HR Outsourcing - Is it the next wave?

Human resources business process outsourcing (HR BPO) continues to be a major component of the overall worldwide BPO market, as worldwide HR BPO is expected to reach $24.6 billion in 2006, an increase of 4.7 percent from $23.5 billion in 2005, according to Gartner, Inc. The overall worldwide BPO market is expected to reach $134.7 billion in 2006, an increase of 8.3 percent over 2005. However, the HR BPO market has reached a crossroad in 2006, as some vendors struggle with profitability and retrench to improve their bottom-line results. This will exert a drag on the market especially on the growth of the U.S. segment through 2007.

HR BPO is the biggest component of the overall worldwide BPO market at 18.7 percent of the market. Payroll services and benefits administration services comprise the largest segment of the total worldwide HR BPO, together comprising nearly three-fourths of the market in 2006. The remainder of the market is composed of education and training, hiring and recruiting, and personnel administration services.

“HR has long been identified as a key area for outsourcing, usually in the areas of payroll and benefits administration services,” said Robert Brown, research director for Gartner. “As a back-office function, aspects of HR are often deemed critical, yet non-core functions for outsourcing and are usually most companies’ first stop on the sourcing journey for BPO. Payroll outsourcing is also a key area for consideration among small and midsize businesses that are often underserved by larger, more-strategic forms of BPO.”

Gartner said that more companies are looking to leverage HR outsourcing as a way to drive increased amounts of automation to achieve reduced costs and improved service levels. Many organizations that consider using HR BPO have created shared-service centers, where they have already standardized many processes. Benefits administration, payroll and basic HR call center functions are good candidates for process standardization in internal-shared service centers. However, many companies often seek an outsourcer that can provide the next level of leverage to lower cost and continue to innovate on service delivery.

Profitability concerns will lead many of the largest vendors to try to consolidate, rationalize, standardize and leverage their current HR BPO assets to drive up the profitability of the BPO portfolio. “Currently, there is much scrutiny by investors of HR BPO vendors’ profitability on their larger, strategy-complex BPO contracts. In the drive to top-line market share and revenue growth in the first half of the 2000s, many of the largest, most comprehensive end-to-end deals were highly customized in nature, with very little leverage built into the delivery model,” said Mr. Brown. The internal staff is the biggest competitor to external HR BPO providers

Fear of losing control is a major obstacle to BPO adoption, so Gartner analysts recommend that organizations carefully weigh strategies to displace internal functions and staff. “Fears surrounding the loss of internal expertise often include the loss of ‘tacit’ knowledge (undocumented process knowledge carried intuitively by workers). Loss-of-control fears can also encompass dread that, once a process is outsourced, it will be difficult to ever reinsource, and users want to know how to transfer a process back if needed,” said Mr. Brown.

While payroll BPO is generally mature, Gartner analysts said there is still room for growth and evolution in niche areas. For traditional payroll outsourcing, most buyers service single-country operations. Multinational/global payroll outsourcing in multiple countries to a single provider isn’t yet mainstream and has little customer adoption making it a potential key growth area in the years to come. Gartner Dataquest's Business Process Outsourcing Worldwide program provides history and five-year forecasts for BPO by service line, by region and country. BPO segments include demand management, enterprise services, operations, and supply management.

The Yankee Group, a US research and consulting firm, estimates that the worldwide HR outsourcing services (HRO) market will grow to $80 billion by 2008, at a compounded annual growth of 12 per cent, with non-core transactional duties such as payroll and benefits administration increasingly outsourced (particularly in the US) rather than conducted in-house.

Kelly HRfirst, the staffing alternatives business unit of employment services firm Kelly Services, reckons that about 85 per cent of all US businesses outsource at least a portion of their HR functions.

Cost savings and efficiency gains reaped through HRO services, Kelly HRfirst points out in a report, have paved the way for businesses to increase their use of recruitment process outsourcing (RPO), a “rapidly emerging and high-demand subset of HRO.”

The recruitment consultancy Elixir Web Solutions estimates that the RPO subset— comprising the entire recruitment cycle, from needs assessment to sourcing, screening, and interviewing candidates, and hiring— will account for $30 billion of the HRO market by 2008.

How much of this business has come India’s way, and how much of it can India expect to win in the years ahead, given the scale on which offshoring is taking place?

Gautam Sinha, CEO of the Bangalore-based IT recruiting firm TVA Infotech, points out that within the Indian market, the total annual spend on recruitment is Rs 700 - 800 crore— so this can theoretically be considered the potential size of the RPO business (and RPO is only a subset of HRO) that can be generated from locally-based companies.

Then there is offshoring. Of the $3.6 billion in revenues that Indian companies earned from IT-enabled services in 2004, only 2 per cent or some $70 million were from HRO services.

But the potential is indicated by several factors: large global players such as Fidelity, Exult and Hewitt have set up operations in India (there are also others such as Hyderabad-based Kenexa India, Bangalore-based TVA Infotech, and Chennai-based Secova eServices); a Nasscom-McKinsey report has projected that Indian firms’ revenues from HRO will increase to $3.5 billion by 2008, while Gartner thinks India can expect to win 10-15 per cent of the US HRO services market; and finally, only 6 per cent of US HR spend is offshored, a figure that is certain to rise.

Raghuvir Sakuru, Managing Director of the US-owned Kenexa India, a provider of outsourced HR services, says 20-30 per cent of the non-customer interface functions segment of the HRO pie can be offshored, and India can hope to win a substantial share of this. Kenexa India, he says, accounts for 10-15 per cent of the RPO business done by its US parent company.

Sinha notes that HR outsourcing has certainly begun in India— payroll and benefits administration has been for some time, as has training. Recruitment has not yet been outsourced on any significant scale, except for modest chunks— the risk involved (arising from the need for confidentiality) prevents companies from doing more recruitment outsourcing.

The aspects of HR that are most amenable to outsourcing, Sinha says, will be payroll and benefits administration; helplines and the answering of queries relating to HR policies; recruitment by large hirers; training; and performance appraisal.

He believes that the core HR processes— such as careeer development, for example— “will and should be retained in-house.”

In some large software companies that hire in the tens of thousands every year, he notes, there is still a debate on whether recruiting is a strategic function or can be outsourced.

Adds Sakuru: “Three or four years back companies never realised the need for automated processes. Now they do, since they are recruiting in the thousands. And there are also companies that offer automated solutions.” Five years from now, he says, “it will be a completely different landscape.”

However, Sinha lists two problems associated with HR outsourcing, which act as obstacles to the trend gathering momentum: “First, outsourcing is associated with layoffs— which Indian society is not yet ready for, because of the stigma associated with being laid off. Second, people who are in the system should be comfortable with the idea of not having direct control over the HR process. This is not yet happening in India, because individuals tend to measure their professional prowess by the number of people who report to them.”

Of all overseas markets, according to the Kelly report, India holds the greatest promise because it is experiencing rapid growth in the job market across many industries.

It needs R&D talent in the automotive industry, middle and senior-level managers, engineers, MBAs, workers in niche industries (such as biotech and IT product development), and English-speaking employees for retail and call centre jobs. Indeed, the employment boom is creating a talent shortage.

In reality, however, Indian firms, says Kelly, generally feel that it is more economical to manage HR functions internally. There is also distrust caused by substandard deliverables by vendors in the past. Finally, there is also concern about maintaining the confidentiality of data and corporate security.

To date, HRO and RPO are growing faster in the US than in any other global market. This, says Kelly Services, is explained by changes in labour supply and demand that today’s HR departments are ill-equipped to keep up with.

Workers have reduced company loyalty, greater expectations from their jobs, and want to manage their own careers. Significantly, these very changes are rapidly taking place in India too