Foreign companies aiming to take advantage of India's less-expensive IT and back-office employees often take one of two routes -- they set up their own operations in the country, commonly referred to as "captive centers," or they outsource work. But new market research suggests there are cost benefits to turning over software development or business processes to an outsourcer rather than setting up a subsidiary.

Forrester Research Inc. found that hidden costs raise the baseline expense per person per month at a subsidiary to $4,944, compared to the baseline cost of $4,231 per person per month to hire an outsourcer. A number of companies are shutting down their captive centers and turning to outsourcers, said Sudin Apte, senior analyst and country head for India for Forrester.

"Captives centers run as cost-centers and cannot be as competitive as a vendor offering services," Apte said.

The size of the captive center also matters. "My experience suggests that generally the minimum economic size for a captive operation is about 1,000 staff," said Siddharth Pai, a partner at outsourcing consultancy firm Technology Partners International in Houston. A smaller staff means the expenses of real estate, infrastructure, and other overhead keep the cost per person at levels too high to appeal to the parent company, he added.

More than 60 percent of the captive centers in India are struggling with escalating staff attrition and costs, according to Apte. Most of these centers have been set up with the expectation that they can do the work more cheaply than outsourcers as they will not be paying vendor margins. Money saved on the outsourcer's margins is outweighed by the inefficiency of the captive operation, he added.

Because they usually don't do leading-edge work, subsidiaries spend more than outsourcers to attract and retain staff, according to Forrester. Conversely, outsourcers provide staff growth opportunities and the chance to work on a variety of projects from various customers, Apte said.

As the Indian subsidiary does not have processes in place for offshore development, it has to rely on staff skill to get the work done, and hence hire more senior and expensive employees. "Captive centers are hiring people with an average of eight to nine years of experience for low-end work for which vendors would use staff with an average of two to three years experience," Apte said.

Outsourcers like Symphony Services are benefiting from the shift away from setting up captive centers. Symphony offers outsourced product engineering to software companies. Over the last 18 months, the company has integrated seven captive centers into its own operations, said President and CEO Gordon Brooks. About 1,000 staff members from these captive operations have been absorbed by Symphony's operations in India, he added.

"Part of the reason this is happening now is that Symphony and others are getting to scale," Brooks said. "So there is a viable option for a lot of these companies to take under-performing centers and transfer them to us."

The definition of core activity is changing for software companies, said Ajay Kela, COO and managing director of Symphony. For product software startups, for example, product engineering is progressively becoming noncore, with the focus shifting to thinking up the product, getting it to market, and then marketing it, Kela said. Some of Symphony's customers are startups that lack in-house engineers, he said.

Despite data in favor of outsourcing, a large number of multinational companies continue to invest in their own Indian operations, and more companies are setting up subsidiary development centers in India. Semiconductor and systems vendor LSI, for example, has about 1,000 staff working at its development centers in India.