What Happened to the HRO Market?

A few years ago the predictions were lofty. According to the Yankee Group five years ago, the human resource outsourcing market (HRO) would be $80 billion globally by now, with half of that being the U.S. market.

Several years ago Decision Point wrote that by 2008 HR outsourcing would be considered the fastest growing segment of the projected U.S. business process outsourcing market, and that HR outsourcing would generate savings of more than 30 to 40 percent for customers. Two years ago a study by Hewitt predicted that companies would expand HR outsourcing across the board, with significant increases in the outsourcing of leave management, learning and development, recruiting, health and welfare, defined benefit plans, global mobility, and payroll by 2008.

Today, 10 years after its birth, most people I talk with in the industry think the HRO market is stuck in neutral, or even reverse. This sentiment surely comes on the heels of several U.S. companies - including some notable companies such as Starbucks, Wachovia, Conseco, Dell, Capital One, Lehman Brothers and UBS - who have recently terminated or significantly altered their existing HR outsourcing contracts. Others, such as Schneider Electric North America, simply opted against outsourcing human resources. At the end of October, HR outsourcing provider Convergys announced a thirdquarter operating loss in its HR management business of $280 million on revenue of $59.4 million.

So what happened? There is no one finite answer, but clearly a big reason for the slowdown stems from an inability of vendors to meet clients' expectations. It turns out that in terms of outsourcing HR functions, one-stop shopping may not be all it's cracked up to be.

Big market with big growing pains

Despite its issues, HR outsourcing is still a big industry - estimated to be anywhere from $25 to $35 billion today - with growth expected by most financial and industry analysts in the future. Kennedy Information predicts the HRO market should reach $50 billion in 2010, with a compound annual growth rate of 12 percent. It is also dominated by an elite group of vendors.

The Everest Group notes that five vendors control 76 percent of the large company market and the top 10 have 92 percent market share.

This shouldn't be surprising. Outsourcing an HR function is a pretty common practice - almost every company in the United States outsources something. In a study my organization, the Institute for Corporate Productivity (i4cp), conducted a few months ago, 95 percent of the companies surveyed reported that they at least partially outsource one or more HR functions. Yet the exponential growth spurts experienced during HRO's infancy have given way to some serious growing pains.

In the case of Indiana-based energy company NiSource Inc., IBM's inability to help the company achieve projected cost savings was cited as a factor that led to the amendment of a 10-year, $1.6-billion contract after just two and a half years.

Wachovia went through a similar scenario with its provider, Hewitt Associates. Three years into a seven-year deal, the financial services company took many HR functions back in-house or sent them out to other vendors. In news reports about this decision, cost wasn't cited as a reason for the move, but rather a desire to move away from an end-to-end solution to a more blended approach.

These are just two corporate examples of a change to original HRO contracts.

Death of the Mega-Deal

It wasn't too long ago that announcements of singlesource, billion dollar deals were a common practice in the HRO market.

However, with the many reported changes and cancellations to HRO contracts, it begs the question: Is the current climate a harbinger of the death of the HRO mega-deal?

Perhaps. Companies now seem to be more skeptical of vendors' "one-stop-shop" claims, and are more willing to split contracts. An example of this is American Airlines, which attempted to find one single vendor to handle HR administration for the company's entire workforce of 86,000.

"We wanted to work with one vendor, but no single supplier showed any interest in what we wanted to do," Jeffrey Brundage, executive vice president for human resources at the airline told an industry publication. Instead, in the end American opted to sign deals with both IBM and Mercer to handle different parts of its HR function. Granted, each of these deals on its own may be considered sizeable, but the fact remains that no single vendor was apparently able to adequately meet the company's needs.

The list of reasons why companies shift direction with HRO contracts isn't a surprise. Cost overruns, disappointing results, and changing strategies are all reasons that have caused companies to bring HR processes back in-house. But sometimes it's just plain old poor quality that drives this decision. For example, catering giant Sodexho decided not to renew its recruiting contract with provider Berkeley Scott Group after concluding it could deliver better results internally.

And that's ultimately the biggest threat for HR Outsourcing companies - a feeling that "we can do this just as well or better by bringing it back in-house." What does it take to bring an HR process back into the organization? Time and money - and lots of both. When NiSource amended its contract with IBM, it paid the provider $44 million up front to acquire technology assets, and it expected the transition to cost another $10 million, according to public filings.

Fear of this sort of financial pain makes companies reticent to bring a previously outsourced process back in house. And most companies are pretty inexperienced in doing so. In i4cp's outsourcing survey, only 18 percent of companies reported that they had ever taken an outsourced HR function back in-house, with poor quality being the most-cited reason for doing so.

Yet some companies feel it can actually be cheaper in the long run to just end the relationship. The United Kingdom's Automobile Association (AA) - similar to AAA in the United States - terminated a seven-year data center contract with IBM after a little more than two years, saying it could run IT more cost effectively internally.

All of this pain points to the need to approach outsourcing deliberately, diligently, and with a well-thought-out and detailed plan. The most important decision is not how to outsource, but whether to outsource at all. Jumping the gun on an outsourcing decision often seems to lead to buyer's remorse.

One thing many experts agree on is the need to include backsourcing as part of any outsourcing plan. Backsourcing? When developing a strategy for outsourcing a process, companies should be cognizant of the reality that this process may need to come back in-house at some point. Some internal knowledge and expertise should remain, as well as a plan for bringing the process back should the need arise. The contract itself should include terms that lay out events that would trigger backsourcing.

Future Catalyst for Outsourcing?

There are potential catalysts to get the outsourcing market going again. Many believe that a down economy will actually help the HRO space as companies look to shed expenses. An i4cp survey on cutting costs found that 63 percent of the responding companies plan to use outsourcing as a way to cut costs through 2009. Sales cycles, however, are typically lengthened in a recession.

But the emergence of integrated talent management may be the bigger excuse for senior management to make the tough decision. Today, in simplistic terms, the pitch by HRO vendors is pretty straightforward. Convince the CEO or CFO of a company that you can not only manage HR more cost effectively, but you can also make it more strategic.

The promise of integrated talent management has certainly captured the attention of the "C-level," but its implementation also carries a lot of political baggage. Trying to harmoniously unite various HR silos has kept more than one CEO up at night. This is where HRO companies, playing up their expertise in this integration - particularly the technology aspect - will prove awfully tempting for several companies. Look for many more "talent management outsourcing" deals in the future.