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Outsourcing the HR Function

For several reasons, including cost savings and the freeing of human resource professionals to focus on more strategic efforts, HR functions are among the services organizations are most likely to choose to outsource. As a result, HR professionals are being asked to identify outsourcing solutions for businesses and guide organizations through vendor selection and management of the outsourcing relationship.

This article serves as a roadmap for HR professionals involved in the HR outsourcing process. It explains the types of arrangements prevalent in HR outsourcing, states the business case for HR outsourcing and discusses HR's role in the process. It then examines various HR functions suitable for outsourcing: compensation, workforce administration, external recruitment, relocation, employee rewards and recognition, and benefits administration. The article outlines special considerations for developing an outsourcing agreement and transitioning from in-house to third-party administration of select HR functions. It concludes with the discussion of successful vendor relationship management.

HR outsourcing is a contractual agreement between an employer and an external third-party provider whereby the employer transfers the management of, and responsibility for, certain HR functions to the external provider. Many types of HR outsourcing options are available to employers. The options can be as specific as outsourcing one particular aspect of one HR function—such as applicant tracking for affirmative action purposes—or as broad as outsourcing the entire human resource department. The terms and types of arrangements prevalent in HR outsourcing are outlined below. See Small and Large Employers Outsource HR Duties Differently and HR Advice for a Department of None .

Software-as-a-service

Software-as-a-service (SAAS) is a software licensing and delivery model in which software applications are hosted remotely by a vendor or service provider and made available to customers via a Web browser. This model of software delivery creates greater organizational agility and provides an opportunity for cost savings. In the HR realm, employers most commonly pay for access to talent management (e.g., applicant tracking and training/performance) and payroll applications. See Viewpoint: How to Maximize HR Software-as-a-Service and   Platform-as-a-Service and App Marketplaces Fill Gaps in HR Technology .

Business-process outsourcing

In a business-process outsourcing (BPO) arrangement, an employer contracts a single business task, such as payroll, to a third-party service provider. This contrasts with SAAS outsourcing in that the BPO provider is providing the service as well as the software. A common BPO arrangement is the outsourcing of benefits administration, which removes the administratively burdensome and specialized functions for benefits auditing, processing and reporting to a third-party.

Single-source outsourcing

Under this outsourcing arrangement, also called single sourcing, HR professionals access one solution to meet their needs, from welcoming new hires to managing turnover, and all the tracking in between; a single supplier covers the full employee life cycle. This type of human capital management technology starts at talent acquisition, includes time and labor management and payroll, covers talent management, picks up benefits administration, and supports the separation-of-employment process.

Shared services and shared-services centers

These terms refer to consolidation of a business function within an enterprise to a highly skilled internal department or group. Shared services may also be provided to third parties. When the services offered by the shared services team are combined into a central operation, they are often referred to as shared-services centers.

Broadly defined, shared services are marked by the consolidation of administration or support functions for several departments. Among HR processes that may be folded into a shared-services plan are payroll, procurement, accounts payable and receivable, travel expenses, health benefits enrollment, and pension administration. Under the shared-services model, the administrative functions can be handled in-house or outsourced. Technological advances and increasingly sophisticated use of Internet communications have played a major rule in spurring shared-services arrangements in recent years.

Professional employer organizations

A professional employer organization, or PEO, is an organization that provides—via a co-employer relationship or employee leasing arrangement—HR management and benefits to an employers' employees.

Employment responsibilities are typically shared between the PEO and the employer; the employer retains management control over the work performed by the employees, whereas the PEO assumes co-responsibility for benefits, taxes and payroll. As co-employer, the PEO pays the wages and employment taxes for worksite employees out of its own account, collects and reports taxes to state and federal jurisdictions, maintains a long-term relationship with worksite employees, and in theory retains the right to hire, terminate and reassign employees. The employer reimburses the PEO for these expenses and pays a monthly administration fee based on the number of employees employed.

Although some PEOs offer services to larger clients, the majority of PEO business is conducted with companies with 50 or fewer employees. PEOs are increasingly becoming the service model of choice for smaller organizations. See What is a PEO? What are its advantages and disadvantages?

Business Case

Outsourcing has become increasingly important as HR professionals seek ways to reduce time and resources spent on transactions and administration, so they can concentrate on more strategic activities. This reduction in time and resources also translates to savings for the business. When HR departments decide which functions to retain and which to outsource, many hold on to talent management, recruiting and succession planning, while handing off payroll, benefits administration and other routine tasks to third-party vendors.

Besides giving in-house HR professionals more opportunity to focus on strategy, outsourcing can:

• Provide companies access to specialized HR expertise.
• Help with regulatory compliance.
• Speed up response times on transactional HR functions such as benefits enrollment and payroll.

In addition, there can be technology benefits. For example, through the use of a SAAS provider that provides and maintains software, employers gain the benefits of advanced software systems and avoid possible technical hassles of managing programs onsite.

HR's Role

The process of deciding whether to outsource HR functions begins with consideration of how outsourcing could help an organization and includes how well positioned HR would be to help the organization manage a transition to outsourcing. It is important to analyze how the company is currently delivering HR and to identify whatever gaps may exist between the organization's HR needs and HR functions. Employers should also research the outsourcing industry and its trends and analyze how industry trends could affect their organizations.

A key consideration is whether the time is right for the organization to outsource HR functions. Outside advisors can help with that question by analyzing data, financial projections and proposed contract terms. For example, even if outsourcing would ultimately save money for the organization, lost productivity during the transition results in initial costs—costs that must be factored into any financial projections. See How to Make the Case for Investing in HR Technology .

When deciding whether to outsource, an organization should be able to answer questions designed to analyze its HR needs, its current HR processes, its business plan and its outsourcing options such as the following:

• Can HR handle outsourcing without disrupting the current operation?
• Do HR staff members have the time and experience to deal with outsourcing?
• Is the HR department sufficiently staffed to manage the outsourcing relationship?
• Is HR providing excellent service with existing staff and processes? Is HR meeting all the organization's needs?
• Most importantly, will the CEO and top management team support and pay for an outside vendor?
• Does the company have a clear mission and vision? Have company values been established?
• Does the situation merit outsourcing?
• If so, what type of outsourcing solutions would best fit the situation?

In addition, it is important to know the ways in which an outsourcing arrangement can fall short of expectations and to mitigate such risks. The main areas of concern are listed below.

It is necessary to determine exactly what compliance services the outsourcing vendor will provide and whether the vendor's services will completely satisfy an employer's legal obligations. This concern is most common when a state requirement is more stringent than a comparable federal requirement.

Service levels

Confusion can arise if a vendor provides a service at a level below or above the level of service performed in-house. There must be full understanding of the services to be provided.

In many instances, outsourcing providers carry out tasks in ways that differ from the methods most familiar to the organization. The client business must understand the vendor's processes fully and must know how the organization may play a role in those processes.

Choosing Functions for Outsourcing

U.S. employers are selective in outsourcing certain functions, among them are benefits administration, recruiting and payroll. Selective outsourcing—as opposed to relying exclusively on a single provider—generally means outsourcing routine, transaction-oriented processes and is popular because it can be tailored to meet an organization's exact needs. Following are major areas of HR expertise and the ways in which they can be outsourced.

Compensation

The compensation functions commonly outsourced are payroll, job evaluation systems, salary surveys, executive compensation design and expatriate compensation. Outsourcing to third-party administrators for payroll and related tax duties helps employers meet filing deadlines and deposit requirements. The reasons for outsourcing may include cost savings, a need to improve customer service, the decision not to develop internal expertise, the ability to take advantage of technology not available in-house, or a desire for the HR department to work more strategically and less transactionally. See Outsourcing HR & Payroll: Questions For Companies To Ask.

Third-party services and systems have historically been used to provide or support complex aspects of compensation administration, including job evaluation systems, salary surveys and executive compensation design, whereas actual administration remained an internal function in large organizations.  As outsourcing continues to evolve, marketplace options for truly outsourcing compensation administration are becoming available, including point solutions, single-process outsourcing and integrated HR outsourcing.

Point solutions. In this approach, the vendor provides hosted software to support the compensation administration process, and sometimes also provides a degree of call center support. However, the client retains responsibility for the overall success of the compensation administration function and for any aspects of the administration not performed by the vendor. Point solutions for compensation administration are limited in scope and are usually associated with the adoption of an external portal for employee self-service.

Single-process outsourcing. In this approach the organization selects one vendor to perform all of its compensation administration.

Integrated HR outsourcing. Under this approach—currently the most commonly used—compensation administration is outsourced in conjunction with a larger outsourcing arrangement that includes workforce administration. In fact, compensation administration can be a natural extension of the outsourcing of workforce administration. Most workforce administration vendors have at least salary and bonus administration capabilities that are linked to their employee and manager self-service capabilities. Those tools make them well positioned to take over many of the more routine tasks associated with compensation administration.

Organizations with specific needs in compensation administration should search for more tactical, subprocess outsourcing arrangements to supplement or enhance their current services. An example of this approach would be to outsource expatriate administration, which is a subprocess specialty within compensation administration and has an established vendor community.

Workforce administration

The term workforce administration refers to the following set of HR functions and activities:

• Development, maintenance and operation of HR information systems.
• Employee and manager policy and procedure support.
• Employee and manager self-service and customer service.
• Employee data management and records retention.

Outsourcing workforce administration is often considered the foundation for the outsourcing of many other functional areas. In fact, many functional areas within HR, such as compensation administration and performance management, are typically outsourced only in conjunction with workforce administration.

External recruitment

Outsourcing is not a panacea for recruitment, but many organizations are testing it and finding it useful. Success in outsourcing external recruitment depends on defining and deploying an effective talent-sourcing strategy, selecting an appropriate area for testing recruitment outsourcing in the organization, establishing clear performance expectations and measures, and carefully selecting a recruitment partner. The potential benefits include building a strategic partnership focused on obtaining top-quality talent critical for the organization's success.

With recruitment-process outsourcing (RPO), buyers take full advantage of flexible options that turn a fixed expense into a more manageable variable expense—a flexibility that enables the organization to adapt to the ups and downs of a fluctuating marketplace.

The need to deal with the unexpected is one reason many HR professionals consider outsourcing various relocation functions. These include claims assistance, audit and payment of invoices, shipment monitoring, expense tracking, reimbursement, and supplementary services. International organizations are much more likely than national companies to outsource relocation services. See Managing Employee Relocation.

Employee rewards and recognition

Recognition and rewards programs are taking their place among services better handled by outside specialists. Recognition programs can provide incentives and reinforcement for desired employee behaviors in areas such as productivity, sales, workplace safety, years of service and cooperation with peers. But the programs can be time-consuming to administer. Even a program that simply recognizes employees for years of service involves several tasks for obtaining accoutrements for the program, such as plaques, certificates or gifts. Administrative tasks increase as the program becomes more complex and specialized. Outside vendors can be enlisted to handle many of the routine tasks of rewards programs, freeing HR for other responsibilities. See Managing Employee Recognition.

Benefits administration

HR managers, who spend an estimated 25 percent to 30 percent of their time managing employee benefits, must protect their organization's bottom line while maintaining employee satisfaction. One way for HR to achieve those purposes can be to partner with a third-party benefits administration provider—a practice known as benefits administration outsourcing. Through negotiated contracts, volume buying and economies of scale, providers deliver program advantages that many individual HR professionals may not be able to secure on their own. Providers can also be enlisted to manage the most challenging part of benefits administration: the annual enrollment process. Among the key services offered by benefits administration providers are:

• Call center support.
• Eligibility management and audits.
• Improved carrier oversight.
• Compliance.

See Employers Use Technology and Outsourcing to Ease Leave Management and Viewpoint: 3 Questions to Ask Wellness Program Providers .

Shaping the Outsourcing Agreement

Negotiating an optimal HR outsourcing agreement requires that HR professionals understand the relevant business issues and settle on a price for clearly defined services.

A business-process outsourcing (BPO) services agreement contains the fundamental deal terms and conditions, and it includes the substantive exhibits. A master services agreement (MSA) is another commonly used outsourcing agreement often used in larger global companies that allows local affiliates to meet country-specific legal requirements and business expectations. But whether using a BPO services agreement or an MSA, the key exhibits should cover scope of services, pricing, service level fundamentals, exit plans and any additional contract terms.

Scope of services and base price

Defining the scope of base services is the first critical decision in an outsourcing contract. The typical contract contains a fixed price for a base amount of work and a variable price for incremental increases or decreases from the base line.

Although most outsourcing arrangements contain a number of pricing methods, best practices involve a contract with predominantly unit-based pricing. At a minimum, the pricing model has to achieve the following:

• Predictability : clear and quantifiable prices for a range of services.
• Efficiency : a pricing model that provides vendors an incentive to drive down costs.
• Competitiveness : keeping the price competitive throughout the life of the contract.

An excellent way to test whether the price is competitive throughout the contract term is to use benchmarking. Benchmarking and the ability to move work to other vendors can be important for ensuring that the price organizations pay remains competitive.

Service-level fundamentals

HR professionals must understand the vendor's performance commitments and have clear and specific service levels and a method for enforcement. Because service levels need to improve over the life of the contract, HR managers must document the services existing when their contract becomes effective to ensure the vendor has accountability.

Most deals provide for service-level credits payable to the organization as the client if the vendor falls short of meeting service level requirements. Such credits are not remedies, though, and their ultimate purpose is to ensure proper behavior by the vendor.

Employers should consider including automatic termination rights in the event of mission-critical service-level failures or chronic poor performance. HR professionals should set out a specific set of circumstances in which a termination right automatically comes into play if service levels are not being met or if credits exceed a certain amount.

Additional contract terms

Among other topics to include in the contract are the degree of exclusivity of the particular vendor relationship and the customer's ability to take back services ("insourcing") and send them to other providers ("re-sourcing"). Service requirements could change significantly if the organization is affected by acquisitions or divestitures, so the outsourcing contract must contemplate how those changes may be managed.

The contract also needs to address:

• Regulatory compliance, especially if there is an offshoring component to the outsourcing deal.
• Control of personnel, including subcontractors, and which staff members will transition over to the supplier.
• Limits on liability.

Making the Transition

Transition is the stage of greatest risk in any outsourcing relationship; it is a sustained period during which both the customer and the supplier acknowledge that failure is possible. This execution phase normally consists of three main activities:

• The moving of responsibility for assets and people, leases, contracts, and licenses from one organization to another.
• The moving of processes from one organization to another.
• The change from the current environment to something better, faster or cheaper. It is almost always the driver for outsourcing in the first place.

The key principle of transition is that the employer owns the relationship with the incoming and incumbent service providers, and thus must own the transition process using a dedicated transition management team that controls the scope and deliverables. This is true for newly outsourced services and for transition of services between outsourcing suppliers.

The sole aim of transition is to ensure that the required business benefits of the outsourcing relationship—for both the customer and the supplier—are achieved by thoroughly implementing the terms of the agreements. To accomplish this, organizations must ensure:

• The transfer of services to the supplier is transparent to the end user—that is, the end user experiences little or no disruption, and service levels are at least maintained at current levels.
• The end user sees the new service arrangements as clear, positive and supportive.
• The employees, whether they are being transferred to the supplier or are remaining with the customer (or the incumbent supplier), are not disrupted and remain focused on delivering—and are motivated to deliver—the service. Employees being transferred must be treated with respect and dignity, and it is appropriate for the customer to have significant input into the supplier's internal communication process to ensure that this is so.
• There is no disruption of work on current projects. All projects under way during the transition should be identified, the responsibilities for completion defined and the tasks/scope of work agreed to by all parties involved.
• Working practices and procedures are established.
• Achievable service levels are defined, sensible measurement is in place, and the supplier's ability to meet these levels is verified.

Ownership and resources

Effective outsourcing relationships are those in which both parties help each other achieve business benefits. Therefore, the customer and the supplier must mutually manage the transition process and work together to ensure successful transition. Most customers will look to the supplier to provide an outline of a transition plan and to support them in constructing their part of the project.

Managing the Relationship

Outsourcing HR functions can involve significant costs but outsourcing to a skilled vendor—and using that vendor correctly—can save an organization money in the long run. The key is to manage the relationship well. This involves establishing a collaborative way of working with vendors that builds trust and open communication. It can be accomplished by setting forth all expected benefits in a written business case that includes quantitative and qualitative targets, and by using practices that have been shown to produce successful outcomes.

Vendor governance encompasses much more than just "resolving issues" and approving fees. Organizations that understand how a third-party vendor undertakes the activities it has been hired to perform greatly increase their ability to provide consistent direction, thereby ensuring that vendors meet the contractual and regulatory obligations outlined in the initial contract. If problems emerge, as they inevitably will over time, this understanding can help the organization resolve those issues quickly.

The traditional vendor manager is a technical or subject-matter expert and not necessarily adept at managing contracts, performance or overall relations with a third-party supplier. Under those circumstances, relations between the vendor and the client organization can quickly become adversarial or strained. A structured approach to vendor governance helps organizations build trust and enhance communication so that all parties feel they are being treated fairly.

For a list of HR outsourcing vendors, see SHRM's HR Buyer's Guides .

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Making the HR Outsourcing Decision

Outsourcing has become increasingly attractive for many organizations. In such relationships, a company contracts with a vendor that rents its skills, knowledge, technology, service and manpower for an agreed-upon price and period to perform functions the client no longer wants to do. Much attention has focused recently on the outsourcing of staffing, including temporary and contract workers, and IT professionals. A much less noticed, though growing, business has been that for human-resources business-process outsourcing, or HR-BPO. 1 Starting with humble payroll processing, outsourcers now offer to take over virtually any HR activity — or even the entire function. In 2000, the HR outsourcing industry had revenues of $21.7 billion, accounting for more than 8% of total HR spending. 2

Some observers see outsourcing as a key trend (perhaps even the key trend) shaping the future of HR. They envision HR departments focused entirely on strategic activities, all performed with an in-house staff consisting of a small number of high-level contributors, perhaps only internal consultants, HR systems designers and HR executives — leaving all the transactional and administrative activities to vendors for which those processes are core. 3 But others doubt that the strategic and operational aspects of HR can be separated so cleanly. Ralph Kimmich, director of compensation and benefits at Southwest Airlines Co., for example, is skeptical about HR outsourcing. “It seems to me,” he says, “that once you do that, you’re abdicating your role as an employer to lead your people.” Consequently, Southwest Airlines has instead been beefing up its in-house HR capabilities. 4

Indeed, outsourcing any business activity creates potential risks as well as benefits: Companies can find themselves overly dependent on suppliers, and they can lose strength in strategically core competencies. Interestingly, given the importance of the outsourcing decision and the amount of academic and practitioner literature on it, there is surprisingly little consensus about the topic, probably because of the multiplicity and complexity of the factors involved. This article synthesizes the strongest of the available research and identifies the six key factors that companies should consider when making important outsourcing decisions. The framework, which helps assess the pros and cons of outsourcing, can be applied specifically to HR functions. In particular, it can help explicate the managerial issues of outsourcing agreements such as the recent landmark deal between BP Plc and Exult Inc. That $600 million, seven-year arrangement provides a window into the many opportunities — and complexities — of HR outsourcing. (See “About the Research.”)

About the Research

This article is based on an extensive review and synthesis of the literature on outsourcing in general and HR-BPO in particular, including separate studies and surveys conducted by Gartner/Dataquest, International Data Corp. and Robert W. Baird & Co. Inc. The case study of the outsourcing agreement between BP Plc and Exult Inc. is based primarily on a series of interviews with two executives who helped implement the landmark $600 million deal.

A Changing Environment

Changes in the broader business environment are affecting nearly every aspect of how companies manage their human resources, altering the balance of pros and cons for outsourcing HR business processes.

First, conflicting pressures in the labor market have brought the role of HR to the fore. On the one hand, the 1990s brought the so-called war for talent. Looking forward, demographers predict a long-term tightening of the U.S. labor market. On the other hand, intensifying competitive pressures have forced companies to be more aggressive in cutting costs, often by reducing head count. HR functions have had to manage such downsizings, while also trying to be innovative in attracting and retaining valuable employees. HR may not be considered a core competence, but its interdependence with strategic factors is growing.

Second, HR departments themselves have become the target for belt-tightening efforts, and they must now find ways to provide more value at lower cost. Many have argued that the key is to focus on activities that are essential and outsource the rest.

Third, the legal environment of HR has grown increasingly complex, and HR managers have struggled to keep up with the regulatory changes, particularly in the areas of health care, stock-related compensation, overtime-pay calculations, pension reform, benefits eligibility for contingent workers and the marriage tax penalty. This has driven the demand for outsourced employee services from vendors that are subject-matter experts.

Fourth, mergers and acquisitions have become increasingly frequent, creating huge HR challenges. Often, HR is charged with the simultaneous tasks of integrating large numbers of employees, managing layoffs from staff consolidations and helping to blend dissimilar corporate cultures. Companies confronted with the challenge of merging heterogeneous HR systems frequently find outsourcing appealing because the specialized personnel required for the task will often be superfluous after completion of the project. 5 Globalization poses a comparable challenge, requiring HR departments to address the needs of employees in, and moving between, different countries.

Finally, of the various forces affecting HR, the development of technology is perhaps the most significant. The Internet and new generations of software have revolutionized HR information systems, significantly improving HR productivity, increasing control of employee benefits, streamlining compliance efforts, facilitating the management of payroll functions and lowering the cost of recruiting. The information from such systems is easier to modularize than that from paper-based systems, making outsourcing more attractive. New technology has also led to Web-based HR portals that provide employees with 24-hour access to information from a variety of sources, including insurance carriers, health providers and asset managers, in addition to up-to-date company information (such as policies and procedures manuals), employee data (allowing individuals, for example, to change their address or tax exemptions online) and management tools (such as performance-evaluation forms). Many companies, however, view the technical challenges of building and operating such systems as a costly distraction, providing neither a competitive advantage nor the prospect of a sustainable lead. For them, out-sourcing is an appealing alternative.

A Segmented Industry

As outsourcing HR business processes has become commonplace, three main industry segments have emerged: consultants, administrative-service providers and technology enablers. HR consultants provide expertise on issues such as compensation, stock-option-plan design, employee benefits and workplace diversity. This industry segment includes large organizations such as Hewitt Associates, Towers Perrin, Mercer Human Resource Consulting and Watson Wyatt Worldwide, as well as a number of smaller, more specialized firms.

Administrative-service providers handle payroll and benefits processing and will themselves sometimes outsource certain niche activities such as the management of workers’ compensation and COBRA. This industry segment includes both back-end processing-centric vendors such as Automatic Data Processing Inc. (ADP) and front-end Web-centric firms such as eBenefits Inc. Interestingly, administrative-services providers that began in payroll, including ADP, Ceridian Corp., Paychex Inc. and ProBusiness Services Inc., have been expanding into benefits out-sourcing and other areas.

Technology enablers help companies that want to continue managing their back-office HR processes in-house (perhaps after purchasing either customized or packaged HR software) but need assistance to do so. This industry segment includes vendors such as USinternetworking Inc. and Corio Inc., which charge a monthly fee for Web solutions that use PeopleSoft software. In such arrangements, the technology enabler is responsible for the implementation, software maintenance, data management, network access and round-the-clock support, and the client provides the functional HR professionals necessary to use the system. Technology enablers also include traditional IT consultants that have formed partnerships to gain access to HR capabilities (for example, Unisys Corp. with Exult and IBM with Synhrgy HR Technologies).

Within each of the three segments, some vendors are specialists while others are generalists. Among administrative-service providers, for example, specialists include Gelco Information Network Inc., the largest outsourcer of travel-expense management, and RewardsPlus, which provides optional benefits to the employees of clients. Generalists include firms such as Exult, Employease Inc., e-peopleserve (now part of Accenture) and Synhrgy, which can integrate the whole spectrum of HR processes.

The vendors also differ in the number of primary segments they compete in. For instance, IBM’s PricewaterhouseCoopers is a vertically integrated generalist, offering a full range of HR services that spans consulting, administrative services and technology. By contrast, PayChex, a specialist in payroll and tax processing for small businesses, does not build systems for clients, nor does it offer consulting services.

Trends in Outsourcing HR Business Processes

Because HR processes differ across organizations, developing solutions that are custom-tailored to individual companies can be prohibitively expensive. Thus many vendors have adopted a strategy of mass customization. For example, when working with the Phoenix Suns, ProBusiness provides payroll-tax solutions that account for the different tax-withholding laws in every state so that the pro-basketball team is covered when it travels to play across the country. ProBusiness has found that the only cost-effective way to handle such variety is to standardize a set of basic modules and equip them with simple switches that accommodate a range of situations.

Another trend is that toward integration and consolidation. Gartner/Dataquest estimates that in 2002 only 10% of HR out-sourcing in the United States was for integrated solutions, but that percentage is expected to grow as companies find greater appeal in obtaining complete servicing from one vendor. Accordingly, many of the key process-centric outsourcers such as ADP, ProBusiness and Ceridian are now providing solutions with greater breadth and higher levels of integration. By selling extra services to clients, those providers can take advantage of large economies of scope, increasing their revenue per employee and spreading overhead costs over more service lines. This suggests that some consolidation of outsourcing contracts is likely through aggressive cross-selling by dominant players, with industry concentration a likely result. A potential risk is that fees might rise and solutions could become too standardized and inflexible. Already, many companies are cautious about entrusting their entire HR systems to a single provider. In fact, businesses currently use an average of 4.5 out-sourcers to fulfill their HR requirements. 6

On a related note, alliances are another likely trend. If an out-sourcer lacks strong capabilities in a given area, it can gain access to them through partnerships with other vendors. A possible scenario is the growth of intermediaries that develop alliances or joint ventures with specialized vendors to provide clients with a broad range of services. Alliances also offer vendors a way to strengthen their sales channels. According to a 2000 report, about 55% of ADP’s small-business clients come through referrals from trusted business advisers and more than 30% of Paychex’s new sales come from partners, mostly CPAs. 7

When To Outsource and When Not

The outsourcing of HR functions has several potential benefits: It frees the internal HR staff to focus on strategic activities that add more value than transactional, administrative tasks; it enables decentralized structures that support higher rates of innovation and flexibility; it alleviates the bureaucratic burden of centralized HR administration; it enables the HR department to play its part in overall corporate downsizing efforts; and it facilitates access to new ideas and approaches outside the organization. 8

But there are risks and hurdles. A survey of 125 medium- and large-sized companies in 2000 found that the most frequently mentioned factors discouraging HR outsourcing were perceived higher cost and lower quality — and fear of losing control. 9 Another study of 150 companies in 2001 found that the most common problems of HR outsourcing were poor service, costs higher than promised, contractors with insufficient knowledge about the client and unanticipated resources required to manage the relationship. 10

These pros and cons play out differently for firms of various sizes with respect to different HR processes. Of the total market for HR outsourcing, large clients (more than $500 million in revenue) account for 55%, midsize organizations ($50 million to $500 million) for 17% and small companies (less than $50 million) for the remaining 28%. In general, large corporations are the main customers for integrated HR services, whereas smaller firms tend to outsource only the payroll function. 11

How, then, should a company decide what and when to out-source? An extensive review of the literature has identified six important factors: 12

Dependency risks.

If a company has to adapt its operations to do business with a supplier, it might then find itself dependent on that vendor. However, if the supplier has to tailor its operations to the needs of a particular client, it could find itself dependent on that customer. In some circumstances, both parties are vulnerable to such risks; in other words, the dependency can be bilateral. Dependency risks increase (thus discouraging outsourcing) when the outsourced activity requires the co-location of facilities, specialized equipment, dedicated capacity or specialized training. A key determinant here is the interdependence of the outsourced process with other activities in the organization. 13 Specifically, if the supplier fails to perform the outsourced function, how will that disrupt other processes? But note that interdependencies can also have an upside: economies of scale from a reliance on common systems, routines or R&D. Thus, when activities are highly interdependent, a company might be reluctant to outsource any of them separately but might instead want to outsource them altogether.

Spillover risks.

Contracting with a supplier can expose a company to the possibility that confidential information might leak, perhaps even to competitors. The risk is heightened when the out-sourced activity involves technology that is novel in some competitively significant way and when the protection for it (for example, patent laws) is weak or unclear and the innovation is easy to imitate. Interdependencies are also of concern: Spillover risks are exacerbated when the interface between the outsourced activity and other internal functions is complex, requiring a company to reveal proprietary information to ensure a good fit between the two.

To protect against dependency and spillover risks, a company can rely on detailed legal contracts with vendors. But such documents are time-consuming and expensive to negotiate, and enforcement is uncertain and costly, thus discouraging outsourc-ing. 14 Instead, outsourcing is greatly facilitated by trust between the two parties, particularly when both organizations are keen on maintaining their reputations as trustworthy partners. However,given the possibility of divergent business interests, trust between independent firms is, by nature, conditional. 15 Note too that the trustworthiness of external partners should be compared with that of internal suppliers, which sometimes rate poorly. 16

Relative proficiency.

Outsourcers can take advantage of economies of scale and scope by aggregating the needs of several clients. In doing so, they can offer great variety and quality at low cost. Furthermore, in knowledge-intensive activities, specialized providers might be better positioned to recruit and retain scarce technical experts. But companies need to examine their proficiency relative to that of vendors on a case-by-case basis. Particularly among large corporations that have sufficient scale, clients may be very efficient. Even then, though, a company might decide that the activity is not sufficiently strategic. Another consideration is whether the client organization is adept at managing suppliers — an issue that is often an unexpected sticking point. 17

Strategic capabilities.

A company should not outsource any activity that directly contributes to its strategic, competitive advantage. In addition to such core capabilities, organizations should also think twice about outsourcing any critical activities — ones that provide no direct competitive advantage but are highly interdependent with those that do. If a company believes it can build a sustainable lead in an activity that offers long-term competitive advantage, then it should refrain from outsourcing that function and instead devote efforts to building superior capability even if its current relative proficiency is modest and other factors make outsourcing attractive. However, if a company doesn’t believe it can build a sustainable lead, then it might be better off outsourcing the activity even if its current relative proficiency is high and other factors discourage outsourcing.

Commitment versus flexibility.

Irreversible commitments (to a core activity, for instance) can be a powerful weapon for a company to signal to competitors its intent to defend its advantage. But strategic flexibility has considerable value, too. For example, a company might be inclined to outsource a function when there is great uncertainty about the future value of that activity’s output. Furthermore, uncertainty about the future trajectory of a technology might make a company less inclined to outsource a process that relies on that technology if the activity is core or critical but more inclined to if it is neither. 18

The relative importance of the six factors varies across situations, and companies need to weigh each accordingly to form an overall assessment. Of the different factors, the first four (dependency, spillover, trust and relative proficiency) can be thought of as short-term or operational. They hinge in part on the assessment of current relational and technical conditions. The last two factors (strategic capabilities and commitment versus flexibility) can be considered long-term or strategic. They hinge on future prospects, involving consideration of long-term changes that a company can strategically influence (and those it cannot).

With respect to HR, an activity such as payroll processing is frequently outsourced because the dependency and spillover risks are low; trustworthy vendors are available; those vendors have accumulated considerable expertise; the payroll function offers little competitive advantage; and clients can switch vendors without excessive difficulty. In contrast, an activity such as HR planning is rarely outsourced because it involves high dependency risks, considerable strategic importance and great interdependency with other key processes.

The six factors help explain why companies of different sizes tend to outsource different HR activities. For instance, small and midsize firms (as compared with large corporations) are considerably more likely to outsource payroll, because they lack the economies of scale to perform that function efficiently. Conversely, large companies are more likely to outsource benefits processing because they typically offer a broader range of benefits, which reduces the economies of scale for handling that activity in-house.

A Case in Point: The BP-Exult Deal

The six factors of outsourcing were major considerations in a landmark outsourcing deal that BP signed with Exult Inc. in December 1999. Through the arrangement, then the biggest HR-outsourcing contract on record, BP agreed to pay Exult $600 million to take over all its HR services beginning in mid-2000. The seven-year contract called for Exult to assume management, ownership and accountability for all of BP’s global HR administrative and transactional processes. 19

One of BP’s precedents for outsourcing as a strategic choice goes back to the 1980s when BP Exploration began to outsource its IT operations selectively. Later, after a series of mergers in the late 1990s, BP was seeking ways to minimize costs and gain efficiencies, and one area that came under scrutiny was human resources. Through its rapid growth, the company had found itself with 100,000 new employees and a proliferation of incompatible systems — for example, literally dozens of different compensation and appraisal systems. According to Nick Starritt, then group vice president for HR, “Our cost of delivering HR activities was uncompetitive, and the quality of delivery was uncertain. Further, the burden of administration on the HR departments in the business units was preventing the function from performing effectively in the more strategic HR services.” 20

To address such issues, BP executives specifically looked for ways to transform HR from a fixed cost to a variable one that the business units would then pay for. In principle, BP could coordinate and streamline the HR systems by creating a large, shared-services group. In practice, though, that approach would be difficult, both politically and financially. Thus the search for an outsourcing partner began in earnest in 1998.

Enter Exult. Based in Irvine, California, Exult takes responsibility for all or part of a client’s existing HR staff, processes, technologies and existing outsourcing relationships with other third-party vendors. Exult provides Web-based software that ties the client into a network that operates from four off-site client-service centers. The outsourcer targets companies that have operations in more than five countries, at least 25,000 employees and more than $10 billion in annual revenue. Typical cost savings reportedly range from 10% to 20% per year.

The BP-Exult deal specified that the outsourcer would handle the administrative elements of compensation, benefits, payroll, organizational development, performance management, employee development, training, recruitment and relocation. That left BP responsible for HR policy, strategy, professional resources and labor relations. As management put it, BP retained “only the things that require judgment and policy.” According to one estimate, the deal would allow BP to cut perhaps 40% of its HR staff. 21 Not surprisingly, the decision to go with Exult was a subject of considerable debate, and much of the discussion involved the six factors of outsourcing.

Dependency risks. The bilateral dependency risks of the deal were obviously considerable. To minimize them, the two parties worked hard from the outset to establish a bond of trust. According to Starritt, “In many outsourcing deals, the client simply presents the overall process cost and asks potential suppliers if they can beat that cost. ... By contrast, we had an open-book approach to Exult — we called it the ‘crystal barrel.’ Our view was that the partnership had to begin on Day One. We needed to show them our detailed cost data, and they needed to show us how they would improve on them and the margins they would earn in the process.”

A big concern for BP was whether Exult could handle such a large project because the contractor was merely a startup. On the other hand, Exult’s founders and staff had considerable expertise, and BP was not impressed by proposals from some of the bigger, more established players. Another issue was BP’s exit strategy should Exult or the deal fail. BP ran several risk-management workshops with Exult to talk that issue through. Internally, line managers at BP questioned whether the new arrangement would improve — and not degrade — HR service levels. In response, BP created a governance structure for the outsourcing process that involved representatives of senior line management.

Spillover risks. BP did not anticipate spillover risks to be much of a problem. But Exult discovered that in Germany — BP’s third-largest location, with more than 10,000 employees — privacy laws made it difficult to process personnel information outside the country. As a result, BP and Exult had to revise their plans to handle all of BP’s needs through Exult’s Glasgow and Houston service centers, and they had to scale back the integration of BP’s non-U.K. European units. 22

In addition to the trust-building efforts described earlier, BP became an investor in Exult. “Our investment in Exult was mainly a sign of good faith,” says Starritt.“BP has less than 8% ownership.”

For BP, one of the key attractions in working with Exult was the outsourcer’s Web expertise. As BP envisioned it, the new HR system would be Internet-enabled, eventually allowing all employees access to HR services and information from their personal computers. In the past, for example, someone considering an assignment overseas might have waited up to 12 days to get all the necessary information from the HR department. The new Web system would allow employees to obtain that data by themselves within minutes. And not only would the new system improve response time and reduce costs, it would free HR professionals to answer more-complex questions and to design policy improvements on the basis of employee feedback. The Web technology has also enabled BP to accommodate new functionality easily. For instance, the company worked with Exult to create a software agent that takes information from employees looking for another position within BP and then automatically searches the posted openings daily for any possible fits.

Some BP managers questioned whether the company should be outsourcing HR, because employees were, after all, one of BP’s key sources of competitive advantage. In response, Starritt and his colleagues argued that processes like payroll were hardly a competitive differentiator. “We needed to focus on more important things,” he says, “such as a worldwide diversity program to attract more diverse talent.”

In its analysis, BP broke the HR function down into specific activities and considered the strategic significance of each. Through that assessment, BP decided to retain several key processes entirely in-house, including HR policy, strategy, professional resources and labor relations. Moreover, in outsourcing other processes, BP chose to remain actively involved in their high-level design, leaving Exult with responsibility for their detailed design and execution.

A key lesson here was the importance — and difficulty — of carefully analyzing all the various interdependencies. In retaining the high-level design and outsourcing the detailed design and execution of certain processes, BP bet that these two sets of activities would prove to be sufficiently independent. Conversely, with its decision to outsource a broad spectrum of HR processes, BP also bet that, by allowing Exult to internalize the interdependencies among those processes, not only could Exult then be held responsible for them, but the two partners would also be able to share the benefits of the resulting economies of scope and scale. So far, these bets appear to be paying off handsomely.

BP’s deal with Exult highlights the importance of strategic flexibility. A major motivation for out-sourcing was BP’s huge challenge — mainly a one-time effort —to harmonize its HR processes across a large number of newly acquired business units. Because the management of HR is highly interdependent with that of other business units, any effort to reconcile different HR systems throughout the company would require tremendous negotiation. Consequently, once BP had concluded that the bulk of its HR activities was not core, such an investment was clearly counterindicated, and flexibility through outsourcing became appealing.

Implementing the partnership was a tremendous challenge. Not only did BP and Exult have to integrate diverse HR systems across BP, they also had to support BP’s line businesses, which were themselves undergoing restructuring. “The range of HR practices existing within the new organization was at times mind-boggling: the multiplicity of payrolls, employee appraisal processes, contracts of employment, salary structures — the list seemed to go on and on,” recalls Starritt. Because of that complexity, BP decided to focus initially on just its operations in the United States and United Kingdom, its two largest concentrations of staff. The company formed joint project teams with Exult, and overall project governance was the responsibility of a special steering group, with senior representation from both BP and Exult, and with line and function management from within BP.

Inevitably, a project of this magnitude has its share of problems. Because relatively few BP staff relocated to the new Exult service centers, the transfer of knowledge between the two organizations was less than smooth. Complicating matters was the fact that the BP systems had not always been properly maintained, and in some cases the documentation was missing. So, for instance, payroll processing had a few glitches. “On at least one occasion,” recalls Starritt, “Exult had to send paychecks by personal courier to ensure that our staff in one location was paid on time.”

Such problems were beneficial, however, in that they helped BP and Exult uncover the internal workings of the various systems. “We discovered more about the ‘string and sealing wax’ which had been used to bind the previous systems and processes together, more than I suspect we would ever have known if we had just kept everything in-house after the various mergers,” says Starritt. Indeed, he adds, “The outsourcing contract forced us to confront the multiple and inefficient instances we had of just about every core HR process.”

The benefits have been tangible. Two years into its deal with Exult, BP says that the payroll accuracy is higher; global employee-appraisal systems have been simplified into just one Web-enabled procedure; the number of different employment contracts has decreased significantly; a new learning-management system has been implemented; and employees have gained vast new functionality through a Web portal. All of that has improved BP’s bottom line. “Could we have achieved all these things without a third party?” asks Starritt. “Personally, I doubt it — certainly not at the cost incurred.”

Exult and the Future of HR Outsourcing

Exult’s experience helps illuminate the various issues and challenges of HR outsourcers, providing clues to the future of that industry. In addition to its contract with BP, Exult has signed several other major deals: Unisys (seven-year contract for $200 million), Bank of America Corp. (10-year contract for $1.1 billion), International Paper Co. (10-year contract for $600 million) and Prudential Financial (10-year contract for $700 million).

The various megadeals have been crucial. “Economies of scale are the key to our business model,” notes Bruce Ferguson, Exult vice president and chief people officer. “To give you an example, we recently took over one function for a client and found that we could replace their staff of over 90 by adding only 15 people to our existing group because we could leverage our existing infrastructure.” But achieving that kind of efficiency requires Exult to avoid excessive customization of its services. “Our value proposition assumes we can standardize around 80% and only adjust —rather than fully customize — the remaining 20% to give our processes an acceptable look and feel,” says Ferguson.

Like its clients, Exult itself has resorted to outsourcing. In some cases, such as for expatriate administration, Exult merely uses tools provided by partner firms. 23 In other instances, such as in the benefits area, the partners provide the HR service. Exult’s role is to aggregate the needs of clients and assure them of access to particular services. In this way, Exult can earn a share of the cost savings that come from the resulting economies of scale. 24 “Overall, we see our competitive advantage coming mainly through hard work — excellence in execution — and through the scale advantage we can establish by being there first — building enough transaction volume to drive down price and enough of a client and partnership network that followers will have a hard time breaking in,” says Ferguson.

Interestingly, in deciding what activities to outsource and what to retain, Exult often goes through the same kind of decision-making process that its clients do. “We outsource some processes, like benefits, where there are already strong providers,” says Ferguson. “So far, our rule of thumb has been to keep in-house and treat as core processes ones where there are low barriers to our entry and where we can establish scale advantages.”

Through the outsourcing of HR business processes, support functions for companies such as BP have become a core business for Exult. The end result, Ferguson notes, is this: “There’s an amazing culture change between in-house and outsourced HR. When payroll, for example, goes from the back office to the front office, when the top executives of the firm are visiting the department frequently, when that department is revenue-creating rather than just overhead, it creates an extraordinary sense of empowerment. Everyone starts contributing improvement ideas. The whole mood of the place changes drastically.”

Acknowledgments

The author is grateful for the time and help of Nick Starritt, former group vice president for HR for BP, and Bruce Ferguson, vice president and chief people officer for Exult. Research assistance was provided by Jill Benner, Maryann Gonzalez, Natasha Jones, Jason McFarland, Koji Takano and Michelle Sippl. Invaluable comments on early drafts of this article were offered by Nick Argyres, Bob Hayes, Sue Helper, Ed Lawler, Arturs Kalnins and Kyle Mayer. Gartner/Dataquest, International Data Corp. and Robert W. Baird & Co. Inc. were generous with their data and time.

1. R. Scholl, “Business Process Outsourcing at the Crossroads,” white paper, Gartner Group, Stamford, Connecticut, Jan. 31, 2002, reports the following: In a survey of 77 midsize and larger companies that outsource at least one process, the most commonly outsourced processes were administrative, 30% (most typically, claims processing); HR, 28%; payment services, 26%; supply-chain management, 25%; and finance and accounting, 23%.

2. See “HR Outsourcing: Time To Deliver Results,” white paper, Gartner Group, Stamford, Connecticut, March 26, 2001. Robert W. Baird & Co. divides the overall human-capital-management industry into administrative services — essentially HR-BPO — and professional services, which include HR consulting (total revenue of $10.9 billion, according to International Data Corp.) and the various segments of the staffing industry. The latter, according to Staffing Industry Analysts Inc., encompass temporary help ($80.2 billion in 2001), place-and-search companies ($13.8 billion), professional-employer-organizations/staff-leasing companies ($42.8 billion) and outplacement ($1.3 billion). HR consulting is arguably at the intersection of administrative and professional services, and this article includes it under HR-BPO because a growing number of HR consultants offer stand-alone BPO services. But this article excludes professional employer organizations (PEOs), which are also arguably at this same intersection. PEOs provide both personnel and many of the associated HR processes; unlike other staffing organizations, however, PEOs also assume the associated insurance and legal liabilities. None currently offer stand-alone BPO services.

3. E. Lawler and S. Mohrman, “Human Resources Management: New Consulting Opportunities,” in F. Poulfelt and L. Greiner, eds., “Advanced Management Consulting” (Palo Alto, California: Stanford University Press, in press).

4. J. Kochaniec, “BP Amoco Outsourcing,” Business Insurance, Dec. 13, 1999, p. 1.

5. See, for example, M. Cook, “Outsourcing Human Resource Functions” (New York: AMACOM, 1998).

6. “Demand Analysis of Integrated Multiprocess HR Outsourcing,” white paper, Gartner Group, Stamford, Connecticut, Sept. 20, 1999, p. 6.

7. “The Internet and HR Outsourcing,” white paper, Robert W. Baird & Co., Milwaukee, Wisconsin, February 2000, p. 11.

8. C. Greer, S. Youngblood and D. Gray, “Human Resources Management Outsourcing: The Make or Buy Decision,” Academy of Management Executive 13, no. 3 (1999): 85–96.

9. Scholl, “Business Process Outsourcing at the Crossroads.”

10. E.E. Lawler III and S.A. Mohrman, “Creating a Strategic Human Resources Organization” (Palo Alto, California: Stanford University Press, 2003). See also J. Laabs, “The Dark Side of Outsourcing,” Workforce (September 1998): 42–46. Laabs lists the biggest reasons for outsourcing failures as vendor’s failure to be proactive, turnover in the vendor team, vendor errors and mistakes, incompatibility of client and vendor cultures, data-transmission errors, technological inefficiencies and contract ambiguities. In particular, she highlights the costs associated with the lack of transaction standardization. M. Useem and J. Harder, “Leading Laterally in Company Outsourcing,” Sloan Management Review 41 (winter 2000): 25–36, describe the new leadership capabilities required in firms that engage in outsourcing.

11. S. Lever, “An Analysis of Managerial Motivations Behind Outsourcing Practices in Human Resources,” Human Resource Planning 20, no. 2 (1997): 37–47; “HR Outsourcing: Time To Deliver Results,” Gartner Group; and “Business Process Outsourcing Popularity Grows in SMB Market,” white paper, Gartner Group, Stamford, Connecticut, January 2003.

12. This framework integrates ideas from industrial-economics analysis of the value chain (M.E. Porter, “Competitive Advantage: Creating and Sustaining Superior Performance” [New York: Free Press, 1985]) and transaction-cost economics (O.E. Williamson, “Markets and Hierarchies: Analysis and Antitrust Implications” [New York: Free Press, 1975] and “The Economic Institutions of Capitalism” [New York: Free Press, 1985]) with three other strands of theory: social exchange theory, organization theory and business strategy. On social exchange theory, see, for example, T. Kern and L. Willcocks, “The Relationship Advantage: Information Technologies, Sourcing and Management” (New York: Oxford University Press, 2001), chap. 2. On organizational theory, see, for example, J. Baron and D. Kreps, “Strategic Human Resources: Frameworks for General Managers” (New York: John Wiley & Sons, 1999), chap. 18. On business strategy, see, for example, J. Barney, “Gaining and Sustaining Competitive Advantage,” 2nd ed. (Upper Saddle River, New Jersey: Prentice Hall, 2002), chap. 6; R. Hayes, S. Wheelwright and G. Pisano, “Vertical Integration and Supply Chain Strategies,” working paper, Harvard Business School, Boston, 2002; J.B. Quinn and F. Hilmer, “Strategic Outsourcing,” Sloan Management Review 35 (summer 1994): 43–55; and J.B. Quinn, “Strategic Outsourcing: Leveraging Knowledge Capabilities,” Sloan Management Review 40 (summer 1999): 9–21. The decision criteria presented in this article also reflect concerns actually encountered in industry practice. On HR outsourcing, see M. Cook, “Outsourcing Human Resource Functions” (New York: AMACOM, 1998); T. Gainey and B. Klaas, “The Outsourcing of Training and Development: Factors Impacting Client Satisfaction,” Journal of Management 29, no. 2 (2003): 207–229. On IT outsourcing, see Kern, “The Relationship Advantage”; L. Willcocks and M. Lacity, eds., “Strategic Sourcing of Information Systems: Perspectives and Practices” (New York: John Wiley & Sons, 1999); M. Greaver, “Strategic Outsourcing: A Structured Approach to Outsourcing Decisions and Initiatives” (New York: AMA-COM, 1999); M. Lacity and R. Hirschheim, “Information Systems Out-sourcing: Myths, Metaphors and Realities” (New York: John Wiley & Sons, 1995); R. Klepper and W. Jones, “Outsourcing Information Technology, Systems and Services” (Englewood Cliffs, New Jersey: Prentice Hall, 1997); F. McFarlan and R. Nolan, “How To Manage an IT Outsourcing Alliance,” Sloan Management Review 36 (winter 1995): 9–23; K. Ripin and L. Sayles, “Insider Strategies for Outsourcing Information Systems: Building Productive Partnerships, Avoiding Seductive Traps” (New York: Oxford University Press, 1999); C. Saunders, M. Gebelt and Q. Hu, “Achieving Success in Information Systems Out-sourcing,” California Management Review 39 (winter 1997): 63–79; and L. Poppo and T. Zenger, “Testing Alternative Theories of the Firm: Transaction Cost, Knowledge-Based, and Measurement Explanations for Make-or-Buy Decisions in Information Services,” Strategic Management Journal (1998): 853–877.

13. A. Afuah, “Redefining Firm Boundaries in the Face of the Internet: Are Firms Really Shrinking?” Academy of Management Review 28, no. 1 (2003): 34–53; K. Mayer, “Managing Buyer-Supplier Relationships in High Technology Industries” (Ph.D. diss., University of California, Berkeley, 1999); and K. Mayer and J. Nickerson, “Antecedents and Performance Implications of Contracting for Knowledge Workers: Evidence From Information Technology Services,” unpublished, 2002.

14. J. Barthélemy, “The Hidden Costs of IT Outsourcing,” MIT Sloan Management Review 42 (spring 2001): 60–69.

15. K. Artz and T. Brush, “Asset Specificity, Uncertainty, and Relational Norms: An Examination of Coordination Costs in Collaborative Strategic Alliances,” Journal of Economic Behavior and Organization 41, no. 4 (2000): 337–362.

16. Baron, “Strategic Human Resources,” chap. 18.

17. Gainey, “The Outsourcing of Training and Development.”

18. P. Ghemawat, “Commitment: The Dynamic of Strategy” (New York: Free Press, 1991); D. Besanko, D. Dranove and M. Shanley, “Economics of Strategy,” 2nd ed. (New York: John Wiley & Sons, 2000); and T.A. Luehrman, “Strategy as a Portfolio of Real Options,” Harvard Business Review 76 (September–October 1998): 89–98.

19. In November of that same year, BP signed a $1.1 billion agreement with PricewaterhouseCoopers to outsource all its finance, accounting and MIS-applications work in the United States. See F. Hansen, “Global BPO: Reshaping Credit Management,” Business Credit 102 (April 2000): 18–20.

20. Unless otherwise indicated, quotations and descriptive material are drawn from interviews conducted by the author in spring 2002.

21. G. Donnelly, “Do It Yourself: Browser-Based Technology Gives Rise to True Self-Service HR,” CFOEurope, April 15, 2000, http://www.cfoeurope.com/displayStory.cfm/1741270.

22. See A. Maitland, “Giant Leap for Human Resources,” Financial Times, March 27, 2002, p. 12.

23. See B.E. Rosenthal, “Strategic Alliance Provides Missing Piece,” http://www.outsourcing-hr.com/strategic.html, for a description of Exult’s partnership with Deloitte & Touche (now Deloitte-ToucheTohmatsu) to integrate Deloitte’s GlobalAdvantage expatriate-administration software into its suite.

24. Exult does not merely contract with the client to manage existing HR-BPO vendor services. Instead, Exult becomes the party responsible for providing those services, and Exult’s providers are paid by Exult rather than by the client.

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The Ultimate Guide to Human Resources Outsourcing

• POSTED ON September 11, 2023
• by Skill Success

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In today’s fast-paced business world, companies of all sizes are constantly looking for ways to streamline their operations, reduce costs, and enhance efficiency. Human Resources (HR) is a critical function for any organization, but managing it in-house can be both time-consuming and expensive. That’s where Human Resources Outsourcing (HRO) comes into play. In this comprehensive guide, we will explore what HRO is, its benefits, how to choose the right HRO provider, and best practices for successful outsourcing. For more information about HRO, check out https://hrcosts.com/ .

What is Human Resources Outsourcing (HRO)?

Human Resources Outsourcing, or HRO, is the practice of contracting out some or all HR functions to a specialized third-party provider. These functions can range from administrative tasks like payroll processing and benefits administration to more strategic functions such as talent acquisition and workforce planning.

Why Do Companies Choose HRO?

Outsourcing HR functions offers several advantages:

• Cost Savings: By outsourcing, companies can reduce HR-related costs, including staff salaries, benefits, and training expenses.
• Expertise: HRO providers specialize in HR, ensuring that your HR functions are handled by professionals with extensive knowledge and experience.
• Focus on Core Business: Outsourcing HR allows companies to focus on their core competencies and strategic initiatives, rather than getting bogged down by administrative tasks.
• Scalability: HRO services can be scaled up or down to meet your organization’s changing needs, making it flexible and adaptable.
• Compliance and Risk Management: HRO providers stay updated on the latest HR regulations and can help ensure compliance, reducing legal risks.

Common HR Functions Outsourced

HRO can encompass a wide range of HR functions, depending on your company’s needs. Here are some of the most commonly outsourced HR tasks:

1. Payroll Processing

One of the most frequently outsourced HR functions is payroll processing. HRO providers handle tasks like calculating wages, tax withholdings, and issuing paychecks, saving your company time and reducing payroll errors. Additionally, many businesses are now leveraging crypto tax compliance platforms to ensure accurate reporting of cryptocurrency transactions.

2. Benefits Administration

Managing employee benefits, including health insurance, retirement plans, and other perks, can be complex. HRO providers can streamline this process, ensuring employees have access to their benefits and addressing their concerns promptly.

3. Recruitment and Talent Acquisition

Outsourcing recruitment and talent acquisition can be a game-changer for companies seeking top talent. HRO providers use their expertise and networks to identify and attract the best candidates for your organization.

4. Employee Onboarding

Efficient onboarding is crucial for employee retention. HRO providers can create a seamless onboarding process, ensuring new hires feel welcomed and informed from day one.

5. Employee Relations

Handling employee relations, including conflict resolution and policy enforcement, can be challenging. HRO providers have experience in managing these delicate matters professionally and in compliance with labor laws.

6. HR Compliance and Risk Management

HR compliance is a moving target, with laws and regulations constantly evolving. HRO providers stay up-to-date with these changes, reducing your organization’s exposure to legal risks.

How to Choose the Right HRO Provider

Selecting the right HRO provider is a crucial decision that can significantly impact your organization’s HR operations. Here are steps to help you make an informed choice:

1. Define Your Needs

Start by identifying which HR functions you want to outsource and your specific goals. Are you looking to reduce costs, improve compliance, or enhance talent acquisition? Knowing your objectives will guide your provider selection.

2. Assess Provider Specializations

HRO providers often have areas of specialization. Some excel in payroll processing, while others are experts in talent acquisition. Evaluate providers based on their expertise in the specific areas you need assistance with.

3. Check Reputation and References

Research potential providers thoroughly. Look for reviews, case studies, and client testimonials. Reach out to references to get insights into their experiences working with the provider.

4. Evaluate Technology and Tools

Assess the technology and tools the HRO provider uses. Ensure their systems are up-to-date, user-friendly, and compatible with your organization’s needs.

5. Consider Data Security

HR data is sensitive, and it’s crucial to ensure that the provider has robust data security measures in place. Inquire about their data encryption, access controls, and compliance with data protection regulations.

6. Review Service Level Agreements (SLAs)

Carefully review the SLAs provided by the HRO provider. Pay attention to response times, issue resolution procedures, and penalties for non-compliance.

7. Cost Analysis

Obtain detailed pricing information and compare it with the value you expect to receive. Be aware of any hidden costs, and consider the long-term financial implications.

8. Cultural Fit

Consider the cultural fit between your organization and the HRO provider. Effective collaboration often requires alignment in values, communication styles, and corporate culture.

9. Scalability

Ensure that the HRO provider can scale its services up or down to accommodate your changing needs as your organization grows.

10. Legal and Compliance Considerations

Consult with legal experts to review contracts and agreements to ensure they protect your organization’s interests and align with relevant labor laws.

Best Practices for Successful HR Outsourcing

Once you’ve chosen an HRO provider, here are some best practices to ensure a successful outsourcing partnership:

1. Clear Communication

Maintain open and transparent communication with your HRO provider. Clearly communicate your expectations, objectives, and any changes in your HR needs.

2. Collaboration

Treat your HRO provider as an extension of your HR team. Encourage collaboration and knowledge sharing to ensure seamless integration.

3. Regular Performance Evaluation

Conduct regular performance evaluations to measure the effectiveness of the HRO provider’s services. Address any concerns promptly and work together to make improvements.

4. Data Security

Continuously monitor and assess data security measures to safeguard sensitive HR information. Stay informed about the latest data protection regulations.

5. Flexibility

Be flexible and open to adjustments in your outsourcing arrangement as your organization evolves. Your HRO provider should adapt to your changing needs.

6. Employee Feedback

Gather feedback from your employees about their experiences with the outsourced HR functions. Use this feedback to make improvements and ensure employee satisfaction.

7. Stay Informed

Stay informed about developments in HR regulations and industry best practices. Your HRO provider should assist with this, but it’s essential to remain knowledgeable.

Human Resources Outsourcing can be a game-changer for companies looking to optimize their HR functions, reduce costs, and focus on their core business activities. By carefully selecting the right HRO provider, defining your needs, and following best practices, you can establish a successful outsourcing partnership that benefits both your organization and your employees. Stay informed, communicate effectively, and continuously evaluate performance to ensure that your HR outsourcing experience is a resounding success.

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Case Study: Outsourcing Critical HR Functions Limits Company Liability

by Terry LaMotte

As a large commercial and residential real estate company, we have to be interested in limiting our liability wherever possible. Since our property management employees access resident’s homes as porters, maintenance and management staff, we need to ensure that we hire individuals with backgrounds that won’t be harmful to our residents, or otherwise jeopardize our business.

Prior to the merger in 1993 of the Sares Company, a commercial enterprise, and The Regis Group, a residential company, checking backgrounds was limited. Then in 1997, we decided that outsourcing services such as employment screening was clearly the answer to solving this ongoing concern. Initially we only ran background checks on our property management applicants, but two years later, we began checking all positions within our company, mainly because of the dramatic improvement in the quality of the employees we hired as a result of doing background checks.

FINDING "THE ONE" When we decided to conduct background screening, we researched several employment screening companies. We interviewed several providers, since we intended to overlay the existing program into a company-wide approach for the newly merged entity, and needed to see how a screening company “fit” into the new scheme. We chose APSCREEN based on the presentation of its products and services, as well as references that spoke highly of the company—in particular its customer service.

An example of a good strategy with respect to vendor integration is our hiring policy, which requires that we check credit first and use that information, as well as other identifying information about a candidate, not only for its face value, but also as a tool in researching criminal convictions in areas not disclosed by a candidate.

We always use a multi-step “candidate identification process” that has clearly worked for us throughout the years in accurately identifying and/or supplementing the identification (by revealing undisclosed aliases) of our candidates. We also always conduct reference checks. It’s not only important that your vendor understands how to do this properly and within the law but is capable in extracting the kind of information that we can base a sound hiring decision.

We have recently become aware of additional, free information available to us through our vendor regarding persons and companies barred from doing business under the federal government’s Excluded Parties List System (EPLS), and those whose assets may be under the scrutiny of the Office of Foreign Assets Control (OFAC). It’s important that your vendor provides this kind of ancillary information as part of their standard package. You need to know that the company cares about its work as much or more than you do, and that it truly believes it has as much of a stake in the hiring of prospective employees as you do.

VENDOR CHECKLIST For others looking to outsource HR-related services, we recommend finding a reputable vendor that has as at least the following:

• Longevity. Longevity suggests that a firm has weathered the storm of changing times and has demonstrated that it is serious about being in its industry.
• Customer Service. Be sure it’s a company that has people you can build a relationship with. In the information business,the allure of automation as a cost-savingmanagement philosophy may not always transfer to the end user.
• Veracity. Research what the company is saying against what you know, and more importantly, what you don’t know. Sales claims abound when profit is at stake, so it is up to you to determine who needs your business, and who wants your business.
• Cost. Price certainly isn’t everything. Look for a knowledgeable support staff that is highly trained in their task. Ask how they would handle different scenarios. Find out if they can testify competently for you if the need arises. What is the vendor’s daily working and depth of knowledge of the HR function and applicable laws?

OUTSOURCING IMPROVED TIME MANAGEMENT As a human resource professional with 550 employees, I have one assistant whose primary focus is benefits and a risk manager for worker’s compensation. For me, outsourcing services such as employment screening makes great sense, because it is such a very sensitive and sophisticated process that requires a careful eye.

We utilize a full-service 401(k) provider; outsource the handling of our unemployment claims, Section 125, and COBRA programs; and use a benefits consultant for contract negotiations. As with employment screening, these disciplines are actually specialties and require up-to-the-minute compliance and attention to detail at levels that neither I nor my assistant have the time for.

With a good outsourced vendor in place I can limit myself to actual management, which means that I can make more effective decisions about the future of my department, and determine the best strategy for the management of the company’s most important assets—its people.

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HR Outsourcing: Case Studies

Human resources is a critical function for all businesses, but it can also be complex and time-consuming. For small and medium-sized businesses, in particular, the cost of maintaining a full-time HR department can be prohibitive. That’s where HR outsourcing comes in.

HR outsourcing is the practice of delegating HR tasks to a third-party provider. This can be an excellent way for businesses to save money, gain access to expertise, and streamline their HR processes.

Is outsourcing HR the right choice for your business?

See how other employers are approaching HR Outsourcing for their unique business needs. HR Works has compiled a collection of case studies that reviews the unique ways our clients were able to outsource different aspects of their HR function.

HR OUTSOURCING

As HR compliance has become increasingly complex, more and more organizations are choosing to outsource their HR support. When you partner with HR Works, you will get customized  HR Outsourcing Solutions  that help you meet the needs of your most critical asset – your employees.

At HR Works,  HR is all we do !

Download CASE STUDIES

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Elevating Organizations with Transformative HR: Real-World Case Studies

Dive into stories that echo the heartbeat of our mission-elevating organizations through expert HR. Witness firsthand how our expertise alongside an understanding of our clients' cultures and goals can help organizations and their people grow and thrive.

Real Impact, Real Feedback: Client Testimonials

Their testimonials highlight the transformative impact of our approach. With us, organizations and leaders experience reduced anxiety, stress, and workload, while seeing boosts in morale, confidence, and stability.

myHR Partner’s efficiency, and the value of that efficiency, can’t be overstated. It allows us to conserve internal resources who can now focus on key priorities like new technology, revenue enhancement, and cost mitigation while myHR Partner handles all aspects of HR. myHR Partner’s functional ownership of our human resources needs – hiring especially – has been key to where we are today.

myHR Partner’s efficiency, and the value of that efficiency, can’t be overstated. It allows us to conserve internal resources who can now focus on key priorities like new technology, revenue enhancement, and cost mitigation while myHR Partner handles all aspects of HR. myHR Partner’s functional ownership of our human ...

We decided to work with myHR Partner because we had no full-time HR staff due to our small staff size. We wanted to gain access to professional advice offered by highly qualified HR consultants. myHR Partner delivered.

myHR Partner is more than a well-oiled payroll management department at our fingertips. They’re a tremendous knowledge bank whose payroll expertise far exceeds ours. They’ve been key to Vicente LLP’s expansion into multiple states and are a reason we’re primed for growth.

Whatever ArtsQuest has asked of myHR Partner, even when we weren’t sure what we were asking – they’ve found a way to take it on, help us out, and make sure every last detail is compliant, fine-tuned, and organized. myHR Partner is collaborative and the best at what they do. We couldn’t ask for anything more.

Our rapidly growing small business needed help professionalizing our approach across a broad spectrum of human resources-related questions. We needed expertise and more timely action than we could supply internally. Outsourcing to myHR Partner frees up time for us to concentrate on using the skills we are good at, and allowing others to support us in our areas of weakness.

Our rapidly growing small business needed help professionalizing our approach across a broad spectrum of human resources-related questions. We needed expertise and more timely action than we could supply internally. Outsourcing to myHR Partner frees up time for us to concentrate on using the skills we are good at, and ...

Outsourcing HR takes the burden off attempting to become self-taught and knowledgeable ‘enough’ about all state and federal labor law paperwork, compliance, and reporting. One less thing for us (me) to worry about!

myHR Partner has been a valuable resource for our company all around. Employees have been able to anonymously request information or seek guidance on HR issues, and it has allowed management to feel secure in the choices offered to employees regarding HR issues.

myHR Partner’s response time is swift. Even more, they bring a transparency that’s rare in professional services. Timeliness and accuracy are important in outsourced partners, of course, but myHR Partner’s accountability and humanity are equally rare and valued.

I acquired a family-owned business and I needed a higher caliber of HR capabilities than what the legacy employees could provide. Outsourcing HR allows me to be more at ease knowing that I have a competent professional HR team handling my people function and ensuring that I have my necessary processes and documents in place.

The myHR Partner team has been a tremendous asset for my business. They are highly competent, proactive and great to work with.

I tried using other outsourced HR providers from my payroll company with mediocre results. myHR Partner is an order of magnitude better than my previous experience.

I acquired a family-owned business and I needed a higher caliber of HR capabilities than what the legacy employees could provide. Outsourcing HR allows me to be more at ease knowing that I have a competent professional HR team handling my people function and ensuring that I have my necessary processes and documents in ...

The world-class HR and the benefits package we’ve created with myHR Partner’s guidance has directly contributed to the strongest overall business results Liquid has seen in its nearly 30 years of business.

Outsourcing (our HR) project made sense because it enabled us to rely on myHR Partner’s expertise. It would have used too many internal resources to overcome the learning curve and get the results needed.

We are large enough to have occasional HR-related issues, but not large enough to afford an HR staff person. Utilizing myHR Partner provides expertise that we don’t have on staff, without the expensive hourly rate of an attorney.

Outsourcing the HR function frees up internal staff time, provides a higher level of expertise than we have on-staff, improves the level of support to our staff and protects us by ensuring compliance with laws and policies that we might not otherwise be aware of.

Our myHR Partner team assisted us with the projects that we asked them to but also took the initiative to make suggestions in other areas where they saw room for improvement with our internal systems. We have implemented multiple changes based on their recommendations.

We are large enough to have occasional HR-related issues, but not large enough to afford an HR staff person. Utilizing myHR Partner provides expertise that we don’t have on staff, without the expensive hourly rate of an attorney. Outsourcing the HR function frees up internal staff time, provides a ...

We were struggling to find, evaluate and hire talented employees. Using new and improved job postings, interview scripts and reference check processes, we were able to make some key hires that helped our company continue its growth. With myHR Partner’s help, I was able to avoid some of the “noise” associated with running a recruiting process. Having the top candidates presented with feedback gave me a chance to spend more time focusing on my main task: ensuring the profitability of the business. HR seems to be an often neglected aspect of small businesses. myHR Partner took the time to learn our business and listen to what our end goals were. I would highly recommend myHR Partner to any firm looking to develop parts or all of an HR department. Our time working with myHR Partner was crucial in the development of Appeeling Fruit’s in-house HR department. When our company was acquired, our HR plans changed in an unexpected way; however, the recruiting process we learned will live on, as we will continue to need employees that have the skillset and core values alignment we are looking for.

We were struggling to find, evaluate and hire talented employees. Using new and improved job postings, interview scripts and reference check processes, we were able to make some key hires that helped our company continue its growth. With myHR Partner’s help, I was able to avoid some of the “noise” ...

While we are a growing organization, we are not yet at a size where it made sense to bring on an HR manager. Our non-profit board approved this move because it was a better way to support the day-to-day needs of the organization (versus an HR board committee or ad hoc committees).

There’s time and energy that goes into HR issues regardless of whether they’re supported by a firm like myHR Partner. But myHR Partner provides a sounding board, experience, in-the-room support, and project management to get through all kinds of projects and HR-related issues. This both expedites certain resolutions and improvements, but also minimizes the worry of “am I doing it right?” for non-HR specialists.

For a non-profit, allocating resources thoughtfully and for mission and impact is a pretty clear imperative. Working with myHR Partner allows us to have much-needed HR support within a small organization without having to “over-allocate” resources to a full-time staff person, when we’re not at that level of need.

While we are a growing organization, we are not yet at a size where it made sense to bring on an HR manager. Our non-profit board approved this move because it was a better way to support the day-to-day needs of the organization (versus an HR board committee or ad hoc committees). There’s time and energy that goes ...

We needed an organization that could provide an additional layer of support yet had the flexibility to be nimble with a positive employee experience. myHR Partner has been great at keeping the lines of communication open and we’ve enjoyed their partnership.

By partnering with myHR Partner, we've been able to focus on other components of our business and yet still provide best-in-class services to our employees.

We needed an organization that could provide an additional layer of support yet had the flexibility to be nimble with a positive employee experience. myHR Partner has been great at keeping the lines of communication open and we’ve enjoyed their partnership. By partnering with myHR Partner, we've been able ...

When most companies consider outsourcing, it is a cost-savings initiative. For Lamtec, it was never about costs. We looked at outsourcing with myHR Partner as a way to increase HR capabilities and bring current, up-to-date HR expertise into our company. We realized most of our HR activities were centered on benefits administration and with the help of myHR Partner we have shifted the priority to organizational development.

Our myHR Partner team is strong and confident. They can work with employees at all levels of our organization; they are comfortable interacting with people from the shop floor to the President’s office. They are also up-to-date with the latest regulations and trends. They have learned our culture and adapted the presentation of information to work seamlessly with our thought and decision-making processes. Their business cards may say myHR Partner, but they are viewed as Lamtec.

With myHR Partner’s guidance, coaching and input, we make confident and timely HR decisions that are positively impacting the daily operation of our business.

When most companies consider outsourcing, it is a cost-savings initiative. For Lamtec, it was never about costs. We looked at outsourcing with myHR Partner as a way to increase HR capabilities and bring current, up-to-date HR expertise into our company. We realized most of our HR activities were centered on benefits ...

Outsourcing some of our HR functions has brought management peace of mind, knowing that a professional resource is a phone call or email away should a problem arise. It also provides our employees with an objective party to direct any HR questions or concerns. Outsourcing has also given us the ability to consult with a professional in order to determine and prioritize HR-related projects to be worked on together under their guidance.

From the top down, the staff at myHR Partner are consummate professionals. The representatives assigned to our company spent time with the management team at the beginning to learn about our culture, HR practices and concerns. Since partnering with them, we have had several HR matters to contend with. Our main contact was readily available and helped us navigate through the process each and every time. We rely on myHR Partner to keep us compliant and help us create a pleasant work environment for our employees.

Outsourcing some of our HR functions has brought management peace of mind, knowing that a professional resource is a phone call or email away should a problem arise. It also provides our employees with an objective party to direct any HR questions or concerns. Outsourcing has also given us the ability to consult with a ...

Working with the myHR Partner team is FANTASTIC! It is as if they are regular full-time employees. We work together well and can work through issues as though we’re one team. Outsourcing payroll was the best thing we could have ever done.

Outsourcing payroll was the best thing we could have ever done. It was not easy to convince stakeholders to make this move but we did. And they couldn’t be happier. The relationship has been great and the burden of turnover and attitudes has been lifted.

Working with the myHR Partner team is FANTASTIC! It is as if they are regular full-time employees. We work together well and can work through issues as though we’re one team. Outsourcing payroll was the best thing we could have ever done. Outsourcing payroll was the best thing we could have ever done. It ...

It's great having the right answers when our employees ask questions. They deserve that.  I'm confident that with myHR Partner's continued support, we are set up for ongoing success as we navigate any and all HR needs moving forward.

Everything myHR Partner has touched has turned to gold. They're a huge asset to our business. Five stars!

It's great having the right answers when our employees ask questions. They deserve that.  I'm confident that with myHR Partner's continued support, we are set up for ongoing success as we navigate any and all HR needs moving forward. Everything myHR Partner has touched has turned to gold. They're a huge asset to ...

Jennifer Shoemaker, PHR

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