Captive/Dedicated Offshore Development Centers - are they really worth the effort?

I have been associated with the offshore space most of my career. I worked initially on the vendor side in delivery, account management and managing P&L for a region. I then moved into a US delivery organization initially to set up a global sourcing strategy and later on in to managing IT delivery using a mix of employee and third party.

I get a lot of questions on challenges faced by captives, JV's and dedicated development centers and thought this would be a good topic for this blog. This is based on my professional experience and research as well as interaction with colleagues in the industry. I have broken the topic into sections which I believe are core issues.

To keep things simple, when I refer to captives, I am generalizing the discussion of captives, dedicated (and owned) offshore development centers and joint ventures as they perform the same function, operate in the same way and have similar benefits and challenges. I have chosen to compare captives against the top players in the offshore industry. Captives are established by mid to large corporations and the alternative to setting up a captive is to work with a TCS, Cognizant, Infosys type organizations. In fact, as I explain below, captives often have to coexist and compete with these vendors.

Attracting Top Talent - The education system in India generates hundreds of thousands of engineers every year but the general feeling is that this is a case of quantity over quality. One only has to look at the schools the top industry players recruit at (by way of onsite campus events) and it is clear of where these companies believe they can find their top talents. Just to be clear - I am not talking about IIT's and IIM's but engineering schools. And companies like TCS, Cognizant, Infosys and Wipro hire anywhere between 10,000 to 50,000 fresh engineers every year so you bet they have perfected the process to make it efficient and worth their while. I do not mean to degrade or imply that the schools that are not able to attract these companies for campus recruitment are in some way inferior. But if companies want to find top talent - and in large numbers, they are likely to have better luck at some schools than others. There is intense competition to hire the top talent at each of these top rated schools between the big players itself, so it is reasonable to assume that a small company with a no name recognition would have a tough time competing with the biggies in attracting top talent from the top schools. You can still find good talent all over the country but it will take a lot more investment in time and money.

Training - You have to train new employees on process, methodology, standards, domain knowledge as well as update technology skills. Large organizations have dedicated infrastructure (e.g. Infosys's Mysore and TCS's Trivandrum facilities) that are in use pretty much all the time which makes the process efficient as well as cost effective. Smaller organizations cannot maintain dedicated infrastructure and have to pull out resources from other areas for training which impacts normal business.

Growth potential and Retention - Typical captives centers are built for a certain capacity and might take a few years to reach full capacity. However, it is extremely rare, in my experience that these centers continue to grow year after year after reaching steady state and this implies limited growth opportunities for the employees. (Almost) Every single software employee working in India is driven, ambitious, career oriented and looking to be a Project Manager in 4-5 years. This kind of career growth is simply not possible in a steady state captive which results in attrition. Employees who have reached their full productivity levels after 2-4 years are easy picking for competing organizations. This is frustrating for the management sitting in the western world - "It has taken us three years to get these employee to understand the domain - how can they just walk out like that"? Sooner or later this ends up increased compensation and other perks which don't really solve the problem but do alleviate the symptoms.

Costs - Captives, more often than not, follow the parent organizations policies. This would include swanky offices, business class travel, generous entertainment allowance, corporate events and more. I was surprised the first time I heard about a small captives team lunch at a 5 star restaurant but then realized this was the norm. However the biggest cost for the industry has always been labor and this is where the difference is remarkable particularly at senior levels where compensation levels are 2-4 times as much as what the top executives at the top players would make. The situation is even more extreme when organization depute executives from the west to manage these captives and provide top class accommodation and other benefits. The end result is that the per hour development cost of these captives turn out to be equal, if not higher, even though captives do not have sales and marketing costs!

Flexible workforce - It is difficult, if not impossible, for a captive to respond to short term requirements. If a project requires say 50 resources with a new skillset for building a new application, a captive cannot find their resources overnight and, more importantly, cannot release these resources after the project is completed. A larger organization can do this effectively. This limits the effectiveness of a captive to steady state efforts which generally turn out to maintenance and support work or where the long term technology strategy is very clear.

Captives v/s vendor competition - In most organization you will find situations where the captives are asked to compete with 3rd party vendors and this a great way to get a comparison and keep the captives in the game. However captives are cost centers and struggle to provide innovative pricing and upfront investment in emerging technologies not knowing if the projects will come through or not. More often than not, vendors invest a lot in onsite relationship building. As a result middle management decision makers on individual projects prefer to use vendors because of the relationships and track record. The use of captives, in spite of all good intention on part of the corporate organization, is seen as a forced directive and often considered a necessary evil.

Conclusion - Captives make sense when set up to protect IP, trade secrets or propriety knowledge. However the driving factor for the vast majority seems to reduce costs presumably driven by the high gross margins of the top players. The top players have economy of scale and control costs very closely. Although it is possible to replicate this model, it is certainly not easy. Organizations need to evaluate very carefully if these challenges can be overcome - and more importantly, if the effort involved in overcoming these challenges is really worth it.