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Offshoring: the captive center rises again

Stephanie Overby | Jan. 12, 2011
High failure rates. Shutdowns. Divestitures. Author and researcher Dr. Ilan Oshri explains why, despite it all, the wholly-owned offshore service center is coming back -- and here to stay.

CIO.com: What was behind the divestitures of so many captive centers around 2008, and into early 2009?

Oshri: In the middle of the financial crisis, some multinationals divested their captives to improve their cash position. There was also interest from local vendors to buy captives that have built scale or have specialized in an area complementary to the line of services the local vendor is providing from offshore.

CIO.com: Has that sell-off slowed down?

Oshri: Indications are that it did not slow in 2009. I do not have full data on 2010. But it has become far more challenging to divest a captive for two reasons. First, local vendors have built massive scale offshore and the acquisition of a captive today will probably not have a dramatic impact on their economies of scale. Second, private equity firms—the other candidate buyers—are not cash rich as they were between 2002 and 2006. Having said that, vendors will consider buying a captive if the purchase includes a long-term service contract.

CIO.com:You say there will always be a need for captive centers, even with the maturation of the offshore IT services industry over the last decade. Why?

Oshri: Some executives believe that certain business processes or an IT function are too important for the firm to leave it in the hands of a third party. Others set up a captive center in a growth market hoping to turn their captive into a success story. There will always be those who hope that the captive center will save costs, but to achieve that the parent firm needs to invest in the captive and ensure that it builds scale.

CIO.com: In your book you note that 60 percent of offshore captives will struggle and perhaps not survive. Why is this model so difficult to set up and maintain successfully?

Oshri: There are two stories here. The first is about captive centers which were set up for the wrong reason—usually a "me too" strategy. These captives often fail to develop scale, cannot follow the evolutionary path described in my book, and therefore will struggle.

Other captive centers had the potential to become successful with the right management attention and allocation of resources. In many of these cases, captive centers become unsuccessful because of the gap between the perceived potential and execution. Most parent firms are attracted to the idea that the captive center can produce massive cost savings, so they go for this sourcing model. They set up captives and expect to see cost savings almost immediately. In reality captive centers face challenges that can erode potential savings if not handled properly: high attrition levels (affecting knowledge retention and higher training costs), tense relationships with the parent firm, inefficient governing structure, and other issues. The captive can cope with these challenges, but it needs resources and management attention from the parent firm.

 

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