Captive centers are back. Is DIY offshoring right for you?

Fully-owned global IT service centers picked up steam in 2023, but going the captive route requires clear-eyed consideration of benefits and risks, as well as desired business outcomes.

Captive centers are on the rise. You’d be forgiven if you’re wondering whether you’ve stumbled on an article from 2016, but, in fact, the practice of launching an offshore IT center wholly owned and operated by the enterprise it serves is back in vogue with notable twists.

Everest Group, which monitors 8,500 captive centers around the world, counted 452 new setups in 2023. “Despite economic and political disruptions, offshore and nearshore captive market growth accelerated with many enterprises expanding and setting up new centers,” says Everest Group partner Rohitashwa Agarwal.

Captive centers are no longer just means of value creation, providing cost savings and driving process standardization. They are driving organization-wide innovation, facilitating digital transformations, and contributing to revenue growth.

Unlike earlier generations of what are increasingly being called “global capabilities centers,” which tended to be large operations set up by multinationals, more than half of last year’s new centers were launched by first-time adopters — and on the smaller side, with less than 250 full-time employees; in some cases, less than 50.

The desire to build internal IT capabilities amid a tight talent market is at the heart of the trend. As companies have grown comfortable with offshore and nearshore delivery, the captive model offers the opportunity to tap larger populations of lower-cost talent without handing the reins to a third party. “Eroding customer satisfaction with outsourcing relationships — per some reports, at an all-time low — has caused some companies to opt to ‘do it themselves,’” says Dave Borowski, senior partner, operations excellence, at West Monroe.

What’s more, establishing up a captive center no longer needs to be entirely DIY. “An ecosystem of partners that specialize in turn-key captive standups or ‘virtual captives’ has emerged,” Borowski says. “Companies no longer need local knowledge and presence or to cobble together a complex web of in-country experts.”

But not every captive center is successful — and captive centers aren’t the right choice for everyone. While a widening range of companies are pursuing the benefits, there are challenges and risks to consider and key questions to ask before going captive.

The upside of captives today

Some benefits of captive centers are the same as ever. “When established and managed effectively, a captive can generate savings comparable to outsourcing — if not greater at scale — but with a higher degree of flexibility and control,” says Borowski.

Most IT leaders have managed offshore or nearshore delivery in one form or another, so there’s a level of comfort with the concept and understanding of how to make it work. That these same IT leaders face strategic talent shortfalls is a key motivator for the model’s resurgence. “It has been increasingly necessary for companies to look beyond their traditional hiring boundaries to find qualified candidates,” Borowski says.

Troubled by turnover at offshore service providers, some IT leaders seek to build greater loyalty and cultural cohesion as employers rather than clients. “Employees actually feel like they’re part of the company — because they are, which is not always the case with outsourcing,” says Borowski.

In some cases, companies see the captives as hubs for talent development as well, says Agarwal, who has seen several examples of key global roles now based within captive centers, especially as, having retained responsibility for the captive center’s day-to-day operations, some IT leaders are growing more comfortable with moving higher-level IT work offshore.

“[It] also mitigates the risk of knowledge erosion, which can be catastrophic when more strategic ‘secret sauce’ activities are performed offshore,” Borowski says.

Everest Group researchers find that some mature captives have built high-value capabilities to support key innovation, transformation, and revenue-generating initiatives. Captive centers can offer more control, not only over talent, but intellectual property, security, regulatory compliance, and “their overall IT destiny,” says Forrester principal analyst Bill Martorelli.

An easier way in

Today, many service providers are willing to work with enterprises in a build-operate-transfer (BOT) model to help facilitate launching a captive center. With this approach, the service provider builds the captive center and then runs it initially, adopting the client enterprise’s processes, tools, and methodologies. The ultimate goals is then to hand over operations to the client during the “transfer” phase. As such, the BOT model helps smooth out the challenges of setting up a center in an unfamiliar location, and it gives enterprises an opportunity to test-drive the value of the center, typically over a period of years, before fully investing in it. Not all BOTs transfer in the end, notes Martorelli.

Beyond BOT, there are firms that specialize in helping companies stand up captive operations, Borowski says. And some service providers have created a hybrid service — the virtual captive — whereby the provider manages the technology and talent infrastructure while the client controls how work is done operationally.

Buyer beware: The risks of ownership

Despite the lower barrier to entry, setting up a captive center still comes with significant risks. First, they don’t all last. From 2020-2023, while 1,450 captive centers were created, according to Everest Group, 50 companies sold their captives to third-party providers. In some cases, divestitures were due to cost pressures, business restructuring, or new executive mandates, says Agarwal. Others resulted from issues with the captive center itself — performance problems, leadership challenges, and lack of cost competitiveness.

“A key challenge for captives continues to be scale,” says Borowski. “For smaller captive operations, it becomes difficult to operate as cost effectively as an outsourcer.”

Fixed and overhead costs are inherently greater when you’re doing it yourself, driving up the cost per resource. It’s also more challenging to scale services up and down. While it’s not unusual for an IT service provider to tweak its employee base and operating structure, including layoffs when necessary, that’s much harder for an enterprise to do, notes Martorelli.

Captives can also face retention challenges, particularly if they don’t provide opportunities for advancement, says Borowski, as they risk losing employees to other captives or IT service providers who offer more upward mobility.

Productivity can also decline over time, particularly for organizations used to working with third parties. “Whereas outsourcing providers often have contractually committed productivity improvements forcing them to continuously improve processes, productivity, and cost efficiency to achieve profitability targets, there’s no similar burning platform for captives,” says Borowski. “Captives can become stagnant with marginal improvements over time.”

7 questions to consider before going captive

Certain situations aren’t conducive to establishing a captive center. For example, if your enterprise faces financial or operational challenges, lacks funding to sustain operations, or has legal or regulatory constraints that preclude offshoring. Moreover, captives are not advisable for temporary services or ones that experience significant variability in demand.

However, a captive center can make sense if the organization is clear about its intentions and aware of the risks and work involved. “When captives experience challenges, it’s typically some combination of a flawed service delivery strategy, poor planning and design, or poor execution,” says Borowski. “This should be a thoughtful, strategic decision that enables an organization’s long-term business direction and objectives.”

The following questions can help you assess whether a captive center is right for your organization:

What are the key business outcomes we’re seeking? Like any IT decision, the primary focus should be on the problem to be solved, not the potential solution under consideration. “The services model, location model, talent model, governance model, performance model, all need to [be] anchored [in] the core objectives,” says Agarwal.

What’s the business case and is it viable? Lay out realistic costs and benefits for both the build (captive) and buy (outsourced) options to determine which approach is most likely to help achieve your desired objectives. The IT organization should also confirm that the business case is achievable for their specific organization, Borowski says. Here, common mistakes include overly aggressive cost savings targets; lack of investment in captive center leadership; moving work offshore too quickly; insufficient investment in knowledge management, learning, and development of captive staff; and a myopic focus on SLAs as metrics of success. “This is a strategic capability for the company if built right, and companies need to approach it accordingly,” says Agarwal.

Can we operate a center that will deliver on our business case? The benefits of captive center ownership hinge on how well you can manage the center’s talent and costs over time. More nuanced questions Martorelli suggests asking include: What makes the enterprise more capable of attracting and retaining talent than potential outsourcing partners? How will the captive center remain competitive with third-party alternatives? What are realistic expectations for managing costs over time?

Are our leaders committed to the strategy? “No model is failproof,” says Agarwal. “You have to commit to it and make it work.” Here, buy-in is vital, especially when challenges arise. “The very factors that propel [captive centers] forward — desire for cost savings and access to talent — can sow the seeds of their eventual decline if expectations are not met or sustained,” says Martorelli, adding that captive center momentum can quickly sag as a result of executive turnover or loss of interest.

What location makes the most sense? Research locations with an eye toward whether it possesses the labor and infrastructure necessary to support the scope of the center and any future growth.

Who will help us set up the center? “Engaging specialists and local resources to support activities such as site selection, recruiting, permitting, and facility buildout helps to navigate pitfalls and accelerates implementation,” says Borowski. Those considering the BOT approach should educate themselves on its pros and cons. “Customers should be realistic about the service provider’s real interests,” says Martorelli. “Don’t expect the service provider to be anxious to simply transfer all of their best people to you.”

How will this affect the rest of the IT organization? Onshore talent could be displaced as a result of the captive center. At the very least, roles will change, and oversight of the captive facility will be needed. “IT leaders cannot forget to consider the impact — real or perceived — on the resources directly or indirectly affected by the offshoring action,” Borowski says. “Developing a retention strategy is key so that resources displaced by the offshoring have an incentive to stay through transition and stabilization.”

Overall, as the trend continues, with companies expanding existing captive strategies, new adopters entering the market, and more companies moving outsourced work to captive operations, the IT leaders most likely to succeed with the model will be those who have experience in driving results from remote operations and take an intentional and selective approach to determining which business outcomes can be achieved via the captive center model.

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