Captive Outsourcing Unit - A derivative prodcuct

GE, the company that pioneered the outsourcing in India, set-up its first captive unit in 1997. Captive outsourcing units are fully owned subsidiaries of the parent company and being so helped the management to have a complete control over the execution and quality of deliverables in the early stages of outsourcing. Additionally, the brand also helped them in negotiating better deals with government and attracting the top talent. Transition of work from U.S to India was not an easy job as there was always resistance from the employees to transition work or co-ordinate work with an off-shore location. The feeling of being the same company helped there as well.

Outsourcing was primarily to reduce the cost of operations(rent, wages, benefit- to name a few). However, GE showed the businesses that there are multiple ways to make money on outsourcing.

When GE built a big outsourcing unit in India, lot of jobs in the U.S /Europe were moved to their Indian operations. By conservative estimates, there should be at least 30% cost savings- Otherwise there was no point in outsourcing. GE engaged their workforces to train their counterparts in India and implemented the quality processes smoothly over a period of 10 years. Within 10 years , GE India unit was supporting most of the business units with different back office works - including analytics, financial transaction processing and customer service centres. That's the time GE businesses globally was aligned with the off-shore operations and the processes become smooth . Then came the news that GE was selling the India unit!

I think it was a brilliant decision GE took to make money out of their BPO operations. GE sold 60% of their Indian BPO operations in 2004 to two U.S private equity companies- Oak Hill Capital partners and General Atlantic Partners -for $480 million and the Indian unit become an independent BPO, Genpact.

GE never had any real estate holding in India. All their equipments were leased. So what did they really sell ? Knowledge about their own processes and the team that possessed it!

Savings to GE actually starts with the deal. GE committed for alt east 5 years of business - this means they continue to enjoy 30% discount on their operations cost. Now GE is a customer, they could always ask for more productivity - Something GE does with other IT vendors in India, where they insist 10% of productivity every year - This mean if you support a project with 10 people this year, you are expected to support the same with 9 people next year through process improvement or expertise building (or just working longer hours for some managers ?). Also, when Genpact renews the contract, pricing could be done based on a competitive bidding. So to an extend GE is insulated with increasing cost of doing BPO business. And who knows, there could be cheaper ways inthe future.

On the other hand, GE still holds a 40% stake in Genpact - good enough to control them along with their committed business(read dependency of Genpact). When Genpact flurishes, GE could still reap the benefit through dividends or capital appreciation. Genpact was listed in NYSE (G) in 2007 and this month we saw GE is offloading another 3% stake for $ 100 Million when the liquidity in U.S market dried up. ( That was another smart move as the Genpact shares crashed since then : from $14.32 to $6.92 as of today).

Well, I am impressed about GE management, ever since I joined them in 2001. What made me write this blog is a 'me-too' deal by Citibank to sell their BPO unit ( Citibank Global Services) to TCS for a $505 Million, with a commitment of business for next 9 years. May be half a billion is not too big for Citi or GE but the idea of capitalising their captive units and ensuring a low cost operations for years to come is definitely a smart move.

In other words, its possible to package the back-office work into a finacial product called captive unit. It has a revenue stream and hence a valuation ( Say 2.5 Billion in case of latest TCS deal). Now its safe to assume that Citi saves close to a 1.25 Billion when they sell their own work to TCS (505MM + 30% savings on outsourcing). And since it was captive, they made sure the new company could deliver the way want.

Not every one is happy. Employees feel betrayed as they signed up for an MNC brand but now they ended up with a less known Indian brand. Uncertainties like what will be the impact on the benefits when the clients squeeze for more productivity every year coupled with increasing cost of doing the business.

So the question is who is next ? Amex, HSBC, IBM ?. Thanks to GE.