Offshoring: The Captive Center Rises Again

High failure rates. Shutdowns. Divestitures. Author and researcher Dr. Ilan Oshri explains why, despite it all, the wholly-owned offshore service center is coming back -- and here to stay.

You can be forgiven for thinking that the days of the offshore captive center were numbered. Citigroup, Unilever, Deutsche Bank, and Dell are just a few of the Fortune 500 companies who have sold or shut down their one of their wholly owned offshore service centers in the last year. Some 60 percent of all such captive centers fail to meet expectations. And the third-party offshore outsourcing industry, particularly in India, has reached a level of provider maturity that one wonders why a company would take on the hassle of setting up their own shop abroad. (Indeed, many industry watchers have.)

But the captive center lives on. Captive activity reached a two-year high in the fourth quarter of 2009, with the opening of 40 new wholly-owned service centers offshore, according to outsourcing consultancy Everest, and the last five quarters have seen growth in the captive market. We talked to Ilan Oshri, author of the forthcoming book, Offshoring Strategies: Evolving Captive Center Models (February 2011, MIT Press) about the resurgence of offshore captives, the centuries-old history of the model, and the continued difficulty of making them work.

CIO.com: Why write about captive centers now?

Ilan Oshri: I have published six books on offshoring and outsourcing. In 2006, I got interested in captive centers while I was visiting Bangalore looking into a problem area between a captive center and a local vendor. That made me think if captive centers outsource work which has already been offshored, they were probably pursuing other strategies. The academic literature offers very little about captive centers and the professional press also did not take interest in captive centers unless it was a failure story. This industry deserves a thorough study starting with the basics: taxonomy, strategies and capabilities.

CIO.com: For the past few years, we've been hearing that interest in captive offshore centers—particularly IT centers combined IT and business process centers—were waning, and companies from AOL to Unilever have shuttered or sold one of their offshore captives. Are they really coming back?

Oshri: According to Everest Research, they are. 2009 saw an increase in the number of captive center setups. My view is that captive center is one sourcing model from the many sourcing models available nowadays. It has its advantages and disadvantages and there will always be firms that will find this sourcing model suitable for their needs.

CIO.com: What was behind the divestitures of so many captive centers around 2008, and into early 2009?

Oshri: In the middle of the financial crisis, some multinationals divested their captives to improve their cash position. There was also interest from local vendors to buy captives that have built scale or have specialized in an area complementary to the line of services the local vendor is providing from offshore.

CIO.com: Has that sell-off slowed down?

Oshri: Indications are that it did not slow in 2009. I do not have full data on 2010. But it has become far more challenging to divest a captive for two reasons. First, local vendors have built massive scale offshore and the acquisition of a captive today will probably not have a dramatic impact on their economies of scale. Second, private equity firms—the other candidate buyers—are not cash rich as they were between 2002 and 2006. Having said that, vendors will consider buying a captive if the purchase includes a long-term service contract.

CIO.com:You say there will always be a need for captive centers, even with the maturation of the offshore IT services industry over the last decade. Why?

Oshri: Some executives believe that certain business processes or an IT function are too important for the firm to leave it in the hands of a third party. Others set up a captive center in a growth market hoping to turn their captive into a success story. There will always be those who hope that the captive center will save costs, but to achieve that the parent firm needs to invest in the captive and ensure that it builds scale.

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