The Evolution of Captive and Outsourced delivery models for business processes: what is the right option for your company?

Graham-Russell We are privileged to showcase the following incisive article from my good long-time friend Graham Russell, who leads Global Transaction Processing for pharma giant AstraZeneca

Graham has been a long-established and respected authority on shared services and outsourcing for many years, and is one of a rare breed of executives who has had many years of experience managing both models.  I can’t think of many other people in the industry more qualified than Graham to discuss the merits and shortcomings of both captive and outsourced delivery models.  Over to you Graham:   

Birth of captives

Once upon a time, global and pan regional companies operated as a collection of single country businesses. Their back-office financial support was organized in the same way, with processes and systems being developed at a local level in each country.  

In the nineteen-eighties, new global companies such as Microsoft entered the scene and were able to quickly organize their businesses and their back-office support services in a different manner since they were able to start with a clean sheet of paper, making them appear very lean and nimble. By the late eighties, the more progressive companies, which were now often being challenged to compete with new market entrants, began to realize that they had been diluting the effectiveness of their Information Technology spend and perhaps more importantly, had become unable to respond consistently to their new, more global customers who were frustrated by different billing systems, account collection approaches and settlement methodologies. Similarly, on the supply side, these companies realized that they were struggling to take advantage of their global spend with global suppliers due to their inability to easily consolidate the information on their spend patterns. Meanwhile, they often had resale inventories stranded in countries, with each country business being unable to view that held by other countries leading to overall inefficiency in the supply chain. In addition, it became apparent that country based financial organization structures, required like pyramids, typically with sub-optimal spans of management and insufficient specialization due to the variety of tasks being performed by the relatively small country based staffs.

The pioneers in this area set about creating accounting centers usually at a regional level, which eventually grew up to become full-fledged Shared Service Centers, now referred to as captives. These centers operating with one support structure, quickly learned the value of standardizing processes, which offered one face to the internal and external customer. In time with the advancement of technology and introduction of networks, the islands of information quickly became the information readily available in one regional server, further enhancing the value to the business. The organization structures at these new centers, flattened out the structures of old, allowing specialization in the various functions and an improved management span due to the critical mass created. Over time, these centers began to move to locations often with lower cost and usually a pool of multi-lingual talent allowing them to serve broader geographies, for example Singapore, Poland, Ireland and Canada. With experience and maturity, it became clear that internal control was also being strengthened as a consequence of the one way of working, and after the passage of some time, the most forward thinking companies started to move their regional centers to global centers to further enjoy the benefits.

Birth of outsourcing

In the seventies, many companies realized that there was value in outsourcing functions, which were not core to their business and payroll, was usually the first of these functions to be performed outside of the business. Companies such as EDS applied the outsourcing approach to Information Technology support and so the models began to form.

In the early nineties, British Petroleum (BP) often labeled as the godfather of business process outsourcing (BPO), entered into an arrangement with the then Andersen Consulting (now Accenture) to outsource many of its back office financial functions from its quickly developing North Sea Operations Center in Aberdeen Scotland. BPO as we know it today, was born!

Outsourcing offered many if not all of the benefits identified under the captive models described above, but introduced the new notion of service performance levels being defined with the external provider.  Moreover, the service provider would often have greater experience hiring and retaining local talent, the ability to offer round the clock support with its global delivery infrastructure, and could also take on the risks associated with running remote service centers, for example currency fluctuations, wage inflation and local political, legal and tax issues.  Over the last decade, the outsourcing providers have expanded their BPO offerings, with finance as the “hub” function, offering HR, inbound customer support and industry-specific processes, such as insurance claims processing or clinical data management, in addition to finance support.  The leading providers are also offering “hybrid” solutions that include the management of the software applications underpinning the business processes being outsourced, where they can help deliver the synergies of having IT and business processes tightly aligned in an outsourced model.

Many of the earlier BPO pioneers, such as BP, Unilever and Proctor and Gamble, saw outsourcing as an opportunity to out-task non-core back office processes, such as payroll, accounts receivable, accounts payable and reconciliations and re-focus their inhouse staff on managing service levels, higher-value controllership activities and other functions that had greater alignment with their core business.  However, as several of the earlier BPO pioneers ventured into outsourcing relationships, they also found several challenges with the model, namely getting constant ongoing value, cost-reduction and innovation from their service provider, which would often provide a reactive service based solely on the contractually-agreed terms.  BPO adopters quickly had to learn how to manage their outsourcing providers effectively, and acquire the  right skills and experience to do so.

Over time as the outsourcing providers matured, and technology advanced, they were able to take their new-found critical mass into markets like India which had only previously been tested in a significant way by companies such as General Electric (GE) who were providing in-house support for some of their companies in their conglomerate business.

Markets like India and the Philippines offered significant cost advantages over the typical European locations like Dublin and Amsterdam which flourished in the early captive days.   In time, GE became an outsourcing provider through the creation of its GECIS subsidiary (now Genpact), and there were new entrants to the market such as Hewlett Packard, ACS, Cap Gemini, IBM and more recently a number of  more newly-established providers that have rapidly grown with outsourcing boom over the last decade, namely Indian owned companies operating the services from India, such as Infosys, Wipro and Tata Consultancy Services.  We are even seeing a further wave of offshore outsourcing providers making attempts to enter the global BPO market, for example Satyam, Cognizant and Patni.

Operating Models

These models have grown up in parallel and can be the answer to many companies looking to improve their effectiveness, reduce their costs and improve internal control. Over time the functions being handled by these models have also moved up the value chain from simple accounting or transaction processing to most back and front office support functions.

For those companies not quite sure about outsourcing, hybrid or “virtual captive” models have been developed by the outsourcing providers allowing for a middle ground which selects from some of the benefits from either model.

It is not unusual for companies to start out with a captive model, and over time move to an outsourcing model. Other companies which started their transformation journey late, often skip the first step and go straight to outsourcing.  However, those companies which have had significant experience with developing a captive model have clearly found the transition to a fully-outsourced model less complex and arduous, as they typically have some degree of standardization of their processes and technology already established.  In many cases, moving from a captive model to a fully-outsourced scenario has proven to be a straightforward advancement in optimizing efficiencies, as outsourcing offers the  logical next step for companies with captives to strip out further costs and find further efficiencies.

The key drivers to selection of the appropriate model include the following:

• Availability of talent

o Company size – is the company large enough to attract, retain and develop the best work force in a given location?

o University access – does the company have access to the best universities to attract the new graduate population in a given location?

o Retention programs – can the company offer sufficient career opportunities either in the Shared Service center environment or in the business in the given location? The outsourcing providers have in cases 10,000 seats and more and multiple clients, which almost guarantees an exciting career path for the successful young graduate.

• Given their size, the outsourcing provider usually had the advantage here in the most popular offshore or nearshore markets such as India and Eastern Europe, but the captive can usually hold its own in the onshore markets.

• Business Control

o Flexibility – many companies require a degree of flexibility, which may not be available in a strict outsourcing scenario, and so propensity for control and flexibility becomes a key selection factor.

o Process documentation – although Sarbanes Oxley has helped improve this for everybody, again the outsourcing provider tends to be more rigid in process and control documentation for no reason other than it is the basis for training the outsourcing provider employee on how to support the client

• Degree of flexibility required will be the key determinant in this area.

• Continuous improvement capability

o Lean/Six Sigma skills – this has become a core competency for outsourcing providers and been necessary to drive the productivity improvement s and consequent cost reductions which are designed into outsourcing contracts.

o Organizational culture around improvement – while many companies have a like appetite for continuous improvement, it is not the norm for all companies.

o Best practices across client base – the outsourcing provider has the advantage of being able to draw upon the best practices from multiple clients.

• The outsourcing provider usually has the advantage here.

• Technology and infrastructure investments

o This is an ongoing requirement for the outsourcing provider in order to drive its productivity. Technologies such as scanning, OCR etc over a greater population are easier to justify and never suffer from the inevitable capital expenditure squeeze. The majority of today’s top-tier outsourcing providers now offer technology workflow tools that can help integrate financial data actoss disparate systems and grographies and provider dashboards for inhouse financial management to gain quicker access to data.

o Contingency planning and back up-many companies even with Shared Service Models do not invest filly in this area, while for the outsourcing provider, it is an imperative otherwise reputations can suffer and costly contract penalties ca trip in.

• Advantage outsourcing provider.

• Deciding whether finance back office is core

o The finance back office is the business of the outsourcing provider and since it represents its product or service, it has to be good or better to stay competitive.

o If the company decides that it does not want its employees, customers or suppliers dealing with a third party for back office support, then it will have deemed these functions as reasonably core and will most likely find the captive model more appropriate.

• Decision here depends on consideration of what is core.

• Service level-internal v external

o Capability to measure-as outsource contracts often have gain sharing or risk/reward clauses which represent compensation for the outsourcing provider, there is usually a robust set of service levels clearly defined and measured. While many companies are good at doing this internally it is still a luxury for many.

o Reporting forums/mechanisms-in order to share the results of performance measurement, the outsourcing providers tend to have portals and formal monthly meetings to review the findings. This may not be the case at every captive

o Performance penalties/incentives-these usually help influence the right behaviors with the outsourcing provider, and may provide a stick or carrot not always available under the captive model.

o Benchmarking-although not offered or used by all outsourcing providers, the existence of such a clause in an outsourcing contract should allow the client company to stay abreast of market developments and take advantage of new practices such as pricing models or latest cost structures in a given location. This may be much less formal or appropriate in a captive model.

• Advantage outsourcing provider 

Conclusions

While I am not a spokesperson for outsourcing, I do believe that with the foregoing selection drivers, outsourcing offers a distinct advantage for many companies today seeking to take full advantage of lower-cost resources and the process acumen being offered by many of today’s maturing outsourcing providers. However, the  captive model is still a preferential delivery model for a company deciding that the support function is core to the business, or whether it prefers the support function remain in the same onshore geography, or it does not have an appropriate plan for potentially displaced employees.  Each of these factors will need to be considered by the company, along with the cost models and goals for productivity and efficiency improvement, internal control improvement and the service culture.

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4 Comments

  1. Stephen Cohen
    Posted June 28, 2008 at 10:32 am | Permalink

    Thanks for featuring this article. Graham Russell hits the nail on the head with this issue. I am surprised that many companies persist with investing in their captives these days, despite the fact they are struggling to manage them with the cost-effectiveness of most service providers.

    Most firms are struggling to retain good managers and junior staff within their captives, especially most service providers offering more attractive career opportunities. Many of the arguments that support maintaining captives for reasons of flexibility and security, simply do not hold up these days when you look at the willingness and flexibility of many service providers to provide a “captive experience” without many of the headaches of doing it yourself.

    Stephen.

  2. Posted June 30, 2008 at 5:09 pm | Permalink

    Nice summary of history and key criteria!

    One other key driver of outsourcing vs. captive is flexibility of a different kind than discussed here: the ability to quickly ramp up/ramp down. It typically takes an outsourcing vendor 3 – 6 months to get a team fully staffed and functioning smoothly. Starting a captive center and getting to the same level of productivity can easily take 12 – 24 months. It may also be very difficult to shut down a captive, since many countries regulate both new business licensing and business closures.

  3. Posted July 3, 2008 at 9:15 am | Permalink

    Graham, nice comparison of the 2 models! Here’s my stance on it.

    Based on how things have changed and are continuously changing in this arena more and more companies will require the best of both the models.

    Captives have some definite advantages such as control, speed of change management and less inter-organizational SLA barriers to cross. However the downsides are the lack of entrepreneurial ownership, innovation and MUST-WIN attitude in the remote company.

    In case of an outsourcing provider, with the company ownership residing fully or majorly with the person running the show remotely, you get the MUST-WIN attitude which can offset the impedance caused by cultural conflicts and localized issues – this is where the outsourcing model looks much better.

    There are many advantages/disadvantages of each of the 2 models, but I’ll highlight just a few key ones for the sake of comparison:

    Captive Advantages
    1. Stronger Control
    2. Faster change management since it has no impact on SLAs and commercials
    3. One-sided agenda driving the operation

    Captive Disadvantages
    1. Less Motivation/Incentive for the person running the captive operation
    2. Less Innovation due to lack of Entreprenuerial Attitude
    3. Higher Attrition – Person heading the captive center at the end of the day is an employee (who can easily switch) as a result causing lower sense of ownership and higher attrition throughout the operation.

    Outsourcing Provider Advantages
    1. High Incentive to go out-of-the-way to make things Happen
    2. High Innovation and Service Improvement (with atleast no direct/upfront cost to the customer)
    3. Less Attrition

    Outsourcing Provider Disadvantages
    1. Less Control and more barriers to cross for change management (SLA revisions and commercial negotiations)
    2. Two-sided (possibly conflicting) agendas driving the services and operations (Outsourcing provider may have an agenda in conflict with that of the customer e.g. more hours being put in on a task/process would mean more money earned by the outsourcing provider BUT less productivity and higher cost for the customer)

    However, as I mentioned earlier, competition and other disruptive pressures will drive customers to ask for best from the both the worlds!

    What’s the Solution? Agile Outsourcing!
    —————————————
    In my opinion the business models around this arena are poised to change fast as we move in to the next decade. We’re more and more in need for hybrid business models which take out best from both the ‘Captive’ and current ‘Outsourcing’ models. We term this new breed of business models as ‘Agile Outsourcing’

    A key component to enable ‘Agile Outsourcing’ is a team-structure which we call ‘Power Teams’ (for the sake of understanding you can call them ‘captive teams’ but we don’t like using the word ‘captive’ as it gives a connotation of reactive, restrictive and enslaved resources ,which in turn can limit innovation and energy required for success).

    So an agile outsourcing model is where the customer works with the outsourcing provider on dedicated resource models outlining a very basic high-level SLA which is subject to change without change in the cost-structure or cash-flows. Wherever the changes do not impact the cost-structures, why fight on agreeing the SLA and commercials. The trust, partnership and long-term commitment to each other’s business success is what fuels and drives such a model.

    Best of both the worlds!
    This gets closest of getting the benefits of both the worlds. With a dedicated team and a reasonable contract duration, 1 year plus you can negotiate a good monthly rate per resource. This relieves you from worrying about the over-head costs and local administrative issues of the outsourcing provider… and at the same time have stronger control and flexibility in how you would like to use the resources on multiple projects or processes.

    Allows for Agile and Change-friendly Delivery Models
    Further, it allows you to utilize the more dynamic delivery models such as Agile to smooth out the frictions which are caused due to change management during the delivery. Outsourcing provider likes this model even at a lower price per resource, as it provides them firmer cash-flow projections… which in turn keeps them motivated to provide more flexibility to the customer.

    Win-Win for Both!
    It’s almost always a win-win for the outsourcing provider and the customer… Ephlux has experienced working in almost all the 3 models (Fixed Price, Dedicated Resources, T&M)… and we’ve found this Agile Outsourcing model to be the best in terms of a good win-win balance between both the parties.

    Finally, such Agile Outsourcing models in turn enable the much-sought after IT/BPO bundled service models which further add to the competitiveness and agility of the customer.

  4. Posted August 7, 2008 at 1:49 pm | Permalink

    Nice to see these comments.

    I am advocate of captive centers. The problems/negatives highligted for captives arise mainly due to
    1. Failing to elect a good leadership. Most parent organisations keep searching for domain skills, team size handled,similar past backgrounds etc.I know when you keep leadership and management skills on top of domain skills, when you look for maturity and sincerity, a jeal to take challanges – you elect a leader.

    2. Poor offshore-onsite management by leaders.

    3. Failure to recognise that relationship management is as important in a Captive as it is in a Outsourced model.

    For those who still feel captives are not good enough or they are looking to test the water or looking for a smal team size, a hybrid model of Managed Offshore model is a good choice, where you can leave all the worries except getting the services quality sucessfully to a providers.

    There are providers like us who are capaable and willing to provide specialised service to establish a Captive and also provide a Managed Offshore setup. One can visit us at http://www.excelict.com

    Sudhir

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