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.

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CIO.com: In your book you note that 60 percent of offshore captives will struggle and perhaps not survive. Why is this model so difficult to set up and maintain successfully?

Oshri: There are two stories here. The first is about captive centers which were set up for the wrong reason—usually a "me too" strategy. These captives often fail to develop scale, cannot follow the evolutionary path described in my book, and therefore will struggle.

Other captive centers had the potential to become successful with the right management attention and allocation of resources. In many of these cases, captive centers become unsuccessful because of the gap between the perceived potential and execution. Most parent firms are attracted to the idea that the captive center can produce massive cost savings, so they go for this sourcing model. They set up captives and expect to see cost savings almost immediately. In reality captive centers face challenges that can erode potential savings if not handled properly: high attrition levels (affecting knowledge retention and higher training costs), tense relationships with the parent firm, inefficient governing structure, and other issues. The captive can cope with these challenges, but it needs resources and management attention from the parent firm.

CIO.com: Your research found that "talent" was cited as the main driver for setting up a captive center offshore. But with unemployment levels in Western countries so high, isn't that just code for "cheaper talent"?

Oshri: True, but I won't call it "cheaper talent." It is talent at the right price and value.

CIO.com: Did it surprise or concern you that 37 percent of company executives you surveyed said they did not know why they set up a captive center—or would not answer the question.

Oshri: There are many reasons for setting up a captive center, beyond talent, costs, infrastructure and government policy, which firms tend not share with the public.

CIO.com: What are the best examples of a successful IT or IT-BPO captive centers?

Oshri: Some experts suggest that the nature and purpose of captive centers must evolve for them to be successful. WNS, previously owned by British Airways, has evolved from a basic captive providing services to a parent firm to a larger center that now provides services to international customers as well. Genpact, formerly a captive center owned by GE, is another successful example. They have transformed from transform service and cost centers to profit centers.

CIO.com: So in these examples, divestiture is not a sign of failure but part of the evolution of a successful captive?

Oshri: Yes.

CIO.com: What industry owns the most offshore IT or IT-plus captives and why?

Oshri: The electronics and computing industry is the biggest operator of captives. The simple reason for that is that this industry has utilized the captive model to do research and development offshore as well as set up shared service centers around the globe.

CIO.com: You found that India is still the prime location for offshore IT captives. Are there any near- or long-term competitors?

Oshri: Countries in Central and Eastern Europe are emerging as serious contenders to India.

CIO.com: It's clear that captives have to be pretty big to succeed. How can small or mid-size companies take advantage of them?

Oshri: SMEs will explore ways to use existing captive facilities. I cannot see the logic for such firms to set up their own captives. There isn't enough scale.

CIO.com: Many of us think of the offshore captive center as a 20th century innovation. But you say it dates back to the seventeenth century when the East India Company first established its factories in India, recognizing the cost-effectiveness, flexibility, and viability of having a company foothold in the targeted trade country. Are captives here to stay?

Oshri: I think it is here to stay but the concept is going to evolve over time.

Ilan Oshri is associate professor of strategy and technology management at Erasmus University's Rotterdam School of Management in the Netherlands.

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Copyright © 2011 IDG Communications, Inc.

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