by Stephanie Overby

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

Nov 01, 20073 mins

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.

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.”

Blended Base Salary Costs

Captives recruit more actively and pay a premium for soft skills, while third parties attract staff more cheaply by providing career paths.

Third parties Captives
Annual salary range $7,770 to $8,200 $9,500 to $10,300

Shift Policies

Third parties have the geographical mix and leverage to operate multishift environments.

Third parties Captives
Shifts per day 1.2 to 1.5 1 to 1.2

Annual Rental Costs (Bangalore)

Third parties build big campuses on the outskirts of the city, while captives tend to operate in more expensive metro centers.

Third parties Captives
Cost per square foot $11 to $13 $14 to $16

Expatriate/General Management Staff

Captives need more leadership bench strength.

Third parties Captives
Expatriates for every 1,000 full-time employees (FTEs) 0 to 1 3 to 5
General management staff for every 1,000 FTEs 12 to 14 16 to 18

Average General Management Salary

Captives’ pay policies are governed by parent company and, because they look for more relevant industry experience, pay more.

Third parties Captives
Annual salary range $55,000 to $65,000 $70,000 to $90,000

Travel and Entertainment Costs

Captives have more liberal travel policy guidelines. Third parties often provide accommodations in company-owned/managed properties and mandate economy-class travel, even for senior positions.

Third parties Captives
Cost per full-time employee $280 to $320 $900 to $1,060

SOURCE: Everest Research Institute