Human Resources Outsourcing: Where’s the Value?
We recently completed an analysis of the value a series of outsourcing programs had created for a very large company. That company had never truly baselined and tracked value outsourcing programs had created. So, the exercise was similar to a paleontology event trying to find the old bones. The client had created value through offshore labor arbitrage, but because senior executives didn’t enforce a “take it to the bottom-line” approach to outsourcing, which is what they had desired, day-to-day operations leaders years later continued to expand outsourcing relationships - with absolutely no savings. Instead, continued expansion was driven by limited investment in automation and process improvement. If the client had invested in technology and process improvements, there would be no need to keep some resources - regardless of where they were located.
Human resources outsourcing has a similar problem…and today we’ll look at the value Human Resources Outsourcing provides. Rather, what it fails to provide.
That’s right, HR outsourcing provides very limited value other than labor arbitrage and reduced capital spending for a vastly neglected internal department (which we’ll explain the reason for in a moment).
The proponents of HR outsourcing tout the savings outsourcing provides, which is generally focused on centralizing and providing state-of-the-art Tier 0 or Tier 1 self-service and call center functionality and supposedly standardizing/providing better deals with enormous number of HR vendors (e.g., printing companies, benefits/insurance, regulatory filing consultants). In some cases, outsourcing provides a significant one-time upgrade to poorly performing internal organizational process: employees wait less to speak with HR teams, self-service information reduces costly high-tough transaction volumes, and outsourcers’ internal teams or their external vendors for insurance provide vastly improved leave of absence management, and other services.
The problem is that these solutions all focus on the cost of the Human Resources department. Let’s be honest here and say that it’s true many human resources teams have long ago lost their strategic focus. Consequently, they have lost their relevancy to the company and justify their existence based on reduced risks (e.g., fewer lawsuits, better employee attendance). Not surprisingly, HR teams receive low or even substandard funding. In tough years, they get even less. Luckily, technology costs have dropped substantially, and many HR teams can now afford HR intranets and portals to provide policies, tools, and communication to managers and employees.
Still, HR teams are pressured greatly by ever dwindling budgets or budgets that do not support expanding employee counts in other teams. The ratio of HR employees to other employees has climbed from 1:50 to often 1:200 or 1:300…or even more. Stuck with the need to provide services on a reduced budget, HR executives turn to Human Resource Outsourcing companies. We’ve met with all the big names and seen their sales pitches about how HR can improve its process performance by outsourcing.
Sadly, most of these companies provide service from costly locations, often from the US or Western Europe. So, labor arbitrage is a one time 10-20% “benefit” companies get from eliminating tenured HR professionals or HR professionals located in expensive areas and hiring the vendor to provide less expensive, less-seasoned employees in cheaper locales. Maybe the company will get that big PeopleSoft upgrade that it so desperately wants (or needs, if Oracle stops supporting older versions many HR teams use). That saves a few million dollars, for sure, as does the reduction in IT staff necessary to support expensive packaged applications.
By now, you can sense our skepticism about Human Resources outsourcing. There’s a pretty good reason, too.
That’s because, with all respect to Philip Fersht’s blog entry at Horses for Sources, and he’s a pretty on the money guy you should trust, the purpose of HR isn’t to be a “driver and facilitator of sound HR practices”. That’s table stakes and represents the bare bones minimum requirements of HR’s service. It’s also the core competence and sole solid service of all the human resources outsourcing vendors.
The purpose of human resources is to manage the cost and performance of human capital. Human capital represents a significant cost to companies - it’s what we pay for our employees. It’s the organization, alignment, and performance of teams and individuals. The true purpose of human resources is to help the company reduce the cost and improve the efficacy of human capital.
Let’s put it this way: a 20% reduction to the cost of delivering human resources services in a large company with a $50M human resources budget is a miniscule $10M as compared to the other $1.5B the same company may spend on human resources.
A good HR team attempts to create a 3-5% impact to the the $1.5B cost of employees. Now, that’s a big impact that absolutely no HR outsourcing vendor is going to contract to. In fact, HR outsourcing vendor don’t even have that level of competency or, in the case of the consulting firms who have created/purchased outsourcing teams, are too expensive and too distant from the clients’ core operations to create an impact.
The truth is that HR teams’ small capital budgets and thusly low efficiency is the result of years of focusing on intranets, portals, IVRs, etc. that create a minor impact to HR budgets. Mired in years of underinvestment, its no surprise HR executives are pulling their rip-cords and outsourcing the entire lot of expensive service for a tiny 10-20% one time savings (that will continue to increase year over year due to vendor COLA adjustments) and a nice one-time upgrade of HR systems they could otherwise not afford. Afterwards, they look pretty good with a smaller budget and better service that is impenetrable to further budget cuts due to vendor contractual requirements. There’s no where else to cut after an HR outsourcing deal, except if you want your employees to talk with Indian HR agents. It’s all great until the contract is up and the vendor raises their rates to “market”, as all vendors do when they own your butt at the end of a 4-6 year outsourcing contract. Explain that to your CFO and your business partners…
Furthermore, I’d suggest that HR is the one part of the company with the lowest level of vendor management skill. Compare HR to IT or Operations. Who understands operational know-how most? Who is more likely to employ a true operational-focused vendor manager in the key vendor management lead role? Hence all the problems already in HR’s core operations.
Now, ask yourself if HR outsourcing brings a company closer to their true strategic mission. Ask yourself if HR outsourcing automatically brings a company more than a one time, minor savings event. Ask yourself if HR outsourcing as managed by a HR professional is more likely to succeed as compared to a call center outsourcing program.
The contrarian will now make the Michael Porter “focus on the core” argument, suggesting the HR outsourcing will free the HR team from focusing on associate complaints or open enrollment and allow them to focus on strategic issues. There is some truth in that argument. However, I cannot remember the last time I saw an outsourcing deal which 1) reduced $10M in annual internal costs, 2) avoided $5M in capital expenditure over the contract term, and 3) funded a larger team, costing an incremental $2M, of super strategists that would focus on core responsibilities. Outsourcing professionals know that #3 doesn’t happen often and good business practitioners would guess that the same team that had $10M of “opportunity” and a litany of service issues probably wont pull of a transition from being a poor operations manager to a enterprise strategic player. At the very least, few business executives are going to put their butts on the line and suggest that $2M can reduce the cost of human capital by 3-5%. That’s the type of gamble that few will take and fewer can succeed at.
Otherwise, they’d already be doing it…
We’d love to hear your thoughts! Let’s us know what you think by commenting below.
This entry was posted on Saturday, December 29th, 2007 at 7:14 pm and is filed under Discipline, Human Resources Outsourcing, Outsourcing, Outsourcing Vendor Management, Vendor Management. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.
on December 30, 2007 at 9:18 am Phil Fersht wrote:
A very good and informed write-up - the HRO situation you describe is certainly typical of many of these ventures, especially where you state “Let’s be honest here and say that it’s true many human resources teams have long ago lost their strategic focus”. Not only that, where functions, like HR, are constantly resistant to change (i.e. HRO), it is very difficult to drive any innovation without bringing in an entirely new team of people to run the function, and conducting a complete review on how to re-focus the role of the HR function in the organization (my definition of innovation here is ongoing cost-reduction, ongoing HR technology improvement, and added rigor and quality to processes). I have also seen similar issues with some Finance & Accounting and IT outsourcing cases, where the strategic focus of many finance functions had been pretty limited… bottom-line, when you’re outsourcing something that wasn’t exactly cutting-edge to begin with, you need to focus on working with the provider to re-engineer the way the function is managed and delivered, structure and determine the retained organization effectively, in order to drive some “strategic” value from the outsourcing experience. As much as I detest this phrase, simply trying to run a company’s “mess for less” isn’t going to deliver a lot of value, and - in many cases - isn’t going to cut a lot of cost either.
The reason why I described the role of HR as one of “facilitating and driving sound HR practice across the organization” is because I believe HR is a pervasive skill and business practice which needs to be instilled into company managers across all business functions. Whereas yesterday’s manager may have been good at training sales people, or a shrewd fiscal manager, he / she should also become adept at optimizing the performance of their talent. Yes, the role of HR is to manage, monitor and optimize the cost and performance of human capital (i.e. “sound HR practices”), but rather than HR trying to deliver this directly into the organization as a standalone business function, I believe it needs to operate more at the management level to align business functions and units with the corporate goals. Basically, if HR executives can help their key corporate leaders deploy sound HR practice into their own areas - and work with the HRO service providers where necessary to help facilitate this, they are fulfilling their role more effectively.
on December 30, 2007 at 11:59 am tony wrote:
Well, said, Phil. I completely believe that HR competencies are table stakes for managers. The folks at Manager Tools (www.manager-tools.com) have hit that nail on the head. They hand out great advice for managers to improve their effectiveness. All managers should understand management and HR laws.
Furthermore, I love your “mess for less” comment! It seems like outsourcing clients continue to hand their headaches to vendors, which in turn struggle to handle the mess. I think HR needs revamping, so much so, that I wonder whether it’s worth the hassle and risk of outsourcing.
With that said, and after a bit of reflection, I due believe that HR outsourcing is a great deal for mid-sized companies, because it allows those companies to divert energy to other areas. Large companies, on the other hand, will have such specialized processes, that I doubt that vendors can provide economical solutions given that large companies already have economies of scale.
However, it gets to the core of outsourcing opportunities: mid-sized companies should actively seek outsourcing opportunities because they do not have the capital, skill, or time to manage certain non-core functions. In turn, the same mid-sized companies should look to become “outsourcers” in their own way, building specialization that integrates and replaces some of their smaller customers’ operations.
on December 31, 2007 at 8:17 am Mark Stelzner wrote:
Interesting dialogue gentlemen. Your conversation is supporting two of my four 2008 predictions, namely that “A Major HRO Provider Will Divest” (prediction 2) and “HR Vendor Scrutiny Will Increase” (prediction 4).
According to The Hackett Group’s latest benchmarking data, an average HR department spends approximately $1,864 per employee per year (i.e., their budgetary spend). In contrast, World Class organizations spend approximately $1,614 per employee per year, largely due to operational efficiencies, shared services offerings and lower HR personnel costs/ratios through the application of self-service technologies and/or outsourcing.
Although these costs are significant, they pale in comparison to the overlay cost of employer sponsored healthcare. A comparable study by Towers Perrin shows an average health care spend of $9,300 per employee per year, with World Class spend at roughly $7,800 per employee per year. So, if HRO vendors are only attacking the HR budget, we need to see an increased investment in innovation and net-new product offerings that dramatically lower the 5x multiple of employer health care costs. There are some limited examples of this associated with absence management, HRAs and associated interventions, but we really have yet to see the HRO providers step into the limelight to strategically remove a block from the health care Jenga without toppling the system.
Happy New Year.
on January 3, 2008 at 10:36 am tony wrote:
My vendor pricing due diligence with HRO companies, both as a potential buyer of services and as a fledgling start-up that never got off the ground, supports your assumptions regarding the cost of providing HR services. Only a fraction of the HR department can be outsourced, and that fraction has only minor savings opportunities. 50% of $1800 = $900, and, if you can only save 10-20% of that, we’re talking a mere $100/employee. At the first point of renegotiation, most of the $100 is gone…
In my opinion, the risks and complexity of managing an outsourcing vendor cannot be justified by $100/employee/year. HR outsourcing just doesn’t make financial sense for large companies.
With that said, small companies can make significant improvement in their HR operations costs. However, Mark point’s out, HR’s budget is a pretty small fraction of the overall cost of employment, which ought to be the true focus of HR.
on January 18, 2008 at 7:39 am Insights on Procurement Outsourcing | 360° Vendor Management wrote:
[...] with his Horses for Sources article on HR Outsourcing. We shared our opinion on the topic in our article debating the value of HR [...]
on February 19, 2008 at 4:29 pm IT Services & Outsourcing mobile edition wrote:
[...] Human Resources Outsourcing: Where’s the Value? : Great insights on the purpose and value of firms which have outsourced their Human Resources function. [...]
on March 19, 2008 at 9:26 am Believer in HRO wrote:
Agree with much of the dialogue which is amazing since I am the believer in HRO. Having said that, I believe much of waht has gone wrong is the model that was sold in during the large wave of client signings in 2004-2005 was simply wrong. First it was lift&shift and then it was business transformation - all of which put the burden on the HRO vendor and nearly nothing on the HRO customer.
If there is to be another phase, I believe it will have to be a well defined offering - where the vendor knows what they are selling and are bold enough to not allow clients to get outside that box (while still interesting them in the offering). This needs to be combined with a 1:many model so that the vendor can provide the functionality sought by the clients but also be able to spread that cost over many and have much smaller incremental cost.
I also believe that HRO vendors need to stop playing in non-value added spaces - which includes areas like recruiting, perf mgmt, learning, and others. These industries are highly fragmented with no clear leader, these vendors do much of what the larger outsourcer does, and the outsourcer adds very little value. The fact of the matter is that it is these ‘other’ domains that are killing the vendors and the clients. The core is much clearer, crisper, and valuable.
Most HR leads do not want to handle the tactical work - too much risk, with too much politics, with too little to gain. Pass that off to outsourcer - even with minimal cost reduction - and refocus energy on other areas like handling M&A work or talent management.
Lastly, and most importantly, the HR industry has to get out of just doing what they have done in past. The world is changing, the new gerenation workforce is used to things like vritual work arrangements, social networking, streaming media and the such. The HR industry has to adapt - and then (and only then) will they actually be valuable to their companies. Handling general HR questions, creating pretty reports, and handling payroll are table stakes. It is what you do above that which will make you a great HR leader.