Outsourcing vs. Captive Operations – Which Model is the Best Fit For Your Business?

While feasibility of using offshore/nearshore resources for the delivery of certain activities or business processes has been already established, long term strategic feasibility and appropriateness of various engagement models are still under scrutiny.

The most common approaches nowadays are either working with a third-party outsourcing provider or establishing captive operations in lower cost locations. Engagement models can be differentiated based upon customer organization’s need for management control, costs of operation, risks and other factors.

Third-party Outsourcing

Third-party outsourcing is classic client-vendor relationship governed by contractual obligations and service level agreements. It is mostly driven by tactical reasons such as short-term cost savings and staffing flexibility. Non-core or non-critical activities are typical candidates for outsourcing.

Traditional third-party outsourcing comes in two main forms:

  • Project-based outsourcing is considered to be the most appropriate for development of software with well-defined requirements and deliverables. It is suitable for irregular but on-going or one-off projects. On-site presence may be required to facilitate estimating, specification and relationship management. Typical pricing models are Time and Materials (T&M) and Fixed Price.
  • Dedicated development center model caters for software with changing requirements, maintenance and support of large systems, research and development, testing as well as other types of complex ongoing medium- or long-term tasks. In this type of engagement vendor provides necessary facilities and allocates a team that works only on account’s projects and is managed by customer representative. This option is usually preferred when resource requirements are low. The customer is charged fixed monthly fee per full-time employee (FTE).

Captive Operations

When considering how to organize the remote delivery of software development services, captive subsidiary option often does not receive full consideration in comparison to outsourcing. While it is generally accepted to outsource certain non-crucial activities, in certain cases this approach is inappropriate for core functions and critical activities. Decision to take work offshore/nearshore doesn’t necessarily mean that you have to outsource it. Use of remote resources for the delivery of functions close to core business while retaining operational control and benefiting from real cost advantages can be achieved by means of setting up captive facility, thus keeping work within the company.

Captive model means that customer organization makes strategic decision to create its presence in the lower cost location and conduct work there as a part of its own operations. The activities are performed remotely, but they are not outsourced to the vendor. Thus the customer is able to retain full control and mitigate respective risks associated with intellectual property and other sensitive business information.

Organizations that want to establish captive centers have similar goals as those deploying traditional enterprise or shared services operations. In the first place captives are supposed to lower cost through labor arbitrage. But recent research shows that buyers are seeking not only cheaper but skilled labor at offshore/nearshore locations. They want to obtain competitive advantage and gains from process improvements. In order to avoid risks of underutilizing captive capacities, organizations must thoroughly assess their long-term operational requirements and predict service needs that may arise in the future.

The most common approaches to setting up captive operations are the following:

  • Creating captive center from scratch (do-it-yourself captive) can be successful when customer organization has necessary resources, local expertise and market knowledge. Decision to set up own captive center may evolve organically through growth. Organization can either perform extensive due diligence on its own or buy existing company with operations in the chosen location.
  • Build-Operate-Transfer (BOT) approach means partnering with third-party vendor to establish and stabilize center. Vendor is responsible for initial setup, staffing and operations of the captive center during the predefined period of time. At the end of the contract period the ownership is transferred to the customer. Thus organization takes over the turnkey captive center tailored to its specific needs. BOT option best suits organizations that do not have local expertise or extensive resources available. In this type of engagement only logistics associated with setup of the captive center is outsourced. Build-Operate-Transfer optimally combines control element of the pure captive model with flexibility of outsourcing. Essentially it provides maximum control at minimal risk.

Main benefits of having own captive center:

  • Ongoing realization of real cost savings
  • Full operational control and monitoring
  • Full ownership after the transfer
  • Minimization of intellectual property and data security risks
  • Retained knowledge of industry, specific business processes and techniques
  • Improved communications by continual reinforcement and experience
  • Easy replication of parent organization’s processes
  • Captive center can be commercialized at some point in the future

Both outsourcing and captive operations have similar driving forces (cost reductions and competitive pressures in the first place) and particular advantages, but main factors for choosing one or another vary.

Both approaches will deliver benefits in terms of improved focus, optimization of processes, reduction of operational costs, faster time-to-market etc. But companies must thoroughly evaluate each option to identify one that represents the best fit for their specific requirements, business culture and strategic goals.

The approach selected will depend on whether the primary driver is short-term cost savings or whether the company has long-term vision for offshoring/nearshoring and wishes to retain control over processes and intellectual property.

Establishing nearshore captive center in Ukraine through BOT model

If software development is a core competency of your company and you have long term specialized resource requirements, it makes sense to build your own capability in order to support the full software life-cycle, secure intellectual property and build up specific know-how. Nowadays this process is not as difficult as it used to be. The key to success is finding a trusted partner that already operates in the environment of country. By doing this you will benefit from:

  • Clearly defined setup methodology and timeline
  • Planned step-by-step implementation
  • Responsibility for all logistics associated with establishing a captive center
  • Practical knowledge of establishing IT business and dealing with related legal and contractual issues
  • Deep comprehension of cost and effort components associated with setting up and running a software development center in offshore/nearshore country
  • Hands-on experience in software engineering, generally recognized methodologies, processes and quality assurance that can be adapted to captive center
  • Established HR practices, experience in recruiting qualified IT staff
  • Attention to addressing security and business continuity issues
  • Consulting and support throughout the setup process
  • High level of business commitment and responsiveness
  • Flexible client-specific approach

China’s Captive Market Captures Foreign Businesses

Fear is not the best way to run a business, yet running a multinational company with an office in mainland China leaves you in a strange limbo.

If you want to relocate, you are afraid to follow through because you presume – not without reason – that China will retaliate if you leave. Not only that, but you are afraid to even say that this is what you fear, for the same reason.

Don’t take my word for it. Ask the anonymous chief executive for Asia at an anonymous company, who declined to let The New York Times print his name because of the legal repercussions that can arise from openly criticizing China. He did say, however, that many companies now are “just convinced if they open that R.&D. center in China, every technical secret they’ve got will be copied, every patent exploited.” (1)

The Times further reported that several multinationals have left mainland China for Singapore, while still others express the desire to relocate but hesitate because of reprisals. Such action is far from unheard of. Jardine Matheson reincorporated in Bermuda in the 1980s and delisted from the Hong Kong Stock Exchange in the mid-1990s. In return, Beijing penalized the company for more than a decade, making it difficult for it to invest in mainland China in any substantial way.

Some companies report having difficulty convincing executives to move to China because of air pollution and limited educational opportunities. Given the climate of fear, however, it seems likely that the real reasons for dissatisfaction run deeper.

I have limited sympathy for the companies that now wish they were less exposed to China. They couldn’t resist the lure of a captive market of over 1.3 billion people. And they couldn’t seem to comprehend, though the risks were already knowable and known, that they would become captives themselves in turn.

Belatedly, however, companies are beginning to realize that choosing China for their Asian center of operations was a decision that held serious drawbacks. A survey of over 500 companies, released in May by the European Union Chamber of Commerce in China, registered an atmosphere of pessimism about Chinese profit margins. (2) Barriers to non-Chinese businesses are well known, both in Europe and the United States, and they seem likely to limit growth there.

China lacks freedom of information, freedom of expression and a legal system free of coercion. These three freedoms – a Chinese-sounding phrase if there ever was one – are essential to good business management in the modern world. But companies stampeded into China over the last 20 years for fear of missing out. Now, like it or not, in many ways they find themselves stuck.

They might get lucky. China might evolve into a more open, democratic and free society. It has happened before in places like South Korea. For a brief moment in the 1990s, there seemed to be hope that it was happening in Russia, though today Russia is an arguably worse environment for business than China.

More likely, however, multinational companies will find themselves divided on opposite sides of the chasm that is opening between China on the one hand and its Asian neighbors and their Western allies on the other, who are threatened by China’s increasingly aggressive territorial claims and protectionist impulses. China is big, but it is not an easy market for foreigners, and it could increasingly cost companies business elsewhere in the region.

For now, however, multinationals already have big problems with their Chinese offices. Major companies have faced complaints from Chinese authorities about everything from food safety to “unparalleled arrogance.” While facing prosecution, foreign companies can also find themselves lambasted by the Chinese press. Companies cannot rely upon the force of law to keep them out of trouble in China when authorities there will act in the best interest of the ruling elite regardless.

We can also be sure that whenever an American or European CEO today visits his company’s Chinese headquarters, he carries no data of any significance on his laptop and uses a smartphone specially scrubbed for the purpose – or, in some cases, a low-tech flip phone without Internet capabilities at all. To carry any sort of intellectual property into China willingly is tantamount to surrendering it to the Chinese government.

It’s a heck of a way to do business, but it is the way these companies chose. Now they have to live with it, or suffer the consequences of leaving.

Sources:

1) The New York Times, “Looking Beyond China, Some Companies Shift Personnel”

2) Bloomberg Businessweek, “Is the ‘Golden Age’ for Multinationals in China Over?”

Is Legal Onshoring the New Legal Outsourcing in the US?

Legal onshoring is a trend that is gaining momentum as an alternative to traditional Legal Process Outsourcing. In the US, a growing number of law firms are exploring onshoring or a hybrid of onshore and offshore legal teams to handle work that was once performed in-house.

How Onshoring Fits into the LPO Mix:

Onshoring involves the outsourcing of work domestically. The onshore LPO model is a viable alternative for legal professionals who are unwilling or unable to send work to outside jurisdictions, and allows LPO vendors to expand their delivery capabilities and service portfolios to new geographies.

Unlike the offshoring model, which focuses on reassigning legal work to lower-cost service providers overseas, onshoring transfers work to lower-income, lower-cost rural communities. Like typical LPO, onshoring allows law firms and corporations in major metropolitan areas to maximize productivity and minimize legal fees. It is no surprise that some big city law firms are sending work to small towns in Texas, the Midwest and the Pacific Northwest, or even to virtual America where costs are lower.

Why Choose to Onshore Legal Work?

US law firms are recognizing that American onshore providers may be a better fit for some complex projects that require a higher degree of expertise and collaboration. The skill, knowledge, and experience of US attorneys are attractive to law firms and legal departments looking to outsource. These attorneys understand the nuances and complexities of the US legal system, which can be an advantage in litigation, IP, and M&A matters. And, while the level of expertise is high, the costs are typically lower. Furthermore, should a problem arise, onshoring is extremely beneficial because the laws of the United States will be enforced. For these reasons, many firms are reevaluating their decision to ship projects overseas, opting instead for US-based outsourcing companies.

Offshore LPOs Come Ashore

As a further evolution of the Legal Process Outsourcing industry, some offshore LPOs, predominantly in India, have opened offices in the US and even employ American lawyers. These onshore service delivery centers are in cities such as North Dakota, Texas, Kansas City and Chicago. Additionally, some LPOs are ramping up the hiring of American lawyers to handle more sensitive client matters, such as military contracts, export control work and patent matters, here in the US.

Expanding Geographic/Jurisdictional Reach

The growth of onshore LPO is a result of third-party vendor investment in onshore solutions as well as captive centers created by major law firms. The onshoring trend illustrates the value of LPO beyond simple labor arbitrage. With the popularity of onshoring as yet another legal outsourcing option, LPO will be viewed as a flexible, effective strategy for delivering legal services to a global business community.