Captive Offshore Centers Remain Cost Competitive With Outsourcing

Despite speculation that the cost competitiveness of captive offshore centers may be fading, most global in-house centers still save companies money over keeping the work local, according to recent research by outsourcing consultancy Everest Group.

Many delivery locations have seen significant shifts in currency valuations and inflation leading to the perception that operating a company-owned IT or business process center offshore is less financially beneficial in the past, says Salil Dani, practice director in Everest Group’s global sourcing team. Wage inflation in India of as much as 20 percent for certain roles and functions, for example, has created questions around the sustainability of the cost arbitrage associated with a captive center.

However, Everest Group found that global in-house centers today deliver 30 to 70 percent savings when taking into account total cost of ownership including salaries, real estate, technology and telecom expenses as well as amortized costs associated with the setup, transition, and ongoing governance of the center.

Factors that Affect Total Cost of Savings From In-House Offshore Centers

Total cost of savings for captive centers vary by location and function. Typical captive center cost savings are 65 to 80 percent in India, 60 to 70 percent in the Philippines, 45 to 55 percent in China, and 35 to 45 percent in Poland, according to the research conducted in conjunction with India’s IT service trade group NASSCOM. In addition, more transactional roles like application maintenance deliver greater cost savings in-house than more complex functions like analytics, according to the study.

[Related: Does a Hybrid Offshore IT Outsourcing Model Make Sense for Your Company?]

New setups of global in-house offshore centers were down slightly in the first quarter of 2014, but the first quarter of the year typically sees lower demand for global services in general, says Dani. This quarter, new captive center activity is steady, and, long-term captive center creation will far exceed divestitures, says Dani. In the last year, companies have opened 70 new in-house centers and divested just two due to company-specific issues, according to Everest Group.

In addition, the appetite for captive centers in locations outside of India is increasing. Companies are setting up shop in Latin America for bilingual English and Spanish support and Central and Eastern Europe to service nearby European operations, for example. And some are expanding beyond India for increased diversification and risk management, adds Dani.

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In-house centers should remain cost competitive for as many as 8 to 16 years for most geographies and functions, according to Everest Group. But exceptions will exist. For example, captive centers in Brazil and those for high-end analytics services may be more difficult to justify financially.

In the meantime, companies are taking steps to further improve the cost competitiveness of their internal offshore operations. Those include reducing general and administrative expenses, increasing capacity utilization, adopting robust talent management practices to reduce attrition, and leveraging tier two locations, says Dani.

Stephanie Overby is regular contributor to CIO.com’s IT Outsourcing section. Follow everything from CIO.com on Twitter @CIOonline, Facebook, Google + and LinkedIn.