The Captive Model for Offshoring Is Thriving, Says Research Firm

As AIG, AOL, Dell, Target and other companies sold or shuttered their wholly-owned offshore IT and business process centers over the past five years, outsourcing industry experts predicted that the offshore captive center model was headed for the history books. But, according to a recent research report by outsourcing consultancy and research firm Everest Group, the captive model is staying alive—and thriving.

In fact, reports Everest Group, most large-scale captives continue to operate and have grown both in terms of scale and the complexity of services they provide. New captive set-ups are outpacing sell-offs, and divestitures are steadily declining. Last year, ten new captives were opened and 13 captives expanded, while just two were sold, according to the report.

Captive centers will continue to play a major role in offshoring for the foreseeable future for two reasons, says Eric Simonson, Everest Group’s managing director. “First, it is a large part of the market, representing about 25 percent of delivery within India. Second, the model is different from third-party models and that is not widely understood. A captive can not only deliver the typical services of a [third-party] service provider, but also many other services which are just part of the normal business. In effect, a [captive center] is a corporate campus which happens to be based offshore.”

The IT captive center in India dates back to the 1990s and was led by technology and financial services companies that set up shop on the subcontinent (see box, below). At that time, the primary motive was to attain low cost while maintaining or increasing quality, says Simonson. Some companies were also spurred by interest in expanding their businesses in the region.

The History of Captive IT Centers in India

1985: Texas Instruments establishes the first captive center in India, focused on research and development.

1990-1998:General Electric, British Airways and Dun & Bradstreet establish and grow captives in India. All are eventually converted into third-party service providers.

1998-2005: The captive model is adopted broadly across large technology, global banking, financial services and insurance firms.

2005-2008:Rapid adoption of captive model across most industry sectors.

2008: More than 500 captives are operating in India.

-—Everest Research Institute

By 2006, captive operations delivered about $8 billion worth of IT and business process activities, according to Everest Group. And even as some industry watchers suggested that the model was no longer viable for most companies, captive center activities grew at a compound annual growth rate of 10 percent, to reach $10.6 billion in 2009, according to Everest Group.

Although divestitures have occurred and approximately 20 percent of captives have downsized, that does not indicate that the model itself has failed, says Simonson. Companies that sold their operations were in search of short-term cash while third-party service providers were looking for acquisitions to expand their capabilities, according to Everest.

Those captive centers that were shut down altogether tended to be newer centers that struggled to build robust operations and recruit and retain talent in an increasingly competitive market, Simonson says.

“This is a sign of some captives struggling, not the model struggling—and most of those shut down were very small and barely got started,” Simonson says. “It should be expected that not all new entities (captives or other operations) will be successful.”

Simonson points out that 30 percent of the top 20 IT service providers that Everest tracks have been acquired in the last three years, yet that does not mean that the IT service provider model is struggling. “Failures of some entities does not mean the model is flawed,” Simonson says. “The landscape continues to evolve.”

While captive offshoring success was defined in the past by meeting cost reduction goals and effectively managing risk, going forward additional value will be required.

“The value may be in terms of ability to ramp up and down resources for ad-hoc needs, create new ideas that advance the status quo, contribute talent to the global leadership of an organization, or provide an option to enter or better serve new geographic markets,” Simonson says. “Success increasingly becomes about the impact the captive has on the broader organization, not just the cost of a process or activity.”

To gauge the health of the captive center market in the future, adds Simonson, analysts will need to look not at the number of new captives established, but at the growth of existing captives. “The captive market will continue to grow, but largely by existing organizations both scaling and evolving the nature of work they perform,” he says. “[But] most firms for whom captives make sense already have a presence.”

While India remains the center of the captive universe, add Simonson, the model will be even more important in other offshore locations. “For example, large high-tech companies will see China captive operations as important for a combination of localization of products for east Asia, providing back-office support to other east Asian geographies, and supporting the domestic China market,” Simonson says. “Due to the diversity of languages, industry knowledge, and domestic market business opportunities, the use of captives outside of India is more precisely defined.”