Mark Dzialga, General Partner at General Atlantic Partners has been closely watching the BPO industry unfold in India. In 2002, GA Partners invested in Daksh eServices, one of India’s largest call-center companies. Last year, IBM acquired Daksh for approximately $160 million.

Sources say that for GA Partners, the capital appreciation was twofold.

IBM’s acquisition of Daksh did not signal the end of third-party vendors and emergence of captive units. IBM’s interest in building their capability in India was necessitated by the fact that IBM had to strengthen its delivery capabilities.

Similar to IBM, bigger players like EDS, Accenture or CSC would like to provide end-to-end solutions including business process such as typical call-center work answering customer queries and more complex areas such as payroll processing and accounting. So, rather than set up BPO operations from scratch in India, with all the hurdles involved, bigger players are keenly looking to acquire a company with existing clients, revenues, BPO service capacity and a successful management team.

This could be good news to some pure-plays because successful businesses in the BPO space in India that want to expand further abroad, need the brand, marketing muscle and financial support. With many MNCs making major moves into offshore outsourcing, will “pure-play” India providers survive the pressure? Managing a rapid growth will be a challenge.

Additionally, human resource issues like attrition and security are emerging as serious management challenges. “The result is that management resources are strained and many entrepreneurs are tempted to cash out while the market will still pay premium prices for their companies,” says Sujoy Chohan, vice president, Gartner India.

While many were writing stories about the end of pure-play BPOs, GE sold 60 percent of stake in its captive BPO center—GE Capital Information Services (GECIS)—to U.S-based investment firms GA Partners and Oak Hill Capital Partners.

End of Captives?
GE’s strategy to divest GECIS reflects a growing trend among multinational companies to move away from having wholly owned subsidiaries doing captive BPO services in India, and to instead outsource to third-party Indian service providers.

“I do not necessarily see what GE did was a trend that going forward we will see many more captives commercialize their units. The processes that many of the captives in India handle are critical part of their business and they want to have complete control of their processes,” says Dzialga.

Ravindra Datar, analyst at Gartner India does not believe so. “Multinational companies initially set up the captive subsidiaries because few third-party companies were not able to offer the quality of service that companies wanting to send work to India were looking for,” he says.

But now multinational companies are finding that the savings from offshore outsourcing are far higher with an independent company than they would be with a captive operation, observes Datar. “While the captive operation is a cost center, the third-party outsourcing company is driven by the profit motive. Also, while the captive operation services the parent company, an independent operation can leverage the same resources across a number of clients,” he says.

For instance, the sale of equity in GECIS has allowed the company to begin working for companies other than GE, including Japan’s Nissan Motor Company, which recently signed on as a customer.

By selling a part of the equity in Indian BPO subsidiaries, multinational companies aim to cash in on investments and pass on the management to others, without losing access to the services. “The captive centers have good business potential if converted to a profit center, because they have strong domain knowledge that could not be leveraged fully while they were captive operations,” says Datar, adding that by continuing to hold a stake in the Indian operation, a multinational company also stands to benefit from the profits of the operation.

What convinces large number of U.S-based VCs and private equity firms to seriously consider BPO investment?

“Large companies in the U.S and Western Europe are highly interested in the build out of globally integrated delivery systems,” says Dzialga. Many see this as an attractive option not just economically but also to enhance quality and productivity around their business process. Many are buying into the concept of building right process, at the right place at the right time, and developing the operational capabilities to seamlessly perform business process using technology.

At the same time, more companies are getting comfortable with a range of processes that can be effectively managed in countries like India.

“With these two dynamics coming together, there will be enormous growth of the industry. Private equity firms are interested in taking advantage of the growth,” says Dzialga.

IP Creation
Though VCs love to invest in software product companies because of the IP value it generates. The same is true in the BPO sector too. There is enormous level of innovation in the way business processes are processed. What VCs look for in BPO companies is the uniqueness in their approach to manage processes. Their usage of technology, ability to put many clients on a common IT infrastructure, ability to be responsive to different customer requirements and concerns opens room for creation of proprietary methodologies and IP.

Driving productivity
BPO companies evolve proprietary methodologies with the motive of enhancing productivity of their clients. Driving productivity of clients is one of the key criteria that VCs look for while investing. Technology-enablement of existing process leads to reengineering of the process and displacing higher cost components of handling a process. Executing the process in a different way compared to how it is handled by client translates to driving productivity. The key is to continuously provide value year-on-year and improve process. Only then does the BPO retain its competitive advantage. VCs closely analyze this metric while investing.

“We are interested to invest in companies that will offer interesting set of economics, not just during the first year but drive additional value during subsequent years of executing the process. We look for a proven record of year-on-year improvement of productivity for the client,” says Dzialga.

Global Management
‘Value-creation’ isn’t an easy ball game, especially while handling complex process. “In order to create a value-driven BPO company, you need to have enormous knowledge of both business and technology,” says Venetia Kontogouris, Managing Director of Trident Capital. This calls for a management team composed of members with international experience. Since most BPO-related work comes from the U.S and Europe, the management must understand the two cultures and the way business in done. “What we look for is an international company. We look for entrepreneurs with international perspective,” she says.

A sound management team will ensure disciplined approach to contracting mechanism. This will enable structuring the business relationship that are economically successful which puts a right alignment between company and clients best interest thereby a benefiting relationship.

Venetia points out that there are incredible opportunities for entrepreneurs having deep knowledge of a particular industry. “Though there is big bucks to be made in claims processing or telemarketing, one needs to understand that that it not high-end BPO. One needs to think out-of-the-box and evolve unique solutions for travel, healthcare or finance industries,” emphasizes Kontogouris.

Both Dzialga and Kontogouris agree that the Indian BPO market is still in its early stages. Indian entrepreneurs should figure out the next competitive advantage and work towards delivery creative solutions.