“Absolute” Control. An enterprise may choose to establish a wholly-owned subsidiary to perform particular services for all corporate affiliates. Such an enterprise is often referred to as a “captive” or a “shared services center.” The enterprise controls all aspects of operations and is able to integrate the back-office operations with its front-office customer-facing business.
Costs. The “shared service” or “captive” model has certain inefficiencies due to size and structure.
- Costs. The enterprise customer’s sole control causes some inefficiency and higher costs, assuming demand for services is constant or at least predictable. By choosing a shared-service model, the enterprise does not have any third party to share in investment in capital equipment or operating overheads (such as high bandwidth telecom, fixed costs of personnel who cannot be redeployed if the demand for services fluctuates). In the case of a classic outsourcing, the service provider may quickly and easily redeploy the work force. In the case of a wholly-owned subsidiary, redeployment may be difficult, requiring potentially unneeded cross-training or one-time retraining, assuming new tasks can be found. If service demand declines, the captive shared-service center may need to terminate employees, with possible added costs of severance that an outsourcer could avoid redeployment.
- Taxation. As affiliates of the customer, each shared service center is subject to transfer pricing rules of each jurisdiction where the customer, its affiliates and the shared service center conduct their business. Under the OECD model income tax treaty, this might not result in significant additional costs. However, not all countries have OECD-type bilateral income tax treaties and not all bilateral treaties are interpreted in the same manner. In particular, for example, the U.S.-India Double Income Tax convention has an unusual definition of “permanent establishment” that tends to allow Indian tax authorities to attribute more income to an Indian service center.
- Human Resource Management. The career path of employees in a captive is more restricted than the career path for employees of an outsourcing service provider. In a captive, there is only one customer. In an outsourcing service provider, there are many customers, and a promising individual can find more new opportunities for advancement than in a captive. For this reason, attrition rates may be higher in a captive, resulting in higher costs of replacement and inefficiencies during more frequent replacement.
Benefits. Of source, the benefits of a shared-service model may be significant, depending on the “outsourced” business processes and core business. With the flexibility of controlling its workforce, the enterprise can redeploy its shared service center’s personnel to new tasks without having to go through the sometimes cumbersome, sometimes contentious process of “change control” with a third-party supplier.
Regional Service Delivery Centers. Multinational enterprises may have several such captives, one in each region, to perform services on a continuous “24/7” basis. Such multiple regional captives serve functions of redundancy and “handing off the baton” at the moment when one center’s day ends and another’s day starts.
Exit Strategy. The enterprise may choose to sell or spin-off the captive entity to a service provider to recoup its investment and achieve a profit, to achieve competitive pricing and to divest a non-core operation. Such sales enable service providers to enlarge their portfolio of service specialties and territorial footprint. Spin-offs have created a number of new service providers.
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