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As the costs of managing HR departments rise, more companies are outsourcing the bulk of services to one-stop shops.
John P. Mello Jr., CFO Magazine
February 15, 2006
Last year, Whirlpool Corp. found itself in a dilemma. The $13.2 billion home-appliance manufacturer hadn't invested enough over the years to keep its human-resources department functioning efficiently, and the cost of updating it was going to be daunting. The technology alone would have cost millions. So Whirlpool, with 82,000 employees and retirees, joined the growing ranks of companies outsourcing to a single vendor all the functions that at one time were considered a bastion of corporate responsibility: the care of human resources.
Whirlpool decided to farm out nonessential administrative work such as the management of pensions, benefits, and payroll to a single company — Convergys Corp., the third-largest outsourcing specialist in the United States — rather than cobble together a slew of best-of-breed service providers to handle individual HR functions. Whirlpool says the deal will save the company money while allowing it to concentrate on its core business. "Do we really want Whirlpool to be known to outsiders as the best payroll processor in the world?" says Rajeev Tandan, a director of human resources. Whirlpool also likes that Convergys is large enough to handle its global workforce.
Terms of the 10-year agreement weren't disclosed, but it is widely considered one of the bigger deals in recent years. (Convergys's $1.1 billion agreement to manage human resources for DuPont Co. until 2018 is regarded as the biggest deal of 2005.) For Whirlpool, headquartered in Benton Harbor, Michigan, Convergys will also oversee, among other things, a complex web of providers that offer health-care services to employees and retirees. "We were looking for a one-stop shop to manage our many relationships," Tandan says.
Hiring a single vendor to handle a variety of tasks is gaining popularity among companies and fueling rapid growth of the outsourcing industry, analysts say. And consolidation among large outsourcing providers, including Electronic Data Systems Corp.'s purchase of Towers Perrin's HR outsourcing division last year, makes one-stop shops a more viable option.
IDC, a market research firm based in Framingham, Massachusetts, says revenue in the U.S. human-resources business-process outsourcing industry topped $8.9 billion in 2005, up 14 percent from 2004. IDC predicts growth at a compound annual rate of 16.1 percent for the next five years.
2006: A Watershed Year
In fact, HR outsourcing is a fairly recent phenomenon. Of the 124 major outsourcing deals struck since 1997, more than half were inked in the past two years, according to Everest Research Institute, an outsourcing research firm in Dallas. Phil Fersht, an executive vice president at outsourcing research firm NelsonHall, predicts that "2006 will be a watershed year for HR outsourcing."
Many of the contracts now being negotiated are long-term agreements of up to a decade or even longer. (DuPont's deal with Convergys is for 13 years.) Both sides say they benefit from longer-term deals. Hiring an outsourcing firm is costly and time-consuming, and few clients want to undertake the process again after a few years. As for the outsourcers, nailing down multiyear contracts is critical in order to recoup the enormous sums of money they have to invest in software and other systems to manage the work. On most contracts, "outsourcers won't break even for three years," says Jay Whitehead, publisher of Roseland, New Jersey–based trade magazines including HRO Today.
Outsourcing HR functions actually dates to the 1940s, when companies began hiring outsiders to handle payroll. Soon, companies were reeling from the time, money, and technology necessary to administer other goodies such as medical and dental coverage, vacation time, tuition reimbursement, and 401(k)s.
Human-resources departments ballooned into mini-empires struggling to manage a typhoon of paperwork. Not only were they taking care of current employees, but they were also administering benefits to a number of former employees. Federal and state employment regulations grew stricter, requiring more paperwork from companies related to compliance with laws prohibiting race and sex discrimination, among other things.
Meanwhile, the costs of managing pensions and other benefits for older workers were swelling. The technology to handle all these tasks grew increasingly complex and expensive. Eventually, companies began to realize they could save money by outsourcing the work.
An Early Stumble
Some of the first efforts to outsource bordered on disastrous. In 1999, London-based global oil and gas giant BP PLC struck a landmark deal: a $600 million, seven-year agreement with an outsourcing start-up. According to reports, chaos reigned for the first 18 months. Web-based tools that were supposed to help employees manage their benefits were glitchy. BP's human-resources staff balked at sharing strategic information with the outsourcer, knowing their jobs were to be axed. Costs soared, at least at the outset. Though the rough edges have been smoothed, BP's fiasco is still cited as a cautionary tale among experienced HR managers.
That may explain why outsourcing has taken so long to penetrate the human-resources departments of Corporate America. According to Everest Research, payroll still remains at the top of the list of outsourced functions. Some 87 percent of all the contracts it analyzed over the past eight years included that function, while 83 percent of contracts included administration of human-resources information systems. Contracts covered other services, too: benefits (81 percent), regulatory compliance (67 percent), compensation (48 percent), recruiting and interviewing applicants (42 percent), performance assessment and management (36 percent), and training and development (32 percent).
Even the biggest outsourcing companies don't have the ability to manage all these HR functions under one roof. However, in the past year or so, they have been racing to put partnerships in place with smaller firms that specialize in certain skilled jobs, such as relocation services for employees who are being transferred. Many of the biggest deals struck last year involved large vendors that assembled a squad of affiliates to handle pieces of the contract while promising clients they would be responsible for overall management of the work. That was the case with Convergys; Tandan says Whirlpool ultimately chose the company because it has solid relationships with third-party vendors that handle certain specialized tasks.
Build or Buy?
Like Whirlpool, PHH Corp. in Mount Laurel, New Jersey, is going the single-vendor route. PHH recently hired Minneapolis-based Ceridian to handle most human-resources services for its 8,000 employees in the United States and Canada. The value of the seven-year contract wasn't disclosed. Among other things, Ceridian will handle administration of payroll, benefits, attendance, recruiting and hiring, medical savings accounts, day-care expenses, payroll tax filings, employee-assistance programs such as family counseling, and compliance with state and federal employment laws. (PHH chose a different vendor to handle training.)
PHH is no stranger to the world of outsourcing: the company itself is an outsourcer, handling mortgages and fleet-management services for clients. But a year ago, PHH found itself in need of some help — quick. It was being spun off by its parent, Cendant Corp., a travel and real-estate services company in New York. Cendant had provided the majority of human-resources services for workers in all its units. After the spin-off, PHH would have to fend for itself.
Neil Cashen, executive vice president and CFO of PHH, says the company did not consider expanding its own human-resources department to encompass the new responsibilities; it would have been too costly. "We were intimately aware of the value proposition," Cashen says. "I think we went into the process knowing intuitively that outsourcing was the way we were going to go."
PHH reviewed a host of vendors offering a variety of services, but ultimately chose a single vendor. "We thought it would be easier from a coordination and communication perspective," Cashen says.
A La Carte
Although the trend to cut a deal with a single provider is gaining momentum, many outsourcing deals still involve multiple vendors. Magazine publisher Whitehead estimates that fewer than one-third of the nation's biggest companies outsource two or more human-resources functions to the same vendor. "A la carte is still more prevalent," he says.
Some companies balk at handing over sensitive tasks to outsourcing firms altogether, fearing the damage done from a job mishandled could be too costly. In recent years, though, outsourcers have made strides in providing more customized services to clients. For instance, NelsonHall's Fersht says, outsourcers are becoming more adept at highly skilled processes that require delicate handling and an intimate understanding of a client's business, such as recruiting and employee recognition.
Whitehead goes so far as to predict, "There will come a time in the next four or five years when it would be insane for you to hire your own in-house vice president of human resources." But that may be a stretch: someone, after all, has to hire and manage the outsourcer.
John P. Mello Jr. is a freelance writer in Woonsocket, Rhode Island.
|Top HR Outsourcing Deals in 2005|
|Company||Length of Agreement
|Employees Served||Outsource Vendor|
|Marriott International||7||$350||128,000||Hewitt Associates|
|Dana||10||NA||70,000||IBM Global Services|
|Duke Energy||7.5||NA||21,500||Hewitt Associates|
|NiSource||10||$1,600*||8,628||IBM Global Services|
|*Includes IT outsourcing services
Sources: Everest Institute; various reports and estimates