As Americas-based outsourcing continues its strong emergence, more sourcing-minded U.S. firms are pulling out their checklists to figure out if it is smarter to send work to an existing provider or take an often more costly route by establishing their own captive center.
We checked in with David Kane, a Director in the Shared Services and Outsourcing Advisory Group at KPMG to help determine how companies can choose the right path. Kane delivered a presentation on this very topic at the Sourcing Interests Group (SIG) Forum in March. We asked him to expand on the points he discussed, as well as his own experiences of both the buy and build options.
Laying the groundwork: How Should Companies Approach the Decision?
When dealing with topics of this complexity, it’s important to establish clear definitions. The Shared Services and Outsourcing Network (SSON) describes captive centers, or the ‘build’ option as “centers set up by companies with upfront investment in an offshore geography. They maintain full control of governance and management, are usually going for lowest operational cost, and define their own quality standards”.
Alternatively the outsourcing provider, or ‘buy’ option, is defined as “contracting operations of a specific business function to a third party service provider, who will typically be responsible for process management, people, and in many cases the software used. There is often a degree of transferable risk to the provider”.
So how should you tackle the buy or build decision? For David Kane from KPMG it’s all about the client’s objectives. “Once we knew what the client’s goals were, we did the analysis in Latin America to understand the possibilities”, he says. “We looked at service providers (the buy option), then we looked at locations to set up (the build option) to see the varying levels of attractiveness in geographies in which we could operate. Finally we went back and researched how the costs compare on an investment perspective”. KPMG recently worked with Equifax to develop the right global offshore BPO model.
“Of course the unique consideration with Latin America is that vendors aren’t as mature as in India, but that is quickly changing” – David Kane, KPMG
Which Path is the Right Path?
In a general sense, most analysts agree that you should consider a third party provider when the function you’re outsourcing is standard, readily available, and supported. Leveraging the provider’s industry experience for a cheaper cost is important for ITO and BPO work. Look for a proven track record, performance and capability standards, and an operating history that gives you comfort.
On the other hand, consider the ‘build’ option when your organization’s core competencies are reflected in the product being developed. In other words if you have the best expertise to perform a specialized function, you shouldn’t be passing it to a third party. For software development in particular, new products must often be integrated with existing systems or quickly adapted to market trends – both of which are best handled by an internal team.
Third party vendors on the other hand bring experience across the board in operating in foreign environments. They have the necessary infrastructure in place so you’re not re-inventing the wheel
Pros and Cons
A captive strategy is generally favoured by companies that require direct management of a high-touch function. “All decision making is in-house”, says Rakesh Sangani, Partner at Proservartner, an advisory firm specializing in shared services and outsourcing, based in the UK. “You have tighter management control, you can retain talent within the organization, and it’s easier to transfer complex tasks”. The build option is all about that control, and being more involved in your project. And if you already have a presence in the country, you can always leverage that to lower costs.
However there are inherent problems with running your operation independently in a foreign environment. “It requires more manpower on your end to manage”, says Kane. “It increases your risk because you don’t have access to the capabilities that service providers have. They’ve done this many times before, while you would be doing this for the first time”. Things that would normally be handled by a provider – finding talent, training, legal permits, infrastructure – are all now your problem. Since captive strategies require significant resources upfront, they are often undertaken by large firms able to fund the investment and possibly miss out on first-year cost advantages because of that investment. If you’re a medium-sized company considering the build option, assess whether you have the capability, available personnel, and resources necessary. In other words, is it really efficient for you to develop your product internally, or would it be better outsourced?
Third party vendors on the other hand bring experience across the board in operating in foreign environments. They have the necessary infrastructure in place so you’re not re-inventing the wheel. While this takes care of the above issues, it does introduce a whole new set of them. Communication is usually a concern. Whether due to culture, low English proficiency, geographic distance or time zone, it negatively impacts the sourcing relationship. Quality assurance, attrition and intellectual property worries also come with the territory unless you’re lucky. Companies that expect to micro-manage their project will usually be disappointed.
What Will it Cost Me?
A common perception is that captive centers are more cost-effective because you’re not paying a hefty vendor margin, but this may not be true. “It often looks cheaper on paper just to hire your own staff, etc”, says Kane. “But if you look at many of the captives in India, they run on a higher cost. Experience has proven that you will typically find a higher operating cost with the build option”.
Over the long run however, it’s really about your determination to cut costs. “Whether it would be cheaper doing it yourself depends on the investment you make, your capability, and focus on delivering significant cost reductions”, says Sangani. Providers can be efficient in a rapid timeframe and deliver savings, but so can organizations that refine their internal processes.
We asked Kane directly which option he would recommend – buy or build. “While each case is different and requires an individual assessment of what works for the client, we frequently recommend going with providers, especially when the scale is relatively low”, he says. “Of course the unique consideration with Latin America is that vendors aren’t as mature as in India, but that is quickly changing”.
Of course very few outsourcing models are entirely one option or the other, and hybrid models are becoming popular. Companies regularly perform specialized value-added work in captive centers, while sourcing lower end functions to service providers. The new trend of ‘onshoring’ also adds a different dimension to the debate. By sourcing work to providers in the US itself, firms can cut costs while still being near enough to monitor their projects closely.
The choice of captive centers versus outsourcing is not an easy one, but has a significant impact on your business. As Rakesh Sangani puts it, “How should US companies approach the buy or build decision? Carefully”.