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HR Outsourcing Grows Up

December 19, 2006
Related Topics: Outsourcing, Featured Article
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Seldom do human resources stories make big news. But the billion-dollar deal that Accenture recently struck to take over Unilever’s HR processes captured the attention of business readers around the world.

    The Accenture-Unilever story is only the latest in a slow but steady stream of big HR outsourcing deals. The first of those was in 1999, when BP handed over many of its HR processes to startup outsourcer Exult in a $600 million, seven-year contract.

    Companies have long outsourced peripheral functions like payroll, but the idea of handing off a core staff function is still controversial. Is this the end of HR as we know it? To answer that question we need to understand what HR outsourcing really is.

Defining HR outsourcing
   Accenture will be handling Unilever’s recruitment, performance management, reward administration and a number of other HR functions. Even so, it is clear Unilever isn’t outsourcing the selection of new employees or decisions on how to manage performance.

    What are being outsourced instead are administrative functions, a practice more large companies almost certainly will adopt.

    "The dividing line between what is and isn’t outsourced is fairly simple: anything that is process-driven can be outsourced; anything else stays in house," says Phil Wilson, who as senior vice president of human resources led the HR administration outsourcing project for the Canadian Imperial Bank of Commerce (CIBC).

    Once upon a time HR administration meant rows and rows of clerks, but today it means stacks and stacks of computers. In fact, the explosion in cost and complexity of HR software is a major driver for outsourcing.

    "At the time of our decision to outsource HR administration we were looking at a cost of $40 million to implement PeopleSoft HR software," Wilson says of the bank’s 2001 outsourcing deal.

    By handing off to Electronic Data Systems Corp., the systems integrator based in Plano, Texas, the bank didn’t have to take on that expense--or that headache. (In 2005, EDS joined forces with Towers Perrin to create a jointly owned HRO business, ExcellerateHRO.)

    In addition to technology, HR administration relies on call centers to field questions from employees. Managing these calls centers is a big part of the expertise offered by HR outsourcers.

    Organizations like Unilever, BP and CIBC are outsourcing administrative HR but still have a significant internal HR function. The difference is that HR won’t be directly handling the technology, call centers and other process-driven activities that used to account for a big part of their department.

Understand the economics
   Having cleared up the "what" of HR outsourcing, we are still left with the question of why companies want to do it at all. It is easy to see how a big outsourcer could have economies of scale over the HR department in a midsize company. And yet, this is not the market being served by the big outsourcers; the target market for outsourcers like IBM, Hewitt and Accenture is companies with more than 20,000 employees.

    "There are no economies of scale to be had by taking over the HR operations of these very large companies," says Kurt Ronn, president of HRWorks, an Atlanta-based recruitment firm that does recruitment process outsourcing. "The big outsourcers are striving to offer a pricing model where they deliver the same service that internal HR administration provided but for 20 percent less cost. I don’t think they can do it."

    University of Southern California professor Ed Lawler notes another oddity of the business.

    "What is surprising is that the companies pursuing outsourcing are not the ones who were struggling with HR. It’s the companies with very good internal HR processes who are signing up for outsourcing," Lawler says.

    In other words, companies that outsource HR administration really don’t need to do so. Why do it? Clearly, they are attracted by the deal that outsourcers are offering. If an outsourcer promises to deliver the same service while significantly reducing costs, then that’s an attractive offer. The question becomes: If there are no real economies of scale, can outsourcers deliver?

    "There is a lot of interest from the senior executive suite [about] the opportunity to get transaction services as an end deliverable and avoid the challenges around handling transactions in the organization," says Michael Janssen, managing director for the Hackett Group. "A lot of IT was outsourced because companies didn’t want their CIOs worrying about a failed tape drive."

    Similarly organizations don’t want HR personnel spending their time chasing lost payroll checks, Janssen says.

    Outsourcing, however, represents a new industry with a smattering of vendors and few mature implementations. It is not surprising that difficulties crop up in such ambitious projects.

    "There are the expected complaints, but no one is going backwards," Lawler says. "I hear this company is dissatisfied or that company is dissatisfied, but that sounds to me like the predictable ‘after the honeymoon’ complaints."

    "When all is said and done, there is really no crisis or disaster," Lawler says. "Maybe our expectations weren’t all met, maybe the costs savings weren’t as great as we hoped, but there is no evidence that the concept is wrong or that the HR administration outsourcing industry isn’t going to continue to grow at 25 percent a year."

    Wilson says that there genuinely are advantages, even for a big company like CIBC, to outsource HR administration. It’s doubtful that EDS (CIBC’s outsourcing partner) knows more about recruitment processes than CIBC’s HR department, but it certainly knows more about managing big software projects and call centers.

    "It’s not just cost savings we were after, it was predictability of costs," Wilson says. "With EDS we know what we will be paying for the next 10 years. That’s very attractive to the CFO. So there is a risk management component to HR outsourcing."

    There is yet another reason why companies with both internal economies of scale and good HR departments are pursing outsourcing, and the reason is wrapped up not just in economics but in current beliefs about how best to run an organization. Companies outsource HR administration not just to save money, get better service or reduce risk; they do it simply because they don’t want to be bothered with an activity that is not core to their business.

    There is the sense that if HR practitioners can shed the administrative burden, they could begin to focus on strategic issues that contribute to top-line revenue.

The beauty of small outsourcing
   While the business world debates the pros and cons of big HR administration outsourcing deals, the niche outsourcing players are happily running successful businesses.

    Payroll has long been outsourced to providers like Ceridian Corp. and Automatic Data Processing Inc. Synygy Inc. built a solid business in outsourcing the administration of sales commissions. Companies rely heavily on third-party specialists to deliver training, although they usually don’t call it outsourcing. As well, recruitment process outsourcing has played an important role for many companies, including well-known organizations like Kellogg Co. and Home Depot.

    "Home Depot outsources a range of recruitment processes to us such as the leadership programs and most of store-management hiring. But we haven’t replaced their recruitment function; we complement it," says Ronn of HRWorks. "We can provide specialist skills and scale when and how they need it. Recruitment process outsourcing simply makes things easier for Home Depot without it being a hugely difficult project."

    Ronn explains: "Recruitment process outsourcing is best when it is a partnership toward achieving a business objective rather than just a cost decision. There are some portions of the recruitment process that companies can do better themselves. The best solution depends on the business objective. All-or-nothing doesn't usually work well."

    The fundamental advantage of niche HR outsourcing is that organizations can get exactly the kind of support they need. Each niche arrangement will have a clear value, and if it ceases to do so, then the deal can be readily terminated. The disadvantage: A big company could easily end up with dozens, even hundreds, of outsourcing partners.

    A second disadvantage is that while niche outsourcing reduces the administrative burden on HR, it does not have the same transformational impact as outsourcing every function. If a company truly believes the future of HR should not include HR administration, it may want to make the leap into a big outsourcing deal.

What outsourcing means to HR departments
   The first thing to happen when a company begins to outsource HR administration is that employees either are transferred to the outsourcing firm or they are let go. The former outcome, while no doubt disruptive, could very well be a good move for HR professionals, because they will be working in a firm where HR is the core business, not a second-class staff function.

    "The second round of layoffs," says Lawler, "occurs after a few years, when companies discover the HR generalists they retained--thinking they would take on more strategic work--are not up to that task."

    Once again, this points to the fundamental reasons why HR administration outsourcing is happening at all: the belief that once they shed their administrative burden, HR functions somehow can leverage human capital to improve performance throughout an organization. From the perspective of a CEO that end result is, or should be, a bigger story even than cost savings or risk management.

    Outsourcing is one of several trends that are accelerating an essential evolution of the HR function, says John Boudreau, a management professor at USC.

    "HR is in the throes of a dramatic extension of what it delivers to the organization. People talk about HR being ‘strategic,’ but that is a vague term," Boudreau says. "What we see happening is that HR is beginning to focus on improving the decisions leaders make about investments in talent."

    "This is quite different from managing compliance or delivering services," areas that are now targets for outsourcing, Boudreau says.

    He likens what is happening in HR to the evolution of the finance function as a "decision science" separate from accounting, or the evolution of marketing as a decision science separate from sales.

    "There is an emerging HR decision science: ‘talentship,’ " Boudreau says.

    Many companies will continue to have traditional HR departments. However, interesting career opportunities are emerging with outsourcing firms, while the evolving world of talentship will attract the very best talent the business world has to offer.

    The future of HR outsourcing will be complex.

    Large outsourcers need to find their way to profitability while better meeting client needs. Niche outsourcers likely will grow as outsourcing gains increasing credibility.

    The big story will come when some company figures out how to deliver HR outsourcing to the vast number of midsize and small companies--the ones who really could benefit from the scale and expertise that outsourcers bring.

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