The Rise of Human Resources Outsourcing

The rise in importance of the human resources department has been relentless over the last few decades. There was a time when it was known more humbly as the personnel department, and its main task was to ensure workers were paid, but now its role has developed to give it far more strategic importance. It is no longer a passive administration unit: its remit is to actively seek ways to increase the productivity of the workforce.

As such, companies want senior HR executives to spend more time on strategy, and less on non-core administrative duties. According to Monty Baker, IBM's VP global business transformation outsourcing HR solutions, this has been a key driver for the rise of HR business process outsourcing (BPO). "The HR executive is looking to work with the CEO to understand their objectives, so they can then look at questions such as 'What kind of workforce do I need?' or 'Where are the labour arbitrage opportunities I could benefit from?' He can't do that if he's running all the administration and the payroll and all the other non-core activity."

While getting a third party to take on the payroll function is not new - Automated Data Processing started providing such a service in the 1940s - it was not until 1999 that the first major HR BPO deal was signed. A start-up based in Irvine, California called Exult can lay claim to be the pioneer of the industry after it managed to persuade oil giant BP Amoco to hand over control of the majority of its HR processes in a seven-year deal worth $600m.

Since then the HR BPO market has grown to $4.6bn according to research company Yankee Group, which expects it to grow at a compound annual growth rate of more than 30%, to reach $14bn by 2009. IDC estimates the growth rate to be a much more modest 16%, but even this represents an extremely attractive opportunity.

The increasingly strategic ambitions of the HR department have helped the market, but as ever money is the real incentive for customer demand. Nearly all HR BPO deals involve transitioning to a self-service model where automation eliminates jobs and many employee services are delivered through an intranet. According to Mike Hogan, VP comprehensive outsourcing solutions, at ADP: "The economics of HR BPO make sense. Large and mid-sized companies are under increasing pressure to reduce costs in terms of people and technology. Today there are more options. In 2000 there were not many suppliers who could offer end-to-end HRO, but now there are more mature business models."

Competition hots up

Indeed, after Exult's initial flush of success, which included winning a $1.1bn deal with Bank of America in November 2000, it had to deal with a deluge of entrants to the market. Accenture, ACS, Convergys, EDS and IBM all won major deals in the next few years, and a number of the HR specialists broadened out their services to offer end-to-end HRO. By 2003, Exult was finding it much more difficult to sign up additional customers.

But it was a smaller player, Fidelity Employer Services, that delivered the knock-out blow. It was providing HR services to the bank Fleet Boston, when the latter merged with Bank of America in 2004. The resulting combination decided to switch most of the processes that Exult was working on to Fidelity, causing Exult to issue a profit warning, which in turn led to it putting up the 'for sale' sign. When Exult sold out to Hewitt Associates in May 2004 for $630m, it was seen as a capitulation rather than a triumphant exit. Hewitt, with its benefits administration expertise, gained payroll knowledge and a solid client base, which it has expanded on to remain the market leader today.

As Hewitt has consolidated its position, the major IT services players have struggled to keep up in terms of contract signings. However, many have made strategic moves in order to increase market share, by pairing up with specialist HR service providers.

Although EDS had scored a few HR BPO contract wins - such as its deals with Canadian bank CIBC and German semi-conductor company Infineon Technologies - it soon realised that it needed to make a bold move if it was to be a significant player in the industry. In January 2005 it created a joint venture, called ExcellerateHRO, with professional services company Towers Perrin. EDS paid Towers Perrin $420m and owns 85% of the venture, which is a combination of the two companies' HRO capabilities with a total of $600m in annual revenue.

EDS reverses its fortunes

The move signalled their intentions in the HR BPO market, and was bold considering EDS's recent troubled history, which was summarised neatly by the company's executive VP, Steve Schuckenbrock, at an analyst conference last month: "Sales volumes went to hell in a hand basket," he said. "In 2003 we didn't even get an invite to the party. In 2004 we were invited but were also-rans. In 2005 we're winning."

So far the venture has not announced any significant contract wins, but EDS' CFO Bob Swan says that it expects it to contribute to its overall contract signings target of $20bn by the end of the year. ExcellerateHRO's CEO Steve Bohannon told CBR that it had $4bn worth of contracts in its pipeline, and was about to sign its first end-to-end deal with an unnamed company worth up to $90m.

ACS also made a major acquisition earlier this year, paying $405m for the HR consulting and outsourcing operation of asset management giant Mellon Financial. Mellon had struggled to grow its HR business over the last few years, and was seen in the market place as being uncompetitive.

ACS's CEO Jeff Rich admitted at the time of the purchase that it was reacting to the Hewitt-Exult combination. "Before last summer we had never lost to Hewitt or Exult," he said. "But in the last eight months we've come up against them a lot; we've won some and they've won some. The acquisition has made them stronger in the market place, so we've looked at what we needed, and we needed to increase our consulting and thought leadership."

Rather than acquire a specialist company, CSC decided to go down the partnership route instead, teaming up with Aon in August 2004. As Larry Kurzner, senior VP of marketing at Aon Consulting, explains: "They don't want to be in the HRO business and we don't want to be in IT services. A server farm is a server farm, but human resources outsourcing requires deep domain knowledge. IT is running out of runway: the natural plan is to extend into HRO."

However, the Aon/CSC alliance has yet to announce a major client win, and its competitors claim that they are no longer coming up against them when bidding. Aon reorganised its HRO unit in May, but Kurzner refutes any suggestion that it showed a change in strategy or that the partnership had been unsuccessful: "The CSC partnership is a significant opportunity that is gaining traction," he says.

Major players hold fire

All eyes are on IBM and Accenture, the two biggest HR BPO players yet to make a major acquisition. Accenture has significant market share, being number two behind Hewitt, and is known for an organic rather than acquisitive approach. IBM, on the other hand, is further behind and is eyeing the market place for targets in order to build scale. It has been linked to many of its HR BPO rivals, but has yet to make its move.

Beyond the major players there are a number of providers targeting the mid-market, which has become a significant opportunity over the last 18 months due to the rise of the 'one-to-many' model. Rather than shipping their ERP systems out to the IT services companies, the mid-market involves the migration of processes over to the systems of the vendor.

While this does not allow for the amount of customisation often needed by large enterprises, the ability of the vendor to deliver multiple clients from the same platform enables it to offer significant cost benefits. "Now rather than sign off on a multi-million ERP project, you can move from a fixed to a variable cost model. Rather than build, you can pay as you go," says ADP's Hogan.

The one-to-many model is gaining traction in the industry and the major IT services firms have been quick to take note. IBM has built eHR, a web-based front end that it can build on to its client's existing systems. Baker uses the example of a pharmaceutical client which has 500 HR systems. IBM has been able to use the eHR platform as a front end to all of those systems to give a common database globally, and can then concentrate on rationalising those underlying systems.

The growth of the mid-market has also tempted some of the IT giants downstream, according to Kasey Crete, VP of market strategy and business development at Brussels-based HRO company Arinso International. "All the major players are competing for smaller deals than they were before. Now they compete for deals which service 20,000 employees," she says.

The market is still maturing and few vendors can claim to have delivered a full set of HR processes that do not rely on sub contractors, or are able to deliver a fully global solution covering separate country payrolls and different sets of employment law.

ADP is building GlobalView, a platform built on SAP's HCM application, which it claims will deliver HR services on one platform to employees no matter where in the world they are based. Arinso, which has built up a pan-European operation as well as expanding into the US, is being coveted by many of its larger rivals, but as CEO Jos Sluys owns a majority of the company's shares, any decision rests with him.

According to Phil Fersht, an executive at advisory firm Equaterra, the top-tier players are not investing fast enough. "On a global basis, BPO investment is slow. A number of tier-one players have a paltry number of European staff; I could name one that has only 150. The major companies are backfilling investments, they are not investing upfront."

Long-term profitability

Fersht believes that the cautious approach by some of the major players may hamper future growth, and points to the lack of profitability in the sector: "Only Hewitt is making a profit," he claims. According to another BPO advisory firm, Everest Group, the pricing of contracts has plummeted in the last few years. This is down to the ability of vendors to deliver at a lower cost, but also a reflection of a highly competitive market. The vendors are all looking at profitability as a long-term aim.

Steve Bohannon, CEO of ExcellerateHRO, says, "Any big outsourcing deal requires us to come to the party with deferred profit satisfaction. Some deals will recoup in a year, although some can be in the transformational stage for three to four years, but every deal must stand on its own."

Baker at IBM agrees. "This a relatively new industry. We have to build assumptions about winning other business when we price deals, otherwise we'd never be able to sign a deal in the first place. We have to invest up front."

10 Key Contracts in HR BPO

CBR Opinion

HR BPO is a massive opportunity for IT services vendors. The cost and strategic benefits are clear to customers, and the market is growing fast. HR BPO is a scale game - the more contracts you win, the more aggressively you can price future deals - so those unable to build on their initial successes will find it hard to turn a profit. Despite consolidation in the market, it is still overcrowded and CBR expects further M&A activity in the coming year.