Vendors Buying Up Capabilities
As providers increasingly bring high-quality, standardized delivery models to the market for midsize companies, the potential value of end-to-end HR outsourcing becomes more evident. But the market is still small, and few providers are prepared to offer a complete set of fully developed services.
Companies looking for a comprehensive HRO provider are often confronted with vendors that have rich offerings from their legacy business but a much lower ability to deliver other services. Vendors are addressing the shortcoming by acquiring firms that provide complementary service lines.
“HRO companies are pursuing acquisitions to expand their services and become comprehensive HRO providers for the midmarket,” says Cherie Smith Homa, managing director for KPMG Corporate Finance’s investment banking practice. Smith Homa advises midmarket companies on outsourcing strategies and believes that the HRO acquisitions trend will continue in 2007.
KPMG’s research reports 60 HRO acquisitions in 2006, reflecting a high level of consolidation in the industry. “A lot of the HRO providers are focusing on acquiring talent management providers,” Smith Homa says. “Four of the 10 deals that occurred in October and November were talent management or applicant tracking deals.”
In October, ADP snapped up VirtualEdge, a recruiting and talent management firm, and Employease, a Web-based HR provider. ADP did not disclose the terms of the acquisitions.
“ADP’s acquisitions in 2006 and the guidance its management is providing to the market clearly signal that ADP sees huge opportunities in the midmarket and is building services to reach down into it,” Smith Homa says. Outsourcing hinges on advancements in technology, she adds.
“Large HRO providers are focusing on the midmarket, and a number of smaller private companies are also focused there,” Smith Homa says. All the providers are pushing pure economies of scale. So much of HR is bound up in technology, and the HRO providers have already made the investment.”
Based on market capitalization, ADP is by far the largest of the HRO providers, according to KPMG’s November valuation update, which covers companies anchored in a single service line—some of which could move into multi-process and comprehensive HRO.
The primary advantages of moving to comprehensive HRO for midmarket companies is that the HR function gains the expertise needed to ensure compliance and improve processes, Smith Homa says. “Companies are increasingly realizing that when HR goes wrong, whether it’s with payroll administration or benefits programs, it harms employees and the whole company.”
Smith Homa says it’s difficult to determine which companies will become the top comprehensive HRO providers for the midmarket, but she believes companies that have served larger clients have an advantage.
“They need to offer a more simple solution for the midmarket, however, and one that is priced appropriately,” she says.
Smith Homa also notes that in the midmarket the number of contracts for comprehensive HRO is small and growth is difficult to gauge. “It’s not like the large-enterprise market where press releases are issued when a provider lands a large deal,” she says. “In the midmarket, no one deal is going to move the dial, but 12 months from now the number of contracts will look very different.”