Outsourcing: Demise of the Offshore Captive Center

CIO - The offshore captive center was once the Holy Grail of offshore outsourcing. As companies got a taste of the cost savings possible by outsourcing IT and business process work to lower cost countries, they began to salivate over the thought of bypassing the offshore vendors (and their pesky profit margins) altogether and saving even more money by setting up their own service shops in India.

But today, those offshore captive centers have become drain on many of the companies that created them-so much so that some organizations are desperate to divest themselves of their offshore units.

In October 2008, financial services leviathan Citi announced a deal to unload its offshore business process outsourcing center to Tata Consultancy Services (TCS). Citi made a similar move last month when it sold its captive Indian IT services unit to Wipro. Also in May, outsourcer Capita Group snapped up a 600-person captive center owned by insurer AXA. And earlier this year, the Economic Times of India reported that IBM and Infosys were bidding on Fidelity's offshore back office operations.

These companies weren't the first big name corporations to back away from their commitment to captive service operations in India. Over the past two years, AOL, Aviva, Prudential UK and Philips-among others-have put their offshore IT and business process services subsidiaries on the block.

And, analysts say, they won't be the last to get out of the Indian services business.

The Changing Economics of Offshore Outsourcing

The global economic recession is a major motivator of these divestitures. According to Gartner, captive centers represent a large, fixed cost for companies-and one that has been growing due to inflationary pressures and exchange rate fluctuations. The near-term benefit of getting those subsidiaries off the books is of great value to struggling companies, particularly those in the most hard-hit sectors of the economy, such as financial services.

"There are a number of drivers for [these transactions]," explains David Rutchik, a partner with outsourcing consultancy Pace Harmon. "And one is to generate some cash."

Such transactions, generally, reflect the reactionary nature of most decisions to insource-or outsource-operations offshore. "Long-term cost savings have rarely been the driver for significant outsourcing decisions in the past," explains Scott Feuless, a senior consultant with IT consultancy Compass. "It's generally been more about meeting short-term budgetary goals: getting assets off the books, temporarily improving cash flow, or all of the above. Companies are realizing that they may have to change their sourcing decisions from time to time to continue getting the most bang for their buck."

But the dramatic about face by companies like Citi, which at one point employed more than 13,000 people in its Indian IT and business processing subsidiaries, may also indicate that these captive offshore centers have outlived their value.