- Recent years have seen a resurgence of interest in GICs in India across a wide range of industries driven by the shift to digital technologies.
- For large enterprises, the favorable labor rates in India can also mean savings in the hundreds of millions of dollars over a multi-year period.
- The opportunity to develop and operate next generation GICs is literally too big to miss for many businesses in numerous industries.
Global In-House Centers (GICs) were first seen in India in the 1990s as an alternative to IT outsourcing arrangements with third-party vendors. The principal driver was labor-cost arbitrage between the United States or Europe and India. The banking, financial services and insurance industries were early adopters. In their original iteration, GICs were known as “offshore captive centers.” A number of these captives were later sold to outsourcing vendors, particularly in the years following the Great Recession.
In recent years, there has been a resurgence of interest in GICs in India across a wider range of industries, including transportation, telecom, media, manufacturing, medical devices, oil & gas, aerospace, retail and hospitality. From 2012 – 2017, Indian GIC revenues have increased at a 12.4 percent compounded annual growth rate (CAGR). According to a recent livemint article citing a Nomura Research report, this compares with a 9.3 percent CAGR during this period for the top-4 Indian IT firms. A Bain & Company Insights report in April 2017 puts the current number GICs in India at about 1,100, employing more than 800,000 individuals and generating $23 billion in revenue. The livemint article also cites the Nomura Research stating that twenty-seven percent of the Global 2000 currently have GICs with the percentage predicted to increase to fifty percent over the next five years.
Writing for The Economic Times, Malini Goyal sees as a major driver in the growth of GICs the shift in enterprise IT budgets towards digital technologies, such as artificial intelligence (AI), data analytics (big data), automation or machine learning, cloud computing, mobile, social and the Internet of Things (IoT). Digital technologies allow businesses to target individual customers and to do so more frequently through more channels of communication. According to the Bain & Company Insights report, executives in impacted industries now prioritize IT cost reduction, the development of highly skilled talent, making IT more flexible and funding digital initiatives specific to their business and its growth. Other research shows that executives also want more control over work performed in order to respond more quickly and effectively to new digital IT, especially after it is deployed effectively by competitors.
This has created a unique opportunity for GICs along with the real challenge to evolve from centers set up to perform a limited number of discrete IT and business processing functions into multifunction centers providing innovative value-added services in the digital economy. This article outlines the business case for the “GIC 2.0,” common GIC business models and key considerations in setting up and operating a GIC in India.
Business Case for Indian GICs
Employee Talent. India is considered to be the software capital of the world, and it has a very large pool of highly qualified software engineers and excellent educational institutions. GICs have the ability to attract superior talent through a combination of favorable compensation packages and the attractiveness of working for well-known U.S. or European brands with the prospect of developing deep industry and company-specific knowledge and engaging in more challenging and innovative work.
Control and Speed. Companies have more control over captive GICs than third party outsourcing vendors, which allows companies to respond more quickly to changing priorities and industry trends. When vendors are paid on a FTE basis, there is arguably little incentive to automate or digitally streamline processes. In a May Forbes article, Everest Group CEO, Peter Bendor-Samuel, observed that “Many clients are frustrated with the slowness of service providers injecting automation and other digital technologies into operations. It’s understandable that they believe they can move into the digital world faster themselves and better manage digital platforms in house or through a GIC than through third parties [with misaligned incentives].”
Cost Savings. The favorable cost arbitrage between labor rates in the United States or Europe and labor rates for similarly qualified employees in India can provide substantial multi-year cost savings. For large enterprises, savings can be in the hundreds of millions of dollars over a multi-year period. GICs may also compare favorably to offshore outsourcing from a cost standpoint. While GICs often pay higher wages and benefits than outsourcing vendors to attract top talent, they eliminate vendor profit margin. In addition, GICs can reduce the cost of managing third-party vendor relationships.
Business Models for GICs in India
Do-It-Yourself (DIY). Some companies set up and manage GIC operations themselves and only retain local market experts in India for discrete tasks (e.g., legal, accounting, leasing and talent acquisition) in order to lower costs. However, that approach carries the risk of encountering unanticipated local issues due to a lack of relevant experience in, and understanding of, the regulatory regime and culture in India.
Build-Operate-Transfer (BOT). In a BOT model, a firm with expertise in setting up, managing and operating GICs (a “BOT partner”) is engaged to perform these services for the company for an agreed-upon term of years (often between four to seven years). Operations (and sometimes ownership rights) are transferred at the end of the term after the enterprise has hired sufficient local talent and gained the requisite local expertise. The legal arrangement may be structured as a Joint Venture or a Services Agreement.
BOTs offer a number of potential advantages, including accelerated timeframes for establishing the GIC, experienced management of the GIC, ability to leverage local knowledge and relationships of the BOT partner, access to talent in India, and the BOT partner’s knowledge of the regulatory environment and local practices. However, these advantages come at a cost. In addition to being compensated on a fee-for-service basis for ongoing services, the BOT partner will likely negotiate a substantial pay-out at the end of the term based on GIC cost savings, productivity improvements and other performance-based success metrics. This back-end pay-out is beneficial in aligning the interests of both parties in the success of the GIC, but can have a material impact on overall cost savings.
Key Considerations in Setting Up a GIC
Setting up a GIC requires careful planning and execution. There are a multitude of interrelated corporate, tax, regulatory, commercial, operational and contractual issues that need to be addressed, including the following:
GIC Legal Entity. GICs are commonly organized in India as a Private Limited Company (PLC). A PLC offers the advantages of (1) a well-developed body of corporate law, (2) established ways to bring in additional investment through External Commercial Borrowing (ECB), and (3) tested ways to deal with operational matters. An alternative to a PLC is an Indian Limited Liability Partnership (LLP). An LLP provides certain tax advantages, such as avoidance of Indian dividends distribution taxes and easier repatriation of profits, but it is a relatively new type of legal entity without a well-established body of case law in India or tested ways to deal with operational matters. The relative importance of tax and corporate considerations should be weighed in selecting the most suitable legal entity for the GIC.
Tax Considerations. Setting up a GIC requires careful tax planning that takes into account both domestic and international tax laws and foreign exchange requirements. In addition to the tax implications associated with the choice of legal entity for the GIC:
- Companies need to determine the appropriate entities within their corporate family from a tax standpoint to contribute capital to, hold ownership interests in, and receive repatriation of profits earned by, the GIC.
- Charges for the services provided by the GIC to the company and its affiliates need to comply with transfer pricing requirements under OECD Transfer Pricing Guidelines as well as domestic and Indian tax laws. Among other things, consideration should be given to potential excess accumulations of profits within the GIC as a result of transfer pricing markups.
- Special Economic Zones (SEZ) in India provide substantial tax and economic benefits, including tax holidays and exemptions from various taxes and duties. Companies will want to locate their GICs in an SEZ enclave and be careful to timely obtain approval of the jurisdictional Development Commissioner to set up an SEZ unit before commencing operation of the GIC.
Human Resources. The caliber of personnel hired by the GIC will play a critical role in the value the GIC brings to the enterprise company. Accordingly, companies would be well advised to engage a talent acquisition firm in India that has a strong track record of recruiting top-tier talent in India for their clients. In offering employment to and hiring candidates, companies should be aware that employment laws and practices are very different in India than in the U.S. or Europe. For example, there is no concept of an “at will” employee in India, and employment contracts are the norm. Companies should also take appropriate steps to mitigate the risk of dual employment claims made against both the GIC and its deeper pocket parent companies.
Facilities. Some companies have experienced challenges in securing desirable office space to accommodate growth in their GICs. Companies leasing space should therefore consider obtaining expansion options to contiguous space as well as long-term extension options on favorable terms. In addition, the commercial terms of leases are not necessarily aligned with those in the U.S. or Europe. Companies would be well advised to seek market information on rent rates, escalations, operating expenses, local taxes and other charges and lease conditions from local experts.
International Trade Regulations. Services provided by the GIC to the company and its affiliates will likely involve the export of technology to and from India. A compliance program should be in place to review all software and other technology prior to export (or deemed export) to identify any necessary export licenses or other actions required to be taken. In addition, consideration should be given to other applicable laws, regulations and compliance requirements, such as the Foreign Corrupt Practices Act, and securing contractual commitments from counterparties to comply with them.
BOT Issues. For companies setting up a GIC under a Build-Operate-Transfer model, there are a host of contractual issues to address with their BOT partner. Among other things:
- Companies should make sure that the relevant agreements give them control over decisions impacting the GIC, including GIC hiring decisions and the type and volume of work to be performed by the GIC. If the BOT model is structured as a joint venture, this will involve multi-layered governance that is subject to strict PLC/LLP statutory requirements. Companies should also consider their future needs and retain the contractual flexibility to materially alter the business plan and objectives of the GIC, if necessary. A BOT partner should not have rights that might frustrate or impede the enterprise.
- As noted above, BOT models often involve a significant pay-out to the BOT partner at the end of a specified term or upon the occurrence of a triggering event (e.g., termination for cause or convenience, change of control of a party, etc.) based on a combination of cost savings, productivity improvements and/or other metrics. It is critical that the methodology and formulas for calculating the pay-out are defined with precision. It is also advisable that the contract include a process for periodic calculations of the pay-out earned through interim calculation dates during the contract term to avoid a major dispute at the time of the pay-out, particularly in a joint venture where the BOT partner holds an equity interest in the GIC.
- BOT partners often use special purpose vehicles (SPVs) in connection with GIC joint ventures. SPVs typically have no assets other than the BOT partner’s equity interest in the GIC. As a result, it is important to secure appropriate guaranties of SPV obligations from parent companies or principals to satisfy the obligations and liabilities of the SPV.
Local Counsel. Experienced local counsel in India is essential to navigate the country’s labyrinth of legal requirements and practices. There are a wide range of critical laws, regulations and incentives in India (such as real property and zoning laws, employment rules, corporate and partnership laws, intellectual property and data privacy laws, licensing requirements and good citizenship rules). Local counsel can be particularly helpful in guiding companies through the regulatory approval processes and avoiding costly missteps. Company counsel in the U.S./Europe should work closely with local counsel in India to ensure alignment of India-specific matters with the broader commercial, legal and contractual framework for the GIC and the enterprise.
The factors driving the resurgence of GICs in India are clear and the technology forces driving the evolution into “GIC 2.0” are not going away. Disruptive digital technologies and increasingly complex and uncertain times for enterprises demand new thinking and practices. The opportunity to effectively develop and operate next generation GICs is literally too big to miss for many businesses in numerous industries. However, despite the attraction of the talent pool in low cost India, success is not guaranteed. Careful planning and execution—including the commitment of necessary resources and an understanding of the unique requirements in India—are required for companies to realize the potential of GICs.