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Perspectives

Is It Time to Reduce Reliance on Captive Services? 15 Factors to Consider

2020-11-12


Shared service centers remain compelling for some businesses. But our research finds that companies are twice as likely to reduce their use of captives — and post-pandemic realities will likely accelerate the trend.

As COVID-19 continues to disrupt all aspects of life, companies are re-evaluating how they get work done. For many large enterprises, reassessing their use of, and future investment plans for, shared service centers (frequently called “captive” centers — we use both terms) is a key part of this strategic planning.

Working with ESI ThoughtLab, we recently surveyed C-suite leaders representing 1,500 organizations worldwide regarding their plans around captives. A clear message stands out: the business logic behind captives (standardization, economies of scale, lower cost labor) is still compelling, but the associated risks (geopolitical and business continuity concerns and the risk of diminished innovation) are increasingly pressing issues. (For more information on our research, including its methodology, see “Shared Service Centers: Risks & Rewards in the Time of Coronavirus.” Also see our associated position paper, “Shared Service Captive Centers: Assets or Liabilities in the Post-COVID-19 Era?”) 

Captives have historically been thought to offer many of the benefits of outsourcing while mitigating some of the risks of working with external service providers. But in the time of coronavirus, the nature of this tradeoff must be recalculated. Globalization, though currently out of favor, will continue to be a motivating force for large enterprises everywhere. However, the tactics used to operate globally are set to change profoundly.

Businesses evaluating their captive center plans should consider 15 findings that emerged from our research.

The main benefits of captives include economies of scale, lower costs, and financial and tax advantages.

All were cited by more than half of respondents, regardless of industry or company size. Greater productivity and high quality of service are also common benefits, which more than one-third of executives mentioned.

For most companies, high capital investment and inability to innovate are major drawbacks.

Many of the biggest drawbacks of captives relate to costs, from large capital investment and long payback periods to opportunity costs and high cost of service.

The pandemic has hurt captives in three main ways: slowed service, disrupted work and heightened risk.

COVID-19 curtailed service from captives in several ways: It slowed down service, made it difficult to complete manual processes and disrupted the delivery of IT services. Working became more challenging, with productivity declining as staff moved to remote work and resources were constrained by illness and layoffs.

More than 40% of companies intend to decrease their use of captives; fewer than 20% expect to use them more.

The pattern is different, however, for the largest companies in our sample — those with more than $10 billion in revenue. Of these, only 36% plan to decrease their use of captives, while 31% plan to increase their use. The following figure illustrates the reasons cited.

The main reason cited for increasing reliance on captives over the next three years is to standardize processes.

Although fewer businesses cited it as a benefit that they’re realizing today, process standardization across functional areas and geographies is the main reason cited for increasing the use of captives. One-quarter will increase their use of captives to leverage increased remote working.

Businesses will decrease their use of captives mainly because they drain management time, fail to deliver return on investment (ROI) and don’t meet with regulatory hurdles.

Two-thirds of companies reducing their use of captives will do so because they require too much management time. Many organizations also point to insufficient ROI of captives and the associated high operating costs. Regulatory challenges trouble more than half of all organizations.

The vast majority of companies decreasing their use of captives will outsource more to external service providers (ESPs).

Of the businesses that plan to reduce their use of captives, 81% plan to outsource more to ESPs by 2023. The main reasons relate to cost: lower cost of service of ESPs, greater profitability of processes, and reduced management time and overhead.

Businesses offer many reasons for deciding against ESPs, including the inability to innovate and adapt, manage risk and meet expectations.

About four out of 10 businesses prefer not to outsource because ESPs are not innovative enough, and another 28% say these providers are less able to adapt to market changes. About 30% believe ESPs are too risky, with intellectual property and data protection being particular concerns.

The jury is out on whether the ROI on captives is better or worse than on ESPs.

Captives provide higher ROI for very large enterprises and lower ROI for smaller ones. The largest percent of businesses (38%) believe the ROI on captives and ESPs is similar, but equal numbers (31%) feel the ROI is either higher or lower. Most organizations under $1 billion believe the ROI on captives is lower than that on outsourcing, whereas companies over $10 billion think the reverse is true.

About 40% of companies would sell their captives to an ESP.

A similar percentage would not, while the remainder are on the fence. The percentage of those willing to sell is higher for smaller businesses (43%). Companies in Europe and South Africa are more prone to want to sell.

The most common reason that companies want to sell their captives is because they take up too much management time (67% cite that reason).

Other cost-related issues are often cited — for example, more than 40% note opportunity cost. A large minority of businesses would sell to reduce capital expenditures or generate capital.

Reasons not to sell captives run the gamut — from cost and quality of service, to inability to innovate and provide a career path for employees.

About four in 10 businesses say ESPs cannot deliver the cost or quality of service needed, nor can they provide attractive career paths. One-third mention poorer innovation, business continuity, resilience and cybersecurity.

Of businesses interested in selling, almost half want to sell their procurement captives.

A similar percentage would like to dispose of captives that handle supply chain management, while sales and accounts-payable captives are farther down the list.

More than half of companies expect to have less captive capacity by 2023.

Larger enterprises are less prone to reduce capacity. In line with this sentiment, 48% of businesses expect to be more outsourced by 2023, while fewer expect to be less outsourced (23%) or see no change (29%). 

Captives that draw on resources in developing countries may also be on the wane.

Sentiment toward captives in such countries may be shifting. A mere 15% of businesses expect to have more headcount by 2023, while 40% expect to have less, and 45% anticipate no change. However, this view is not shared by companies with revenue over $10 billion, of which a much higher percentage (27%) expect a rise in captive headcount in developing countries.

To learn more, read our ebook,Shared Service Centers: Risks & Rewards in the Time of Coronavirus,” visit Cognizant’s Center for the Future of Work or contact us.

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