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Monday, April 30, 2007

The Imploding Captives

I recently wrote offshore based'Captive' IT companies/units, serving dedicated western clients will have to consolidate to drive scale and increase attractiveness to talented prospective employees. The attraction for larger players to buy them out is on account of their highly trained staff and acquiring a marquee western client (or a few clients) in the process. Captive units of large global business providing offshoring business may also find the goings unattractive and may opt towards taking services from service providers. Third-party service providers generally outperform captive offshore facilities – a point that I have repeatedly highlighted.

The trend of establishing a "captive center" in offshore locations like India, China, or Russia continues to find converts – these are setup with an aim to lower the costs of product development or back-office operations. The recently released Forrester report report finds that the majority of the reasons firms cite for building their own facility versus outsourcing to a third party are flawed. Lack of management support, spiraling costs, skyrocketing attrition, and a lack of integration all contribute to the adding list of struggling captives. Forrester believes that more than 60% of captive centers set up in places like India fail to meet expectations. Common reasons for failure: a poor delivery track record, operational problems, a lack of scale, poor morale, rampant attrition, and high costs. The report points out that the loaded cost of captives with nil margin on transfer pricing may be more than the loaded cost of third party providers even after factoring in a reasonable margin. The problem is not just relevant to India but extends to wannabes like china, Malaysia etc. In fact research throw up same levels of attrition and wage inflation pressures as captives set up shop there. The best indication of how tough operations management in offshore comes from Manish who points to TCS challenges in china (though this is not related to a captive unit but is a pointer to the cahllenges even established players can face in retaining competitive talent). And more importantly the cultural idiosyncrasies of locations like Malaysia and Brazil tend to make staff much less amenable to travel and shifting work hours to better align with the parent country time zones. Today’s reality is that barring those that are focused on product development, or support functions involving multiple of hundreds of people working or those focusing on research – the R part of the R&D line item, most of them are grappling with which exit option to choose - ranging from closure to outright sale.

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