"Summit HR Worldwide provides competive edge to Staffing and RPO companies." - Managing Offshore - a CMP publication,  July 2005 

HRO, Release 2.0

With a flourish of mergers and mega-deals, human resources outsourcing (HRO) is growing up fast. Yet with many managers still uncomfortable with offshoring HR, leading providers strive to offer global services, provided locally. Contributing editor Peter Krass explores the best ways to approach HRO offshoring.

Long perceived as a "noncore" corporate function, the floodgates have opened for human resources outsourcing (HRO). Once a poor relative of IT and business-process outsourcing, HRO is making a 180-degree turn. In the first half of this year alone, four major M&A deals among HRO suppliers were announced, and no fewer than a dozen large contracts were signed with corporate customers. "We've seen an incredible uptick," says Peter Allen, managing director of global practices at outsourcing advisory firm TPI. Yet offshoring remains, if not exactly an afterthought, then a decidedly secondary aspect of many HRO deals. Only 10% of HRO engagements are delivered exclusively offshore, according to the recent BPO Customer Satisfaction study by Managing Offshore, InformationWeek, and EquaTerra. A Deloitte Consulting study put the number closer to 5%. And while these figures seem likely to change as HRO clients grow more comfortable with the idea of offshore service delivery, for now most clients want their HR services delivered locally.

That's because HR-unlike IT and many other back-office business processes-has a pronounced cultural flavor. Personnel and employment rules, tax codes, and benefits practices differ dramatically from country to country. Then, too, most workers want their HR issues dealt with by someone from their own country who shares their cultural assumptions. Political issues are a factor as well. "If you lost your job to an Indian, you don't want to call someone in India to discuss your unemployment benefits," says Michel Janssen, managing research director at the Everest Research Institute.

Think Globally, Deliver Locally
Ironically, one major driving force behind several of the recent supplier mergers and acquisitions was the need for these suppliers to offer globally delivered HRO services. As HRO deals become bigger and more encompassing, vendors must be able to serve their clients' global operations. But this
shouldn't be confused with traditional offshoring. An IT outsourcing (ITO) supplier, for example, can offer low-cost services from India to clients anywhere around the world. But when it comes to strategic HR, rather than transactional or administrative services, most client companies want to keep the work far closer to home.

As a result, HRO providers find they must deliver services from clients' geographic regions. This, in turn, is driving many of the recent mergers; by forming large, global firms, HRO providers can service multinational clients locally. For example, a single HRO provider might serve a client's U.S. employees from operations in Florida, European employees from Poland, and Asia-Pacific employees from the Philippines. Mike Nosil, VP of client executive at ExcellerateHRO, an HRO provider recently formed by EDS and Towers Perrin, puts it this way: "We're using global tools, but on a localized basis."

Even those companies comfortable with offshored HRO services may not be able to find suppliers capable of providing them, at least not yet. "As a prospective client, you have to ask how global is global," says Janssen of Everest Research. "While the suppliers are building up the capability, nobody has a complete global solution right now."

Sourcing
In this, our second look at the rise of offshore human resources outsourcing (HRO), we see a maturing market still struggling to overcome customer concerns that stretch beyond the usual issues of time, quality, and distance into cultural and privacy concerns. While transactional HR processes, including payroll and benefits administration, gain traction, other more strategic offerings are rare. For this report, contributing editor Peter Krass interviewed many of the leading domestic and offshore HRO service
providers. He interviewed several customers. He also tapped into recent studies by Deloitte Consulting, and the findings of a BPO Customer Satisfaction study that we introduced in June that was produced by InformationWeek, Managing Offshore, and EquaTerra. The study of 200 BPO customers found only moderate satisfaction with HRO services delivered onshore or offshore.

That said, HRO clients are already gaining major benefits from the international reach of suppliers. Take, for example, PrO Unlimited Inc., which finds and hires temps ("contingency workers," in the company's lingo) for major corporate clients. But PrO doesn't actually do the finding. Instead, it subcontracts that portion of the job to a group of qualified suppliers. So, when a client asks PrO to fill a temp spot, PrO in turn alerts its suppliers, which then locate qualified temps and bid for the job. One of PrO's suppliers, Echo Outsourcing, has an edge on its competitors: The company is owned by SummitHR, a company with major offices in the U.S. and Chenai, India. "We're effectively an outsourcer to an outsourcer," says Ranjan Sinha, Summit's chairman.

In fact, says Terry Weinand, PrO's COO and executive VP, Echo's distant location means it can work when U.S. suppliers are sleeping. This gives Echo a jump on filling temp orders, and that, says Weinand, "means our customers can get faster turnaround on their requirements, which allows them to get to market faster with their product." How do PrO and its clients feel about using temps in India? "While it is rather novel to take this abroad, when it's done well, most of us don't even know what's going on," he adds.

In a possible sign of things to come, some global companies already find the notion of offshoring HR functions perfectly acceptable. One such manager is Peter Childers, VP of global learning services at Red Hat Inc., a supplier of Linux open-source computer software. "We're a global company, so for us,
offshoring is a funny concept," he says. "The Internet provides a global, collaborative framework and medium for software development, and our Linux and other open-source code bases are contributed to by people all over the world."

Four years ago, Red Hat outsourced portions of its global training and certification program to e-learning outsourcing supplier DigitalThink. Last year DigitalThink was acquired by Convergys, which continues to offer e-learning and certification for system administrators to Red Hat customers
worldwide. "Having a partner like Convergys is critical," says Childers.

In the Beginning
For a market segment that is only now coming of age, HRO has been around for a long time-since 1949, to be exact, the year when ADP (then known as Automatic Payrolls Inc.) first offered its payroll services. Though no one used the term "outsourcing" back then, that's basically what it was.
Customers appreciate the service, and ADP is today a $7.75 billion (sales) corporation.

ADP has plenty of company. As much as 50 cents of every dollar spent on corporate HR services in the U.S. now goes to a third-party provider of one type or another, says Deloitte Consulting. But until recently, most of that spending was done on so-called point solutions. These provide a single HR
service, such as payroll (again, like ADP), workers compensation, payroll taxes, benefits, or training. A company using a point solution essentially outsources a small number of back-office HR functions while keeping the rest of its HR function intact.

That has changed, however, with the emergence of what's being called HR BPO (human-relations business-process outsourcing). Companies are essentially dismantling their internal HR function and instead outsourcing the whole kit and caboodle to an HRO provider. All that remains of the former HR function are a few senior executives, who manage the HRO relationship and coordinate their efforts with the organization's top executives. These so-called megadeals typically require the HRO supplier to provide services for seven years for fees worth $250 million, according to TPI.

Selected Recent HRO Deals
Client	Supplier Announced	Deal Covered	Areas (in Years)	Term
PepsiCo	Hewitt	4/7/05	Comprehensive HR services	N/A
Kmart	Convergys	4/7/05	Training of district managers	N/A
Hyatt Hotels	Convergys	4/7/05	"Gold Passport" training	N/A
Red Hat	Convergys	4/7/05	E-training for software certification
BT Global Service	Convergys	4/5/05	Strategic billing services	N/A
Delta Air	ACS	2/14/05	End-to-end HR BPO	7
Marriot	Hewitt	2/14/05	U.S. workforce administration, benefits, compensation, recruiting, relocation, learning, and development	7
Thomson	Hewitt	2/4/05	U.S. benefits, compensation, payroll, learning, recruiting, staff development	5
BT	Accenture	2/2/05	Global call center, recruitment, pension, payroll, benefits, performance management, health & safety, advisory and information services	10
BASF	Fidelity	1/27/05	U.S. HR operations, payroll, benefits, retirement	5
Chubb & Son	ACS	1/17/05	U.S. payroll, benefits, staffing, training, relocation	7
Rockwell	Hewitt	1/13/05	U.S. workforce administration, payroll, health & welfare, defined benefits	15
Texas Health & Human Services	Convergys	10/18/04	Comprehensive HR and payroll services	5
TRW Automotive	Fidelity	6/14/04	Administration services: stock option, 401(k), pension, benefits	N/A
Goodyear	ACS	2/2/04	North American payroll, medical benefits, call-center, training, recruiting, staffing, plus global relocation	10
DATA: Company reports

The first HRO BPO megadeal was a 10-year, $400 million HRO contract signed by IBM and Proctor & Gamble back in 1998. Some industry watchers have likened this deal to the landmark ITO arrangement signed in 1990 by IBM and Eastman Kodak, which legitimized ITO on a grand scale. "If outsourcing IT can work for Kodak, it might work for me," was the thinking back in the early 1990s. Fifteen years later, the same logic applies, only with P&G replacing Kodak in the bellwether position, and HRO replacing ITO. (The fact that venerable IBM is the supplier in both deals doesn't hurt, either.)

The upshot has been an avalanche of HRO deals worth $940 million in the last two and a half years alone, says Everest Research. That's more than the value of all HRO contracts signed from 1998 to 2002. Most of the companies signing these recent HRO contracts are well-known names, including BASF, Delta Air, Marriott, and PepsiCo (see table). Another, the financial-services company Wachovia, recently said it plans to select an HRO supplier this summer as part of a companywide efficiency drive.

All this activity is making HRO the fastest-growing portion of the total BPO market. In fact, HRO contracts accounted for nearly 45% of all BPO deals by number in the first quarter of this year, and nearly 60% of the total contract value for all BPO deals, according to TPI. And multiprocess HRO contracts-as opposed to contracts covering only a single HR process-are growing at a rate of greater than 20%, roughly double the rate of all HRO growth.

To date, HRO is primarily a North American phenomenon. Three of every four HRO deals made since 2001 were signed by clients based in the U.S. and Canada, according to TPI, with only the remaining one in four signed by European clients.

Urge To Merge
Responding to the HRO's market's new maturity, suppliers are busy merging and acquiring. Since 2003, the industry has seen seven substantial M&A deals, of which four were signed this year alone (see table). This is a widespread phenomenon: Many, if not most, of the major suppliers have been
involved, including ACS, CSC, EDS, Exult Hewitt, IBM, and Towers Perrin. And industry watchers expect even more deals to be announced later this year.

What's driving this industrywide urge to merge? Four main factors: 

 

• Broader skill sets: As HRO deals become ever more inclusive, suppliers realize they must be able to offer an increasingly wide range of services. For a supplier, the fastest way to add services it lacks is to acquire a competitor that possesses them.
  

• Regional delivery on a global basis: As the breadth and depth of HRO deals grow, suppliers need to be able to offer local HR services anywhere on the globe. Again, the fastest way to open an operations center in a new region is to add someone else's.
  

• ERP alternatives: Many users of SAP, PeopleSoft, and other enterprise HR systems (including PeopleSoft's new parent, Oracle), have put off upgrades as a way to stall spending. Now that improvements to the economy are creating new demands on HR, these companies face ERP upgrades that typically cost anywhere from $5 million to $20 million. HRO suppliers need to be able to offer clients a choice of ERP platforms, including, in many cases, proprietary systems that allow clients to move off SAP, PeopleSoft, and other enterprise systems entirely. 
  

• Graceful exits: As winners emerge among the HRO suppliers, many that are not winning have decided to "monetize" what they've built (that is, cash out) and then either exit the business or pair up with a winner. "Exult wasn't going to go out of business on its own, but Hewitt and Exult are much better as a combined entity," says Mark Hodges, head of strategy and corporate development at outsourcing advisory firm EquaTerra. "Similarly, Mellon was snot winning a lot of HRO deals, so moving over to ACS made a lot of sense."

Conspicuous Consultants
As the HRO market matures, the market is realigning to create new winners and losers. For example, consultants have emerged as major beneficiaries of HRO's growing maturity. That's due in large part to the high degree of complexity involved in the average HRO deal. A typical HRO sales cycle lasts anywhere from six to 12 months, providers say, and clients find they need help navigating through the sea of suppliers, dealing with legal and tax rules, and considering the myriad of global issues. Many potential HRO clients also use consultants to visit offshore HRO facilities, a form of long-distance due diligence. Finally, potential HRO clients hire consultants to gain an edge in contract negotiations, hiring an adviser whose experience in negotiating HRO contracts is as extensive as the provider's. In fact, HRO suppliers say that a prospective client's use of a consultant sends a powerful message. "If we're approached by a third party, or we're answering an RFI or RFP that is monitored by a third party, then we know the client is serious," says Cindy Frie, senior VP of business and marketing development for global HR solutions at ACS. "Most of these translate into real, viable opportunities. We think [consultants] are an important part of an HR outsourcing engagement."

In fact, as many as 85% of all HRO deals are executed with the help of third-party consultants, estimates Peter Hirano, VP of professional services at HRO supplier Convergys. "You can get anywhere from 15 to 25 subprocesses within HR," Hirano says. "[Selecting an HRO supplier] becomes a very complex decision process."

Attorneys, no surprise, form another group of HRO winners. Every HRO deal needs a contract, and retaining the services of a lawyer who has prior experience with HRO deals can give the client yet another edge during vendor negotiations. "We focus on the holy triad of service quality, pricing, and
scope because they're all interdependent," says William Bierce of the law firm Bierce & Kenerson. "You have a suite of services that you're buying; they have to be integrated, and there are interesting questions of pricing, flexibility issues, and the impact of certain changes in the universe of covered employees."

The scorecard is decidedly mixed for corporate HR departments. The short version: While many HR staff at a company that outsources HR will lose their jobs, those who remain can focus on more strategic projects. For example, 40% of HR managers at companies that have outsourced at least one HR function say their department is shrinking, according to a 2004 survey conducted by the Society for HR Management. And nearly half of the HR managers at these same companies say job opportunities within HR are decreasing. Yet for those who keep their jobs, three out of four of the HR managers in the survey say HRO has allowed them to focus more on core business functions.

How To Select An HRO Provider
Once you've decided to outsource one or more HR functions, what's the best way to select a service provider? The simplest approach is to hire a consultant, develop an RFP or RFI, ship it out, and see what comes in. But you can do better.

As Mark Hodges, chairman of EquaTerra, an outsourcing advisory service, explains, managers can seek out provider candidates on their own. Key categories for evaluation, Hodges says, are relationship skills and culture. If, for example, one HRO provider's culture is extremely rigid while yours is laid-back, the fit could be less than ideal. Another factor is the supplier's level of HR investment in its own operations; for example, does the SVP of HR report directly to the CEO (good) or to a lower-level executive (not so good)?

Yet another important factor, says Hodges, is the HRO provider's functional capability. In other words, is HRO its core business? How many HRO service centers does the supplier run, and where are they? What formal alliances exist for the delivery of HR capabilities?

Or you could do as the HR pros do. In a recent survey, HR professionals revealed what they consider when selecting an HRO provider. As the table below demonstrates, their top factors are a vendor's track record, costs, and service-level guarantees:

Supplier Factor	Percent Considering
Proven Track Record	89
Cost of services	82
Guaranteed service levels	64
Flexible contracting	53
Recommendations from other customers	41
Compatible corporate cultures	40
Niche capabilities	38
Vendor-to-client ratio (i.e., no: of employees assigned to a customer a/c)	20
Supplier's size	19
Supplier's geographical location	14

Note: Multiple responses were allowed | Data: Society for HR Management, July 2004 survey of 168 HR professionals at organizations that outsource at least one HR function. --By Peter J. Krass 

Given this impact on HR departments, it's not surprising that most HRO deals are driven by C-level executives rather than heads of HR. "We see these [HRO deals] being driven by the CEO or COO, typically in the wake of a leadership change or a major strategic initiative around cost, improving performance, or trying to raise shareholder value," says Hamill of TPI. In fact, many initiatives are led by a CFO at the request of their CEO, Hamill adds.

What's Next?
None of this should give the impression that the HRO market is fully mature. On the contrary, say market watchers, HRO is still very much a work in progress. While the best advice we've seen on the subject of forecasting the future is "predict early, and often," there are some educated guesses as to
the future of HRO market: 

 

• Mid-market expansion: While, to date, big corporate clients have dominated the HRO headlines, this is likely to change. Just as ERP vendors discovered that much of the business was with midmarket clients, so are HRO suppliers likely to move downmarket. "There will be a larger number of transactions, but with smaller values, as some mid-market companies really embrace outsourcing as a way to become more competitive and to be more attractive to potential employees," predicts David Michelson, director of BPO strategy and solutions at outsourcing vendor CSC.
  
  Yet this prediction could be wrong. Naysayers point out that few midsized companies can afford HRO, at least at its present levels. TPI, examining nearly 75 HRO deals signed in the past four years, found the average contract value to be $25 million-a big number for smaller companies. "There aren't many mid-market firms that spend over $25 million a year on the HR function," says TPI's Allen.
  

• More mergers and acquisitions: Everyone expects to see more. But some industry watchers warn that future M&A deals will be more selective, and less spectacular, as HRO suppliers buy smaller specialty suppliers to fill their functional or geographic gaps. For example, an HRO supplier that is strong in payroll and benefits services might acquire a company that specializes in training. Or a supplier with operations in the U.S. and Asia might pick up a supplier with operations in Europe.

• Big growth: The market is far from tapped out. In fact, says TPI, only 5% of large companies in finance and manufacturing-typically big users of other forms of outsourcing-have signed major HRO deals, suggesting that some portion of the remaining 95% could get on board soon. Each deal, in turn, contributes to an overall market momentum, leading corporate leaders to think, in effect, "Gee, if our company X is doing HRO, maybe there's something to it." While early deals were signed by pioneers, the next wave of HRO contracts will go to their followers.
  

• More offshoring: Call it the comfort factor, but most industry watchers are bullish on the ability of HRO suppliers to figure out how to offer HR services from locations with cheap labor. For example, Hodges of EquaTerra believes that fully half of all HRO work can be executed successfully outside the U.S. within the next three to five years. "We tell customers it shouldn't concern them whether the work is being done in India or Indiana, as long as the service levels are being met and the price is what they contracted for," says Scott Golas, chief strategy officer in Aon's HR outsourcing group. "That's the vendor's responsibility."

Will HRO clients accept this line of reasoning? The answer will determine whether we soon see an explosion of HR services offered offshore-or a retreat to closer, more familiar shores. 

By Peter J. Krass in New York