July 18, 2024
Keeping hands-on control of outsourcing has advantages, but the flexibility of using trusted third parties will likely yield better results for most businesses.
Across the world, from Mumbai to Manilla, North American firms have set up remote outposts of their outsourced operations, employing local staff directly and managing them from head office.
It’s called the “captive” model of outsourcing and has yielded impressive results for some businesses who, for various reasons, are keen to play a hands-on role in managing the work they pay to have done offshore.
They may have set up a software development house, business process outsourcing division, or call center, realizing labor cost savings enjoyed in various offshore locations while managing people precisely the way they want to. This, hopefully, results in higher-quality products or services that fit their customers’ needs.
BPO: The Mainstay of Captive Outsourcing
For years, captive outsourcing was the domain of big corporations like GE, Sony, JP Morgan, Target, and British Airways. They set up their captive divisions in India and elsewhere, sometimes employing thousands of employees at large campuses and even competing for talent with
established local outsourcing companies.
Initially, these captive organizations focused on large-scale business process outsourcing (BPO). But as the model has matured, higher-value operations like research and development, advanced manufacturing, specialized software development, and even marketing have been given captive treatment.
At Accelerance, we’ve studied the captive outsourcing market closely and even worked with companies deploying the model.
The Approach Has Three Key Benefits:
- Protection of intellectual property: Many technology companies have captive operations overseas to tap engineering skills in another part of the world and closely control the intellectual property they use and create offshore. The threat of data breaches, industrial espionage, and IP theft is reduced when you work with your people, operate within the perimeter of your network, and follow your policies and practices to the letter.
- Ultimate control: Many businesses are known for having exacting standards and a particular way of doing things. In a captive situation, you can apply the company’s ethos and operational template to an offshore operation, ensuring uniformity across borders.
- Long-term cost savings: While the initial setup costs with captive arrangements are high, over time, with effective management, captive centers can generate savings, especially at scale. You can become a significant employer in a region, attracting support through tax incentives, cheap real estate, and grants or investments from governments. For Fortune 500 companies with ongoing requirements for service delivery, captive outsourcing has the potential to be a cost-effective option.
However, there are also notable disadvantages to captive outsourcing:
- High initial investment: Setting up a captive center requires significant upfront investment in infrastructure, hiring, and training. By having people on the payroll in another country, you need to own all of the issues you probably pursued outsourcing in the first place to avoid. In an uncertain economic climate and geopolitical tensions, the captive approach increases the risk of changing circumstances or localized events, destabilizing your captive operation.
- Operational complexity: Managing an offshore campus adds complexity to the business, requiring attention to local regulations, real estate, and administrative functions. While you may achieve cost savings due to lower labor costs, the overhead in running an offshore campus can be significant. While your captive outsourcing team is fellow employees, you still face many of the issues that come with outsourcing, such as language and communication challenges and cultural and time zone differences.
- Inflexibility: Scaling operations up or down in response to business needs can be challenging and costly with captive outsourcing. It’s hard to be nimble when running recruitment and HR functions in an offshore market. It may also limit your ability to source the needed expertise and technical skill sets, as often this resides in smaller companies that would instead contract their services rather than be co-opted into captive outsourcing arrangements.
The Alternative: Third-Party Outsourcing
In contrast, third-party outsourcing, which Accelerance specializes in facilitating, is when a third-party service provider is assigned responsibility for the outsourced operations in close partnership with the customer.
This is primarily done to reduce the cost and improve the overall efficiency of the whole organization. Suppose a company outsources its processes to a third party, depending on the industry, location, level of complexity, and various other dynamics. In that case, they can save up to 30 - 70% of their current costs.
There are three key benefits of outsourcing work to trusted partners:
- Flexibility: Companies can quickly scale services up or down, adapting quickly to changing market conditions. You don’t have permanent employees to cater to, so you are removing HR administration and can match labor requirements to the ebbs and flows of your business cycle.
- Access to expertise: Partners often bring specialized knowledge and experience, which can be leveraged to improve service quality and innovation. However, this can be harder to obtain when recruiting talent for your captive operation. By leveraging multi-partner relationships, you can obtain the exact capabilities and skills you need without hiring teams of people at great expense and wasting valuable time on the recruitment process.
- Risk mitigation: Distributing work across multiple vendors can reduce the risk of service disruption and dependency on a single provider. It also mitigates the impact of economic shocks, where a captive operation may have to lay off staff in significant numbers and incur restructuring costs. With third-party partner arrangements, the risk of having to deal with a significant mismatch between demand and supply is greatly reduced.
Third-party outsourcing also has potential drawbacks:
- Quality control: Ensuring consistent service quality across different providers can be challenging, and dysfunctional relationships between customers and their outsourcing partners can quickly lead to project timelines slipping and budgets blowing out.
- Coordination effort: Managing multiple relationships and ensuring seamless integration of services requires significant coordination. Effective communication and collaboration is critical. Shared goals need to be agreed upon, with processes to help achieve them. Coordination can be challenging with teams separated by time zones and vast distances.
- Potential for higher costs: While operational costs may be lower with third-party outsourcing, managing multiple partners can lead to higher administrative costs. If a successful working relationship between a customer and its outsourcing partner is not established, the financial and opportunity costs of not having new products or services in the market can be substantial.
Why Working With Trusted Outsourcing Partners is Usually Better
For most companies, especially in the dynamic IT sector, sourcing services from various partners is often the better option. This approach provides greater flexibility, allowing companies to respond swiftly to technological advancements and market demand. It is particularly effective for mid-sized organizations.
It also lowers the risk associated with captive centers, such as the high initial investment and the challenge of scaling operations. Working with experienced partners also frees a company to focus on its core competencies, driving innovation and growth.
The expertise supplied by specialized partners working on a contractual basis can improve service delivery and customer satisfaction.
Given the rapid pace of technological change and market conditions, quickly adjusting and leveraging specialized skills is invaluable, tipping the scales in favor of sourcing from trusted third-party outsourcing partners.
Accelerance has over 20 years of experience matching customers from a wide range of industries with software development partners around the world. We’ve vetted thousands of software firms, settling on the top 1% of them to pair up with customers. It’s a tried-and-tested model that, when effectively managed, pays dividends for companies.
Contact our advisors to learn more about how outsourcing software development to high-quality partners in low-cost outsourcing destinations can help you achieve your business goals.
