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Why Captives Are More Expensive and Offer Less Access to Quality Labor

Why Captives Are More Expensive and Offer Less Access to Quality Labor

“More third party outsourcers in Central America, South America and Mexico are building facilities.. to compete with India and the Philippines”

By Tarun George

In a special Q&A, Pace Harmon partner David Rutchik explains why the Nearshore has traditionally seen greater numbers of shared service centers, and why the trend will soon be changing to favor third parties.

What are the benefits of going with a third party outsourcer?

 Rutchik – I’d talk about that in terms of the counterargument to captive centers. With a captive, you’re greatly reducing your flexibility by taking on facility obligations, hiring obligations and labor liabilities. That’s because of the fixed overhead costs of course, but also because of the difficulty in shedding resources. If you hire a worker one day, you can’t simply fire him the next day, especially in Latin America. It’s difficult to scale up and down labor if you’re doing it by yourself.

D.Rutchik 221x3001 Why Captives Are More Expensive and Offer Less Access to Quality Labor

Rutchik: “In a general sense if your business is not big enough, a captive strategy doesn’t make sense.”

In terms of cost, even though you avoid the margin that goes to the third party, captive centers are comparatively more expensive. It’s also not easy to attract quality talent in the first place, since workers always see more of a career path with third party providers. If you start with a company like TCS, Infosys or Genpact, you’ve got a career opportunity that’s beyond the captive environment.

 So why do companies still set up captives if they’re more expensive? What are the advantages?

 Rutchik: As I said before, one advantage of a captive center is you don’t have the margin that a third party provider adds to the cost. But more than that, you can also absorb increased workloads either without paying anything more, or certainly without paying the cost you would to a third party. Whether your payment structure is transaction based or time based, with a provider you’re fundamentally paying more for greater usage. Using an internal shared service center however, you can absorb many of the spikes in activity.

Another advantage of a captive is greater control. From a resource perspective, you can determine each individual that you hire, and from a security perspective, you can ensure that no other company is sharing your facilities or technology. If you plan on providing services or products in the country where your captive is located, you’ve already created a legal entity in that country which is now a great base from which to build further capabilities. So certainly captives make sense for many firms.

Which strategy have most US companies in Latin America been going with?

 Rutchik: We see a lot more shared service centers in Latin America, but it’s important to note that many of them were put there not as an alternative to third party outsourcing. Costa Rica for example has many captives, to leverage the lower cost location, educated workforce, stable economy, good English, etc. But those captive centers were not a decision between outsourcing vs internal – they were really seen only as an internal decision, mainly because the third party option was not fully developed and available at that time.

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I think that is changing. We’re starting to see more third party outsourcers in Central America, South America and Mexico now building facilities and service capabilities in the region to compete with India and the Philippines. So the trend in Latin America may soon swing away from building more shared service centers.

(Editor’s note:  A similiar viewpoint from NelsonHall’s Andy Efstathiou is published here. )

 Is there a difference in terms of talent or labor quality between captives and third party providers?

Rutchik: Absolutely. The outsourcing providers have better access to more qualified workers, because they have experience in that local labor market. They essentially have a recruiting engine hiring thousands of people a year, so they’re more focused and experienced in that field. As I said earlier, they’re also better positioned to offer greater career opportunities, so the human resources that they attract on average are more talented and less expensive than those that captive centers attract.

Something that many buyers want to know – Is there a profile of company for which one or the other strategy is better?

Rutchik: In a general sense if your business is not big enough, a captive strategy doesn’t make sense. For a captive center, the profile would be a project of at least 150 seats, more product development based, and with a significant security or data protection concern. Also if you’re committed to remaining in the location for a longer period of time, or contemplating selling in that domestic market, a captive center is a great way to make your business quickly market-facing.

The growth rate of your firm is another differentiator – if your firm is growing dramatically, then a captive makes sense. If it’s not, or you’re not sure, then you should probably go with the flexibility of a third party provider.

If your company is not big enough, your project is not mission-critical or strategic in nature, the services you’re looking for are generic, and if you’re not willing to commit to the location for an extended period of time, you’re always better off with a third party.

 Read previous coverage of how companies should tackle the Buy vs Build decision here.

 

About Tarun George

2 comments

  1. Good article. Mr Rudchick his the nail in the head – captive centers are for organizations with a lot of scale. He suggests a threshold of 150 seats, my guess is that the thershold is much, much higher that that. If you see what has been happening in India and the Philippines, captive centers are being "sold" to service providers at a rapid pace, and only the largest of the largest are surviving. A god example in Mexico is HP in Guadalajara. HP has a very large (in the thousands) captive center for F&A that works well because it has massive scale. Of course we are talking about "commodity captives" – F&A, backoffice, etc. However – there is some subtelty here: scale applies to "commodity" functions. The other type of captive center that would make sense is something that is highly specialized, with a very high level of skills, with a very high degree of intellectual property. For example – Intel has a captive center in Guadalajara Mexico that specializes in computer chip testing.

  2. Captive centers require a lot of planning before execution. In a sense, this business model is not for everybody. If companies are looking for a quick buck, then the captive center is not for them. The captive center may save an international company lots of money. But it also takes a lot of work and maintenance to make this work.

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