By Luke BujarskiIt’s time for captive centers across Latin America to grow up. While recent data published by Everest Research officially took the captive center model off the endangered species list, changing tides in management and increasing global competition suggest that it will be far from smooth sailing for LatAm’s captives industry.=
Captive Centers 101
Captive centers are wholly-owned business units that provide services such as IT and back office operations to a parent company. A 2009 policy brief from the Inter-American Development Bank entitled “The Offshore Services Industry: A New Opportunity for Latin America,” put the number of captives in LatAm between 100-150, concentrated heavily in six countries – Argentina, Brazil, Colombia, Costa Rica, Chile and Mexico. But after a rash of divestitures and closings of Indian captives in the wake of the 2008 financial crisis, some analysts posited that the captive model had outlived its value for companies, and that the third-party option would dominate the offshoring space going forward.
“There are shared services centers that have been created and run well across multiple companies in places like Panama and Costa Rica, where there is a lower cost of living, high literacy levels, time zone benefits” – David Rutchik, of Pace Harmon
Gloom or Boom for LatAm’s Captives?
Had this been true, it could have spelled disaster for fledgling markets in LatAm pitching global services deals. Luckily, the love-love relationship between captives and multinationals appears to be going strong, according to Everest Group’s Q2 Market Vista Report, which pointed to a 42-month high in new captive announcements (globally).
Now Costa Rica’s captive managers and country promotion agencies in Guatemala can finally breathe a sigh of relief, right? Not so fast, exclaims Ilan Oshri in his newly published book entitled Offshoring Strategies. Oshri stresses that “the nature and purpose of captive centers must evolve in order to be successful.” Looking to the evolutionary path followed by India’s now mature outsourcing industry, most of the big players including TCS, Infosys and Wipro, all started as basic captive centers providing services to their parent companies. But, according to Oshri, scale and capability were the two critical ingredients that allowed these basic captives to make their transformation into full-blown third-party providers.
And while total divestiture doesn’t have to be part of the longer-term strategy, scale and capability allowed these basic captives to do three essential things: First, they got the needed respect and attention of their parent companies, which channeled the necessary resources to grow even bigger. Second, it gave them the capacity to sell their services to external clients. Behold the shared service center, a proto-third party player still beholden to their parent company, but able to bring in revenue from outside customers. Third, it allowed these captives to attract outside investors and position themselves internally for successful divestiture, as opposed to migration or even worse, termination.
This change process from cost center to a profit and innovation center is what allowed India’s basic captives to grow into sophisticated shared service centers and multi-billion dollar companies. The question for Latin American captives is, will they continue to deliver on the scale and capability needed to follow along a similar evolutionary path? According to David Rutchik of outsourcing advisory firm Pace Harmon, the answer is yes. “There are shared services centers that have been created and run well across multiple companies in places like Panama and Costa Rica, where there is a lower cost of living, high literacy levels, time zone benefits, etc.” The question for Latin American captives is, will they continue to deliver on the scale and capability needed to follow along a similar evolutionary path?
Otto Acuna, Partner at Costa Rica based advisory firm Excelencia Financiera reminds us that Latin American companies had been running captive center operations in Central America well before the multinationals took interest. Cormar Corporation, Durman Group, among others all had accounting and IT operations in the region. These were subsequently divested to companies like DHL and Aliaxis of France in the early part of this century. Today, FIFCO a major beverage company and AviancaTaca a Latin American airline consortium both run very successful shared services facilities in Costa Rica.
Longer-Term Planning Brings More Competition
As this chapter and understanding of global services management develops, executives are becoming smarter about captives and are looking at the longer-term when setting shop in offshore markets. “We advise our clients interested in Central America to think three to five years down the road,” said Dwayne Prosko of KPMG. “When looking to build your own center, is there a desire to move beyond basic finance and accounting processing and basic level one IT support? If not, there is a risk that the captive delivery center will lose value over time.”
And while the ultimate objective for a basic captive may not focus on turning it into a multi-billion dollar company, this shift toward a longer-term thinking will encourage global competition not only between markets, but also between captive centers. As some managers look to maneuver their offshore operations down the path of successful divestiture, captives will have to fight harder for new clients, and potentially later on down the road for investors. According to Oshri, this will require captive centers to beef up their sales and marketing, business development, and project management capabilities.
This will present challenges across the Latin American market spectrum. The bigger markets – i.e. Mexico, Brazil, and Argentina, are more attractive when focusing on availability of skilled labor and market potential, but there are hidden risks when considering inflation and factors such as political uncertainty in Argentina. As for smaller markets, they will have to work that much harder to prove to their parent companies that they are following a sustainable longer-term plan. Revenue generation and multi-client management capability will have to be added to list of obstacles to be overcome.