Taking it outside

Like it or not, there is a growing trend to outsource the HR function.
Margaret Harvey, who oversaw the BP/Amoco contract, reviews the background to
the current growth in the HR outsourcing market and examines the key issues HR
directors should consider before embarking on an outsourcing strategy

HR outsourcing is a hot topic in many boardrooms. Last year revenues
generated by HR outsourcing projects exceeded growth predictions, while the
size and nature of the deals demonstrated that the HR outsourcing market is
coming of age.

Traditionally customers have parcelled up discrete areas such as
recruitment, benefits administration or training, and outsourced these to
service providers with reputations as specialists in the niche service areas.

The next generation of HR outsourcing will be characterised by customers
taking a more strategic, integrated approach and the advent of new providers offering
"life cycle" services, which handle all employee issues, from
recruitment to retirement and beyond. Technology will also play a large part in
shaping HR outsourcing.

Landmark HR deals

A number of the landmark HR outsourcing contracts that were signed in 2000
reflect a move towards an integrated approach. Some include HR as one of
several outsourced business processes, for example, Pricewaterhouse Cooper’s
global contract with Nortel Networks, which includes Nortel’s human resources,
training and finance functions. Other contracts relate exclusively to HR
functions, but on a grand scale, such as Exult’s $600m (£430m) contract to
outsource British Petroleum’s entire global human resources function.

Catalysts for change

Achieving cost savings is often cited as a reason for embarking on an
outsourcing programme. However, in the HR environment, cost reduction alone can
rarely justify the fundamental change that HR outsourcing involves. Anticipated
savings as a result of HR outsourcing are typically in the 10 per cent to 20
per cent range over the life of a multi-year contract, but this rarely
represents a major percentage of a company’s overall cost base.

For some companies a major structural event, such as a merger or
acquisition, may bring about wholesale changes. In these circumstances
outsourcing may be seen as an effective means of harmonising a number of
different legacy HR systems.

Other organisations consider outsourcing as an alternative to making a
capital investment in the new technology required to support the HR function.
Investment drivers of this kind often play a part in decisions by public sector
bodies to outsource.

Some companies have progressively outsourced more and more non-core
activities, and as the HR outsourcing market matures, outsourcing will
increasingly be seen by these organisations as a viable option for the HR
function. BP is a good example of a company which has, since the late 1980s,
championed outsourcing as a business model and progressively outsourced various
activities, including IT, telecommunications, finance, accounting, procurement
and, in 2000, HR.

Another reason for outsourcing may be when a customer forms a joint venture
with a service provider to develop a HR share service centre. The joint venture
can deliver services back to the customer as well as offer services to the
wider market on a commercial basis. An example of such an HR-based joint
venture approach is BT’s alliance with Andersen Consulting/Accenture.

The impact of technology

Many companies have historically under-invested in the technology used to
support their internal processes and HR is no exception. This has led to
reliance on labour intensive manual systems for generating, processing and
storing the significant volumes of paperwork involved in many HR processes. In
decentralised organisations there are often many different systems used by HR
professionals in various business divisions or geographic sites, leading
inevitably to the duplication of effort and inefficiency.

The advent of modular software applications, such as SAP and PeopleSoft,
which are specifically designed to integrate a range of HR processes, has had a
major impact on the role of the HR function. It has liberated HR staff from the
routine of low value tasks and has allowed resources to be focused on more
strategic matters, such as the development of policy. It has also allowed
companies to standardise their HR processes, sometimes into shared service
centres, and gain economies of scale as a result.

The development of the Internet has also had a major influence on the change
in the HR outsourcing marketplace. It has encouraged people to think
imaginatively about radically re-engineering the HR function. In companies
where employees have computer facilities, such re-engineering results in a
"self-service" approach which allows employees to have direct access
via an employee portal to information on employee benefits, training, internal
job vacancies and so on, as well the ability to update personal records on-line
and carry out other routine transactions.

The role of the contract

An outsourcing contract, whether for HR or any other business process is the
permanent record of the commercial deal between the parties. It must therefore
be a clear and unambiguous reflection of that deal. The contract must
accurately record each party’s rights and responsibilities at any given time
during its term. It must also anticipate and cater for the many events that
will occur during the life of the contract, including changes in the customer’s
business needs. The contract must be a living document and the tool used by the
parties to monitor performance. It must provide a framework for resolving
disputes and ultimately legislate for how the relationship can be
"unwound" on the termination or expiry of the contract.

The contracts needed to support a joint venture approach will differ from
those supporting a traditional customer/supplier relationship. Equally a
contract for the outsourcing of a company’s global HR requirements will have a different
order of complexity to a contract for a limited number of HR processes in a
single jurisdiction. However, the following issues should be considered in
relation to every HR outsourcing contract.

Selecting a service provider

It is vital that an effective long-term partnership can be established and
maintained between a customer and a service provider. Selecting a provider that
is financially stable and has a proven track record will obviously be key.

Cultural compatibility between a customer and supplier organisations is also
likely to be a core reason for selection. Although this is difficult to
legislate for in the contract, it is possible to focus attention on cultural
issues by aligning the personal objectives/ reward plan of the provider’s key
employees with the desired culture.

Scope – strategy v process

Establishing a clear idea of the service levels is fundamental to the
success of any outsourcing arrangement, which in relation to processes such as
HR, is not easy. Many organisations do not document their HR processes or
measure internal performance against pre-defined service levels. You need to
factor sufficient time into your procurement process to develop the scope of
the service levels, which will then form the backbone of the ultimate
outsourcing contract.

Service levels and service credits

A contract should include terms that relate to monitoring the delivery of
services. The parties should also agree on key measures or service levels to
which financial service credits are attached. If the provider fails to meet the
agreed service levels it should be liable to pay (or credit) you with service
credits. Service levels must be set against measurable, objective criteria, by
focusing on aspects of the services that could have a material impact.

Benchmarking and audit rights

The contract should allow you to review the provider’s performance and the
costs associated with the services on a periodic basis against an appropriate
external benchmark. The precise terms of any benchmarking clause will
inevitably be the subject of negotiation. If the benchmarking exercise reveals
over charging or underperformance, the benchmarking provisions should force
changes in the service levels, charges and any other key aspects of the

People issues

Staff transfer is a major issue in most outsourcings. In the UK and other EU
member states the Acquired Rights Directive (Council Directive 77/187/EC) and
its local implementing legislation will dictate whether the customer’s existing
HR team will transfer to the service provider. Managing the issues associated
with personnel transfers will be a key issue, particularly given the HR
expertise of the employees involved!

Protecting data

The protection of sensitive employee related data is naturally of major
concern when outsourcing HR services. You must ensure that your organisation is
in a position to comply with its obligations under the relevant data protection
legislation. The outsourcing contract will therefore need to contain detailed
provisions relating to the supplier’s handling of data, including your rights
to monitor the supplier’s compliance with these obligations.

Planning for change

A customer’s HR needs will change over the life of the outsourcing contract
and there will be improvements in the processes and technology used to deliver
the HR services. You must ensure that the contract is flexible to manage this
change and reap its benefits. The contract must also provide the way in which
the services can be transferred from the original service provider to a
successor provider or back to the customer on its termination.

Does outsourcing deliver?

In December 2000, IDS analysed nine examples of HR outsourcing projects in
both the commercial and public sectors. In the resulting publication,
Outsourcing HR Administration, IDS concluded that while a number of high
profile contracts have recently been signed, it is not yet known whether the
customers’ objectives have, or will, been achieved over the longer term.

Some organisations, such as BP and BT are keen to be at the forefront of
developments in the HR outsourcing area. Others are adopting a more cautious
approach, preferring to gain the benefit of others potentially hard won

Margaret Harvey is a partner and outsourcing specialist at Addleshaw

Growth forecasts

2000 may well have been a breakthrough year, but it does not represent a
blip, it is indicative of a significant trend. In a report produced last year
by Morgan Stanley Dean Witter, the market for HR outsourcing was forecast to
grow from $1bn (£712m) in 1999 to $12bn (£8bn) by 2003. This mirrors a general
growth in the overall business process outsourcing market, which Gartner
Dataquest estimates will generate revenues in excess of $500bn (£356bn) by

Customers’ strategy

Key planks in a successful
outsourcing strategy are:

– a thorough business case which has senior management

– a clear and rigorous procurement and evaluation process

– an effective negotiating team and strategy

– an appropriate contract which embodies the commercial deal  

– an on-going contract management process

– a "win/win" relationship with the service provider.

Drawing up the contractual service

When drawing up the contractual
service definition, you should focus primarily on the "what" and not
the "how". Specify the outputs you need from the services and do not
be over prescriptive about "how" the provider actually structures its
internal processes.

Outsourcing by its very nature means relinquishing a
significant degree of control over the day-to-day operation of the processes.
If you seek to be actively involved with ever step of the process the
provider’s ability to be creative and achieve efficiencies or even cost savings
will be stifled.

And if the contract legislates for precisely how every task
will be carried out, then any changes, however immaterial, will become the
subject of contract change control. This will impose a significant
administrative burden on both parties.

You will, in almost all cases retain responsibility for
developing strategy and establishing policy. The provider’s role is to provide
the services and administer the processes in line with the strategy and policy
set by you, the customer. The contract should clearly delineate between each
party’s roles and responsibilities.

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