A few years ago, analysts had sounded the death knell for information technology and business process outsourcing (BPO) captive units set up by multinationals in India. Their logic was simple: The cost equation of outsourcing was more in favor of third party players, and captives, with their small team sizes, could not be competitive. In 2007, a research report titled, “Shattering the Offshore Captive Center Myth,” noted that more than 60% of captive centers were struggling due to “lack of management support, spiraling costs, attrition and integration issues.”

But captives are now proving the naysayers wrong. According to a recent study done by the Everest Group, 37 new captives were set up in India by multinationals between January 2008 and December 2010. Of these, 23 were established last year alone. Twenty-one captives have also announced significant expansion. Meanwhile, only 13 were divested during that two-year period, more for internal reasons of the parent company — for instance, Lehman Brothers, which went bankrupt and closed operations — than for specifically India-related causes.

“Earlier, the conversation [in a multinational] used to be around either having a captive unit or a third party vendor. Now it’s no longer an ‘either–or’ conversation,” says Gaurav Gupta, managing partner (India) for global services advisory firm Everest Group. “The model that is clearly emerging is a hybrid one. Companies have realized that in order to get the best value, they need to leverage the multi-sourcing model.”

Karthik Ananth, director at Zinnov Management Consulting, points to the fundamental shift in the drivers for captives. “In the initial years, it was all about cost and talent. But over the years, this has fundamentally shifted to also add innovation and access to emerging markets. Companies are looking at India as a hub for driving innovation for not only the domestic market, but also for other emerging markets like West Asia [and] Africa. So captives now are no longer about a tactical play, but a strategic pillar for multinationals.”

Talking recently to Indian economic daily Business Standard, Sandeep Dhar, CEO of Tesco Hindustan Service Center, the Bangalore-based captive unit of the U.K. retailer Tesco, noted: “For Tesco, the India center is 75% of its IT capabilities and talent base. Besides, the cost it incurs would be a fraction of what the company earns. [Moreover], a third-party vendor would treat the CIO of Tesco as his customer, but for us the person walking into the store is the customer.” Dhar added: “The Bangalore team is making a serious … contribution for Tesco’s business to grow. At present, we are largely working for the U.K. business. But our mandate is to work for all the centers of Tesco stores across the globe, to provide standardized operations for all the Tesco units and also run innovation initiatives for the group.”

Zinnov’s Ananth suggests that going forward, multinational captives in India will not only take on more high value and critical work for their parent organizations, they will also start owning a lot more of their companies’ relationships with the third party vendors in India. “Being based locally, they understand the local realities better and can have better conversations with the vendors,” he says. “And vendors, in turn, will augment the capabilities of the captives by providing them with access to the ecosystem.” Gupta of Everest adds: “The onus … is on the captives to remain ahead of the curve.”