HR outsourcing (HRO): an in-depth guide

HR outsourcing (also known as HRO) is the process of sub-contracting human resources functions to an external supplier.

Reviews of business processes have led many organisations to decide that it makes business sense to sub-contract some or all non-core activities to specialist providers.

HR, as a non-profit centre, is an obvious candidate for outsourcing.

There are many ways in which outsourcing human resources can be done:

• Business process HR outsourcing (also known as BPO), where an external supplier manages discrete HR activities, such as payroll administration or recruitment, or perhaps the whole human resources function.
• Shared service HR outsourcing, where only the transaction or administrative elements of HR’s activities are subcontracted to an external supplier. This may include the personal interface with employees.
• Application (and facilities) service HR outsourcing, where external providers look after the technological (and physical) infrastructure to support human resources activities.

Outsourcing human resources or some of its processes to an external provider is a major business decision as, while it may be cost-effective, it introduces new elements of risk, including:

• Loss of control
• Impact on the employer/employee relationship
• Loss of flexibility
• Failure to deliver cost benefits
• Legal or regulatory requirements
• Industrial relations issues

The operation of any HR outsourcing arrangement should be governed by a service level agreement. This will define the required standards of performance by both parties and any penalties for non-compliance. A service level agreement is a crucial document and must be negotiated with great care to mitigate the above risks.

People management plays a crucial role in delivering organisational performance. In today’s modern, knowledge economy this is more true than ever before. The decision to outsource human resources is therefore not to be taken lightly.

There are many circumstances in which outsourcing HR services can deliver tangible benefits to the organisation, for example by freeing HR professionals to devote more time to a strategic role supporting organisational performance.

The CIPD identifies a number of strategic drivers for outsourcing HR services:

Advantages and disadvantages of HR outsourcing

Potential benefits of HR outsourcing

• Reduced cost
• Increased efficiency
• Access to improved HR IT systems
• Improved management information (including human capital metrics)
• Access to HR expertise not available internally
• Increased flexibility and speed of response
• Philosophical reasons (for example the organisation is outsourcing a number of its support functions, of which HR is just one part)
• Reduced risk
• To free HR resources to operate more strategically.

Potential pitfalls of HR outsourcing

• Don’t outsource what you don’t understand. The HR outsource provider will only have to subsequently solve the problem (at a cost) and the provider’s solution might not be most suitable from your organisation’s perspective
• HR outsourcing does not absolve the organisation of good people management practices nor of overall responsibility for the provision of HR services
• Increasingly, HR outsourcing arrangements are often long term (five to 10 year contracts are not unusual). An understanding of the organisation’s current and future business strategy and potential changing business (and hence risk) profile is important before entering into any contractual arrangement. This helps to avoid being tied into unfavourable contractual arrangements
• Loss of local knowledge and processes which instead reside with the outsource provider
• Standardisation of processes in line with outsource provider not organisational preferences.

NB. Where this process involves the outsourcing of human resources to another country, this is known as HR offshoring.

HR outsourcing data and statistics

Mid-to-large businesses (with between 5,000-25,000 employees) have overtaken large-to-very-large businesses (companies with more than 25,000 employees) as the main drivers of HR outsourcing, according to Datamonitor.

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Its findings echo research from the Yankee Group, which estimated that global HR business process outsourcing was worth £27.3bn in 2004 and is expected to grow to £42.8bn by 2008.

Almost 50% of human resources outsourcing businesses have an offshore component.

This article was originally published on 1st January 2008