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Total Cost of Ownership: Comparison of Outsourced Versus Captive Solutions for Capturing Outsourcing Value

With companies like Citigroup putting their wholly owned offshore service centers up for sale, there's been much discussion about whether the captive model makes financial sense. A recent study from the Everest Research Institute confirms that going with a third-party provider is usually cheaper.

By Stephanie Overby

November 01, 2007 — CIO — Outsourcing to a third-party IT services provider offshore is typically 5 to 15 percent cheaper than the offshore captive (company-owned) alternative, according to a recent study by the Everest Research Institute . The “Comparison of Outsourced and Captive Solutions for Capturing Value from Outsourcing” offers an evaluation of total expenses of each model, including operating costs, productivity, transition, sales and marketing, and margins.

Although one might assume that a captive offshore center might be cheaper, given that there are no sales expenses or profit margins built into their cost structures, that wasn’t the case in this study. The cost advantage of the third-party model derives from better leverages of scale and leaner processes of third-party operations as well as the greater overhead management and higher investments in knowledge transfer required to set up and manage your own offshore center.

However, that rare breed – the best-in-class captive center – can match third-party performance, says Everest. In some cases, a well-run captive center is cheaper than outsourcing.

Value, not cost, should be the driving factor when you decide whether to work with an offshore vendor or go it alone, says Everest. The third-party model may be better suited for customers who value minimizing geographic risk, attracting scarce talent not core to the business, and scaling costs to match demand for processes with fluctuations in volume. The captive model may work better for organizations that value gaining access to new geographic markets, direct access to local management talent, total control and greater integration with the parent company.

“Many of the factors that drive up the near-term captive operating cost structure can be valuable investments in the long term to create business and strategic impact,” says Nikhil Rajpal, vice president of global sourcing for Everest Research Institute. “To capture the value associated with the captive model requires an investment of effort and finances, and the company moving the work offshore as a captive operation must maintain focus on cost-reduction opportunities where relevant.”

“In many cases,” says Eric Simonson, managing principal of Everest Research Institute, “a combination of both models is the optimal solution.”

 

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