Globonomics!

Consulting|Technology|International business

Captive centres in India

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There has been a significant trend in establishing cost centers and profit centers http://www.answers.com/topic/profit-center offshore in recent years.

Let us examine the business model of such centers and why so many companies are exploring this.

First of all, there are two ways for MNC’s to setup operations in India. Either open a captive unit or have an offshore subsidiary and an outsourcing company taking care of their day-day needs.

The trend has caught up with captive units in recent days because firms believe they have a significant advantage.

Disadvantages with outsourcing methodology

This has been the achilles heel of many MNC’s where they try to work through consultancy companies. The cost factor is high since the consultancies need to be paid a premium and per hour billing rates for the manpower they source.

Advantages with outsourcing

Companies will not have to worry about attrition and other local operational activities and are free to focus on growing their business

Disadvantages of captive units

The cost overhead is high. Initial fixed costs run extremely high. You need a competant management team to manage the offshore operations. Attrition is one of the biggest worries because any attrition directly tends to impact business.

Advantages of captive units

Its definitely got a cost advantage and companies can choose to run their units either as cost or profit centers. Management control is easier since the hierarchy is defined as within the organization. Exogenous factors limiting organizational strategies are lesser.

However, according to a recent Forrester research study analysing captive centres, it finds more than 60% of captive centres located in India are struggling to cope and meet expectations.  The link is here: http://www.forrester.com/Research/Document/Excerpt/0,7211,42059,00.html

Why does this trend arise?

Lets look at the outsourcing scene in a country like India.

Outsourcing is driven by really large players that occupy the top heap of the Pyramid followed by smaller and niche players at the bottom end of the Pyramid.

The larger players already have sufficient staff – ex: Infosys, Wipro and TCS plan to ramp up almost to 100000 people! This is to achieve revenue targets of about $4 billion in the near term. This is fine. What happens when they need to grow to $8 billion? Can the same 100000 people do the job? The answer is no. They need to double this manpower to almost 200000+ people. Why 200000+ is because of the law of diminishing returns. http://en.wikipedia.org/wiki/Diminishing_returns

In other words, this industry is not scalable in the true sense and even if it is achieved in terms of expanding the manpower base, the requirements are humungous. Think about hiring/staffing and getting the right talent of almost 100000 people. Its no mean feat. Indian colleges would possible fall short of churning out that many graduates in 1-year so firms have to compromise on quality and this will in turn affect their productivity and lower their revenue. Its a vicious cycle. Also, factor in the real estate costs required to double the manpower base. Think about the H1-B Visa limitation with the recent controversies surrounding visas being given out to companies like Infosys, TCS etc. A small percentage of their staff would have to travel overseas to maintain their onsite/offshore ratio so how do they go if they don’t have valid work permits for that scale of people (remember 10% of 100000 is 10000 and 10% of 200000 is 20000) since the supply of Visas to primary markets such as USA are still far lesser than the demand that exists for the same.  As though these problems were not enough, the companies will have to start dealing with the impending reality of lesser returns on their business as they grow to large proportions.

You also have the industry threats from MNC’s running their own service units out of India and are not even obligated to report revenues out of India operations because they are mostly cost centers. Accenture, EDS, IBM etc. work in direct competition to the likes of Infosys, Wipro, TCS etc. and the other Indian biggies such as HCL etc.

Typically IT service companies are manpower intensive businesses. This is a given. Now, for the typical MNC to setup shop and work through these as some of the recent companies such as Bank of America etc. did – what does it require? It requires them to source talent at the right levels, competant project/program management professionals to handle the offshore activities and serve as the bridge between the onsite and the offshore consultancy teams to churn out delivery requirements in a timely manner so headquarters is satisfied etc. Even Bank of America has gone in for its own captive unit called the BoA Continuum. Does this model succeed? Time will tell. Will all MNC’s benefit from the fruit of the captive unit rush? No way!

Product firms and are they scalable from both ends – userbase/manpower required to support the product?

Yes. Its quite obvious. ex: is Microsoft building its XP OS with about an intial capital investment of about $1 billion and thereafter they had incremental costs to burn that same OS technology onto a CD and selling it to almost 95% of all PC’s across the world. Think about their profits. Obviously, they are a Monopoly and can earn super normal profits but still it gives you an idea that this product business is a high margin scalable business IF the concept works.

Difficulties in hiring the right mindset people for IT product companies when it comes to establishing captive units

Product companies require a different mindset in people that not too many people in India are exposed to – as yet. Product Managers are hard to come by. IT Service companies churn out thousands of Project Managers but not Product Managers. There is a significant difference in the two. Product Managers working in the technology intensive industry typically need to see the big picture of things and the holistic perspective. This is different from Project Managers working in the IT Service industry where their main job is people management. You have 100000 people and you have ever thinning middle management positions open, you obviously want good quality Project Managers to manage the work of say 50% of the 100000 people who might be entry level candidates i.e. 50000 people! This is whopping! IT product managers are expected to play a hand in technology (As expected by Goldman Sachs and other firms), they are expected to bring in business or contribute to business development and given that team sizes are small – also expected to play the typical Project Manager’s role.

Also, the very fact that supply is far less than demand when it comes to genuine talent meeting above requirements shows that recruitment of the right talent is one of the most biggest challenges the Captives will face in coming years.

India does have a lot of IP (Intellectual property). However, our service industry model is primarily based on a different revenue generation methoodology and there is little emphasis on IP creation in that industry.

Product companies typically create IP. This is after all an Asset and therefore has to be protected. Therefore, come in Patents, Trademarks and copyrights. Now, IP creation in a dynamic industry such as the product industry esp. with its high levels of attrition is going to pose a challenge to any MNC setting up shop as a captive unit.

Coming to cost advantages of captive units – its a given. However, are we seeing the big picture? Operational sustainance of such units is quite a challenge for most MNC’s. Rising labor costs are only one of the many challenges they face. Increased training/retraining/controlling turnover rates all play a role in retaining the best of talent.

Many businesses such as BoA expect that the incumbent be well versed in the technical, operational and the business side of things. Can they get the right talent – its not easily available – this is a reality they have to face in captives.

On the other hand, IT services are an easier bet. They have people working on competing firms they can poach easily. Quality is not an issue. You have low productivity with a team of 5 – simple. Pump in another 10 to do the same job and get it done. Value creation is lesser – this is my opinion – others might differ.

Overall, the risks of opening a captive are quite high. You need to deal with regulatory requirements, comply with the legal framework of the country, be established on the higher end of the supply chain to source the right quality talent to run your captives.

Else, as the Forrester report suggests (I have not read it – all opinions expressed above are purely my own), you are taking a big risk.

Please also look at one more of a related topic posted by me earlier on a similar topic: https://ecofin.wordpress.com/2007/04/01/it-services-versus-it-products-which-is-better/

For a different perspective, please see: http://blog.cioinsight.com/research_central/content001/outsourcing/captive_offshoring_centers_are_imploding.html

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Written by Naveen Athresh

May 17, 2007 at 11:03 pm

6 Responses

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  1. I have been spending quite some time on this. As has been indicated by some of the reports the objectives defined for these captive units tend to be that for step child of the parent.

    If the captive requires technical skills then the quality of people hired should be commensurate with the needs which should be complemented by domain skills. For reasons ( that are perhaps obvious) these captives assume that technical ability automatically exist (I am speaking about IT Captives of typically large organizations like Banks). The argment is – I am establishing a captive in the region that has abundant Technical skills and I know the business. Invariably the best talent get missed by these captives.

    Extending this argument, the captives tend to be willingly or otherwise guided on the rails by the parent and rarely do they become centers of excellence.

    One argument to effectively manage captives is that captives should be a centers for excellence for the job that is in a segment different from that of the primary objective of the parent organization (e.g. Banking with an IT captive). The philosophy should be generic, how can the output of the captive change the world space rather then having a narrow motive of just the parent organization. Innovation is killed if this is not done, and the captive will not have the drive to sustain itself. Over a period of time quality (if acquired initially) will wither away if not harnessed and one will be left with dead wood that requires to be supported.

    DN

    May 18, 2007 at 1:14 pm

  2. What did I say about talent shortage affecting productivity of the IT biggies in the above post. Below link substantiates that fact: http://ibnlive.com/news/infosys-going-through-bad-phase-faces-talent-crunch/46712-7.html

    Naveen

    accounting101

    August 13, 2007 at 5:03 pm

  3. […] Captive centers in India Vs Globonomics The Author highlights here the significant trends in establishing cost centers & profit centers and the various business models followed by MNC’s to set up operations in India. Outsourcing methodology & captive units are the two most popular business models. Here in this write up both the advantages and disadvantages of both the business models are compared and then author finds that 60% of captive centers are struggling to survive. The article also brings out some crucial points as to why this trend is arising? and considering the outsourcing, the author mentions about the scalability issues, also compares large MNC’s and small companies in detail. The author also makes a point to differentiate Product managers vs Project managers and describes in detail about the product companies, captive product development centers and the challenges by them due to lack of product engineers. Click here to read the full article […]

  4. […] The author also makes a point to differentiate Product managers vs Project managers and describes in detail about the product companies, captive product development centers and the challenges by them due to lack of product engineers. Click here to read the full article […]

  5. […] Posted by Naveen Athresh on May 22, 2008 Before I begin this post, this is my mantra since the last few years when I have been exposed to this: I have a fondness for IP creation or Intellectual Property creation! I have written about this earlier too: https://ecofin.wordpress.com/2007/05/17/captive-product-units/ […]

  6. Do you think outsourcing is the best way to do things?

    David

    June 2, 2010 at 2:25 pm


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