In the Path of Trailblazers

As outsourcing contracts come up for renewal, ponder these lessons learned from the pioneers who blazed the HR BPO trail.

By Ann Pomeroy Mar 1, 2005
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HR Magazine, March 2005They’re known as trailblazers—risk-takers who try something new and untested before everyone else. In HR outsourcing, the pioneers were those companies that embarked on total HR business process outsourcing (BPO) in the late 1990s while most companies still debated whether or not to farm out one or two HR functions.

Fast-forward to today, as the BPO industry stands poised to explode, and a handful of those pioneers are in the process of renegotiating the huge contracts they signed five or seven years ago. (Some are renegotiating midway through their long-term contracts.) These pioneers must decide how to go forward with their original outsourcing provider—or even whether to go forward with their original provider—and they have some concrete information that wasn’t available the first time around. Employee and customer service usage trends, information about how well company needs are being met, and other hard data collected during the first contract period can help them—and HR professionals considering jumping into HR BPO for the first time—negotiate lower costs and improved service quality for the future.

Set Your Course

For those considering BPO for the first time and for those whose contracts are up for renewal, the first piece of advice is to figure out what you want out of the deal. “Sure, you want to save money,” says Robert Crow, senior consultant at Watson Wyatt in San Diego, “but first and foremost, [you need to determine] what you are trying to do. Are you trying to deliver a certain level of quality of service, a certain level of accuracy, a certain level of responsiveness to your organization?” If so, he says, the next question is, “What are you willing to pay?”

One HR executive at a large corporation (who spoke anonymously while contract negotiations were under way) agrees that companies should be clear on what they’re asking for when they set up the contract. “Do you want to be in the engine room watching the wheels turning all the time?” he asks. “Or do you want to be more hands off?” Deciding ahead of time will help guide the contract in the right direction.

Experts agree that issues like data privacy, business continuity, protection of intellectual property and Sarbanes-Oxley Act support are of increasing concern and need to be more carefully addressed in tomorrow’s contracts than they were the first time around.

HR professionals also should be aware that vendor-buyer relationships today are becoming more collaborative and are focusing on business strategy, rather than solely on tactical operations. Kevin Campbell, market strategy and development leader at Hewitt’s outsourcing practice in Charlotte, N.C., advises companies to ask their outsourcing provider how it can help with such business issues as rising health care costs, pension costs and global sourcing. After the issues are identified, you can develop a “good commercial construct that works for both sides. Win/win shouldn’t mean that one side won twice,” says Campbell.

Campbell advises companies considering renewal to “look in the mirror” and ask themselves some questions: “What was my part of that bargain, and did I keep it? Are both sides committed?”

Remember, though, that business priorities change every two or three years, and the future is unpredictable, says Campbell, who warns that “writing a contract based on the past is like driving down the street looking in the rearview mirror—you get in a lot of accidents that way.”

Even if everything worked like clockwork during the life of the first contract, companies need to review the arrangement carefully before renewing. Scott Gildner, an outsourcing adviser and president of Gildner & Associates in Scottsdale, Ariz., advises clients to benchmark their relationship—cost, quality, value, and terms and conditions—against current marketplace norms.

A common mistake, he says, is to think that “if they get a deal kind of like the one they have, that it’s a good deal.” Prices have fallen 10 percent to 15 percent during the last five years, says Gildner, so a new contract will be overpriced at the previous level. He advises companies to test the market because he expects prices to continue to fall for the foreseeable future.

A factor in HR’s favor when renewal time comes around, he says, is that it requires great time and expense for vendors to respond to requests for proposals, so they are “motivated to work with companies to renew rather than [risk their] going to market.”

Another common mistake, says Gildner, who is co-authoring an upcoming book on HR outsourcing to be published later this year by the Society for Human Resource Management, is failing to make the agreement specific enough about the provider’s responsibility in tying up loose ends when the contract expires or is terminated. “Always write for the end of the agreement,” he advises.

How Long?

In addition to knowing what they want, companies need to give themselves plenty of time to ensure that they get it. Gildner warns his clients to begin reviewing the contract at least 12 to 18 months in advance of the expiration date. If you wait too long, he says, you’ll have no leverage in the negotiations and therefore “no option but to renew.” Renewals offer a great opportunity to “fix everything that doesn’t feel right in the relationship,” says Gildner. One thing that may change is the length of the contract. Gildner says he sees no benefit in committing to a long-term renewal, because amortization of up-front costs is complete. “I think two to three years is long enough [for a renewal period],” he says. “There is seldom a reason to go over three years.”

Opinions vary about the optimum length for renewals, however. Kevin Berchelmann, president of Triangle Performance LLC, an outsourcing provider in Bellaire, Texas, thinks a year is long enough, whether it’s a renewal or a first contract. Berchelmann recently signed a 12-month contract with a small company (about 400 employees). “I think we are about to see the last of the seven- to 10-year contracts,” he says. “I’d be shocked to learn six months from now that people are signing these long-term contracts.”

Crow says renewal term length is unique from company to company, depending on what the organization is trying to accomplish. A year for renewal may be fine, he says, if a company has recently gone through an acquisition and “just needs another year to finish out,” or if it is testing a vendor’s capabilities. In general, he thinks three to five years is a good length for mid-sized and large companies.

Because of the increasing number of outsourcing providers competing for business today, “the pricing of a three-year deal now is just as good as a seven-year deal [was in the past],” Crow notes. There is no need for a company to lock into the longer term, he believes.

“If you are only looking at cost,” says Glenn Davidson, chief of market strategy and corporate development at Accenture in Reston, Va., “a shorter contract may be better.” If you want to build a collaborative relationship with your vendor, however, Davidson advocates a five- to 10-year contract that can be renegotiated midway if necessary.

Because these contracts are so complex, companies understandably don’t want to go through the pain of setting up a new contract more often than necessary. David Dell, president and CEO of Sustainable Profitability Group, a business development, investment and research firm, and author of a series of reports by the New York-based business research firm The Conference Board, says there is “no reason to assume that a well-structured agreement shouldn’t last a good while. Five years comes up sooner than you think.” Even small companies should consider long contracts, he believes, because “the cost of changing everything is large and visible and the same,” no matter what the size of the company.

Forging a Partnership

Indeed, terminating a contract involves very expensive transition costs, says Danny Ertel, founder and director of Boston-based Vantage Partners, a third-party outsourcing consultant. Besides, he says, it can be scary to think about starting over, given how much time, money and effort has gone into the process. It may be a matter of “better the devil you know,” he says.

One thing the early BPO users learned was to be careful about with whom they chose to enter into a long-term contract.

How do you know you have found someone you can work with for five years or more? A good buyer-provider relationship has several characteristics, which can be tracked objectively, says Ertel. One example is an effective issue-management process that examines the kinds of issues the company has and how they get resolved.

Most important, though, is trust, which falls into the category of “I know [a great relationship] when I see one,” says Ertel. Mutual trust and respect between the buyer and the vendor allows them to create value by coming up with solutions that are not in the contract as more information becomes available.

Being flexible in today’s changing environment is also important. “No matter how much due diligence the company conducts,” says Ertel, “things change, even before the ink is dry on the contract.” Companies merge, they acquire other companies, they grow or contract.

But even a trusting relationship requires structure, so Ertel advises companies to “spend time getting governance right and making it very operational.” Ask questions about the relationship: What is each side trying to do and what’s going to make it difficult? Is the relationship complex or straightforward? Above all, both sides need to agree on the business reason for the relationship.

“Once you’ve done that,” says Ertel, “you can plan how the relationship will work.” That may involve putting in place protocols for decision-making, good mechanisms for managing conflict and problem-solving, and agreeing on scope management procedures and change management methods.

Managing the relationship well is also a bottom-line issue—one in which trust is key. value is destroyed, says Ertel, when companies don’t trust their provider to do a good job. They waste resources on “shadowing the provider,” he says. They also waste vast amounts of time dealing with escalating conflicts, sitting in unproductive meetings that fail to resolve the issues and doing work themselves that should be handled by the outsourcer.

This is the stage at which third-party consultant Ertel often is called in to help repair the relationship, he says.

Third-Party Advisers

Another lesson learned from the first-generation contracts is the need for third-party help in negotiating complex contracts and covering all the issues.

Where demand has increased so has supply of the number of outsourcing advisory firms to help companies navigate the process.

“It’s ironic how ill-prepared HR organizations are to manage all the changes involved in outsourcing HR functions, including managing the outsourcer relationship,” says Ertel. “How you manage that relationship has everything to do with getting the value you are looking for,” he says, whether that value is cost reduction, business transformation, process improvement, “or just having one less thing to worry about.”

Dell agrees. He says HR departments “haven’t been effective in using consultants, either in choosing the right ones or in using them to strengthen the outsourcing relationship.” Recent Conference Board surveys found that only about half of outsourcing deals were set up with the help of consultants and that only 33 percent of respondents hired outside legal counsel. Dell says that is beginning to change, with lawyers and consultants being brought in early in the negotiations rather than at the end.

Although the cost of this outside help can be high, ranging from several hundred thousand dollars to a couple of million dollars, according to Dell, it can be worth it. “Doing a major outsourcing operation is much more than a back-of-the-envelope activity. It’s quite intricate, and it needs people who know what they are doing,” he says.

What Does the Future Hold?

The trend toward total outsourcing of HR business processes is expected to continue for the foreseeable future. “HR BPO to date has been the enclave of the large firms,” says Davidson, “but that is changing.” As prices head downward, Davidson expects more mid-sized companies to get into the HR BPO market.

“Four years ago, you couldn’t find many companies that thought [HR BPO] would work” for them, says Dell. Companies didn’t believe it would save them money, he says. Even large organizations that had outsourced other business functions for years were leery of total HR outsourcing because of the complexity involved in outsourcing multiple types of interlinked services at various global locations.

However, companies have discovered, says Dell, that HR outsourcing not only can save money, it also can improve services, help avoid capital costs and, most important, help professionalize the HR function by freeing up the remaining staff to focus on strategic issues.

Davidson says he began noticing more companies “shopping” about a year and a half ago, as they explored the possibility of outsourcing some of their HR functions. “A year and a half later,” he says, “they’re not shopping; they’re buying.”

Ann Pomeroy is senior writer for HR Magazine .

An Early Adopter  

One of the first large companies to sign an end-to-end business process outsourcing contract was Newark, N.J.-based Prudential Financial, which has nearly 30,000 employees worldwide.

The first step in planning a move to total HR outsourcing, says Sekhar Ramaswamy, Prudentials vice president of planning and human resources administrative services, is to get really clear about what you are doing and why you are doing it. At Prudential, he says, HR led a cross-functional team made up of representatives from the finance, operations, legal and communications departments plus various business units, which worked during much of 2001 to answer those questions.

The company hoped to save money, of course, but Ramaswamy says Prudentials paramount goal was to move to a true variable cost model. The company had gone public in December 2001 and, in anticipation of expected mergers and acquisitions, Prudential wanted to be able to respond quickly as staffing volumes went up and down. In addition, he says, the market changed during this period, which also affected the companys staffing costs.

Along with a variable cost model, the outsourcing team placed a high value on working with a single vendor. We thought working with one vendor offered a better opportunity for integration, says Ramaswamy. It meant fewer relationships to manage, and it was a good cultural fit for Prudential.

In April 2001, the Prudential outsourcing team met with Exult (now Hewitt Associates) to begin hammering out the contract. Exult agreed that it could fulfill Prudentials requirements, and the 10-year contract, which includes the option to end the agreement after seven years, was approved and signed in January 2002.

Ramaswamy says Prudentials leaders helped the organization navigate the sometimes bumpy rides on the road to total HR outsourcing. We communicated constantly [with employees], he says, through conference calls, town hall meetings and frequently updated information on the company intranet. Although about 280 positions were eliminated as they moved to outsource 10 or 11 HR processes, Ramaswamy says company morale remained generally good, as reflected in employee opinion surveys, because workers understood the business reasons for the change. (For more information on communicating an HR outsourcing change to employees, see Spread the WordCorrectly.)

Prudential has had some good, challenging intellectual debates with our external partner, says Ramaswamy, and that is to be expected. We will have problems, so how will we work through the problems is the question to ask, he says.

Committed leaders and trust between outsourcing partners will get you through, says Ramaswamy.

Ann Pomeroy

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