Are IT captives back in vogue and will they threaten Indian offshore dominance?

Captives go back a long time. Big businesses have been setting up operations to carry out business processes in low cost regions since the 1980s.

Like offshoring work to an overseas supplier it is a way to cut costs but unlike offshoring work to an oversea supplier it is a way of retaining ownership of everything.

Apparently after a slowdown in setting up captives during the recession there is growth again.  According to figures from Nasscom, quoted in the Economic Times, India, there were over 70 new Indian captives set up by multi-nationals in 2012 and 11 existing ones expanded.
Despite these figures describing the large number of captives being set up in India Professor ILan Oshri at Loughborough Business School believes it is Eastern Europe where most the activity is.

He says this is because of the hidden costs associated with Indian captives. These include extra costs caused by high staff attrition and travel expenses.

Mark Lewis an outsourcing lawyer at Berwin Leighton Painsner, says there is also a trend towards setting up captives onshore. US and UK companies are setting up centres in lower cost regions of their home territory. He says he is working with a large UK organization that is planning to set up a centre in the North of England near a university. This is to take advantage of lower skilled labour at a competitive cost.

He says this is because of regulations that are starting to look at captives and the risks associated with them. For example financial services regulators are looking closely at operational risk and captives might be seen as being risky.

The recent case of the UBS rogue trader is a good example. The rogue trades should have been spotted by a captive centre in Hyderabad, India. But a mistake by a worker meant the fraud which cost the bank £1.4bn went unnoticed.

An increase in captives is a threat to the big Indian IT services suppliers because it takes work away from them. You don’t need to hire an Indian supplier to take advantage of skills and competitive prices when you have you own set up. But the setting up of captives onshore or in Eastern Europe could threaten the entire Indian IT sector, not just the suppliers.

Eastern Europe is already seen as a good alternative to longer haul regions and there has been recent talk of US firms rural sourcing, which is the practice of having work done in low cost onshore places.

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I suspect that the lure of cheap labour in India is running its course. From my own experience in the I T support industry, I never had a satisfactory conclusion to any work I had done in India. It inevitably ran over budget, was late or a shoddy product. Frequently all three. If you can price the work such that a rework can be accomplished within the price, a cleaning up of the code and adequate testing, and still deliver on time, then it can work. But you must be ready for huge travel costs. staff turnover, especially if they travel to the UK or the some other western country where they quickly disappear, and little or no initiative. Their use is all about price, not quality or schedule. How many recent disasters have been traced back to shoddy Indian work?

Last summer's RBS/NatWest debacle cost RBS millions and was reportedly caused by an error by an inexperienced system maintenance worker in India, compounded by the failure of anybody else to spot and fix the error properly for several days, only a few months after RBS had outsourced most of its system maintenance work to India. The only reason this fell out of the news so quickly was that the emerging LIBOR scandal gave us an even bigger banking IT screw-up to talk about. Outsourcing is costing companies and the taxpayer millions - perhaps even billions - but it's impossible to reverse the trend now because (a) they've fired all the people who used to know how things work and (b) too many short-sighted but bonus-bloated senior managers would have egg on their faces if they did so.

Cost arbitrage has ceased to be the only component of value in the output of captives with rising cost and changing global dynamics. It is important to understand and evaluate all the parameters of the captives to ensure their success, as highlighted in this report.>