Outsourcing vs. Captive Operations – Which Model is the Best Fit For Your Business?

While feasibility of using offshore/nearshore resources for the delivery of certain activities or business processes has been already established, long term strategic feasibility and appropriateness of various engagement models are still under scrutiny.

The most common approaches nowadays are either working with a third-party outsourcing provider or establishing captive operations in lower cost locations. Engagement models can be differentiated based upon customer organization’s need for management control, costs of operation, risks and other factors.

Third-party Outsourcing

Third-party outsourcing is classic client-vendor relationship governed by contractual obligations and service level agreements. It is mostly driven by tactical reasons such as short-term cost savings and staffing flexibility. Non-core or non-critical activities are typical candidates for outsourcing.

Traditional third-party outsourcing comes in two main forms:

• Project-based outsourcing is considered to be the most appropriate for development of software with well-defined requirements and deliverables. It is suitable for irregular but on-going or one-off projects. On-site presence may be required to facilitate estimating, specification and relationship management. Typical pricing models are Time and Materials (T&M) and Fixed Price.
• Dedicated development center model caters for software with changing requirements, maintenance and support of large systems, research and development, testing as well as other types of complex ongoing medium- or long-term tasks. In this type of engagement vendor provides necessary facilities and allocates a team that works only on account’s projects and is managed by customer representative. This option is usually preferred when resource requirements are low. The customer is charged fixed monthly fee per full-time employee (FTE).

Captive Operations

When considering how to organize the remote delivery of software development services, captive subsidiary option often does not receive full consideration in comparison to outsourcing. While it is generally accepted to outsource certain non-crucial activities, in certain cases this approach is inappropriate for core functions and critical activities. Decision to take work offshore/nearshore doesn’t necessarily mean that you have to outsource it. Use of remote resources for the delivery of functions close to core business while retaining operational control and benefiting from real cost advantages can be achieved by means of setting up captive facility, thus keeping work within the company.

Captive model means that customer organization makes strategic decision to create its presence in the lower cost location and conduct work there as a part of its own operations. The activities are performed remotely, but they are not outsourced to the vendor. Thus the customer is able to retain full control and mitigate respective risks associated with intellectual property and other sensitive business information.

Organizations that want to establish captive centers have similar goals as those deploying traditional enterprise or shared services operations. In the first place captives are supposed to lower cost through labor arbitrage. But recent research shows that buyers are seeking not only cheaper but skilled labor at offshore/nearshore locations. They want to obtain competitive advantage and gains from process improvements. In order to avoid risks of underutilizing captive capacities, organizations must thoroughly assess their long-term operational requirements and predict service needs that may arise in the future.

The most common approaches to setting up captive operations are the following:

• Creating captive center from scratch (do-it-yourself captive) can be successful when customer organization has necessary resources, local expertise and market knowledge. Decision to set up own captive center may evolve organically through growth. Organization can either perform extensive due diligence on its own or buy existing company with operations in the chosen location.
• Build-Operate-Transfer (BOT) approach means partnering with third-party vendor to establish and stabilize center. Vendor is responsible for initial setup, staffing and operations of the captive center during the predefined period of time. At the end of the contract period the ownership is transferred to the customer. Thus organization takes over the turnkey captive center tailored to its specific needs. BOT option best suits organizations that do not have local expertise or extensive resources available. In this type of engagement only logistics associated with setup of the captive center is outsourced. Build-Operate-Transfer optimally combines control element of the pure captive model with flexibility of outsourcing. Essentially it provides maximum control at minimal risk.

Main benefits of having own captive center:

• Ongoing realization of real cost savings
• Full operational control and monitoring
• Full ownership after the transfer
• Minimization of intellectual property and data security risks
• Retained knowledge of industry, specific business processes and techniques
• Improved communications by continual reinforcement and experience
• Easy replication of parent organization’s processes
• Captive center can be commercialized at some point in the future

Both outsourcing and captive operations have similar driving forces (cost reductions and competitive pressures in the first place) and particular advantages, but main factors for choosing one or another vary.

Both approaches will deliver benefits in terms of improved focus, optimization of processes, reduction of operational costs, faster time-to-market etc. But companies must thoroughly evaluate each option to identify one that represents the best fit for their specific requirements, business culture and strategic goals.

The approach selected will depend on whether the primary driver is short-term cost savings or whether the company has long-term vision for offshoring/nearshoring and wishes to retain control over processes and intellectual property.

Establishing nearshore captive center in Ukraine through BOT model

If software development is a core competency of your company and you have long term specialized resource requirements, it makes sense to build your own capability in order to support the full software life-cycle, secure intellectual property and build up specific know-how. Nowadays this process is not as difficult as it used to be. The key to success is finding a trusted partner that already operates in the environment of country. By doing this you will benefit from:

• Clearly defined setup methodology and timeline
• Planned step-by-step implementation
• Responsibility for all logistics associated with establishing a captive center
• Practical knowledge of establishing IT business and dealing with related legal and contractual issues
• Deep comprehension of cost and effort components associated with setting up and running a software development center in offshore/nearshore country
• Hands-on experience in software engineering, generally recognized methodologies, processes and quality assurance that can be adapted to captive center
• Established HR practices, experience in recruiting qualified IT staff
• Attention to addressing security and business continuity issues
• Consulting and support throughout the setup process
• High level of business commitment and responsiveness
• Flexible client-specific approach