The recent announcement of UBS, a global financial services firm, selling its captive in India to Cognizant Technolgies is the latest in a series of such sell-offs. This only reiterates what Evalueserve had predicted way back in 2007 that the capacity addition by third-party service providers (‘Buy’ option) is likely to surpass additions by captives (‘Make’ option). After a study of about 100 captives of western companies in India, Evalueserve confirmed that a majority of these captives are in serious trouble:
- Sixty-one percent of the captives studied have faced significant issues, with many of them already shut down.
- Smaller captives have been the worst hit; many of the larger ones are not in good shape either.
- Captives across all segments—Information Technology (IT), Business Process Outsourcing (BPO) and Knowledge Process Outsourcing (KPO)—have fared somewhat similarly.
In contrast, third-party service providers have been scaling up during this period. Access to new markets and increasing maturity of the service providers have helped them stay ahead.
Majority of Captives Face Serious Issues
In April 2007, Evalueserve predicted in a report titled ‘The future of KPO – Make or Buy? that the capacity addition by third-party service providers (‘Buy’ option) is likely to surpass additions by captives (‘Make’ option). The report also identified three distinct phases in the lifecycle of offshore units in the ‘Make’ model: the set-up phase, the honeymoon phase and the stagnation period.
As a follow-up, Evalueserve studied 100 captives, not only from KPO, but also from BPO and IT segments
that have been in operation since January 2006. These included 30 BPO, 38 KPO and 32 IT captives, from the 300-odd captives in India. In cases where the captive catered to overlapping areas (which was the situation in 34 percent of the sample), the predominant area of operation (i.e., IT/BPO/KPO) was selected to classify the captive. The captives were selected randomly and were of varying sizes with 54 percent of them having more than 500 employees. The current study confirms the earlier theories. Sixty-one percent of the captives studied have gone through varying degrees of turbulence in the past four years—27 percent of them either shut down or were sold to third-party service providers. For example, Citigroup sold its BPO arm, Citigroup Global Services, to Tata Consultancy Services and its technology captive, Citi technology Services Ltd., to Wipro technologies.
HCL Technologies bought Adaptech’s India technology centre, Symphony Service bought biotechnology firm Biolmagene’s India R&D centre and the AOL contact centre in India was sold to Aegis BPO. Besides, companies such as Bose Corp., PowerGen, Riya, Inc. and BelAir Networks shut their captives in India.
Thirty-four percent of the captives studied either remained stagnant or have scaled down. These captives are under great pressure, and we may see many of them exiting in the next 1–2 years. However, small captives cannot be sold off at a premium, and they will find the exit much harder.
Small Captives Worst Hit; Larger Ones Also Not Spared
It is well established that smaller captives with fewer than 500 employees are likely to face greater challenges to survive. In fact, 74 percent of such captives have gone through a difficult time in the past four years. Employee retention is a serious issue in small captives since they are unable to provide good career opportunities. An interesting finding from the study is that many bigger captives (with more than 500 employees) have also been under tremendous pressure to survive in the past four years. It is evident from the fact that only half of such captives have been able to scale up during this period. The break-up of how small and large captives under study fared, is depicted in the following diagram:
Poor Performance Across All Segments
Captives across IT, BPO and KPO sectors have all been hit somewhat similarly—62 percent of IT captives, 67 percent of BPO captives and 55 percent of KPO captives studied have had a difficult time in the past four years. The break-up is depicted in the following diagram:
What Led to The Decline of Captives?
The change in the position of captives from a seemingly ‘enviable’ position to an ‘unviable’ condition can be attributed to several factors. The most prominent of them are the following:
- Significant management involvement is required while setting up a captive. If the support is sporadic, the transitioning and ramp-up process slows down, leading to cost escalations. In case of third-party providers, the parent company can manage the vendor as per pre-agreed Service Level Agreements (SLAs) and engagement terms, which does require some effort, but is much less than what is required for a captive.
- After an initial phase of intense growth—the honeymoon period—many captives tend to stagnate in size. This leads to higher attrition due to uninteresting work and limited career opportunities, which in turn increases recruitment and training costs significantly. Also, to attract talent, captives are often forced to pay a premium of 30–50 percent, further escalating the costs. In contrast, third-party providers use their scale and brand reputation to contain these costs very well.
- Captives have several hidden costs, including management time and travel costs, incentives to divisions in the parent firm to outsource work to captives, among others. All these drive the fully loaded costs of captives well beyond free market costs, making them unrealistic and unsustainable. According toForrester, it is 25 percent more expensive to operate a captive centre than have an outsourcing firm do the work.
- The global recession in the past 12–18 months has accelerated the pace of decline. Many firms that
have been under tremendous pressure to perform have realised that letting go of their bleeding captivecentres can breathe more life into their already stretched financial statements. Apart from monetisation of assets, this also helps the firms to focus on core activities.
Third-Party Providers Scale Up
Meanwhile, third-party service providers have, by and large, been scaling up since 2006. Their basic advantage over the captives is that they are not bound by many of the constraints that the captives have. Therefore, these players can expand into new areas with differentiated offerings.
Several geographies outside the conventional markets such as the US and the UK have become increasingly open to the concept of outsourcing. Further, the share of the domestic market in India in the outsourcing pie has also gone up. Leveraging this, large IT and IT-enabled services (ITeS) firms in India have expanded and gained global foothold in the past four years. Interestingly, small and medium-sized firms have also been making the best use of such opportunities. According to a recent study by the India Brand Equity Foundation (IBEF) and Ernst and Young, mid-cap IT and ITeS firms have been expanding aggressively and exploring new markets.
NASSCOM, the apex body of IT and ITeS firms in India, estimates the combined (total) revenues of IT and ITeS services for 2008–09 at USD 58.8 billion, a growth of about 13 percent year-on-year despite the recession. Also, NASSCOM estimates that the industry grew at a compound annual growth rate of 28 percent in the past five years. Most of this growth has been through third-party service providers.
Which Captives Will Win The Race?
The answer seems obvious. If the data for the past four years is anything to go by, it is large captives with a well-defined growth strategy and excellent management focus that are expected to survive. Many of these firms are likely to keep their captives as centres of excellence and retain high-end core activities, moving everything else to third-party service providers. Innovative business models may emerge in firms’ choice of ‘Make’ versus ‘Buy’. Global firms are becoming increasingly wary of starting new captives. For example, according to Zinnov Management Consulting, only 15 overseas technology firms opened IT captives in India in 2007, compared with 76, 70 and 48 in each year, 2004 through 2006. The figure fell even further in 2008 and 2009 due to the global slowdown. Given the poor track record of captives, the number of firms willing to go for the ‘Make’ option is likely to remain low in the coming years.
Manoj Madhusudanan is the principal author of this article. Manoj is Vice President and Head of Business Research at Evalueserve. Marc Vollenweider, CEO and Co-founder of Evalueserve.