HR Outsourcing for SMBs

Transcription

1 HR Outsourcing for SMBs The Essentials Series sponsored by

2 Ar ticle 1: The Business Drivers for Outsourcing Human Resources... 1 Th e Early Days of Human Resources Outsourcing Early to Mid 2000s... 1 Business Drivers for SMB Outsourcing... 1 Se rvices Outsourced... 2 Transactional... 3 Traditional... 3 Transformational... 3 HR O in a Struggling Economy... 4 Changes to Business Drivers for SMB Outsourcing... 4 Se rvices Outsourced... 5 Transactional... 5 Traditional... 6 Transformational... 6 HR Outsourcing Future Strategies... 6 SMB Planning for the Future... 7 Creating Flexible Technological and Operational Strategies... 8 Ar ticle 2: Risks and Realities of Outsourcing Human Resources... 9 Pe rceived and Actual Risks of HR Outsourcing... 9 Small Companies Midsize Companies Re alities of HR Outsourcing Small Companies Midsize Companies Ad justments to Approach for HR Outsourcing Small Company Models Midsize Company Models Article 3: Successful HR Outsourcing Strategies i

3 Int ernal Analysis and Baselining Understanding Cost vs. Value of HR Identifying Core Competencies Aligning Technology to Support Operational Objectives Ag reeing on Expectations with HR Outsourcer Addressing Performance Metrics Enforcing Performance Metrics Me thods for Shifting HR Functions Outside Company Realignment of Internal Staff to Transformational Functions Support through Training/Additional Education Conclusion ii

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5 Article 1: The Business Drivers for Outsourcing Human Resources The Early Days of Human Resources Outsourcing Early to Mid 2000s Since the late 1990s, companies have leveraged third parties to help with human resources (HR) functions. At that time, these functions were often services such as recruiting (particularly within tight employment markets such as information technology IT) and payroll. Small and midsize businesses (SMBs) in particular needed services that would supplement the tasks carried out by their overly taxed employees. Oftentimes, HR functions in small companies were handled by an executive or office manager. For this reason, SMBs leveraged external resources to fulfill HR functions either because it was believed those functions didn t require a full time employee or the company was unable to invest in a skilled, full time employee. Thus, SMBs sought expertise provided by HR outsourcing (HRO) companies. Business Drivers for SMB Outsourcing In the late 90s, unemployment was low, and the demand for technologically savvy employees was booming. Suddenly, experience counted for less, and knowledge of Internet technologies and software drove hiring decisions. This trend continued until the post 9/11 recession, aka DotBomb, which increased the supply of unemployed workers. Outsourcing, and even offshoring, had been a popular model, but companies faced with a skilled, affordable labor market and the need to tighten the corporate belt began pulling projects in house. Then came the rise of enterprise resource planning (ERP) software. Demand for ERP consultants, particularly those with strong communications skills, skyrocketed as companies clamored for people to help them roll out their new software and understand how to use the data they were now receiving to make better business decisions: An unexpected benefit of ERP software was that executives were enabled to see how each of their lines of business (LOB) fed into one another, and the practice of finance and accounting outsourcing (FAO) and HRO were a logical next step. Payroll, a function often handled through HRO, ties in closely with financial decision making, which is often managed via FAO. Once companies had outsourced one service, they became increasingly interested in outsourcing another. 1

6 Technology provided faster, data driven decision making, and through continued software advances, companies were able to use intelligent software to handle functions previously performed by employees 1. However, with fierce competition in the US marketplace, companies had to consistently find additional ways of selling better, faster, and cheaper. One of the strategies was to shift costs from fixed to variable a perfect option was to outsource personnel, which allowed for utilization of human capital when needed. By leveraging outsourcers, companies were able to cut headcount while maintaining acceptable service levels and gaining agility to scale up or down as necessary. Until the economic collapse of 2008, this widely accepted practice fit well into organizations make or buy strategy. Services Outsourced Typical HR services outsourced in the beginning were those most unlikely to incur high costs due to uncertainty, the threat of opportunism, asset specificity, frequency, and ease of measurement according to Jean Woodall et al. in Making the Decision to Outsource Human Resources 2. In simpler terms, companies outsourced those HR functions that were unlikely to put the company at risk yet were tied to specific company assets, occurred with regularity, and were easy to manage and measure. Woodall also found that companies in the US and Europe most commonly outsourced outplacement, pre employment testing, training, payroll administration, employee assistance, [counseling], and pension plans, while retaining the strategic functions of policy making, succession planning, and employee relations in house. HR functions can be categorized into three arenas: transactional, traditional, and transformational. Benefits administration and payroll occur with regularity and are largely administrative functions, thus they have been considered transactional HR functions. Traditional functions in HR are those of recruiting, staffing, performance management, and training. Strategies for compliance, labor relations, and strategic workforce analysis, as well as overall HR strategy as part of an organization s overriding business practices are considered transformational HR activities because these are the approaches that can change a company s business. Unfortunately, within HR departments in the 1990s and early 2000s, only a few companies had these change agents at the top of the HR hierarchy. Thus, within HR departments at the time, most employees had duties that fit within the transactional or traditional categories. 1 James H. Lee, Hard at Work in the Jobless Future, Futurist Jean Woodall et al., Making the Decision to Outsource Human Resources, Personnel Review,

7 Transactional In The Influence of Business Strategy on the Decision to Outsource Human Resources Activities, Hasliza Abdul Halim and Norbani Che Ha cite non core functions are transactional activities that are administrative and routine that can easily be replicated and duplicated. 3 In transactional functions, small scale, repeated functions are fulfilled by the individuals acting as HR agents. These functions are necessary to the organization; however, they are not considered value adding activities. Typically, benefits administration and recordkeeping are considered transactional because they are necessary and happen on a timely basis, but, being more of an administrative function, they add little value to the company itself. For this reason, transactional functions have a history of being outsourced, particularly within small companies, which, as they grow, find they must leverage additional third party resources to meet internal needs and objectives. Traditional Similar to the way they have handled transactional functions, SMBs have historically used third parties to fulfill the traditional HR role: recruiting/staffing and training. Small companies in particular had budgetary challenges and were mindful of building a tight organization of like minded individuals who would have longevity with the company. Thus, outsourcing the recruiting and staffing function to a third party provider was a wise move. By leveraging consultants for either short term projects on an as needed basis or by using contract to hire employees, SMBs could spend their limited budgets wisely and build relationships with their provider that leveraged the provider s knowledge and expertise, particularly within employment law. Transformational Although most SMBs were familiar with the concept of outsourcing transactional or traditional functions, many had not considered utilizing a third party provider to realize their organizational goals because it was not considered an internal function of HR at the time. Until late in 2007, when HRO became popularized, few SMBs had considered the possibility that HR could be a strategic player (as evidenced by the lack of HR staff appointed to board positions). For this reason, most HR functions that were outsourced were transactional or traditional. The period from the 1990s to the mid 2000s saw the rise and growth of outsourcing from IT to HR, finance, and other departments. This growth developed as companies sought ways of leveraging outside expertise, mitigating risk, maintaining compliance, and embracing a flexible staffing model that allowed for scaling up or down all while shifting labor costs from fixed to flexible, thereby increasing shareholder value. 3 Hasliza Abdul Halim and Norbani Che Ha, Exploring the Effect of Business Strategy on Human Resource Activities: A Study of Malaysian Manufacturing Organisations, Singapore Management Review,

8 HRO in a Struggling Economy Through the summer months of 2008, some SMB executives discussed possible increases in corporate taxes and how their organizations would deal with such rises in cost. At the time, I was working 120 hours each week to provide hundreds of candidates to a well known global consulting firm for their college recruiting and ERP training initiative. Through this initiative, they would roll out ERP consultants throughout the US to meet the increasing demand. Within one week of the students beginning their new lives as ERP trainees, they watched, as did the rest of the world, as in late September, the US stock market crashed. And crashed in October. Then continued to crash for eight consecutive trading days 4. According to Lakshman Achuthan, managing director of Economic Cycle Research Institute (ECRI), 7.9 million jobs have been lost since 2008, and that number is factoring in nearly 600,000 private sector jobs that have been created since that time 5. As a result of the economic instability, capital crunch, mass layoffs, and sheer lack of experience in running a company through such difficult economic times, executives have had to find ways to get the greatest performance out of the smallest number of employees. Although the National Bureau of Economic Research report declared that the recession ended in June 2009, SMBs, in particular, are still struggling to do more with less. From this situation comes the rise of HRO. Changes to Business Drivers for SMB Outsourcing The cost consciousness of companies in a struggling economy has made the move to HRO not only desirable but necessary. Of primary importance to small companies is the flexibility to staff up or down as necessary without affecting service levels. However, both small and midsize companies benefit from the variable versus fixed cost of outsourcing. Within their research, Woodall et al. found that HRO enabled a small finance company to avoid training employees in employment law and a telecom company to cut risks around contractor recruitment. In addition to reduced employment costs and risk, a desire to achieve best practice, to improve service quality, to focus upon the core competences of an [organization], and to [utilize] new technology are also prominent reasons offered by [organizations] for utilizing HRO. Authors Abdul Halim and Che Ha found that in considering outsourcing, companies also are looking at operational efficiency, which ties into their strategies for either [providing] a service in house or [buying] it from the market. 4 Money zine, Stock Market Crash of Qtd. in Chris Isidore, 7.9 Million Jobs Lost Some Forever, Cable News Network,

9 Services Outsourced According to Amy Pena in Contracting a Third Party to Cut Costs, some of the key reasons for current outsourcing have been to cut or control costs, focus on core competencies, access additional capabilities, and mitigate risk 6. Abdul Halim and Che Ha found that after surveying 113 companies, they were able to match the business strategies of companies to their HRO practices. Of the four business strategy categories proactive, reactive, breadth, and quality based, the strategy that most closely correlates to SMBs is that of a proactive strategy in which the company focuses on using innovation and the differentiation of its products through unique designs and features. Such was particularly the case of SMBs engaged in technology. The findings of Abdul Halim and Che Ha were that companies using a proactive strategy tend to outsource payroll, HR information system (HRIS), and benefits because it is critical that the company maintain a strategic focus and concentrate on innovative and differentiated products that will positively impact [organizational] performance. Proactive companies also had a tendency to outsource traditional functions, such as training, that require significant investment to tailor to the needs of the organization, which would take the focus from the companies core competencies. Finally, outsourcing traditional functions for these companies was beneficial for the purpose of maintaining flexibility during times of change by allowing them to monitor the frequent modifications of the functions and reduce capital investment. Transactional Transactional HR functions are often outsourced because maximizing flexibility and focusing on strategic practices are much more significant than monitoring day to day operations (Abdul Halim and Che Ha). Particularly in the case of small businesses, the use of their limited employee resources to complete repetitive, low value tasks such as payroll is wasteful for a company that needs to focus on delivering innovative products and services to the marketplace. At a minimum, SMBs should outsource payroll and benefits administration to a third party; doing so frees up employees for activities that will add value to the organization. The Kaiser Family Foundation and the Health Research Education Trust conducted a study in 2007 that concluded that health care premiums [have been] outpacing both inflation and employee wage increases which has forced companies to introduce various tactics for controlling both the costs of benefits and the costs of administering those benefits programs. 7 As mentioned earlier, small companies often have HR functions completed by someone other than a HR expert who is handling HR management in addition to other tasks that fall within their line of expertise. It is critical that these companies shift those tasks outside the organization to allow that person, be it the CFO or CEO, to focus on activities that will strengthen the company s competitive position. 6 Amy Pena, Contracting a Third Party to Cut Costs, Hispanic, Current Benefits Trends: Cost Saving Practices & Better Employee Communications, Compensation Benefits for Law Offices,

10 Traditional Although Abdul Halim and Che Ha found that proactive companies consistently outsourced transactional activities, the same companies hesitated to outsource traditional HR functions. These companies feared that by outsourcing training and recruiting, they might drain intellectual capital, which is of particular importance to proactive companies. They also feared that it would take a significant upfront investment to enable outside suppliers to understand the [company s] particular requirements. Although such might be the case within midsize companies, which typically have some specialized HR personnel, smaller companies simply don t have the internal resources to provide necessary recruiting and staffing efforts, and training is relegated to a luxury item. Unfortunately, these companies are ill prepared to address external influences such as legislation changes, particularly with labor laws. For these reasons, outsourcing traditional HR functions is a necessary, astute practice. Transformational A common struggle of SMBs is to decide which functions to retain in house and which to outsource. Activities that are considered transformational present the opportunity to change the business. Unfortunately, when it comes to small companies, HR functions are oftentimes not performed by an individual who specializes in strategic workforce planning, labor relations, or human capital management. Thus, for small businesses, keeping the HR function in house is not an option. There is no one who can internally address these sophisticated employment measures, so the company can either make the decision to outsource these functions to experts or choose to ignore these strategies and hope for the best. With midsize companies, there is typically an individual whose function is HR, and if the individual is an expert in human capital management, labor relations, and strategic workforce planning and analysis, it makes sense that the individual (if not overcommitted with other duties) provide that expertise. If such an employee does not exist (or if the employee has expertise in only one of the core strategic areas), the company must outsource these functions in order to maximize employee engagement and performance, maintain regulatory compliance, and refrain from charging an employee with duties for which he/she lacks the know how. HR Outsourcing Future Strategies After reviewing the rise of HRO over the past two decades, it is easy to see how outsourcing has grown in response to the need for outside expertise in HR. However, what strategies can be enacted by calculating companies for competitive advantage? By spreading risk to the outsourcing company and by leveraging information systems and human capital expertise offered by the HRO provider (who presents not only actionable intelligence but an expert to explain trends), SMBs can leverage HRO providers as a strategic partner for employment decision making and become a best in class employer with the operational flexibility to meet market demands. 6

11 SMB Planning for the Future Although SMBs have started getting on the HRO bandwagon by shifting more of their transactional and traditional activities to a third party, HRO providers have been largely untapped for transformative HR activities. Once executives of SMBs realize the impact of leveraging human capital experts to help grow their companies while increasing productivity, efficiency, and transparency, reliance upon transformational HRO will increase. Although research firm Gartner notes that comprehensive HRO accounts for only 15 to 20 percent of all HRO deals, the trend is growing from a need to have a unified view of the company for operational decision making. 8 By having a standardized platform and delivery model, and by bringing multiple processes under a contract, Gartner notes that employers can then realize the full benefits of HRO in terms of cost reduction and process improvement (qtd. in Hansen). According to Outsourcing the HR Function: Possibilities and Pitfalls, the Corporate Research Forum found that HR [has failed] to engage with a strategic vision to transform itself. 9 This finding is concurrent with the conclusions drawn by Woodall et al.: Once functions had been outsourced, the key personnel retained to achieve higher order were often unable to transition from traditional and transactional duties to those of a change agent, strategist, and business partner because they lacked the necessary skills. One respondent to the survey conducted by Woodall et al. stated, The remaining HR staff are more generalist and tend to get involved at a level down from previously. A second respondent remarked, We would like to think that [HRO] frees up internal staff for higher value activities, but in reality, staff reductions are the most common outcome. Because of this tendency, in the future, SMBs will have an even greater reliance upon HROs, as they focus further on their core competencies and leave HR activities and strategies to the human capital management experts. 8 Fay Hansen, Special Report: Midmarket Outsourcing, Workforce Management, Corporate Research Forum, Outsourcing the HR Function: Possibilities and Pitfalls,

12 Creating Flexible Technological and Operational Strategies Unlike enterprise organizations, SMBs have to be able to cope with rapid market changes that could require that they scale up or down within a short timeframe. In response to the survey by Woodall et al., a respondent from a professional services firm remarked that their decision to outsource was driven by a need to [cope] with growth, as its staff expanded from 69 to 160 within a single year, which created significant capacity issues with the HR staff. Another respondent remarked that, The decision to outsource was driven by the collapse of the old payroll system due to overload. Our initial thoughts were just around outsourcing payroll, then as we looked at it, we saw the other bits fit around this and decided to outsource administration. We then thought if we are outsourcing most of it, we might as well outsource it all. For this company, outsourcing all services helped to scale its systems and processes to meet the challenges of exponential growth. Although outsourcing all HR activities under a single, comprehensive contract was a sensible move for this particular company, other companies engage a staggered approach. Through this method, they outsource a few functions at a time, carefully reviewing metrics for delivery upon expectations. 8

13 Article 2: Risks and Realities of Outsourcing Human Resources Perceived and Actual Risks of HR Outsourcing Human resources outsourcing (HRO) is still a relatively new concept. As such, there exists some trepidation against outsourcing, with a common fear being a loss of control, particularly when it comes to releasing sensitive employee information to a third party. 10 Based upon research, however, the risks associated with HRO are not loss of confidential employee information or reduction/dilution in intellectual capital from engaging with an outside party for internal resources. In fact, the most common downside of HRO has occurred in terms of failure of the organization s internal, retained HR executives to contribute as change agents or strategic business personnel which was part of the purpose of outsourcing in the first place. This consequence is most commonly realized by midsize businesses that choose to outsource transactional and traditional functions for the purpose of moving key HR personnel further up the value chain. A second risk of HRO results from a lack of understanding between the outsourcing provider and the client. For example, in Making the Decision to Outsource Human Resources, Jean Woodall et al. noted, Very few respondents admitted that they had a good understanding of the cost of delivery of their HR service to the rest of the business, and only [one company] felt confident that they were aware of this prior to outsourcing. Yet, paradoxically, a good understanding of the cost of the HR function was a necessary prerequisite for successful outsourcing, as well as being a desired outcome. 11 Although it seems obvious that a company would understand the cost of and value delivered by its personnel prior to considering outsourcing, findings have shown that typically the cost considered was solely that of employee overhead rather than additional costs savings in terms of in house HR information system (HRIS), project management, and more. Finally, as one would expect, some companies have had negative experiences with HROs because the provider selected was unresponsive, did not meet customer expectations, or did not fully understand the organization s culture and needs. Because of this lack of understanding or delivery upon expectations, costs associated with outsourcing were higher than expected, and in some cases, the functions were then brought back in house (Woodall et al.). 10 Current Benefits Trends: Cost Saving Practices & Better Employee Communications, Compensation Benefits for Law Offices, Jean Woodall et al., Making the Decision to Outsource Human Resources, Personnel Review,

14 Small Companies A senior manager from one of the five small companies that had outsourced HR and was surveyed by Woodall et al. remarked, There have been some instances where employees do not know whom to contact, and some occasions where no one was available to answer the phone. Particularly within small companies where personnel are used to being able to easily access one another, working with an HRO provider can be tricky. For this reason, it s critical that expectations are addressed prior to engagement with the HRO provider, metrics are established, and performance reviews occur on a regular basis. Additionally, companies need to closely consider their service level expectations prior to reviewing potential vendors because the most cost effective providers are not going to be able to provide the highest levels of service. Of the HROs available, Professional Employment Organizations (PEOs) offer a comprehensive suite of services within the HRO industry. By contractually assum[ing] certain employer responsibilities and employment related liabilities, PEOs are a valuable resource for small and midsize businesses (SMBs). 12 Some of the most common services contracted through PEOs are benefits administration, regulatory compliance, recruiting, and retention all of which are of particular concern to small business owners. In Three Million Reasons to Add Payroll Services, Julie Lubetkin writes that almost 60 percent of surveyed small businesses with less than 20 employees still manually process payroll. They are short on time and resources, so one in three small businesses incurs [sic] an average of $1,500 in late tax payment penalties every year. 13 For this reason, small companies are encouraged to outsource the transactional HR duties to a third party provider. Midsize Companies The dynamics of midsize companies being too large to have close interaction with all employees and too small to be able to rely upon extensive financial and personnel resources mean that companies within this category have unique considerations. Unlike small businesses, midsize companies tend to have individuals whose primary role falls within HR. For this reason, executives look at how they can leverage these individuals in the most cost effective manner that will help contribute to the company s continued growth. A standard approach is to outsource transactional and traditional HR functions but retain transformational functions in house. The goal is to retain key HR executives and move them further up the value chain to become advocates for employees, business strategists with insight into labor relations, and change agents who are able to help C level executives execute upon corporate strategy. 12 Outsource HR to Achieve Value, Accounting Technology, Julie Lubetkin, Three Million Reasons to Add Payroll Services, Accounting Today,

15 Unfortunately, as discovered by Woodall et al., One unintended consequence was the disappearance of in house HR expertise. This was due to the effect of the downsizing that appears to have accompanied the outsourcing of HR in many organizations. Predictably, the radical change brought by outsourcing left problems in terms of knowledge management and corporate memory. For this reason, it is imperative that organizations pursuing HRO partner closely with their outsourcing provider to ensure that there is not a drain on corporate knowledge as well as making sure that retained HR personnel are trained and supported. At a minimum, midsize companies need to closely monitor knowledge transfer through the outsourcing process. Realities of HR Outsourcing In a survey of 129 companies cited by Todd Henneman in Measuring the True Benefit of Human Resources Outsourcing, the top three reasons for HRO were to gain outside expertise, improve service quality, and focus on the core business. 14 These findings are echoed by Woodall et al. who found that [organizations] undertake outsourcing to reduce costs, gain access to HR expertise, achieve workforce flexibility, and to focus managerial resources on strategic matters and also to keep up with workplace regulation. These findings reflect that companies today are using HRO in much the same way that they were a decade ago. However, Workscape analysts presented interesting observations in their Annual Benefits Study 2008: 15 Web based technologies are the primary means of accessing benefits information, but they are often used in tandem with other traditional personnel communications methodologies. CEOs are significantly more likely than HR and benefits professionals to see 24/7 access to benefits support as being important. [Firms having] already invested in internal technology [feel] no current pressure to switch. Although cost savings from outsourcing can be significant, the return isn t necessarily immediate, especially if a firm looks only at HR labor costs associated with enrollment and does not associate other related expenses, such as IT support. 14 force Management, Todd Henneman, "Measuring the True Benefit of Human Resources Outsourcing." Work Current Benefits Trends: Cost Saving Practices & Better Employee Communications, Compensation Benefits for Law Offices,

16 Small Companies According to research conducted by Woodall et al., the main difference in outsourcing practices between larger and smaller companies is that smaller companies are much more likely to outsource the whole or the majority of their HR activity, whereas larger companies focus primarily on the more routing transactional work. As previously mentioned, of those interviewed, employees within a benefits or HR role were as much as half as likely as CEOS to see 24/7 benefits access as important to employees. Access to Web based portals for benefits, performance metrics, or organizational insight is not only costly but risky to build in house, making this an area where small companies are able to leverage the technologies provided by HROs. Midsize Companies Like most midsize companies, Business Advantage, Inc. came to their comprehensive HRO decision following an initial decision to outsource payroll. After their initial outsourcing foray, Business Advantage began investigating other services to outsource but soon realized that with multiple vendors, integration would be an issue. Trying to handle some processes ourselves and some through separate outside vendors was like trying to manage a herd of cats, according to Business Advantage CEO Stanley Joseph. After modifying and expanding Business Advantage s outsourcing arrangement five times in 3 months, the company finally decided on a comprehensive HRO/finance and accounting outsourcing (FAO) contract with an estimated savings of 30 to 40 percent annually compared with the in house cost for similar functions 16. SMBs can also leverage outsourcing companies during times of growth and transition like expanding into new markets in order to adhere to local employment laws and payroll tax regulations. 17 Similar to Business Advantage, Inc., Catalina Restaurant Group is a midsize company that has leveraged HRO. Samuel Borgese, CEO of Catalina, made the decision to outsource HR in 2002 (following a spin off). The decision to outsource was primarily driven by a need for standardization and economies of scale without having to invest a lot of capital. By utilizing an outsourcing provider, Catalina was able to keep strategic tasks in house with tactical support from the outsourcing vendor while utilizing the vendor s HR platform (qtd. in Hansen). According to Borgese, It s very hard for a VP of HR to be a strategic player if he or she is managing the HR infrastructure. If they are freed from this, they can concentrate on workforce deployment and strategic issues. Of additional note, Catalina s executives were concerned about regulatory compliance. Citing tax regulations as a strong factor in the decision to outsource, Borgese noted, You need to have great confidence in your ability to meet requirements. On the F&A side, we must close our books with complete accuracy within five days. As midsize companies, Business Advantage and Catalina executives both found that, through HRO, they could build in operational flexibility and efficiency without the significant capital investment that would be required to perform the same functions in house. 16 Fay Hansen, Special Report: Midmarket Outsou rcing, Workforce Management, Paul McDougall, Help with Human Resources, InformationWeek,

17 Adjustments to Approach for HR Outsourcing Outsourcing significant functions is complicated and bears risk. Thus, it s important that firms closely examine what is currently being delivered by internal resources and the full costs associated with those service levels. Organizations can then determine value that can be aligned with their expectations of outsourcing. From this point, executives must set clear objectives with the outsourcing partner and agree upon metrics to reflect performance. From their survey, Woodall et al. determined that many companies had not factored in the full cost and value of their internal resources prior to outsourcing. This situation in turn meant that the cost of reaching previous service levels was more significant than anticip ated. In review of their practices, respondents made the following remarks: [a big weakness was] not base lining our own service before we started No cost evaluation was made against internal or external providers this would be a weakness Most HR directors only understand 75 [percent] of their cost base Don t outsource what you don t understand Small Company Models Although many small company owners dream of the day when their company experiences exponential growth thus propelling them to a midsize company such growth carries drawbacks. A company that cannot scale systems and processes to meet the needs of the accelerated growth can find itself just as quickly losing customers and employees. For this reason, small companies that are experiencing rapid growth should consider outsourcing systems and processes that fall outside of their core competencies. By shifting these functions and tasks to an outside vendor, focus can remain on areas that provide competitive advantage without sacrificing quality. Midsize Company Models For companies that have been used to having in house resources, HRO can require a period of adjustment. In addition to agreeing upon expectations, midsize companies must realize that they are shifting functions outside the company. This shift makes it critical for companies to think of their vendor as a partner and engage strategically with that partner before, during, and after outsourcing in order to realize the full benefits of outsourcing. As stated by Borgese, If the vendor is truly responsive, it will be like having the functions inhouse. This commitment must be considered long before engaging in negotiations. Although service levels can be negotiated, relationships with a vendor should not be one of those negotiations. Executives will need to spend a lot of time with their provider, so the rapport needs to be strong and mutually beneficial from the beginning. 13

18 Article 3: Successful HR Outsourcing Strategies Internal Analysis and Baselining It is impossible to determine whether value is being delivered by an outsourcing partner without first understanding the value delivered by internal resources. For this reason, companies must pay close attention to the full costs of and value delivered by their current operations. The most common factor for determining value of human resources (HR) departments is by examining headcount. By reducing headcount but maintaining productivity (a sign of increased efficiency), companies are able to exact greater value from their employees. However, there are additional factors to consider, such as attrition levels, employee morale, reduced litigation, and reductions in time to hire. Without understanding these factors, companies are unable to properly baseline in house operations prior to shifting functions externally. Companies also need to factor in the expense of building and supporting in house technology platforms and 24/7 benefits administration portals when considering whether to keep functions in house or outsource them. In looking at these factors, Linda Merritt, AT&T HR strategic planning director, states, I advise people to think about not what you want on Day One but what do you want in Year Four, Year Five, Year Six and think about how you re structuring the deal that will allow that to evolve or develop over time. 18 Echoing her advice, Robert Brown, Gartner analyst, remarks, Before companies seek bids, they should quantify their current service levels and costs (qtd. in Henneman). These quantifications are essential to understanding how to structure outsourcing deals to ensure that companies are not disappointed in subsequent years. 18 Todd Henneman, "Measuring the True Benefit of Human Resources Outsourcing." Workforce Management,

19 Understanding Cost vs. Value of HR Although employee morale, satisfaction, and turnover are some indicators of HR performance, researchers have a difficult time agreeing on the most important HR performance indicators. The reason is possibly because HR has historically been viewed as a department that does not add value in terms of competitive advantage to the company; therefore, one of the more popular measures of its performance has been cost reduction. The theory is that by outsourcing HR functions and lowering headcount, remaining employees can focus on the company s core business, driving greater efficiency and overall performance; however, it is obvious that there is value in human resources. The difficulty arises in how HR can contribute to the competitive advantage of a company which begins with HR working alongside company executives to align corporate objectives to the skills, abilities, and motivations of personnel. Identifying Core Competencies The first priority in determining whether HR outsourcing (HRO) will help a company achieve competitive advantage is to outline the company s core competencies. By identifying those areas that define a company without them, the company would have no advantage at all executives can then isolate those areas as core competencies. Once those areas have been isolated, all other areas are possible avenues for outsourcing. In addressing this strategy with me a couple of years ago, a CIO friend of mine, and 25+ year technology executive, stated that he considered all the operations within his department and wrote them on a page. He then drew a line between those that, if held inhouse, would add value and competitive advantage to the organization and those that would not. Everything that fell below the in house value line was outsourced to a provider that specialized in that area. This focus on core competencies is essential to small and midsize businesses (SMBs), which must always be mindful of the opportunity cost of their operations. By investing money into an operation that does not deliver competitive advantage, an SMB is wasting capital that could be better used elsewhere. Aligning Technology to Support Operational Objectives A growing reason for SMBs to outsource HR functions is the desire to leverage current HR information system (HRIS) technologies. Current platforms are expensive to roll out and maintain, and the window for technology obsolescence continues to shorten, making it impractical for SMBs to build these applications. For this reason, it is far more sensible for SMBs to leverage their vendor s platform, the expense of which is stretched across many clients (making it more affordable to the vendor). Furthermore, by using a vendor s technology, the SMBs are able to mitigate the risk of building such an application in house. 15

20 The types of technologies available extend from simple payroll and benefits administration platforms to sophisticated dashboard/business intelligence tools that provide reporting metrics across the company. Of additional benefit to organizations are the HROs that utilize Software as a Service (SaaS) based platforms that require minimal computing resources, are scalable across the enterprise, and can be delivered in as little as weeks as opposed to years for in house developed applications. 19 The company will quickly become reliant upon the vendor s technology (which may create a barrier to exit for the client company), so it is imperative that in reviewing potential vendors, an organization chooses a company that will be in business several years into the foreseeable future. Agreeing on Expectations with HR Outsourcer Engaging vendors in technology discussions over upcoming years might seem a little outside the immediate needs of a company; however, it is important that executives understand what types of technologies are offered by potential vendors, the costs associated with those technologies both in terms of external fees for technology and support and for internal maintenance (hardware/storage requirements) and the vendor s future technology planning. If the company s data will be housed externally, the executives of the firm must feel confident that the HRO partner has plans to address obsolescence, upgrades, governance, business continuity, and security. These expectations must be discussed early with vendors so that both parties have a clear view of what is being offered and what is being requested. Similar to technology discussions, all stakeholders of the organization need to have input into the HRO discussion to ensure that all parties agree upon a set of achievable objectives that can then be passed on to the vendor. Once expectations are clear and the deal is finalized, it is important that periodically the vendor s performance is reviewed and matched against expectations, and measures are taken to bring performance in line with expectations. Addressing Performance Metrics In addition to addressing technology concerns, SMB executives need to lay out expectations for delivery of all functions. These metrics can be as simple as response policies that lay out how quickly a firm returns a call to time to fill ratios for recruiting and selection. Increased employee morale as seen by decreased attrition levels (employee relations) and increased job performance through training are additional metrics that can be used to determine delivery of objectives. 19 Fenil Shah, The New Era of Outsourcing Why Web Based Human Resources has Come of Age, Workspan,

21 After understanding business needs, determining future strategies, and having examined the costs and benefits of keeping HR functions internal, savvy executives should consider the performance metrics they will establish with their service provider. One of the benefits of outsourcing HR can be access to business intelligence technology that would be otherwise unavailable to a small business, making it critical for metrics to be considered closely and agreed upon as part of negotiation. In "Measuring the True Benefit of Human Resources Outsourcing," Todd Henneman notes that by mutual agreement of metrics, which can include data on cost per person accuracy of work, timeliness and customer satisfaction, both parties will have an understanding of expectations, which will create a stronger, more successful partnership. (Henneman was paraphrasing Larry Kurzner, senior VP with Aon.) By mutual agreement of metrics which can include data on cost per person, accuracy of work, timeliness, and customer satisfaction both parties will have an understanding of expectations, which will result in a stronger, more successful partnership. After all, the closer the vendor comes to being a trusted advisor, the closer the organization will be to having third party services feel more like they re being handled in house without the hassles of overhead or compliance. Enforcing Performance Metrics Once companies have invested the time and energy into understanding the baseline performance metrics of in house functions, they can identify achievable objectives and the coordinating metrics with their HRO partner. Once those metrics have been verbally agreed upon, it is important to have expectations and penalties stated within the outsourcing agreements. Outsourcing can be expensive both in terms of time and capital, so it s imperative that all parties agree upon what will be measured and how, in addition to when and how often the measurements will be taken. SMBs want to feel that they have security that their expectations will be realized, and vendors want to show their clients how they are meeting and exceeding objectives. For this reason, all objectives and penalties for nonperformance should be clearly stated in the outsourcing agreement. Although it is assumed that the person in charge of the HRO initiative maintains consistent communication with the vendor, regular reviews of the expectations compared against performance should happen at a minimum on a quarterly basis to address any issues early on and give the vendor time to fix any problems. Methods for Shifting HR Functions Outside Company Once the company has agreed upon its HRO policy and secured its preferred vendor, the process of shifting the functions externally begins. In the case of small companies, it can be as simple as a CFO happily turning the HR reigns over to the vendor and refocusing his or her time on finance and accounting measures. In the case of midsize companies, the roll out can be more complicated. 17

22 Midsize companies have more employees, some of which might be HR staff. These companies have a tendency to outsource functions that were previously completed by staff. This situation can oftentimes result in layoffs of non essential employees and promotion of those deemed key players into more strategic roles. Unfortunately, as recent research has shown, too few of these employees are able to make the transition to strategist and advisor. If part of a company s strategy is to focus on getting higher value out of HR personnel who were previously performing traditional or transactional functions, it is imperative that the company provide extensive training and continued support to prepare the employees for the new role. Realignment of Internal Staff to Transformational Functions In addressing the difficulties of post outsourcing with internal HR staff, Samuel Borgese, CIO of Catalina Restaurants remarked, It s a question of whether the HR executive wants control or wants what is best for the organization. The HR executive has to look at the business intelligence and constant process improvement that can be achieved, and at his or her goals and responsibilities within the executive team. 20 For any person, being promoted into a new role carries with it excitement as well as anxiety particularly when a staff member has previously been involved with the business but not considered a key, strategic member of executive decision making. This evolution can be a difficult one that can only be resolved through extensive, continuous training and education. Support through Training/Additional Education The transition to HRO can be difficult on HR staff, making it critical that sufficient time, training, and education are given to foster their growth into higher value activities. In Jean Woodall et al., Making the Decision to Outsource Human Resources, an HR director of a surveyed telecom company observed, HR staff needs to be up skilled to work as HR Business Partners and form part of the leadership team. 21 Two other organizations surveyed (one a county council and the other a finance company) stated that, since outsourcing, their key HR staff had moved into change management, consultancy, learning, management development, and governance and standards roles. The results were mixed, however, with some respondents indicating that personnel were actually less skilled in their new role and that the quality of strategic insight or consultancy skills was lacking. For this reason, companies should look closely at the personnel they want to elevate into change agent roles, and provide adequate training and support for those staff members. Otherwise, companies might be better off outsourcing the transformational function to a company specializing in these higher value operations (some of whom have the titles of HR consultant or human capital management consultant ). 20 Fay Hansen, Special Report: Midmarket Outsourcing, Workforce Management, Jean Woodall et al., Making the Decision to Outsource Human Resources, Personnel Review,

23 Top Ten Recommendations for HRO Before a company engages in HRO, it should have: Identified how outsourcing fits with strategic objectives Agreed which core strategic competencies must be kept in house and what can safely be outsourced Identified a complete view of internal HR service delivery costs, the main cost drivers, and the potential savings and investment Assessed internal outsourcing and explored how shared services might deliver the same benefits but with greater retained control Identified the technological challenges and solutions around outsourcing have the costs of running and retiring legacy systems been calculated accurately, for example? Developed a clear view of the capabilities and reputation of each of the main outsourcing providers Standardized and simplified processes and procedures prior to considering outsourcing Discussed in detail the concept of outsourcing with customers (employees and business managers) and other key stakeholders in the company Defined the key success measures that will be used to judge the performance of the outsource provider and the structure of the deal Considered the history of the organization in terms of managing complex transition processes is there the will to see an outsourcing initiative through to completion? (Source: Corporate Research Forum, Outsourcing the HR Function: Possibilities and Pitfalls ) Conclusion HRO is a complex industry with a broad spectrum of products and services that can be bundled or delivered a la carte, depending upon the individual needs of the company. Because of its complexity, potential risk, and requisite capital expenditures, HRO is not a practice to be engaged lightly. For a successful HRO endeavor, companies must be mindful of the value of and costs associated with their internal operations and understand the service levels provided by those in house functions prior to entering into relationships with potential vendors. Although deals can be structured any number of ways to meet the unique needs of an individual company, the one area that cannot be overlooked is that of the client vendor relationship. For SMBs considering outsourcing, particularly companies seeking to leverage the vendor s platform, nothing is more important than creating a partnership built on trust, respect, and commitment to meeting a company s organizational goals. 19