Captives Don’t Make Much Sense in the Era of Automation and Cloud

The interest in captives in Latin America seems to be increasing, but the investment and upkeep needed for captives rarely make sense given the advances in automation, cloud, and SaaS.

captives cloud

As the pace of technological change continues to accelerate, service providers are struggling to keep up — and the it is making many question the appeal of captives altogether. While Nearshore Americas has been hearing a great deal of chatter about increased interest in captives in the nearshore, not all are as optimistic, especially in when it comes to data center services and maintaining application services.

Steven Kirz, managing director of Pace Harmon, believes that “captives don’t make much sense in the context” of the dramatic technological changes shaping the industry.

Steven_Kirz906
“Because the power of automation can be so dramatic and the cost reductions and efficiencies from cloud can’t even be matched by traditionally large organizations, captives can’t compete,” – Steven Kirz of Pace Harmon

Kirz emphasized that the trends are dramatic. “We haven’t seen anything like it in our lifetime in terms of the speed and the amount of reduction in cost associated with technologies provided in these areas,” he said.

Data Centers and Application Maintenance Hardest Hit

Two primary areas have been particularly impacted. The first is data center services, where the cloud option has become has become acceptable to most industries now. It is not just small companies that are taking advantage of it, although, he believes it is ideal for small companies.

Kirz cited the example of General Electric and Netflix. “Netflix, which accounts for 37% of all internet traffic, is 100% in the cloud,” he said. “GE used to have 34 data centers worldwide and it now has four. It is not just a matter of cutting back on physical data centers. They have stated overtly that they will move all of their data centers into the cloud.”

The increased efficiency and reduced cost of the cloud, whether that is from storage or computing power, are the key drivers. And it just no longer makes sense for many to host their own centers when the major players have already established so much of the modern infrastructure. “Even traditional outsource providers, even large ones like HP, CapGemini or Tata, are finding it extremely hard to compete with new providers Amazon, Google, Microsoft,” said Kirz.

“The folks that have data centers in that traditional bucket are trying to sell those off because those assets are not going to return much on their investment,” he said. “They can’t compete with the new service providers. On the data center side, it is clear that captives are not a trend.”

Cloud is unlikely to go anywhere. In fact its use is growing exponentially. IDC’s FutureScape 2016 report predicts worrying implications for IT vendors, stating that, “by 2020, more than 30% of the IT vendors will not exist as we know them today.”

The other area of impact that has implications for captives is the application maintenance side, where we are seeing the same result but for slightly different reasons, driven largely by the advent of and comfort with software as a service (SaaS). Again this is unlikely to disappear any time soon. Forbes reported last year that it is likely that the global SaaS market will grow from $49 billion last year to $67 billion in 2018.

Automation Changes the Captives Game

Kirz cited IDC’s predictions that in the future $1 of every $5 spent will be spent on SaaS. “There is no maintenance associated with those solutions, so maintenance costs are going down,” he said.

But it is automation that is the real game-changer. “More importantly, more dramatically, is the power that automation and AI is bringing to ticket resolution – in terms of issues I have with my application, such as it being too slow or people being unable to access it so it generates a ticket with the service desk.”

Large companies have realized that they cannot survive doing it at a rate arbitrage person-to-person, so they need to take their understanding associated with ticket generation and automate it and use AI to predict and address issues before they show up. “They have all made a huge investment and are talking about their investment in this area,” he said.

Pace Harmon examines managed services deals over a period of 60 months, so it is able to look at what pricing will be every month and predict what a deal will cost in five years time. This, Kirz said, has significant implications for people who are competitively procuring application services today. Because what Pace Harmon is seeing is a cost reduction of 70% to 75% on the current cost. “The cost reduction is dramatic,” he said. “It is like nothing we have seen before because of these tools. Between 36 and 60 months from now you see a 75% reduction in cost.”

Sign up for our Nearshore Americas newsletter:

Significantly, captives are not investing in the latest automation tools that can compare with what the suppliers have developed. They are relying on outside providers to do that.

“Because the power of automation can be so dramatic and the cost reductions and efficiencies from cloud can’t even be matched by traditionally large organizations, captives can’t compete,” he said.

New Opportunities to Create a Niche

Kirz is cautious, though, emphasizing that he is not implying the impossibility of a captive doing this. He explained that if a company like Wells Fargo decided that it wanted to develop its own automation tools, the bank could take its free cash flow and invest in it.

“But in my opinion investing in automation for your own captive isn’t worth it,” said Kirz. “When you look at the business decision between reducing your costs by leveraging an outside suppliers’ solutions versus developing your own tools, developing something outside their own core competency does not make sense.”

Kirz added that, for the service providers, this type of investment is existential. To survive amid harsh competition, they have to do it. But it makes little business sense for a bank, airline, or manufacturer to invest upfront then continue to pay all the ongoing costs. “The manufacturer is focused on automation in manufacturing not automation in application maintenance,” he said.

Kirz is not predicting large-scale movement away from captives necessarily, and he still believes that there are many great reasons to have captives: intellectual property concerns or a higher degree of service to the rest of the organization or customers. But, he said, when it comes to captives that are specifically driving applications maintenance or captives that are providing data center services with lots of service center infrastructure, he expects to see a move to outsourcing solutions because there are only a handful of companies in the world that can compete.

What this means for service providers and captives, whether in Latin America or elsewhere in the world, is that people have to quickly generate the expertise required to support a different solution.

“On the data center side, the fact that Amazon or Google have these great cloud solutions doesn’t mean that the clients of them don’t need need help moving to cloud and efficiently managing cloud,” said Kirz. He explained that while traditional data centers are always on, cloud is like the lights in your house. When you are not using the computing system you have to turn it off — or it will become terribly expensive.

The opportunity is large to jump into the market specific to interfacing between the cloud suppliers and client because you no longer need the infrastructure in order to compete.

Kirz believes there is a niche in this area, where providers and captives can develop skills to help clients effectively manage these technologies and the benefit is that it does not involve much investment in infrastructure. “Now I just need smarts inside the brains of individuals who can help me manage that and help me develop the tools to manage that,” he said.

On application maintenance side, it is similar. “If you are a small supplier and want to continue to support application maintenance, you will have to find a way to leverage those tools. I am not convinced you can invest the money necessary to develop those tools,” said Kirz.

Again he believes that large providers might look to Latin America for delivering the services. “When they are automated, you need fewer people and as a result the labor portion is less important to the total cost. So it is easy to put your team in Costa Rica, Mexico, Brazil, or Argentina but also Philippines, South Africa or just about anywhere around the world. You can be leveraging Latin America strengths in various ways,” he said. “It doesn’t spell the end of anything, just a change.”

Tags

JOIN THE CONVERSATION

JOIN THE CONVERSATION