HR outsourcing – opportunity or risk?

Germany is the latest country to experience the gradual arrival of Business Process Outsourcing (BPO) to its shores, and it is in human resources that outsourcing is having the most impact. Customers and service providers alike are taking advantage of the major opportunities on offer – but at the same they open themselves to risks that need to be watched closely.

Outsourcing HR processes is the first step towards BPO

When a company does not
count HR amongst its core
competencies, outsourcing
is increasingly being seen as
the solution; but how much
monitoring should it need?

Classic IT sectors such as application training or support are traditionally the ones that have been the prime candidates for outsourcing, but these days outsourcing is also a consideration for central business sectors as well as their business processes. One such key sector for outsourcing is human resources (HR), where little stands in the path of the different ways in which HR processes can be outsourced – anything is possible, so long as the money makes sense. The spectrum of services ranges from printing and sending out payslips to taking over nearly the entire HR department and its various functions, including employee recruitment and management (payment of travel expenses, additional training, timekeeping), registrations for pension and social security, and even dismissals (outplacement). It can be shown that about 80% of all companies that have split off their HR processes have benefited from the contract. It is equally rare for outsourced HR departments to be reabsorbed; rather the contract is usually continued with another service provider.

The outsourcing scenarios are matched in their variety by the reasons for companies taking such a step. First and foremost it is to reduce costs; secondly in the belief that specialised service providers have more expertise and more efficient processes, at least in some HR subsectors; and thirdly, because of a lack of resources in the in-house HR department. Lastly, an imminent major upgrade of HR software can also lead to the work being outsourced.

On the up and up

As a result, the market for outsourcing HR processes has been expanding for quite some time. Analysts at Forrester Research do not anticipate a slowdown in growth in the near future – quite the opposite, in fact: market observers in Europe are expecting an average annual growth rate for the HR BPO segment of 11.4%, with an upward trend. The fact that HR is generally no longer counted as a core competency for a company works in favour of the service providers. The bigger the company, the more they are willing to leave the beaten track: the deluge of regulations means that few firms are able to keep track of all of the legal standards and guidelines. Above and beyond that there is the cost of data maintenance arising from statutory changes, an expense that for service providers is usually minimal because of the number of client companies. Corresponding batch sizes and increased automation mean that service providers can operate much more economically than an individual company, ideally realising cost savings of 20–30%. However, this is only the case if the service provider is able to take on entire business processes and restructure them efficiently. For IT service providers, one of the biggest challenges lies in bringing specialist know-how and technical know-how together.

Easy transition

The transition is normally fairly easy for the service provider. For one, in most companies HR is a self-contained division, and in many cases even has its own IT section, which makes separating the processes from their existing context relatively simple. For another, most of the services the HR department provides are subject to clear legal guidelines, which gives rise to another importance benefit for customers: it is the service provider, not the company, that has to supply the competencies.

Once a contract has been agreed, it is the service provider that bears the lion’s share of the risks. These are primarily determined by the client’s needs. The service provider must endeavour to automate their sector as much as possible. Company wage agreements and labour agreements make their work more complicated, for which they may need to be paid extra. Statutory changes also have to be handled in a manner that does not result in the provider being further compensated by customers. A new wage agreement, for example, can lead to a significant amount of work, as parameters such as one-off payments, changes to working hours and wage increases have to be integrated.

Service provider at risk

A further risk for the service provider comes from supervision of its work by the client. It makes sense for the customer and service provider to work closely together, but the customer is often tempted to keep the service provider on much too short a leash, e.g. by dictating which hardware and software they should use, or demanding to see the cost accounting. This extreme form of governance makes the service provider’s work far more difficult.

The same applies to process monitoring: the service provider has to be given a relatively free rein to be able to pass on the optimisation to the customer; that, after all, is what outsourcing providers are there for. If a company has complex processes but does not want to optimise them, then the company will not benefit from outsourcing. If the client allows the outsourcer to improve their HR department, however, then the contract can benefit everyone. Otherwise both sides become increasingly discontented, a downward spiral that begins with ever more frequent meetings and often ends with a mutual loss of trust between the service provider and the client. In addition, the market plays host to rumours and half-truths. Prevailing public opinion says that a payroll costs five Euro per employee per month, a raw figure that customers readily adopt and submit to the service provider. The costs of HR outsourcing do indeed shift, because the processes become more efficient, but as yet no service provider is in a position to offer its services to a large concern for five Euro. Prices are heavily dependent on individual complexity, but by and large they are significantly higher, and a monthly payroll, inclusive of travel expenses and time management, can amount to as much as 15-18 Euro per monthly payroll.

No cost breakdown

The HR departments in most companies are only a small cost pool, and exact details of the section’s expenditures are rarely known. Most customers are therefore very surprised when they receive a monthly HR bill. Although the costs had also been incurred previously, they were not always broken down and presented so clearly. Then as the months go by the client experiences growing concern that they are being taken for a ride; after all, the standard prices are dropping elsewhere. A regular review of expenditure shows the customer whether their service provider is making an effort to provide a fair price/performance ratio.

For service providers, on the other hand, a cost benchmark is worthwhile. It allows them to identify potential areas of improvement and to target those areas where costs have got out of hand. It also affords them the opportunity to be actively involved in formulating market-driven prices. Maybe one day even the dreaded five Euro per payroll will be close at hand.

An ideal arrangement

In June 2006, the conglomerate Unilever agreed a contract with Accenture to outsource their HR sector. The negotiations between the two parties are reported to have taken more than 6 months. Other interested service providers had been discounted beforehand. It is a 7-year contract, and the estimated total volume is as much as $1 billion. This means that the annual volume exceeds that of the contract agreed between Convergys and DuPont in 2005, which runs for 13 years and is worth $1.1 billion. The functions outsourced to Accenture by Unilever include, amongst others, recruitment, payroll accounting, performance reviews and employee training. Accenture has the support of some smaller service providers. The contractual partners want to use milestones as part of the process optimisation to decide how many, and which, of the approximately 3,300 Unilever employees are to switch to the service provider.

A growing market

Outsourcing of HR departments represents the biggest segment of business process outsourcing. According to Forrester Research, the annual market volume in Europe is expected to increase from the current 3.7 Euro billion to 6.3 billion Euro by 2011. At the moment the bulk of that volume consists of payroll accounting, but Forrester indicates that more and more companies are handing other HR sectors over to service providers in addition to the classic payroll processes, which explains the high growth rate of the market as a whole. In a current Forrester study, Germany ranked second in Europe, ahead of France, with a market volume of nearly 590 million Euro. Unsurprisingly, Great Britain was far and away the market leader. Whereas the market for payroll processing has matured, the same cannot be said for neighbouring HR segments. Applicant management, HR strategy formulation and HR portal implementations are a challenge even for service providers. The list of potential providers is shortened considerably by specialisation, and if the customer requires it on an international scale, then the number of service providers can be counted on one hand. For their part, the outsourcing firms contend with such cases by sub-contracting to specialist service providers.

Offshore a consideration

Offshoring – outsourcing work to low-cost areas such as Eastern Europe, India and China – should also not be discarded as an option. Payroll accounting would appear to be well-suited to an offshore arrangement precisely because of the high level of standardisation involved. It is noted, however, that many clients flatly reject nearshore or offshore data processing solutions for their HR sectors, in part because they assume that those service providers would not be in a position to understand Europe’s complicated laws, rules and processes. Many clients are also critical of having HR data that is classified as highly sensitive processed in a foreign country or continent where it is outside their immediate reach.

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