A Crowded Space

A growing HRO market has attracted more new providers. What does it mean for HR?

By Pamela Babcock Mar 1, 2006
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HR Magazine, March 2006 While the overall marketplace for business process outsourcing (BPO) has been somewhat tepid, the number of human resource outsourcing (HRO) deals which is a subset of BPO has been a notable bright spot for the industry. That demand has lured providers into the HRO space so many, in fact, that competition for business is heating up and may result in lower costs and improved service for some HR clients.

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A growing HRO market has attracted more new providers. What does it mean for HR?

HR professionals looking to purchase outsourced services may be able to gain both lower costs and improved service at the same time, as they capitalize on provider’s efforts to offer competitive pricing and as providers expand their skills and processes through mergers and acquisitions.

But it won’t necessarily be without some turbulence for potential HRO buyers.

The HRO market is changing and evolving very rapidly, says William Martorelli, a principal analyst with Forrester Research Inc., a technology and market research firm based in Cambridge, Mass. And both HRO buyers and providers can expect a rocky road and continued volatility and evolution in the months and years ahead.

What many HR professionals are likely to see is a marketplace that continues to experience growing pains. The fact that the marketplace is growing is clear. The total value of all HRO contracts in 2005 was nearly $6 billion up from $2 billion in 2004, according to the TPI Index, a quarterly report on global outsourcing. And Martorelli predicts that the market for multiple-process HRO will continue to increase by 15 percent to 20 percent annually for the next few years.

At the same time, however, the marketplace will continue to mature, and outsourcing providers will strive to develop and refine their business models. As a result, there are a number of factors HR professionals must understand before they can make informed outsourcing purchasing decisions.

The first step, though, is getting up to speed on the demand for, and supply of, HRO.

Demand Drivers

There are several factors driving the demand for HRO, according to Martorelli. These include marginalized perceptions of human resources, increasing globalization and the fact that existing vendors have a captive audience with organizations they already support.

Another key factor is rising information technology (IT) costs. HR executives facing the prospect of high costs to install, support, upgrade or consolidate Enterprise Resource Planning software often opt instead to outsource, according to Michel Janssen, managing research director of the Everest Research Institute, a Dallas-based firm specializing in IT and BPO. Addressing the Conference Boards 2005 HR Leaders & Practitioners New Tough Issues Forum in New York in October, he said, Technology has emerged as the No. 1 factor considered by today’s buyer of HR outsourcing services.

In addition, growth in the HRO market has been fueled by buyers expanding their current HRO contracts, adding countries to a master service deal originally drawn up only for U.S. operations, adding processes to the agreement, or adding capacity when they acquire another company and need more employees covered under the agreement, says Mark Hodges, chairman of Equators Inc., a New York-based global sourcing advisory firm.

Many clients are also opting for longer HRO contracts. While the median contract length of deals negotiated in 2005 was seven years, contract length on more recent deals is increasing upward to 10 years, making the total contract value larger.

The deal sizes are increasing, but I think it’s just because the length of the contracts and even some of the capability requirements are increasing as well, says Jason Corsello, a program manager with Yankee Group, an IT research firm in Boston. Instead of just doing a few processes, they’re adding multiple processes, and the scope and length of the contracts are increasing.

Where HRO Is Moving Forward

Currently, the discrete HR functions most frequently outsourced fully or almost fully are outplacement services, employee assistance programs, defined contribution plans, COBRA administration (for more on COBRA outsourcing, see Sending COBRA off to the Experts), and defined benefit plans, according to the 2005 HR Outsourcing Trends & Insights survey from Lincolnshire, Ill.-based HRO and consulting firm Hewitt Associates.

Of the 129 employers responding to the Hewitt poll, 94 percent outsource at least one HR function. By 2008, study participants expect to expand HR outsourcing across the board, with significant increases in the outsourcing of leave management, learning and development, recruiting, health and welfare, defined benefit plans, global mobility, and payroll. (For more information on outsourcing payroll, see Payroll: In, Out or In Between in the March 2005 issue of HR Magazine.)

According to Hodges, transactional functions currently are the most frequently outsourced processes. They include employee call centers, employee and manager self-service, domestic relocation, payroll, and expatriate administration, Hodges says. More-strategic functions are outsourced least frequently. They include HR strategy, employee development, performance management, organizational development and succession planning, Hodges says.

Fluctuations in the Field

The demand for HRO has lured many new providers into the space. And that can potentially bode well for employers.

Overall, increasing competition among HRO providers has created benefits for buyers, especially in pricing. Since 2000, the average annual price per employee for HRO has declined by 15 percent per year, says Hodges.

In general, analysts say that further price reductions are unlikely, and that prices in the market overall are likely to remain relatively stable.

Still, deals may be available for certain types of clients in certain market sectors.

For example, Yankee Groups Corsello says pricing has been affected by vendors aggressively pursuing marquee clients that are really a good match for them, and [they] are willing to be really competitive with price to land those ideal customers.

Whets more, the number of providers is rising, particularly in the mid-market range. The resulting flurry of activity could be a benefit to buyers, in terms of both price and service. In the United States, mid-market HRO buyers have at least eight providers to choose from a dramatic increase since the year 2000, when there were only three, Hodges says.

The number of specialized firms focused on strategic HR also is growing, says Hodges, and new service providers are coming both from the service provider space as well as from traditional technology product firms building out their outsourcing offerings.

He believes that a recent spate of mergers and acquisitions among HR outsourcing providers is another factor that, in general, should benefit HRO buyers and providers. The reason: Service providers can leverage more scale and add more capability.

The linkups include an agreement by industry giant EDS, in Plano, Texas, and consulting firm Towers Perrin of Stamford, Conn., to create an HRO company, and the acquisition of HRO provider Exult by Hewitt.

This translates into increased investment in improving their HRO solutions, thus providing buyers with better service over time, Hodges says. That being said, mergers between outsourcing service providers are often challenging to consummate. So, while there are success stories such as Hewitt/Exult, in other cases results have been less than stellar.Graph 4

Hodges also believes that the HRO marketplace will benefit from drawing new players into the field. The HRO market has already attracted non-HR providers, and it has been great for the market, he says. For example, Dallas-based technology outsourcing firm ACS, Convergys and IBM were previously not players in the HRO space, yet they entered the market over the last four years and have been very successful.

Satisfaction Not Guaranteed

Surveys show that HRO buyers, while generally satisfied, have mixed feelings about their outsourcing experience.

First the good news: An EquaTerra BPO survey released last May and conducted in partnership with Managing Offshore newsletter and InformationWeek magazine found that 41 percent of buyers were highly satisfied and 55 percent were moderately satisfied with their HRO's performance. In addition, more than 70 percent of HRO buyers felt that BPO has improved HR business process performance, Hodges says.

And the Hewitt study found that 89 percent of participants were satisfied or very satisfied with their current HRO arrangement and 85 percent realized hoped-for benefits from HRO.

One-fifth of companies also realized unexpected benefits, including a substantial increase in process efficiency in non-HR areas; greater discipline in demand prioritization, cost control and planning; more cost savings than expected; greater employee awareness of the outsourced benefit plan; and higher levels of employee savings in the outsourced plan, the study found.

Now for the bad news: Approximately one-fifth of respondents to the Hewitt study experienced significant problems. Complaints about vendors included poor execution; unacceptable service-level agreement performance and cost management; overpromising and under delivering, including an inability to deliver purported global service; and turnover on the vendors project team. Additional issues companies cited included underestimating the complexity of and time required for transition, organizational resistance and IT compatibility.

Almost one-quarter of those surveyed by Hewitt have brought an outsourced HR function back in-house. The functions brought back most often, according to the survey, were payroll, recruiting, learning and development, COBRA administration, and HR call center operations. It was most commonly because of poor quality of service, the study found. (For more on customer service issues in outsourcing, see Get Star-Quality Service.)

Gaining Greater value

Nathan Blain, managing director for the Corporate Leadership Council, a Washington, D.C.-based organization centered on HR leadership, says hype surrounding HRO and conflicting stories about its success have caused HR executives to question whether returns warrant large-scale HRO.

Fluctuations in the Field

The demand for HRO has lured many new providers into the space. And that can potentially bode well for employers.

Overall, increasing competition among HRO providers has created benefits for buyers, especially in pricing. Since 2000, the average annual price per employee for HRO has declined by 15 percent per year, says Hodges.

In general, analysts say that further price reductions are unlikely, and that prices in the market overall are likely to remain relatively stable.

Still, deals may be available for certain types of clients in certain market sectors.

For example, Yankee Groups Corsello says pricing has been affected by vendors aggressively pursuing marquee clients that are really a good match for them, and [they] are willing to be really competitive with price to land those ideal customers.

Whets more, the number of providers is rising, particularly in the mid-market range. The resulting flurry of activity could be a benefit to buyers, in terms of both price and service. In the United States, mid-market HRO buyers have at least eight providers to choose from a dramatic increase since the year 2000, when there were only three, Hodges says.

The number of specialized firms focused on strategic HR also is growing, says Hodges, and new service providers are coming both from the service provider space as well as from traditional technology product firms building out their outsourcing offerings.

He believes that a recent spate of mergers and acquisitions among HR outsourcing providers is another factor that, in general, should benefit HRO buyers and providers. The reason: Service providers can leverage more scale and add more capability.

The linkups include an agreement by industry giant EDS, in Plano, Texas, and consulting firm Towers Perrin of Stamford, Conn., to create an HRO company, and the acquisition of HRO provider Exult by Hewitt.

This translates into increased investment in improving their HRO solutions, thus providing buyers with better service over time, Hodges says. That being said, mergers between outsourcing service providers are often challenging to consummate. So, while there are success stories such as Hewitt/Exult, in other cases results have been less than stellar.

Hodges also believes that the HRO marketplace will benefit from drawing new players into the field. The HRO market has already attracted non-HR providers, and it has been great for the market, he says. For example, Dallas-based technology outsourcing firm ACS, Convergys and IBM were previously not players in the HRO space, yet they entered the market over the last four years and have been very successful.

Satisfaction Not Guaranteed

Surveys show that HRO buyers, while generally satisfied, have mixed feelings about their outsourcing experience.

First the good news: An EquaTerra BPO survey released last May and conducted in partnership with Managing Offshore newsletter and InformationWeek magazine found that 41 percent of buyers were highly satisfied and 55 percent were moderately satisfied with their HRO's performance. In addition, more than 70 percent of HRO buyers felt that BPO has improved HR business process performance, Hodges says.

And the Hewitt study found that 89 percent of participants were satisfied or very satisfied with their current HRO arrangement and 85 percent realized hoped-for benefits from HRO.

One-fifth of companies also realized unexpected benefits, including a substantial increase in process efficiency in non-HR areas; greater discipline in demand prioritization, cost control and planning; more cost savings than expected; greater employee awareness of the outsourced benefit plan; and higher levels of employee savings in the outsourced plan, the study found.

Now for the bad news: Approximately one-fifth of respondents to the Hewitt study experienced significant problems. Complaints about vendors included poor execution; unacceptable service-level agreement performance and cost management; overpromising and under delivering, including an inability to deliver purported global service; and turnover on the vendors project team. Additional issues companies cited included underestimating the complexity of and time required for transition, organizational resistance and IT compatibility.

Almost one-quarter of those surveyed by Hewitt have brought an outsourced HR function back in-house. The functions brought back most often, according to the survey, were payroll, recruiting, learning and development, COBRA administration, and HR call center operations. It was most commonly because of poor quality of service, the study found. (For more on customer service issues in outsourcing, see Get Star-Quality Service.)

Gaining Greater value

Nathan Blain, managing director for the Corporate Leadership Council, a Washington, D.C.-based organization centered on HR leadership, says hype surrounding HRO and conflicting stories about its success have caused HR executives to question whether returns warrant large-scale HRO.

Initially, a lot of the impetus for HR outsourcing had to do with folks being dissatisfied with cost or quality, Blain says, with buyers looking at outsourcing to improve the quality and timeliness of selected activities. Now, he says, clients are finding the answer isn’t so much outsourcing processes as it is centralizing and pulling the activities out of the line and into a shared services function.

Blain says the council also has heard of dissatisfaction from members who may have rushed into outsourcing deals and then failed to manage the post-outsourcing process effectively.

It often wasn’t done with as much care as they might have liked, he says. Blain adds that he has heard reports of vendor management problems that resulted from some companies being careless when drawing up service-level agreements, being unclear on potential cost savings or not understanding the cost structure.

Its classic post-contract value leakage, he says. You expect these benefits, and they don’t come if you don’t manage the new structure carefully.

A November 2005 study by Yankee Group found that service excellence has now become more important than cost savings when selecting an HRO provider. The survey of top executives, including many in HR, at companies with revenues from $100 million to $40 billion in more than two dozen industries found that the value of the corporate brand is a key factor in vendor selection, along with service excellence, cost savings and domain expertise in that order.

The study found that IBM, ADP and Hewitt were favorites or the firms most organizations were considering, while Accenture, ACS and Hewitt ranked tops for scope and flexibility of offerings. Meanwhile, Excellerate HRO, AON and Convergys were leaders in satisfaction and the HRO firms most recommended by those already working with them.

There’s an opportunity for vendors to differentiate themselves by service quality, and, if they do that, it really eliminates the price pressure that’s in the market today, Corsello says. It shows the evolution of a market that is focusing less on cost savings, which seems to be more of an assumption at this point, to one where the market and enterprise customers are becoming more intelligent in terms of understanding HRO

Pamela Babcock, a freelance writer in the New York City area, has been a reporter for The Washington Post and the News & Observer in Raleigh, N.C., and has worked in corporate communications.

More Observations on HRO  

William Martorelli, a principal analyst with Forrester Research Inc. and author of the study HRO BPO Accelerates: Transition from Single- To Multiprocess-Focus HRO is Underway, offers these insights on HRO:

  • Benefits will remain critical. Among clients in North America, where benefits administration is a key HR function, demand in this category is highest. Interest also is growing in Europe.
  • Other HRO processes are growing in importance. For buyers, learning, recruitment and compensation administration are becoming increasingly important. Emphasis on individual HRO processes varies by customer and industry. For example, recruitment is critical in retail, where turnover is high, while learning is significant in industries such as financial services, where personnel costs are higher.
  • Multi-tower HRO will remain a challenge. Buyers can expect fewer end-to-end HRO transactions to be completed and more shifts in decision-making. HR executives are more likely to make payroll and benefits decisions, while multi-process deals may involve the CFO and the chief information officer. Full-scope providers must navigate the players to ink end-to-end deals.
  • Mid-market will take off. Interest in HRO among mid-market companies is rapidly emerging and often involves different suppliers. Mid-market HRO buyers are more likely to buy one process at a time and less likely to select an end-to-end engagement, although there are exceptions.
  • Pure offshore will remain on the sidelines. Providers are expanding offshore capabilities, but customers will remain hesitant to implement pure HR process outsourcing offshore partly due to offshore players reluctance to take on the transfer of assets, including software licenses.
  • Profitability will remain elusive. Consolidation in the HRO market will continue, but profitability will challenge vendors. Unless a provider makes money directly or has other revenue strategies, its commitment to the market may waver. Also, some companies may be subject to industry consolidation.

Pamela Babcock

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