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The Release of the Captive


The Release of the Captive

Captives, or Global In-house Centres, contributed about $20 billion of India’s total of $146 billion in software and services exports

A recent study commissioned by Nasscom, an industry lobby group, on “captives” (now more elegantly referred to as GICs or Global In-house Centres) revealed that there are over a thousand of them in India, and that in the financial year ended March 2015, these captives contributed about $20 billion out of India’s total of $146 billion in software and services exports.

The study went on to say that the growth of captives continues apace—with 220 captives having been added in the five years before Nasscom published its report.

The original business rationale given for these GICs was that they could take advantage of India’s gigantic pool of skilled labour to focus on tasks that were central to the operations of the mother company, while still allowing the mother company to outsource less critical tasks to the true exporters of software and services—the IT (information technology) and BPO (business process outsourcing) services providers.

However, the truth was always that these centres found themselves to be the recipients of many non-core services as well, simply because India’s labour arbitrage advantage was too great to be ignored, and once the mother company had a large enough, sustainable operation in India, it was easier to shift the work to their own company-owned centres than to enter into protracted negotiations with service providers in order to outsource the work.

And the fixed costs, such as real estate associated with operations, typically go down as more employees are added to a GIC. In simple words, as the denominator of a fraction goes up, its size reduces; this arithmetic holds for GICs just as it does for any other business. As a result, the type of services performed by GICs in general has veered more toward generic business processing or garden variety information technology than it has toward highly specialized information technology or strategic, leading-edge work that is core to the mother company. The latter has largely stayed on site in California, New York and London.

In my years as a sourcing consultant, I often encountered captives and captive management teams, and had many a discussion with both IT and BPO service providers as well as the captive “owner” firms back in the US and the UK about the viability and sustainability of these centres.

In the wake of the 2008 financial crisis, many financial services firms that maintained large GICs in India became enchanted with the idea of “monetizing” these centres.

Many large “monetizations” took place, where the mother company sold its India operations to an India-based services provider, in exchange for a long-term exclusive services contract with the provider. The rationale was that the specialized operations in the centre would allow for the services provider to build industry-specific solutions that it could then take to other clients in the same industry, thereby creating a large advantage for itself over its rivals, while the client company could be freed of what had essentially become a “stranded” asset.

One of the most notable of these deals in 2008 was the Aviva-WNS transaction, where Aviva Plc, a UK insurer, sold its India operations to WNS Global Services Pvt. Ltd, an Indian BPO firm, for $238 million in exchange for a multi-year services contract that had the potential to be worth over $1 billion in cumulative revenue to WNS. Apart from the fact that the 2008 financial crisis had taken a toll, the UK had suffered disastrous floods in June and July of 2007. As an insurer, Aviva had an immediate liability since it needed to make good on the insurance claims that ensued from the floods. The extra $238 million in cash came in handy.

The other rationale for selling GICs—apart from freeing up asset value through “monetization”—was that outsourced contracts are much easier to govern than intra-company arrangements. The existence of specific rates and fees, and service-level agreements (or SLAs) to ensure performance of a certain quality, along with penalties for an SLA lapse, allows for client companies to strictly manage the provisioning of services with commercial levers, rather than by using intra-company human resource performance management systems that are notoriously porous and can easily be gamed.

Nasscom’s study shows that the monetization window that opened up in 2008 did indeed shut, and that GICs have continued to grow since. The BPO services firms have been the worst hit by the continued growth in GICs—witness the consolidation taking place in the industry and the near deathly silence from its usually cacophonous leaders. In my mind, however, what we are witnessing is the coiling of a spring that is about to break free from its tension.

Large private equity (PE) firms, such as Blackstone Group Lp, have bought out firms like Mphasis Ltd and Serco Group Plc’s processing business. The PE community is on to something. The traditional rationale of “consolidation” (that is, the same arithmetic referenced earlier in this column) is only one piece of the puzzle. The other is the continued bloat in Western company-owned GICs in India. Watch out for another window opening up soon in the sale of these GICs to the newly well-funded “consolidated” PE-owned BPO services firms.

Siddharth Pai is a world-renowned technology consultant who has personally led over $20 billion in complex, first-of-a-kind outsourcing transactions.

Source: Livemint

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