Approaches to setting up Engineering and IT captive centers

There are a number of key advantages for organizations to set up a captive or global in house center (GIC) for Engineering, IT or Shared Services. The key drivers of setting up a GIC have changed in the last 5 years. While the primary driver to set up global In house centers remains cost and access to talent, we do believe there is a greater focus on defining greater value creation in the long term from such facilities.  Organizations are hoping to create value from their center in the form of innovation for new products and services, process improvements and access to newer markets adjacent to the location where the facility is being set up.

In -sourcing as an option continues to retain some of the main advantages over outsourcing to a vendor in a remote location. Having an in house center allows for faster decision making on delivering core services from an offshore location. It is also the preferred option when there is a need for IP and business knowledge sensitivity.  In house centers still provide you with a major advantage when it comes to building and retaining specific domain knowledge for an industry. Captives also give organizations a local footprint to understand emerging markets and potentially drive innovation for the local markets.

Some of these reasons have been the key drivers that have resulted in over 2000 R&D Centers come up in India and China over the last decade. Though there was a significant drop off in the number of new centers being set up in India and China from 2011 -2013, 2014 has seen interest peak amongst global organizations to set up their own presence in emerging locations. The drop in new centers had less to do with any fundamental change in the core value proposition of having an in house center. The lull was more driven by overall downturn in business and a focus on getting the product market fit right in a rapidly evolving market landscape.

Over 20 new centers came up in India in 2014, and we expect this number to more than double in 2015. We have seen organizations consider four broad approaches to setting up their own presence in India/ China:

The first approach is to set up their direct captive center. This approach involves setting a legal entity in India with the team on the direct rolls of the company. In such an approach the entity is a wholly owned subsidiary of the parent. While this approach has many advantages, the approach also takes significant time. In our experience it can take anywhere between three months to six months to get a Greenfield center off the ground. A major concern with setting up a center on your own involves the capex investments that need to be made upfront. In addition to that there is a need for a clear charter for the center and the center needs to have a roadmap to have sufficient scale to be viable.

Another challenge with setting up a direct presence is that the organization will have to make significant investments in branding in order to hire the right kind of talent. This takes time and significant effort. Also, there is significant pressure on the center to deliver to expectations on day one, else they run the risk of having multiple internal teams second guess the decision to set up a direct presence in a remote location.

The second approach preferred by many organizations is to do a build operate transfer contract with a vendor. In this approach there isn’t much of a capex investment upfront for the organization driving a globalization program. This approach has the advantage of leveraging the service providers proven recruitment and training engine to get the center up and running. The BOT also comes with the advantage of proven delivery capabilities in the form of proven processes of the vendor.

A BOT is typically exercised after3-5 years with the organization having the flexibility of rebadging all or part of the staff at the vendor into their own premises. BOT is a very flexible model in that it allows an organization to delay a transfer decision in case there isn’t complete buy in for going in for an own center. However a major challenge with a BOT is that the organization might not be able to attract the right kind of talent that it wants, because it is dependent on the vendor’s brand and hiring engine.

Apart from these two most prominent approaches to setting up a captive presence, we have observed organizations adopt other approaches to set up a center with varying degrees of success. One of the common approaches taken is to look at acquisition of a small service provider in a remote location that has the right kind of skills. Alternatively, organizations may look at acquiring another organization’s captive that might be looking to consolidate its operations across multiple locations. Both these approaches come with their own pros and cons. Also these approaches require significant time and effort on due diligence to ensure that the acquisition being addresses the talent, skills and cultural compatibility requirements.

Recently, we have observed a phenomenon where organizations are looking at India and China purely from an innovation standpoint. Organizations have setup incubators or accelerators for start-ups . In this approach, the objective is to encourage start-ups to build solutions in areas of interest to the organization and support them through funding, mentorship and access to customers. This is a more recent approach and the value derived from such an approach is beyond cost. It is a good way to innovate, and access new markets. This approach is less of a captive approach and more of an extended innovation engine that helps drive open innovation.

Irrespective of the approach, we foresee 2015 to be the year global in house centers are back in the reckoning when it comes to strategic planning for large global organizations.

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