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Measuring the True Benefit of Human Resources Outsourcing

Experts say it’s not all about upfront cost savings; smart companies will also consider factors like organizational performance and worker satisfaction

July 5, 2005
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When Delta Air Lines signed an agreement this year for end-to-end human resources outsourcing, it had a key goal: to cut costs.

    The No. 3 airline in terms of U.S. traffic anticipates that the deal, valued at $120 million, will save it 25 percent, or $42 million, over its seven-year term. Outsourcing also averts the need for Delta to spend $50 million on updating human resources technology.

    Saving money is vital to the struggling carrier, which posted a first-quarter loss of $1.07 billion. So a governance team will monitor 50 metrics in hope of ensuring that the deal with Affiliated Computer Services delivers on its promises.

    "We understand that promised benefits are only delivered if you actually measure and track them," says Robert Kight, Delta’s vice president of compensation and benefits.

    Human resources outsourcing is booming this year. In April, Pepsico signed a 10-year agreement with Hewitt Associates. In May, Duke Energy announced a 7 1/2-year contract for Hewitt to handle payroll, performance management and other HR back-office administrative services. So perhaps it isn’t surprising that human resources is the fastest-growing segment of the business process outsourcing sector, according to sourcing advisory firm Technology Partners International.

    But as Delta, Pepsico and others mark another swell of HR outsourcing, experts say the first wave of pacts shows the importance of firms understanding why they’re outsourcing, and matching metrics to those goals.

    "What didn’t go so well in the first generation was setting expectations," says Phil Fersht, vice president of BPO research for the Yankee Group, a technology consulting firm. "There were too many organizations rushing in. We saw initial contracts that weren’t scoped out so well. Buyers were getting pissed off with their vendors in 15 minutes."

    Companies need to look beyond initial cost savings, Fersht says, and track how outsourcing affects employee satisfaction and organizational performance.

    Outsourcing is also supposed to free a company’s HR executives to focus on more important matters, says Arthur Mazor, vice president of business development for ACS.

    "Strategic measures such as those which link various inputs to outcomes are far more critical to the business," Mazor says.

    For example, a company’s HR team can look for the link between recruitment sources and recent-hire performance results. They can connect performance rankings to training investments. They can compare employee exit data with their total rewards programs. All of those give a company a better basis for evaluating its organizational programs, Mazor says.

    The domestic market for HR outsourcing, which involves outsourcing at least three human resources functions, will reach $42 billion by 2008, according to the Yankee Group.

Finding baselines
   
Before companies seek bids, they should quantify their current service levels and costs, says Robert Brown, a principal analyst with research and advisory firm Gartner Inc.

    Employers won’t know if they’re setting the bar too high or too low, or if outsourcing is right for them, if they don’t know their starting point.

    If they lack in-house resources to determine baselines, they should consult an impartial third party, Brown says.

    "One of the things that we advise Gartner clients to do is to really take a hard and long look at their motivations for outsourcing and come up with metrics that govern the relationship around those," he says. "The last thing you want to do is abdicate the setting of metrics to your outsourcer. It would be like the fox guarding the hen house."

    When BPO deals disappoint, the failure often is caused by not setting expectations upfront and instead concentrating solely on service levels that govern the contract, Brown writes in a recently issued report.

    Linda Merritt, human resources strategic planning director for AT&T, agrees that companies risk disappointment if they don’t structure their deals to match their expectations or fail to consider how their expectations might evolve.

    "I advise people to think about not what you want on Day One but what do you want in Year Four, Year Five, Year Six—and think about how you’re structuring the deal that will allow that to evolve or develop over time," Merritt says. "If you focus solely on cost, you’re going to find vendors out there who can run your basic services quite well and quite comfortably. But if you want some of these other things of value-added planning and improvements, you have to structure the deal a little differently to not have expectation gaps in Year Two or Year Three."

    In 2002, AT&T signed a seven-year agreement with Aon Human Capital Services to provide end-to-end human resources administration.

    Three years later, AT&T executives say the agreement has provided quality service and double-digit savings, the chief goal. One reason for the success: aligning the deal’s structure, expectations and its 45 metrics, Merritt says.

    "Our expectations were modest," she says. "We were dealing with cost. We didn’t go in with the idea that we were going to change out a whole new generation of everything. From that point of view, we are very satisfied."

    The prospect of cutting costs is often what motivates companies to consider outsourcing.

    And though HR outsourcing vendors say savings can range from 15 percent to 25 percent, long-term data on net savings is scarce because of the infancy of the market. In 44 percent of the cases, net cost savings remain "undetermined," according to research by the Bureau of National Affairs.


"What didn't go so well in the first generation was setting expectations. Buyers were getting pissed off with their vendors in 15 minutes."
--Phil Fersht, vice president of BPO research for the Yankee Group


    But several analysts say that after the initial excitement about potential savings, savvy companies focus on business metrics like productivity, profitability and employee satisfaction.

    A recent report backs up that perception. Hewitt Associates surveyed 129 companies and found that 45 percent didn’t deem cost savings as a top goal for their human resources outsourcing. The top three reasons cited were gaining outside expertise, improving service quality and focusing on the core business.

    "The benefits of outsourcing to me are around structure, standardization, efficiency, technology, compliance and risk mitigation," says Bob Crow, a senior consultant for Watson Wyatt Worldwide’s strategic sourcing practice. "The yet-to-be-proven are radically improved service levels and cost reduction on an ongoing basis."

Keeping score
    To track performance, Crow recommends that companies create an "outsourcing scorecard."

    The scorecard should link outsourced services to objectives such as improving technology and efficiency and include metrics to evaluate results, he says. It will help answer questions like "Do I have better technology than I had before?" "Am I doing it for more or less money?" and "Are my processes more efficient?"

    "Based on whatever reasons you decide to outsource, you should mutually develop measures and metrics with your vendor to ensure that those objectives are being met and achieved on a regular basis," Crow says.

    Metrics frequently sought by clients include data on cost per person, service levels, accuracy of work, timeliness and customer satisfaction, says Larry Kurzner, senior vice president with Aon.

    "That whole paradigm of the HR professional acting more strategically and less tactically, the only way they can get strategic is to get the data so they can be strategic," Kurzner says. "Firms like ours collect it, crunch it and deliver that data."

    United Parcel Service, the world’s largest package carrier, says outsourcing has allowed it to do just that: focus on its core competencies. Since the late 1980s, it has gradually increased its human resources outsourcing. UPS now outsources 401(k) management, health care administration, the hiring process, employment verifications, relocation services, new-hire compliance data, administration of retirement plans and its bonus stock program.

    "We simply came to recognize that there were outside experts who could do a better job than we could in certain areas," Lea Soupata, senior vice president of people programs for UPS, told attendees at a conference in April. "Cutting costs, by the way, was not our primary consideration, although it was a nice bonus."

    When cost reduction is a goal, it may take self-restraint on the client’s part, not just the vendor being responsive.

    AT&T prevents costs from sneaking up and eroding savings by having the outsourcing governance team screen requests to see if the work falls within the bounds of the agreement and, therefore, won’t cost extra.

    "If people can go unconstrained directly to any service provider and order service," AT&T’s Merritt says, "history has shown they tend to spend as much or more as they ever did."

Buyer's market
    With the intense rivalry to win contracts, buyers are getting better deals because competition has driven prices down. For contracts covering more than 25,000 employees, advisory firm Everest Group estimates that the average per-employee, per-year price fell 33 percent to $358 in 2004, compared with prices averaging $538 from 1998 to 2003. For smaller firms, the price fell 50 percent during the same period to an average of $540 from $1,082.

    The downward pricing trend means buyers should realize what might be a good price today may not be a good price tomorrow, says Michel Janssen, president of the supplier solutions division at Everest Group. "From a buyer’s perspective, they should think about doing deals that have pricing deflators built into them," Janssen says.

    Despite industry buzz, experience suggests that comprehensive outsourcing deals might not be the best route for everyone.

    Companies that use a mix of in-house resources and outsourcing appear to operate in a "sweet spot," according to a Watson Wyatt survey released in May.

    They have relatively low budgets and have fewer HR staff members per full-time employee than their counterparts in firms that primarily handle human resources internally or primarily outsource.

    "At either extreme you may end up doing something that may not be truly optimized," says Rick Hubbard, global director of the technology solutions practice at Watson Wyatt in Cleveland.

    Another trend on the horizon: buyers wanting more per-unit pricing and cost data, says Robin Rasmussen, managing director of HR research at EquaTerra, which advises companies on outsourcing decisions.

    Many of the pioneering comprehensive agreements guaranteed a certain percentage of savings compared with baseline costs.

    "Customers are getting more sophisticated," Rasmussen says. "They’re saying, ‘I need to understand where that’s coming from. If it’s coming from squeezing a third-party provider, that might not be a good idea. We want to understand how you’re going to get those costs out.’ "

Workforce Management, July 2005, pp. 76-77 --Subscribe Now!

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