Offshoring: rent vs. own The outsourcing vs. captive debate

Contents

1. Offshoring, an introduction

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2. Accessing the offshore market – buy or rent?

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3. Outsourcing is the future: the case against captives

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4. Still flourishing: in defence of captives

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5. What’s the right answer?

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6. How do you decide?

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7. How should I take this forward?

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8. Why Deloitte?

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1. Offshoring, an introduction What you need to know The Oxford English Dictionary defines Offshoring as; “the practice of basing some of a company’s processes or services overseas.” Offshoring is increasingly becoming a ubiquitous part of almost every midto large-size organisation and is being applied across all kinds of sectors. Furthermore, the take-up of this powerful enabler is growing rapidly. Starting with Information Technology, offshoring is increasingly common across various business processes; including Finance & Accounting, Human Resources and Procurement, as well as industry-specific practices such as claims processing in the insurance industry, and credit card and mortgage processing in banking. As offshoring continues to grow, there has been a subtle shift in the underlying drivers. While most have remained unchanged, their relative importance in the minds of leadership have changed considerably. • Cost: In spite of recent inflation in India and other popular destinations, the arbitrage on labour cost and the resulting reduction in the total cost of delivering service remains extremely attractive and this remains an extremely important driver for offshoring. The importance of this driver, however, has shifted from being the near-sole objective of offshoring to becoming one of the many things that organisations look for. • Access to talent: Organisations are increasingly viewing offshoring as a means to accessing high quality talent. Organisations often find it easier to attract highly skilled individuals with significantly better qualifications for the same jobs offshore than they would in their onshore home locations. Indeed, in some cases, such as actuarial analysis in insurance firms, there are chronic shortages of skills onshore and the availability of these skills offshore is seen as an essential way to access talent.

• Quality of service: While areas such as customer service for UK consumers have seen challenges, offshoring has yielded improvements in service quality as well as greater efficiency in most business processes. Most organisations have identified the possible benefits available through applying the talented and highly motivated offshore workforce available to them. • Competitive pressure: Until a few years ago, most firms evaluated offshoring as an option to improve their competitive position relative to their peers, with all of the factors above contributing to a potential advantage. The prevailing economic situation and the increasing adoption of offshoring have changed the paradigm; instead of asking ‘Should we offshore?’, leaders are now wondering ‘Can we afford not to offshore?’.

Offshoring: rent vs. own The outsourcing vs. captive debate

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2. Accessing the offshore market – buy or rent? Before you commit … The question of how to offshore is one that a lot of firms raise. Firms looking to dip their toes in the offshore market often ask about the best way to make a start. Experienced offshorers who have gone down a certain route in the past often weigh up the options whether to change or enhance their approach. In recent years, firms who have inherited offshore capability via a merger or an acquisition have also pondered what to do. Of the various options available, two are most common. The first is the ‘Captive’ route where the organisation sets up its own delivery capability in the chosen offshore destination and continues to deliver the services in-house. The other is the ‘Outsourcing’ option where the responsibility for delivering the activities in scope is transferred to a third party. There are a multitude of other options available that straddle the continuum between pure Outsourcing and Captives. These include structures such as: • Joint Ventures, where the organisation sets up a shared ownership entity with a third party (typically an experienced outsourcer). • Build-Operate-Transfer, where an outsourcer sets up the captive offshore entity and the customer has an option to buy it after a few years. • Virtual Captives, where the client leverages an outsourcer’s physical and management infrastructure to build its offshore presence. While there has been a lot of interest in all of these options, the two most common approaches remain Captives and Outsourcing. So, which option is better?

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3. Outsourcing is the future: the case against captives Time to cut and run? A number of offshore industry practitioners argue that the captive model is dead. Unsurprisingly, a number of them are outsourcers themselves. However, there are a number of strong arguments that are worth considering: • Maturity of the supply market: When the pioneers of the industry, like GE Capital and American Express, wanted to start leveraging offshoring in the late 1990s, there were no credible and mature suppliers who could provide that service. They had no choice but to set up captives of their own. The supplier market has evolved dramatically in the last 10 years to a situation where there are now a variety of suppliers who have proven capability in delivering offshore services. • Competition for talent: As in any fast growing market, the demand for talent in popular offshore destinations like India is extremely high. With outsourcing suppliers setting up massive operations recruiting tens of thousands of people every year, captives, especially small to medium sized ones, can struggle to attract and retain talent.

• Access to expertise and best practice: Mature outsourcers are providing services to a large number of clients and have the ability to bring to bear expertise, tools and technologies that captives may not have access to. Also, serving multiple clients provides outsourcers with an excellent view of best practices that they can leverage to drive effectiveness and efficiencies. • Focus on core business: With the availability of credible suppliers, organisations have the option to focus on their core businesses and focus management attention on key strategic issues. Delivering routine technology or business processes may be best left to an organisation for whom it is core business. • Cost: Inexperienced organisations can envisage eliminating the supplier’s margin and business development costs will result in a lower cost. However, outsourcers can often leverage their superior knowledge of the market, greater scale and efficiency to deliver a lower total cost than most captives.

Figure 1. The case against captives, the evidence

UBS

Citigroup

• UBS India Service Centre had 2000+ associates based out of Hyderabad. • Service scope included BPO, KPO, IT and RIM services. • Entity divested to Cognizant for $75m in 2009 with a 5 year, $450m outsourcing deal. • Poland captive retained.

• Citigroup divested its offshore captives in 2008: – BPO arm (CGSL) sold to TCS for $500m (along with a $2.5b outsourcing deal). – IT arm (CTSL) sold to Wipro for $125m (along with a $500m outsourcing deal).

Unilever

Philips

• India F&A captive based on Bangalore and Chennai divested to CapGemini in 2006. • Two additional centres (Santiago and Sao Paulo) providing F&A services to 20 countries in South America divested in 2008.

• Network of 3 captives in Poland, India and Thailand – 1400 FTEs. • Divested to Infosys in 2007 for $25m. • Signed an outsourcing contract worth $250m.

Source: Public sources, Deloitte analysis Offshoring: rent vs. own The outsourcing vs. captive debate

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4. Still flourishing: in defence of captives An enduring relationship? Estimates of the number of captives currently in operation vary – analysts report that there are anywhere between 350 and 750 captives in India alone. A large number of organisations continue to use captives – indeed, a large number of new captives continue to be set up and a number of existing captives are being expanded. The arguments made by Team Captive are equally interesting: • Flexibility: Captives by their very nature are more flexible than outsourcers. In many outsourcing relationships, both parties get tied down by a contract and changes can be extremely hard to implement. On numerous occasions, the client’s urgent priorities cannot be met in a timely manner because of the commercial conversations required before anything new can be implemented. On the other hand, Captives are not tied down by these constraints and are much more flexible and in tune with their parent’s needs than any outsourcer could be. • Management of risk: Being extensions of their parent companies, captives can manage risk more effectively. They tend to have a better understanding of the parent’s business and can tailor their risk management approach as required. The parent company too has a greater sense of comfort with a captive from a risk perspective. This is particularly true when dealing with sensitive data; the loss of which could potentially be embarrassing or commercially damaging. • Breadth of services: Driven by the reduced perception of risk, captives can help offshore a broader scope of services than outsourcers. Captives find it easier to be seen as ‘partners’ than third party outsourcers and therefore more readily gain buy-in to offshore more sensitive/strategic and higher-end processes than outsourcers generally would.

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• Managing attrition: Managing attrition is definitely a challenge – for both outsourcers and captives. While outsourcers typically tend to be better at managing attrition because of the career paths they are able to offer, captives actually do have more flexibility to manage attrition. This is particularly true as they tend not to be locked into contracts that they need to protect margins on. Also, in many areas such as Finance, captives are able to demonstrate long term career paths to employees, reducing attrition rates related to short term compensation.

Figure 2. The case for captives, the evidence

Organisations setting up or expanding captives • Franklin Templeton • Deutsche Bank • JP Morgan Chase • NYSE • Allianz • Avaya • DHL

• Ericsson • AIG • Credit Suisse • Pfizer • Novartis • Dupont • Amazon

Source: Public sources, Deloitte analysis

5. What’s the right answer? Do I have to choose? Outsourcing or captives; both options have significant advantages and challenges. The best of both worlds? It is not necessary to choose one model over the other. Indeed, experienced users of offshoring frequently recognise the merits of each option and are increasingly using a combination of both to achieve their objectives. Some of the common models being used to combine the best of both worlds include: • BPO/ITO Split: Some organisations are using third party suppliers (single providers or a portfolio of multiple suppliers) for Information Technology Offshoring (ITO), and engaging captives for Business Process Offshoring (BPO). • Functional/Process Split: Other organisations are carving up their offshore portfolio to use third party suppliers for relatively transactional business processes while using captives for more complex processes, or those where there are greater risk concerns.

• Overlapping scope: Organisations with large volumes are also experimenting with using suppliers (often more than one), as well as captives in the same broad area. The obvious advantage this model offers is promoting healthy competition and sharing of best practices. However, this model can typically only be deployed in areas such as customer service where metrics are relatively easy to compare and volumes are large enough for it to be effective.

Figure 3. Prudential case study

• Prudential initiated its offshoring programme in 2003, setting up a service centre in Mumbai, India. • While ICICI Onesource assisted in setting it up, the entity was a captive with Prudential retaining ownership and responsibility of service delivery. • The captive ramped up rapidly and grew to ca 1,800 FTEs. • In 2007, as part of its wider outsourcing programme, ca 1,200 offshore FTEs were transitioned to Capita. • The remainder were retained in the form of a captive to create a hybrid model.

Source: Public sources

Offshoring: rent vs. own The outsourcing vs. captive debate

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6. How do you decide? Circumstance, circumstance At Deloitte, we are often asked “How should I choose which approach to take?” The simplest answer is it depends on your circumstances ... Whether your organisation is new to offshoring and evaluating the most appropriate approach to initiate your programme, or whether you already have an established offshoring programme that needs finetuning, it can be a tough decision with significant implications. Some of the factors to think about when weighing up the options include: • Scale: Without significant scale, captives tend to struggle. The lack of scale impacts not just efficiency, but more fundamentally the ability to attract and retain the best talent. With employment markets in popular offshore destinations booming, often staff do not see the same career growth prospects in a small captive that they would in a larger operation. Outsourcers who employ thousands are often able to leverage their scale to have a stronger influence on the labour market, as well as use their scale to drive significant efficiencies. However, with the right scale, captives have the potential to be as effective as outsourcers. Conclusion: If your scale is small, consider outsourcing. At a large scale, both options are viable. The scale required in each location is different. • Local presence and brand: Setting up and running an offshore operation is a complex management challenge. Having a strong local presence and understanding of the local market can significantly improve the chances of an organisation’s captive being a success. Also, having a recognised and sought after brand is a major factor in recruiting and retaining staff. For an organisation that lacks the local presence, using a third party outsourcer is an easy way to ‘buy-in’ that capability. Conclusion: If you have a strong local presence and brand, a captive may be viable. Otherwise, consider outsourcing.

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• Processes in scope: Captives tend to be seen more as extensions of the organisation rather than outsourcers. This is sometimes reflected in captives providing a broader suite of processes than outsourcers – particularly high end/complex processes where the organisation may have concerns about risk. They also tend to have greater ‘permission’ to explore new areas in the organisation. On the flip side, outsourcers tend to be better at ‘industrialising’ transactional processes to drive the greatest efficiencies. Conclusion: For routine transactional processes, outsourcing is certainly viable, while a captive doing just those processes may struggle. For more complex processes, consider both options. • Supplier market: The current BPO market has its roots in the early captives set up by American Express, GE and others in the early ’90s. As pioneers, they did not have the choice available today – the supplier market did not exist. Over the last decade, the supplier market has matured significantly and organisations now have the option available to use third parties for most types of work. Even in very specific areas where suppliers may not have prior experience, most have demonstrated the ability to learn rapidly and deliver to client needs. Conclusion: Evaluate the maturity of the supplier market for the specific areas you are considering. • Risk/Regulatory: The risk, and more importantly the perception of risk, has a significant bearing on this decision. While most suppliers have world class data security measures in place, some organisations continue to hold the view that captives are to be preferred in some areas, particularly those that may be impacted by regulatory issues. Conclusion: Objectively analyse the real risk issues, keeping vested interests aside, to determine the best option for your situation.

7. How should I take this forward? Looking at the options Like many decisions in the area of offshoring, this discussion tends to attract a fair amount of attention across the organisation with strong points of view being expressed by most individuals involved. In making the right decision for your organisation, it is helpful to keep three things in mind. Firstly, involve the right set of senior stakeholders up front. Secondly, to prevent emotion from clouding the issue, establish a clear process with early agreement on goals, objectives and evaluation criteria to enable the decision. Finally, this is a decision an increasing number of organisations are grappling with. Ensure you have the right expertise to help make the decision.

8. Why Deloitte? The perfect partner In today’s pressured market, our clients require a comprehensive offshoring advisory service, one which encompasses the full range of both BPO and ITO services. Our offering answers all of these requirements. Calling upon an exceptional breadth of skills, Deloitte’s solution is delivered through an integrated approach across our Consulting, Tax, Audit and Corporate Finance service lines. Our joined up approach to delivery enables us to provide the full gamut of services; from business case modelling expertise to advising on the tax, finance and regulatory implications of all the sourcing options. And, due to our firm’s breadth and depth of capability, independent stance, global presence, comprehensive lifecycle view, peerless market knowledge and industry presence, our service is truly unique.

Offshoring: rent vs. own The outsourcing vs. captive debate

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Contact us

If you would like to discuss any of the issues arising from this short paper, or any aspect of offshoring or outsourcing, please do not hesitate to get in touch. Neville Howard Outsourcing Advisory Services Leader [email protected] Peter Moller Business Process Outsourcing Leader [email protected] Punit Bhatia Business Process Outsourcing and Offshoring [email protected]

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