Captive or third party is no longer a question that is faced by most product companies that offsore. The real question is how can one extract maximum value with a two-pronged attack? Is it possible to have a business and governance strategy which is non-partisan or better, bi-partisan? Should enterprises view setting up a captive as an offshore aggregator and program office? Does it make sense for companies to invest in their third-party vendors - to groom them into a value adding partner, when they can invest in building a fully owned offshore office?

Abstract

This sparkling debate evaluates how one can leverage maximum benefits either by setting up captives or going with third-party vendors. The discussion highlighted the trends on setting up captives and also their exit, the reason behind the same; what companies envision about captives and third-party providers and the pros and cons of having captives or third-party providers. The panelists conclude that companies must consider the cultural issues and the strengths and weaknesses of offshore destination like India and China before setting up captives there.

Discussion

Ramesh Pillai: The session today is on the approach towards captive centers Vs third-party. We will try to understand and figure out that what are the motivation factors for organization to look at captive centers. It could be to do with control, intellectual property, cost, a variety of other factors. What we are trying to arrive at not exactly conclusion or discussions as when not to or when to get captivated by the captive center options. So what we are trying to figure here and at the end of the discussion, we will have some thoughts, where this is going and just as to discuss a little bit about the captive center. A captive center is company setting up its own operations to take advantage of several factors could be caused - IP protection.

What are your views based on the experience of having set up captives in China and now in India?

Will Taylor: If you look at China Vs India, we have an extensive operating foot front in China and we also have our global operational foot print with a fairly extended supply chain. So we want to make sure that we keep control over the intellectual property. It's extremely important and that of course is a much different situation when we do within India . We also want to work with a captive in China , because we look at engineering outsourcing particularly with regard to product development and product maintenance. The outsourcing model is that we discovered in China are not very well developed. So in fact we want to keep control of the engineering and resources and keep control over the intellectual property. As far as India is concerned, we look at India as being a platform for our global engineering and global product development base. So we tend to look at captive in India as a very focused way to look at product development. Accomplish a target product development for the global models as opposed to regional or country models.

Rahul: Many decisions made by CEOs in relation to how to set up whether it be by way of captive or third party. Without sufficient thought put in to the factors that might drive you in one direction versus another. What is you goal trying to access the local market? Are you trying to provide services in to the local market, or are you trying to provide a set up in the operations that provide services outside of that local market. What service are you providing? Is it human touch service such as what we are doing in our venture with HCL, or is it kind of manufacturing service that relies less on human interface, human interaction.

I would suggest that lot of Bill's experiences in China are because of the point in evolutions that China has had. India on the other hand is very evolved in some ways and very unevolved in other ways. Infrastructure in India something that still needs to be built up, the supply chain in India something is need to be built up, but in terms of the human touch or the intellectual services and there is nothing like it. There are structural issues, regulatory issues, many countries will provide OEMs or manufacturing companies with benefits in grants do it themselves in the countries as opposed to do through a third party provider. There are unique considerations, such as IP protections and finally cultural fit. All these factors in my view are important factors to take in to account in the melting pot in deciding what structure you are going to use in which country. I am really to come up with a right answer that works for me.

Ramesh Pillai: In your views if you really look at what are those strategies for captive center initiatives?

Sandeep: I think I will build on what both Bill and Rahul just said. For us it was a very deliberate decision, long, it took us a long time to plan it and think about how we want to enter India from a technology set up of our own. We did a lot of research on our own to try to understand the market, but at the same time the other dynamics in the market place is where we saw the quality of the intellectual capital and at that time, definitely, cost was a big factor as well. We wanted to leverage on all those and that is how we decided on doing captive in India. We were not here just because today certain conditions that have arrived. We all know today things are as there are pressure wage inflation and on. So we had factored those in and so I think my thought on that is that whoever wants to do captives, first of all you have to have really a long time horizon on that and be prepared to go through some roller coaster rides.

Ramesh Pillai: Sudin, in your view how do you achieve that ideal offshore state? How do you successfully implement this strategy?

Sudin: I try to give you a few headers under which one need to look at what components were needed to take care of. Our first and foremost is you need to have a top management support right from CEO. The second aspect is you need to have very prudent and very validated cost model. The costing in India is a very dynamic change and not only because of that, because of dollar or staffing. I see lot of captive struggling, there is privatization of work. What are you going to send to offshore, in what sequence and what is that it will go first, what will go next. Our fourth area is very clear road map. So it is not only privatization but milestones driven, metrics driven, a road map which one need to have in place and one need to have a strong control mechanism. As in say, C level involved steering committee to track that road map in going forward and then you obviously need to have a governance model for typical project management and lastly one need to really look at do the whole captive strategy has good enough flexibility, because there is a good possibility. So you really need to have exit strategy at each point. So it can be full exit, it can be partly exit, what is full exit? Just selling out. More than 2 dozen companies have completely sold out, but there is also lot of part exit. People start the captive with the concept of what I call going solo, and they move from going solo to you will hear lot of words like partnering for innovation and partnering and all that stuff. So you need to have that strategy in place for flexibility.

Ramesh Pillai: Your captive in India is going to be operational about 3-4 weeks from now. In terms of exit strategies, what are the things which you have taken in to consideration?

Bill: The strategy in China is very much driven by market access. We want to develop them locally. So market access plays a very significant role in our strategy. Let go the point where we believe that captive is not working. We believe in that the resources that we have hired because we have established discrete centers of excellence inside the captives to be reabsorved by the divisions. So we believe that we have gone through the trouble to enquire the intellectual assets, the human assets, and if the captive model does not work, we can reabsorb those people, those assets, back into the divisional structure, we continue to have them add value.

Rahul Suri: India has a very evolved third party systems. There are few reasons for anybody in India particularly with BPO and IT outsourcing. There are few reasons for anybody in India to get into Indian captives. So it almost sounded to me like you were building on the experience on India itself, so whereas again I come back to number of reasons why captives may be more appropriate depending on the market you are talking about what you are trying to achieve.

Sudin: I think broad criteria for being successful whether captive or offshore are fairly common. In third party you need exit strategy, but that may be relatively easy than removing a legal established, permanent establishment. There is a big challenge on exit strategy. It is much stickier and second thing in outsourcing, you can have multiple engagement models first of all, but more importantly offshoring can become very profitable from any amount of work that you may send. There is a good possibility that with all good support from top and decent governance, your engagement can be profitable, but the minimum threshold in captive is much higher, because to gain that staffing savings you need to achieve lot of change. You need to deploy a very different set of work flows and collaboration tools and there is a lot of expatriate costs, technology transfer cost, and there is lot of management overhead in total. So that minimum volume is one biggest reason why the costing model and steering committee under road map become for more important in case of captive than compare to a third party.

Ramesh Pillai: How are you going to link your market access with the ITT China and ITT India strategy, again connecting it that with the regional and the global strategy what you talked about.

Bill: If we look at India and China, market access is key focus, because we understand from a strategic point that for the commercial products and the services that we provide, these are the long term growth areas. So market access is key in India and we want to make sure that from product development standpoint we use the mix model we were talking about captive as well as third party. Captive gets very focused on the global products, new product platform development. we tend to look strategically at our third party partners as the path towards localization. If you take a look at China, the are some unique aspects to the market in China. A lot of customers in China are less sophisticated than we see globally even in India . So we want to be very focused on new product development specifically for China, particularly in water treatment market and some of the other commercial markets, because of the unique aspects of those local models.

Rahul: People use their India development center as an extension of their global R&D and people use China for very specific skills to handle Japan or Korean market, so you get double by skills, more cultural proximity and that is a one thing we have seen quite regularly.

Ramesh Pillai: I am pointing is or trying to ask you is there is a changing reality here. you look at if you take India as a market, for example, this context there is a lot of things which are could be surprise, right. So is it spoiling the captive center initiatives in such in your views?

Rahul Suri: If I was looking to outsource in to India, today my bias would be completely different. I wouldn't be setting up captive center at all. And that is not withstanding the changes that are taking place in the outsourcing industry, such as wage inflation, infrastructure cost, all those kinds of things, because if you are entering a market you have got to have a long term view on things, and there will be inflation back and forth and frankly, India has done a great job being very competitive on the world market place. It has to continue to do that. India's productivity has to keep improving to keep up the realities that multinational companies are facing, companies that access the services that India provides. The value of the dollar is just one set of factor most of the multi national companies that are outsourcing to India are companies that naturally hedged. They are less susceptible to the dollar movement then we might think. Just the fact of the dollar movement back and forth is not going to affect, in my view, their long term view on what India can provide to them.

Ramesh Pillai: Dollar not impacting the operation. I would like to Sudin to pick up point talk little bit about that.

Sudin: We are just missing the point that we are not looking at the entire companies' sustainability on a global hedging. It is a question about India development center's cost equation and that is going to dramatically change with the 15% change or 18% change in the rupee to dollar conversion equation. If I am not going to send jobs to India where am I going to send? Which other location can help me build 2000 people BPO center or 500 people IT or product development. I must say this and I want to bring this point on table. There are several captives, which are actually using this falling dollar as a reason or excuse to paint their failing captives, reasons for failing. So there are cost already in bad shape. They have already had some series of challenges.

Sudin Apte: I am not saying that trend on offshoring is going to reverse as there is no alternative. Off shoring trend is going to continue. But I want to tell one point here and as I studied 40 captives those who just use captives. I talked to 25 companies who use both 3rd party as well as captives, we talked to head hunters, PR companies, construction companies to find out what is happening on a range of stuff. I will tell you one very interesting think that we found and it's a pattern. Captive is a lifecycle to go to offshore. It is not end destination. Whatever is critical today and high IP today is no more critical and high IP two years down the line. The range of factors, so to whom you are speaking in captive and which face of lifecycle they are in from newbies to enthusiasts rationalize to exit strategists. I am not against captives, but it does not suit every one. Not every product companies can scale up to 300 people, which is the minimum threshold for justifying IT or product development captive. If you want to start a BPO, anything less than 1000 or 1200 based on how much is your voice and non-voice combination. It is not going to justify, because the savings in staffing are going to completely over shadowed by the management overhead, exchange management, monitoring expatriate cost, whole lot of cost. So there is a minimum threshold and not every one can bring up that scale.

Ramesh Pillai: Sandeep why do you think Franklin Templeton captive center what you guys have here is successful? What are some of the success stories you have there?

Sandeep: I think first we were able to capitalize on the fact that Franklin is a global brand; we had very good brand recognition in India. So, for us hiring people was not bit of a challenge and our attrition rate. I can speak of my captive. you guys have data from Forrester but it is better than industry average. So we have been able to keep people, because we have instituted our own program like an ambassador program where we are able to rotate people from India who can travel our offices in Edinborough, or in Canada, or in the US. We are able to keep our people engaged in technologies, ways that we can, that we have seen how our partners are doing. So I think we are able to learn a lot from our good partners.

Ramesh Pillai: I wanted to understand from you your planned strategy of extracting value from two pronged approaches, because you talked about having captive center and using third party providers. How do you extract value out of this?

Bill: Let see India as the example. We planned to use our third party providers. We need to enter to the market in several different segments. We needed to do quickly to make sure that they were offering the products that customer is needed and willing to pay for it. We can't do that with the captive in India. So the value extraction, the value proposition of using thid party providers is market access and rapid growth in the market. We take a look at the captive. This is the area where we focus on technological centers of excellence where we can take our time in developing new global product platforms that forms the 3 year plan, the 5 year plan and support the growth plans in the out years. It really a mixed model. I want to go back to the whole issue of cost and productivity just for a second because I think it is very much the case that cost is the one of the initial considerations for us. However, productivity is clear. I agree the productivity in India is much higher than it is in North America and or Europe, particularly in Engineering disciplines. So the force multiplication effect is not just cost savings, it is moving faster.

Ramesh Pillai: Now I am coming back to subject on 3rd party Vs captive. Now when I start comparing there, I think the productivity is low. When I start comparing the cost what I incur here Vs my 3rd party, if I am going to compare the cost, my salary, and my expenses, with the cost in Manhattan it is a different story. I think that comparison is not the right comparison if you are trying to compare a productivity of you are having a captive center at 70% productivity with the X percentage productivity in Europe. Even that is not right. So how do you, what is your view on that?

Bill: I think we can do the internal comparison between a 3rd party supplier and a captive. In terms of extracting value, once again I want to set back from strategic standpoint. We do not believe we can stand back in the Americas, stand back in EMEA, and look at Asia, and gain the kind of market access that we want. You can argue cost differential between the captive and the 3rd party supplier and we can argue about raising cost in India or China for that matter. But the bottom line is that the ultimate end game at least is market access and it is little bit different to some of the others, for us market access is a strategic direction.

Ramesh Pillai: I think I would like to go to Rahul and ask the same question which I asked to Sandeep on the success.

Rahul: We had great success in our both of our models in India. You are assisting us with the global platform designing products for our customers and which has been tremendously successful thing, looking forward for more success there. Let use India as an example. When you are comparing the value that you can extract out of a captive Vs value that you can extract out of the 3rd party arrangement. Each of the factors that I talked about earlier has to be ascribed the value. So there is a tremendous amount of value in the time-to-market for instance. Being able to scale with the 3rd party in a way it couldn't, with the captives. That has to be juxtaposed against the value that the uniqueness of the captive gives you which is greater control, greater process control, greater product control, protection of IP and all those things. You have to balance all those factors when you looking at which is the better value creation vehicle, and we ended up with one of each for different reasons.

Ramesh Pillai: So is that what you call an ideal state in your, when you talking about a balance. You have captives and you have 3rd party and you have the control and you have the impact.

Rahul: Our two organizations in India are established the way they are for different reasons. From manufacturing perspective, we need the process controls, we need the IP controls, our customers come to us because of the process we put in place and the reputation we have. From the perspective of our 3rd party arrangement with you, product design is not in our core competence. Product design is in your core competence. But product design is something that we have to able to offer to our customers, because they are asking for end-to-end solutions. So frankly in my opinion that is the only way to go. Tiwan is another market and I am looking at very actively right now, because many of my customers are designing servers and the center of server designing and in all likelihood would go in to Taiwan with a 3rd party arrangement as well.

Ramesh Pillai: What are some of the parameter for assessing the health of the captive center which you guys are working on?

Rahul: I think for us the success has been in the results. We have seen the work that has been delivered out of our captive, obviously on talking about the quality and the productivity, for us they are very good. We have our own methodologies and our own very clear metrics of what is that we are tracking and we follow our budget in that.

Mike Jacson: I am Mike Jackson from Rockwell Automation, I think Sandip touched on the subject a little bit and I understand that while making the decision on captive Vs outsourced, there are multiple factors always in it. There is no one factor I could dig deep and get your opinion across the board on one factor. And that is that wage inflation, job attrition, fact that you know every month another major company is coming in and setting up 10,000 jobs; so difficult to obviously attract and retain key talent. Does that drive you toward captive center or away from captive center?

Rahul Suri: So let me take the first crack at that, wage inflation is an issue. There is no question. I think if you look at wage inflation is about supply and demand in balance. There are many people coming out of this great machine that's India. So in terms of number of people they can satisfy the requirements. The question is the suitability of the people and in my view that's a factor I mean if India is going to continue to be as productive as it is and as competitive as it is on world stage, that is an aspect India has to plan for and has to address and has to fix. In the greater scheme of things, the whole outsourcing industry in this country still very much in its infancy. So wage inflation in my view is something that has to, that the reality of short term. It will sort itself out in the long term, because India cannot afford to lose the advantage that it has on the global scale.

Ramesh Pillai: We talked about Celestica success initiatives, initiatives on India, so what are your comments?

Sandip: I can just say that that is why we have that hybrid model. We started without partners first. And we learned the lessons there. That was the training ground and then we setup the captive and again it was seeded, it was grown over time and I believe there is room for both and if you do it right you do not have to exit. I will make one very interesting line. If captive was a great story, why those who entered 6 years back or 10 years back are exiting. One question, second thing I will tell you, this is a very layman's language sentence and I am very bit fond of that company, whatever GE does, everyone else follows a decade down the line. They came to India, every one came to India, they exited from captive. Watch my words. Last 6 six months we have seen at least 30 odd captives have left this captive model. Again no one has gone out of India. So I do not want to say offshore trend is a way. Out of 300, 35 people have already sold and I have heard at least 150 companies, 200 companies saying lets partner for innovation and I always asked them what is your pricing model. Pricing model is end M. I do not know how innovations happen, material and time, and those type of stuff. So I guess yours is much more complex issue than stuff like that.

Audience: I am Bob from research. My question is over the comments made on productivity. I believe it was you, Bill, that made those comments and I am interested to know how you established in the metrics of engineering products productivity and what your observation from those metrics have been?

Bill: We would look at the number of hours that we put in to the captive in China, because that where we have the experience with the captive. Look at the numbers of hours we put in and how quickly we turned as hours into finished component designs, into finished analysis. So that is one measured of productivity. We also obviously look at those hours and I would say that even today with the weakening dollar and growing costs in China, we still have a favorable cost/hour comparison between China and North America and Western Europe and we expect the same in India.

Audience: I am Siddarth from UK sales, HCL. What I wanted to ask was that does captive center, does it have expiration date? Hearing all the reasons that I have heard today, it is sooner or latter going to catch up and it is going to reach a critical mass where you not going to extract the value of the captive. So does it come with a built expiration date, depending on the industry it might be 3 years, 5 years, but what are your views on that?

Rahul Suri: Let me take the captive Vs 3rd party. In a 3rd party arrangement, you have the flexibility to change the arrangement, pull the plug at any time, at least in the contract that we negotiate. You do not want to captive arrangement with an expiration date. You will never hire people, you will never attract people. So this goes back to Sudin's point earlier, which is exit strategy. You are getting into geography; you are setting up an operation. Yes, you got to think about what if exit strategies are not going to be front center, success is going to be front center.

Audience: I am Sumindra. In the spectrum between the 3rd party and captive, how does the build, operate and transfer model come in. How does it fit in? - the BOT model.

Sudin: I think BOT is insurance. You don't buy life insurance for encashing. So BOT is to protect your interest. If your vendor is acquired, if you have some unpleasant experience with the vendor, but I have not seen any transferred deal being successful subsequently. May be 70% transfer deals are facing challenges on attrition and cost and 30% transfer have been successful.

Closing comments:

Bill: Don't be afraid. Yeah! You have to have your game face on and you have to be very clear about what your objectives are. But don't be afraid about doing this. The potential lop side is enormous, so regardless of what you heard from any of us that rang true or sounded a false note. Continue to evaluate plan and execute.

Rahul: This debate is certainly should not discourage people from getting into new areas, new countries, new arenas. For goodness sake there is a lot of opportunity out there. Go grab it.

Sudin: I think three points. One, size doesn't fit every one, look at what is that best option. Second point, going to offshore is a long journey, not a quick fix, and point number 3, I believe, captives are way to go to offshore, not essentially end destinations.