Outsourcing vs. Establishing Captive Facilities Offshore

The choice between outsourcing or operating a captive facility for call center services, non-voice customer services and back office processing, offers advantages for both approaches. Here we examine the advantages of outsourcing and two principal strategies for outsourcing. In an upcoming article, the advantages of establishing a captive facility will be detailed.

There are two principal strategies being pursued for outsourcing: strategic and market-driven outsourcing. Strategic outsourcing is addressed first because it does not lend itself to the establishment of captive offshore operations as easily as market-driven outsourcing.

Strategic Outsourcing

Strategic outsourcing aims to redirect an organization's resources to focus on its core competencies. Core competencies for some organizations consist largely of strategic planning, brand management and project management.

Strategic outsourcing enables organizations to quickly change course, enter new markets and access new technologies. Strategic outsourcing focuses on results. Market-driven outsourcing is often more process oriented, with greater attention paid to how results are achieved.

Strategic outsourcing often involves large projects or indefinite quantity contracts (ICQs), managed by a primary outsourcing service provider and supported by smaller specialty firms that serve as subcontractors. Administrative fees charged by a prime contractor for passing funds through to subcontractors often range from 25 percent to 35 percent. In comparison, brokers generally charge a 5 percent commission for placing outbound voice work and 10 percent for inbound customer service contracts.
Strategic outsourcing lends itself to process redesign and organizational transformation, but not to the relatively long-term, more capital-intensive tactic of establishing captive offshore facilities. Market-driven outsourcing, in contrast, can serve as a stepping stone to establishing a captive operation offshore.
Market driven outsourcing enables buyers to gain familiarity with a location before deciding whether to commit to setting up their own operations there. Familiarity is no guarantee that a captive operation will be successful, as Apple (Nasdaq: AAPL) demonstrated by pulling the plug on its captive operation in Bangalore on May 29.
Market-Driven Outsourcing
The key variables in market-driven outsourcing are the capabilities and prices of available service providers. The decision to outsource is often based on short-term cost savings from using qualified talent pools and cheaper infrastructure in offshore locations.
The direct costs and levels of effort required for project management of market-driven outsourcing projects are usually greater than for strategic outsourcing ones. Full support of project management activities in market-driven outsourcing projects lowers the risks and total costs of running these programs offshore.
Customer service outsourcing from the U.S. and Europe during the years 2000 through 2006 has often not been highly cost-sensitive for large projects, due in part to the administrative challenges that buyers face in undertaking their first major round of offshore outsourcing. In offshore outsourcing version 1.0, half a buyer's payments for offshore services are often applied to service providers' administrative expenses, profits and marketing costs.
In outsourcing version 2.0, large buyers of outsourcing services are increasingly seeking a multi-source approach that enables their outsourcing efforts to be more market driven. Buyers are building up internal capabilities for managing outsourcing projects executed by smaller, cheaper vendors. Whereas outsourcing 1.0 vendors present themselves as capable of handling anything and everything, the new generation of outsourcing 2.0 firms often need institution-building assistance before launching a program.
In outsourcing 1.0, service providers help buyers with institution building. In outsourcing 2.0, buyers are showing greater sophistication and a stronger interest in achieving better value for money. This makes it more likely that buyers will consider the cost effectiveness of establishing stand-alone operations overseas.
Characteristics of Captive Operations
Whereas outsourcing entails having a third party perform tasks, captive facilities are established by a parent company to perform its own tasks.
• Captive operations can be commercialized, as GE did in India by founding Gecis Global and spinning it off on Dec. 30, 2004. GE retained a 40 percent equity stake in Gecis, subsequently renamed "Genpact."
• Captive operations can utilize service level agreements (SLAs), metrics and reporting systems along the same lines as those used in commercial outsourcing arrangements. The best types of processes to initially send offshore are often those that are the easiest to measure. Once initial successes have been achieved and management systems stabilized, tasks that are unique or less suitable to intensive metrics analysis can be considered, such as research tasks, content generation projects and those associated with knowledge process outsourcing or KPO.
• Cost projections for captive facilities can borrow data from commercial outsourcing facilities. However, in-depth cost analysis at commercial facilities can be difficult in areas where IT and IT-enabled services (ITeS) businesses are given major tax breaks (primarily India). The difficulty emerges because of internal cross-subsidization. The expenses of tax-exempt business units may be inflated or paid by non-exempt units, thereby increasing the amount of income that can be declared tax free.
Reasons to Retain Outsourcing 1.0 Arrangements
Traditional wisdom has held that outsourcing a call center program for longer than three years is more expensive than running a captive operation. This equation does not hold up in India and Pakistan, where locally owned facilities are capable of maintaining lower operating costs and lower profit margins indefinitely. The equation is likely to hold true for Western-owned merchant facilities in India and large Indian-owned call center companies, which charge more than their mid-size domestic offshore counterparts.
There are good reasons for U.S. companies to select large, relatively expensive U.S. providers. The principal reason is the weak offshore project management capacities that large U.S. outsourcing clients are faced with internally. They may not be able to recruit and manage their own staff to build up the institutional capacity of an experienced big-name outsourcing outfit to accept and run a large program properly and quickly.
Customer service and some back-office operations can be so critical to a company's image and brand integrity that it is worth paying premium rates in order to minimize risks. The best choice for risk minimization is usually made by trusting an experienced market leader, despite the higher prices levied by the major firms. Higher prices pay off for many buyers because of both the reduced risks and the reduced level of effort it requires to provide such operations within a buyer's organization.
Large-scale disapproval of outsourcing or offshoring among the majority of a U.S. company's staff can translate into reduced capabilities to implement a project properly, whether or not it results in job losses. Reluctance of U.S. personnel to assist in an outsourcing process can range from open hostility to overt non-cooperation and intentional bungling of an outsourcing project. By bringing in an experienced outside team, an outsourcing client can lower the risks of project failure and help ensure a satisfactory result.
Advantages of Outsourcing
• Outsourcing requires little capital to establish. However, significant spending is needed for onsite training and monitoring -- even in simple programs.
• Outsourcing contracts can include provisions for hiring out local staff in the event that a client decides to establish their own operation. Personal ties and the investments in training that a client makes during an outsourcing project are resources that can be retained once a commitment has been made to establish a captive facility.
• Outsourcing to a facility overseas shifts the risk for site selection, government permits, tax compliance, personnel recruiting, technology deployment and cost control. Establishing a captive facility brings those risks back in-house.
• Western firms in India are often overcharged for non-IT inputs in comparison with local businesses, and are also vulnerable to extortion attempts. The extent of overcharging is often keyed to perceptions of ability to pay. Corruption in India is not limited to the public sector or to Indian nationals, and is not an easy topic to discuss, except to say that outsourcing to a reputable vendor often removes these risks.