In today’s cost-cutting environment, some executives have wondered aloud whether creating a shared services organization makes better financial sense than outsourcing back office operations. While giant-sized corporations can realize economies of scale that lead to cost savings, implementing shared service center is no easy task – and numerous challenges block most enterprises from realizing a captive’s full potential.
Building an entire service operation from scratch involves significant sweat equity that’s often underestimated: establishing physical facilities, obtaining local business licenses, complying with complex local regulations like labor and tax laws, hiring and training staff in another country, and more.
The upfront capital investment and transition costs are substantial – stretching the timeline to produce expected savings. Lack of proper planning can also create organizational misalignment and poor change management that causes C-suite support of a captive strategy to wane.
Not surprisingly, the number of businesses in a pre-pandemic McKinsey survey creating a shared services organization had dropped from 79% to 59% within four years, while reliance on an outsourced or hybrid approach jumped 21% to 41%.
In the post-pandemic era, Deloitte reports that 65% of successful organizations currently include outsourcers in their delivery models as senior leadership looks for ways to accelerate digital transformation, cut costs, access best-in-class talent amidst the U.S. labor shortage, and focus internal staff on core competencies.
Determining the best strategy for back office support requires considerable thought and due diligence. Consider these key factors as you evaluate opening your own captive shared services center or outsourcing to a third-party provider:
Do you have existing operations in the country you are targeting?
Without question, standing up a creating a shared services organization involves less complexity and risk when you already have a presence in the country.
Without an established brand, it’s harder to attract talent. Existing legal entities and operations also bring practical know-how and cultural savviness that makes it easier to obtain local operating licenses, negotiate economic development incentives, resolve regulatory issues, and otherwise manage your build-out.
You can also leverage existing infrastructure, reducing the substantial time, effort, and cost of starting a new operation.
Is cost the biggest factor in your decision to outsource vs. insource?
Only a handful of geographic locations can deliver substantial savings to U.S.-based organizations considering of creating a captive shared services organization. That number shrinks even more for companies looking to avoid challenges that plague Asian-based solutions, like cultural and language barriers and difficulty doing business across faraway time zones.
While the labor arbitrage in many countries is compelling, it’s not the only factor when building your own solution. Other labeled-in costs like training, IT infrastructure, and facility expenses will chip away at your savings until the difference from outsourcing is minimal – and a captive becomes more hassle than it’s worth.
Outsourcing is also more attractive for companies looking to achieve rapid cost savings and implementation speeds. After building a business case for outsourcing vs. implementing a shared service center, an Auxis client discovered that the payback period of insourcing was more than double (>4 years) the positive cash impact of outsourcing (<2 years).
Finally, keep in mind that captive solutions are a long-term investment. Once they are built, it’s pricey and difficult to reverse course.
By comparison, outsourcing provides the flexibility and agility to react to changing business needs. It also changes fixed labor costs into a variable cost – enabling you to easily scale resources up and down instead of carrying hired staff.
Do you have sufficient scale to make the economics work?
Scale is a key factor when evaluating captive shared services. A corporation that moves a critical mass of work to a captive in another country can achieve worthwhile savings despite initial costs - if the large headcount is sustainable long-term.
Tapping into an outsourcer’s ready-made economies of scale makes better financial sense for companies shifting smaller operations.
Can you match an outsourcer’s productivity and efficiency?
“Standardization and process efficiency” ranked as the top outsourcing objective in 2021 – dropping cost savings to the #2 spot, states Deloitte’s Global Shared Services and Outsourcing Survey. However, most enterprises lack the expertise to optimize inefficient and bloated operations on their own.
Unfortunately, lifting and shifting a back office function to a captive is not the same as tapping an outsourcer with a proven Center of Excellence to run operations.
Exceptional outsourcers have streamlined processes, best practices, automation technology, and the right leadership structure already in place to maximize productivity and efficiency. They are experts at creating detailed documentation that leads to repeatable processes, an extensive knowledge base, and a seamless transition.
In top nearshore locations in Latin America, resources have deep experience performing similar work for a wealth of North American enterprises. Service-level agreements also incentive outsourcers to maintain a continuous improvement mindset, sharing the cost of innovation across many accounts.
By comparison, companies building a captive tend to be hyper-focused on quickly lowering labor costs. However, failing to invest in process optimization leads to many pain points, including:
Poorly defined processes that impede efficiency and true economies of scale.
A poorly executed transition and knowledge transfer that impacts quality of service.
Minimal emphasis on continuous improvement that restricts the captive’s ability to demonstrate sustainable value and maintain a strategic fit with the organization.
Hiring a partner to improve captive operations is possible but stretches the payback period even more. Not surprisingly, captives generally require a larger headcount to perform the same work as outsourced operations – dropping productivity an average 20%.
How will you overcome the challenge of recruiting and retaining quality talent?
Talent acquisition challenges like attrition and poor leadership are serious concerns when shifting back office operations to a captive in another country.
Sourcing the right candidates and filling leadership roles to manage operations can be difficult in low-cost and remote locations. In popular Asian-based markets, high demand and an abundance of available jobs create alarmingly high turnover as workers constantly take advantage of better opportunities.
For instance, Deloitte reports that India’s finance sector suffered a whopping 26.8% attrition in 2019 – the highest of any local industry.
In a heated war for talent, captives struggle to compete with outsourcers, who have better career progression paths that make it easier to attract and retain quality staff. Established outsourcers also have a recognized brand and recruiting strategy in the market.
Unfortunately, high turnover will hurt productivity and service consistency at your captive location. It also impacts training costs – demanding an extensive, continuous program to offset the constant loss of intellectual capital.
The decision of creating a shared services organization or outsource to a third-party provider is never black and white.
Outsourcing partners perform service delivery, but they also own and operate the infrastructure and assume the headache of hiring talent for your operations. When enterprises implement a shared service center, they retain those responsibilities – significantly increasing costs, complexity, and risk.
Choosing an outsourcer with an “extension of your team” mentality can further negate the allure of in-house solutions. Not only do these partners perform your same processes remotely, but they also provide constant communication and operational visibility - ensuring service delivery isn’t lost in the “black box” model that dominates many offshore solutions.
Take time to evaluate your organization’s capacity and appetite for navigating the challenges of a captive journey. And make sure you fully understand how the risks and rewards apply to your specific situation.
Nearshore Americas reports that it’s not unusual for organizations to scale back the size and scope of their captive centers - or divest their captive delivery capabilities entirely to outsourcing providers – after failing to achieve targeted savings within two or three years. Understanding the realities of each operating model is vital to determining the best strategy for meeting the unique back office goals of your business.