Decision Framework, DF J. Holincheck. Application Service Provider Traditional Payroll/Benefits Outsourcing Business Process Outsourcing

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1 Decision Framework, J. Holincheck Research Note 28 February 2003 Deciding to Insource or Outsource for Human Resources Enterprises making new technology decisions are often considering various types of outsourcing. However, they should look at outsourcing as only part of an overall sourcing strategy for service delivery. Core Topic Workforce and Workplace: HCM and B2E Technology Key Issues How will enterprises select, implement and support their human capital management/business-to-employee technologies? How will enterprises use and manage human capital management/business-toemployee processes and technologies to gain competitive advantage? Strategic Planning Assumption By 2005, 70 percent of enterprises will still consider outsourcing one human-resource business process or function at a time, suboptimizing their sourcing and service delivery (0.7 probability). When selecting new human resources () technology, the decision is often more complicated than figuring out which technology vendor is the best fit. In almost all cases, enterprises also consider outsourcing. Even with outsourcing, different types of relationships are possible, including those in Table 1. Type Application Service Provider Traditional Payroll/Benefits Outsourcing Business Process Outsourcing Table 1 Outsourcing Relationship Types Function/Process Technology Ownership Ownership In-House In-House/External Service Provider External Service Provider External Service Provider In-House/External Service Provider External Service Provider An application service provider (ASP) hosts the technology at its site and supplies technical support. The enterprise is responsible for performing and owning the business function/process. In traditional payroll/benefits outsourcing, the external service provider (ESP) plays a more-active role in the business process. In addition to providing technology or technology support, the ESP also performs and manages part of the business process. For example, in payroll outsourcing, the enterprise is responsible for providing inputs into the pay process. The ESP takes these inputs and performs the remainder of the process (such as calculating pay, performing direct deposits, printing/mailing pay slips, tax filing). In business process outsourcing (BPO), the ESP owns the business process or function, including the technology or technology support. In this case, the ESP owns the inputs and outputs, and the Gartner Reproduction of this publication in any form without prior written permission is forbidden. The information contained herein has been obtained from sources believed to be reliable. Gartner disclaims all warranties as to the accuracy, completeness or adequacy of such information. Gartner shall have no liability for errors, omissions or inadequacies in the information contained herein or for interpretations thereof. The reader assumes sole responsibility for the selection of these materials to achieve its intended results. The opinions expressed herein are subject to change without notice.

2 enterprise is responsible for strategy, policy setting and vendor management. Drivers of Outsourcing Regardless of the service type, there are common drivers that enterprises share when examining outsourcing, as Figure 1 shows. High In-House Effectiveness Figure 1 What a Client Should Outsource Keep In-House or Outsource Outsource Retain Internally Develop or Outsource Low Low Focus on Core Competency Business Value High Many enterprises go though an evaluation process to determine core competencies. Much of this analysis centers on determining whether a specific function or process has high or low business value. Tactical, low-value business functions or processes typically do not need to be core competencies, and are strong candidates for outsourcing. In, payroll and benefits are often viewed as tactical, administrative functions that are outsourced via traditional outsourcing. Many enterprises are also starting to consider BPO. Early adopters of BPO have viewed this alternative more strategically. By outsourcing the entire administrative function, these enterprises are looking to free up remaining resources to focus purely on strategic activities. Reduce Costs Many enterprises want to reduce costs by outsourcing functions and processes to a third party. Cost reduction can be a benefit of outsourcing. However, this is not always the case. A 2002 Watson Wyatt study of 105 U.S. enterprises with more than 5,000 employees showed that full BPO can be more expensive ( costs) than keeping functions and processes in-house, or using selective outsourcing. First, an enterprise needs to 28 February

3 understand its own costs to deliver the same services. These costs should be compared to the ESP's costs in an "apples to apples" fashion. It is important to understand what the ESP is providing in terms of service, and what activities will remain inhouse. If the outsourced option is the lower-cost option, then an enterprise should determine if it can achieve similar cost savings by developing or enhancing its internal capabilities through business process re-engineering (BPR), and use of shared services. In many cases, especially for larger enterprises (with more than 5,000 employees), the savings from BPR or implementing shared services is equal to or greater than the savings achieved from outsourcing. Acceleration of Implementation Time Many enterprises want to hasten the introduction of new capabilities through the use of outsourcing or ASPs. However, there is little advantage in implementation time over an in-house solution when comparing apples to apples. The perceived advantage of outsourcing or ASPs is that the solution is already up and running. Customers believe that all they need to do is configure the system, load the data and interface it to other systems. However, similar productivity gains can be achieved inhouse by working with ESPs and vendors which already have the solution up and running (for example, in a competency center) to start the implementation process. Improve Service Levels Most enterprises look at more than costs. Typically, there is a balance between costs and service levels. Some enterprises hope to reduce costs and increase service levels. However, in some cases, service levels are so poor that the push to outsource is motivated more by service level than cost. Leverage Specialist Resources Enterprises with fewer than 1,000 employees are the predominant users of outsourcing services. These small and midsize businesses (SMBs) typically do not have the depth of specialist resources that are found in larger enterprises, in terms of functional and technical resources. SMB organizations are staffed with more "generalists" than training, benefits and payroll experts. In addition, SMBs often have limited IT resources. Thus, building and retaining adequate application specialists can be an issue. However, in addition to providing greater compensation, ASPs and outsourcers can often provide more and better career-path options for these specialists. For SMBs, both ASPs and outsourcers can provide effective access to specialists, as needed. 28 February

4 Larger enterprises typically have fewer issues in building and retaining functional and technical resources for. In addition, larger enterprises have more options to address issues (such as creating centers of excellence) that facilitate different pay structures and career paths. The Insource vs. Outsource Decision Most enterprises look at the insource vs. outsource options for in a very narrow context. They look at one specific area, such as payroll, to the exclusion of the rest of. By 2005, 70 percent of enterprises will still consider outsourcing one business process or function at a time, suboptimizing their sourcing and service delivery (0.7 probability). organizations should use Gartner's strategic sourcing methodology as a way to think through the service delivery strategy (see "How to Build a Sourcing Strategy" and "The Five Dimensions of Strategic Sourcing" for more details about strategic sourcing in the context of IT; these same approaches can also be used for ). Creating an effective sourcing strategy is only the first step. Figure 2 shows all the steps required in relationships with ESPs. As part of creating the sourcing strategy, it is important to account for environmental factors. In an outsourcing relationship, the customer relinquishes some flexibility and control. If the business is in a constant state of change (for example, mergers, acquisitions, divestitures, high growth, downsizing), then the enterprise may not be a good candidate for an ASP solution or traditional outsourcing (but an BPO relationship could facilitate some of these changes). Accommodating these types of changes is not part of the standard set of services. These changes are typically handled as separate projects at consulting rates. 28 February

5 Sourcing Strategy Alignment Organization assessment Core competencies Market scan Make-or-buy decisions Risk analysis Figure 2 Gartner's Sourcing Life Cycle Strategic Phase 1 Tactical Phase 2 Evaluation and Selection Identification Criteria development Organization fit Selection process Partnership opportunities Sourcing Management Relationship Performance assessment Goals: Reach business objectives, efficiency, quality, innovation Transition Phase 4 Phase 3 Contract Development Governance model Metrics Payment models Terms and conditions Provision for changes Once the sourcing strategy is in place, evaluation and selection of in-house and outsourcing vendors can go forward. The list of vendors to consider will be based on the sourcing strategy. If the strategy indicates that many functions/processes should be outsourced, then an enterprise will want to look at full-service BPO vendors. If only a few specific functions/processes are to be outsourced, then traditional payroll/benefits outsourcers and ASP vendors will be most appropriate. The choice between a traditional payroll/benefit outsourcing relationship and an ASP usually depends on the degree of function/process ownership that the enterprise wants to maintain. If the enterprise wants to retain full responsibility for the business function/process, then the ASP option, as opposed to traditional outsourcing, is usually indicated. Complicating the Situation The situation becomes more complicated because some vendors offer solutions in all categories. For example, ADP and Ceridian offer in-house solutions, ASP solutions, traditional payroll/benefits outsourcing and BPO. Figure 3 shows the scope of offerings for some key vendors in the marketplace. 28 February

6 Figure 3 Solution Scope for Selected Vendors Oracle PeopleSoft SAP ADP Ceridian Watson Wyatt Fidelity In-House ASP Hewitt Traditional Payroll/Benefits Outsourcing Exult BPO Enterprise resource planning II (ERP II)/human capital management application vendors such as Oracle, PeopleSoft and SAP offer in-house solutions and ASP solutions (alone and via partners). Fidelity provides several solutions for benefits outsourcing, and is expanding the scope of these solutions to payroll and other areas, which will position Fidelity to offer a full BPO offering. Watson Wyatt is an consultancy that provides a variety of compensation/benefit solutions that can be delivered in an ASP mode, or via traditional payroll/benefits outsourcing. Hewitt Associates is an consultancy that has been active as a third-party administrator in benefits, but has expanded its service offerings to provide broader outsourcing services. Exult focuses purely on BPO. Acronym Key ASP Application service provider BPO Business process outsourcing BPR Business process reengineering ERP II Enterprise resource planning II ESP External service provider Human resources SMB Small and midsize business Bottom Line: Outsourcing considerations add another layer of complexity to software selection. Enterprises should create an overall sourcing strategy before moving forward with insourcing or outsourcing decisions. This will enable them to more clearly identify the scope of services required from the outsourcer, and identify which group of providers will be most appropriate to deliver those solutions. 28 February