INDUSTRY ANALYSIS
Outsourcing vs. Establishing Captive Facilities Offshore, Part 2

In considering whether or how to reorganize customer service and back-office functions offshore, the option to open a captive subsidiary service center may not receive full consideration in comparison to outsourcing options. Here we look at the case for Western companies to establish their own dedicated service centers -- especially in India.

The previous article made the argument for outsourcing instead of establishing dedicated operations. The two options are not always incompatible, with many companies outsourcing to a preferred destination before establishing their own facility there.

Issues with captive facilities often include staffing questions to an extent that is usually not experienced in an offshore outsourcing arrangement. Both captive and outsourcing arrangements carry risks of fraud and issues regarding overall cost. These will be examined here from the perspective of a captive operation. We begin by looking at economies of scale that may be achieved with a captive approach.

Economies of Scale

Economies of scale are available to companies that locate both customer service and research or production facilities in the same city. In India, collocation can make it easier to conduct financial transactions, since each company in that country is only allowed to maintain one domestic Indian bank account. This restriction is intended to make it easier for tax authorities to monitor business activities.

A company that serves both Western and local customers from the same offshore facility can make better use of its facility investments. Local customers are served during daylight and evening hours offshore, with U.S. customers taking priority during the night.

It is easier to leverage access to local markets through captive facilities than through merchant ones. At merchant facilities, adjustments to a scope of work (SOW) can be time consuming and can lead to price increases for clients, especially clients who lack the negotiating leverage of multiple programs or a large single-volume program.

Minimizing Risks of Fraud

It is easier to minimize risks at captive facilities from data theft and personnel issues. Captive facilities are easier for a facility owner to monitor and control. The biggest case of fraud from an offshore call center against U.S. consumers occurred at a merchant facility that has since been sold off. The incident is described in: Indian Call Center Fraud Case Highlights Need for Change.

Captive facilities that are poorly supervised are also vulnerable to fraud, as described in: Indian Call Center Agent Arrested for HSBC Thefts. To encourage integrity at U.S. facilities operated offshore, that HSBC article cites the example of Touchstone BPO, an American financial services call center in Islamabad, Pakistan, whose three lessons for success are:

1. Keep a team of American trainers on the ground at all times.
2. Develop local managers -- particularly women managers.
3. Achieve quality first, on a small scale, before scaling up and emphasizing quantity.

Staffing Issues

It can be easier to control turnover at captive facilities, in part because compensation rates and supervisory practices can be controlled.

In India, it is easier for big-name Western firms to hire and retain the best local talent than it is for local outsourcing firms. This holds true for both captive operations and merchant facilities. Western-based firms are seen as less likely to withhold pay from their employees than domestic companies, although this is not always the case. Supervisory practices at Western firms are also seen as superior.

Working conditions and personnel practices at captive, Western-owned facilities in India are generally superior to those at locally owned facilities. However, age discrimination, family background screening, unscheduled withholding of wages and the use of child labor in support positions are widespread at both U.S. and Indian-owned firms in that country.

Agents who are not ready for Western customers can be utilized for local customers. An offshore facility running both domestic and Western programs has the advantage of being able to recruit from a broader and cheaper labor pool than a facility focused solely on Western programs.

In the Philippines, where the labor market has been tightening over the last two years, eighty percent of the applicants that initially appear qualified turn out to be substandard for U.S. programs. Facilities are increasingly picking out the best of these "near hires," as they are called, and grooming them on domestic programs. Once these agents have improved and gained experience, then they may be shifted over to international programs.

Captive Facilities Can Be Cheaper

Captive facilities can be cheaper in part because no marketing or excess-capacity expenses are required. At commercial facilities, profitable and well managed programs subsidize the money-losing programs and the empty seats. The level of control available at captive facilities allows facility assets to be used more efficiently.

Standard prices for standard inbound customer services for western clients are US$18 per production hour at high-profile facilities in India. Production costs for voice facilities can range from $5.50 to $12 per production hour per seat. This includes all telecommunications expenses in and from the U.S., but excludes costs for Western staff onsite.

Except for the big-name companies, locally owned facilities in second- or third-tier metro areas in India and Pakistan commonly cost $8-$9 per production hour for voice programs on a wholesale basis. Facilities used by InternationalStaff.net have a median of 42 production minutes per labor hour for mature voice programs. Programs in the ramp-up phase usually achieve less than 30 production minutes per labor payroll hour. Ramp up periods can last anywhere from two weeks to three months.

Taxes May Be Most Important Variable

The tax system in Pakistan provides a fifteen year tax holiday for commercial facilities running international call center programs or software development projects. Domestic projects in that country are subject to a five percent sales tax.

The tax system in India appears to have been designed to drive business to India's neighbors. It penalizes non-Indian firms seeking to invest in that country. The best strategy for captive facility operators seeking to avoid excessive tax liabilities might be to accept contracts in India from other U.S. sources.

Recent court decisions in India have sided with Western firms seeking to avoid taxes on their captive operations, but the written opinions behind these decisions have complicated strategies for other foreign firms seeking to minimize their tax liabilities. The Government of India's tax collection efforts are lagging and have recently been concentrating on the activities of domestic export-importers from ten years back.

Rather than engage in a detailed examination of the finances of ITeS firms, the Government of India may settle on a presumed profit level based solely on cash flow through an operation, regardless of actual profit. The determining variable for firms considering whether to establish a captive operation in India may ultimately come down to the issue of taxes. With corporate income tax rates ranging upwards from 36 percent, it is an issue that calls for careful consideration.

Outsourcing vs. Establishing Captive Facilities Offshore - Part 1