services Index every year, rating the 50 most attractive
offshoring destinations. Countries are evaluated against 43 measurements across three major categories: financial
attractiveness, labour and skill availability, and business environment.
vendor over a period of three months, after which the vendor would assume full
responsibility over these services. In order to successfully accomplish this outsourcing
project, the captive centre and the vendor agreed on the governing structure, business
processes and knowledge transfer mechanisms and procedures, and the timelines per each
major milestone. As the vendor was one of the leading Indian vendors in this area of services,
Alain felt that he was in good hands. After all, the vendor had undertaken so many similar
contracts that providing the captive centre with such services should not be a major
challenge. Furthermore, there was also the perception that since the client and vendor were
located nearby, any issue which might arise would be easy to handle over a face-to-face
meeting. Having discussed these matters, GlobalSoftware and the vendor were ready to
launch this outsourcing project.
By early 2006, not long after their collaboration had commenced, Alain was not satisfied
with the vendors performance. Things got even worse later that year. Alain complained:
We are so busy managing the vendor that at times it feels that we could have kept this
activity in-house and would be better off. They never catch up with our introduction of new
services. We trained their staff and yet we see that knowledge is not retained within their
teams. We assumed that their employees, who are Indians, have the same perception as we
have regarding quality and service standards. We were wrong!
The project manager from the vendors side, who was also frustrated with the situation, gave
a different picture: True, we suffer from a high level of attrition that affected our ability to
retain knowledge. However, the client does not help with their continuous introduction of
new services. They want far more than what we can deliver for such a small project. Yes, we
have excellent methodologies to capture and retain knowledge and we also have service
standards. But how can we justify applying these methodologies, procedures and techniques
when it comes to such a small project?
Alain was rethinking recent developments within the GlobalSoftware captive centre.
Although the outsourcing project was not going so well, he developed a good personal
relationships with the vendors relationship manager. He was hoping that the relationships
with the vendor could be improved and that soon the performance would also get better. But
what should they do? He was hoping to free up resources who could focus on high value
activities and instead his workforce was now tied up in vendor management activities.
Furthermore, he was wondering whether this outsourcing contract is changing the original
purpose of setting up the captive centre? If so, how did this strategy fit into GlobalSoftwares
overall strategy?
GlobalAirline
In 1996, Nicolas, the now former managing director of GlobalAirline, one of the biggest
European airlines, received a warning alarm: if the company wanted to survive, it had to get
in shape soon. Profits had declined and the cost-base of passenger processing activities had
been rising. Nicolas put together a task-force that included the general manager of the
engineering department. His task was to analyse cost savings. He noticed that passenger
revenue accounting demanded high-volume, low-skilled work that could be moved to a
cheaper offshore location. The passenger revenue accounting unit then had over 600 full-time
staff. Though GlobalAirline was familiar with offshore outsourcing, it had not outsourced
passenger revenue accounting because it was the blood of the organization and had to be
kept under control, according to Nicolas.
that point in time, the captive centre employed 1,500 staff, of whom 65 per cent were serving
the parent company and 35 per cent were providing services to third party clients. In fact, the
35 per cent focusing on external clients generated 45 per cent of the captive centres total $11
million revenue.
Dave, the former captive centre General Manager, remembered that when he forwarded the
five-year additional expansion plan to the management director of GlobalAirline, the director
snapped: What have you smoked? You have put forward a plan for 12,000 staff, which is
about 30% extra headcounts for GlobalAirline. The board of the parent company stressed
that they were running an airline, not an investment house, and therefore rejected the plan.
However, as an external commentator observed: The future strategy of the captive centre
requires investments to fully exploit its growing third party client base (Dow Jones
International News, 2001). Capital was needed to develop skills relating to marketing and
sales and building the scale of transactions within the captive centre. A clash arose between
the parent company and its captive centre regarding the centres strategic direction. It
became obvious that the only way for the captive centre to advance was to be sold off, Dave
commented.
In 2001, GlobalAirline considered a takeover of its captive centre by an investment house.
The basis for the negotiations was that any agreement should allow the future growth and
development of the captive centre, with the airline company still retaining a significant stake
in the business (Reuters News, 2001). The negotiations took over 18 months. According to
representatives from the captive centre side, the airline did not want management overheads
in India and was concerned with service quality and costs once the private equity firm
assumed a majority stake of ownership. Losing key employees was another concern. The
private equity firm wished to see the new captive centre managed without the parent
companys influence. It was prepared, therefore, to sack old employees and let its people run
operations.
Finally, in 2002, a deal was struck. GlobalAirline announced the sale of 70 per cent of its
captive centre equity stake (Financial Times, 2002). GlobalAirline did not intend to be
involved in management decisions relating to the captive centre, now that its major stake was
held by the private equity firm. However, it hoped to still improve the financial performance
from this transaction when the eventual value of its 30 per cent stake in the captive centre
would increase.
GlobalAirline chose the private equity firm for two reasons. Money-wise they came with a
good offer, Dave remarked, and they had the right structure and culture to protect the
interest of the airline, the captive centres principal customer. The takeover would also let
the airline concentrate on its core business and let the captive centre develop new businesses
outside the airline industry.
The private equity firm was interested in acquiring GlobalAirlines captive centre because the
captive had established a leading position in the BPO segment in India. The basis of the
captive centre, its infrastructure, set-up, and management team, was very attractive, Dave
added. GlobalAirlines positive reputation, strengthened by its ISO 9000 certification and Six
Sigma model, also helped the private equity firm make this acquisition decision. According
to the private equity firm, during the divesture the BPO sector worldwide was poised to
witness tremendous growth, and the firm saw the buyout as a valuable investment in building
a leading global organization. The CEO of the private equity firm confirmed: With this
captive centre, we now have deep domain knowledge of the sector. We will let the new
company grow organically as well as through acquisitions in the Indian BPO market. The
new chairman of the captive centre also thought that the captive centre had a great potential
to handle complex and varied business processes, as there was no other captive centre in
India with such large scale and advanced domain knowledge.
After the acquisition, the private equity firm allotted a considerable sum of money to further
develop the services provided by the captive centre. The intention was that the captive centre
staff would increase to 10,000 full time employees in the next 5 years. We can grow
organically at 50% a year to the foreseeable future, predicted the new captive centre
chairman.
Within its first year as an independent company the captive centre revenue grew by 120%,
and by 2005 the BPO firm reported USD165 million in revenues. Supported by this rapid
growth, the captive centre went public in July 2006. It then faced new challenges. The Indian
government applied different regulations to public BPOs and captive centres. Tax breaks for
captive centres shrunk and in June 2006 the captive centre was asked to repay service taxes to
the government for the period 2003-05. Meantime, however, the captive centre had to satisfy
its shareholders, who wanted a higher return on their investment each year.
Despite the difficulties, the IPO still allowed both GlobalAirline and the private equity a
return on their investments. In 2008, according to Dave, only 10-12% of the USD460
millions in revenues were being generated by the former parent company. The captive centre
was able to increase its capacity to over 18,000 employees, who were considered as core staff
and no longer as back-office workers. This attracted more talent to the captive centre and
supported the knowledge-base developed offshore.
According to Dave, fast growth was possible because the private equity firm spent a great
deal of money to rebuild the communication infrastructure and bring in some very senior
management plus their contacts and networks. Fast growth, however, did not come easily.
Dave added: The captive centre had to fight for contracts after larger multinational players
like IBM had entered Indiathere are few contracts left in the market not taken by the big
companies.
Accounting for 40 per cent, travel was still the strongest segment of the captive centres
mainstream revenue. Banking, financial services, and insurance, however, together generated
40 per cent of the revenue. The emerging segments of manufacturing, retail and consumer
products supplied the remaining 20 per cent of the revenue. According to the director of
Investments and Alliances at GlobalAirline, the venture has turned out more successful than
most of the airline leadership expected. There was no question that the airline made the right
decision. The company has benefited from both its initial stake in what later became a
successful commercial venture and also from the fact that its business processes are being
done by a more efficient and viable entity. But one might wonder: have GlobalAirline done
the right thing? Perhaps they should have maintained ownership of the captive centre,
considering its success?
Epilogue
The basic concept of a captive centre is to provide services to the parent company from an
offshore location. However, the above stories illustrate a different reality. Some captive
centres have outsourced part of their activities to a local vendor, while others have expanded
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by providing services to external clients. Divesting the captive centre is another move that
some parent companies have considered, and in other cases the captive centre has been closed
down.
These strategic moves bring to the fore the following questions. How should a parent
company strategically perceive its captive centre in terms of its allocation and utilization of
resources? And in doing so, what capabilities should be developed offshore to support the
evolution of a captive centre?
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References
Dow Jones International News. (2001, 11 23). GlobalAirline Starts W. GlobalAirline Stake
Sale Talk. Dow Jones International News , p. 1.
Farrell, D. (2005). 'Offshoring: value creation through economic change'. Journal of
Management Studies, 42, 3, 67583.
Financial Times. (2002, 04 4). Companies & Finance UK- GlobalAirline sells business
outsourcing arm to W. Financial Times , p. 1.
Friedman, T.L. (2005). The World is Flat. Farrar, Straus and Giroux, NY.
Joshi, K. and Mudigonda, S., 2008, An analysis of Indias future attractiveness as an offshore
destination for IT and IT-enabled services, Journal of Information Technology 23(4),
pp 228-231.
Mishra, P. (2007, 06 15). Outsourcing sees mix and match with captives, 3rd party vendors.
Retrieved 09 05, 2008, from livemint.com- The Wall Street Journal:
http://www.livemint.com/2007/06/15003046/Outsourcing-sees-mix-and-match.html
Offshoring Times. (2008). A look at captive offshoring. Retrieved 09 03, 2008, from
Offshoring Times:
http://www.offshoringtimes.com/Pages/2008/offshore_news1889.html
Reuters News. (2001, 10 23). GlobalAirnline in talks for unit sell-off in India. Reuters News ,
p. 1.
Singapore Press Holdings Limited. (1999, 08 13). Bangalore tech par signs on more
investors. Straits Times , p. 1.
Subramanian, M. and Atri, B. (2006). Captives in India: A Research Study. Infosys.
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Appendix A
Table 1: Setting up costs: Local Provider versus Captive Centre
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