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Human Resource Outsourcing: Issues and Challenges

Article  in  Journal of Nepalese Business Studies · January 2007

DOI: 10.3126/jnbs.v4i1.1028

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The Journal of Nepalese Business Studies Vol. IV No. 1 Dec. 2007

Human Resource Outsourcing: Issues and Challenges

Amitabh Deo Kodwani

ABSTRACT
Business Process Outsourcing has become new mantra in the corporate business world. Modern
as well as traditional organizations are now trimming down their employees from their payroll, and
thus Human Resource Outsourcing (HRO) is slowly becoming the new buzzword. In order to utilize
the true worth of the employees to its fullest, one must outsource the non-core activities of the orga-
nization. The awareness of this has already been realised by the organizations.
Outsourcing has no longer the privilege of only huge multinational organizations. Even the
public sector and government undertakings as well medium size or start-up companies are also in
the race of outsourcing their many HR related activities.
This paper examines the motives that are encouraging organizations to go for outsourcing
HR, drawing the essence from extensive exploratory study of secondary literature. This paper pre-
sents an architectural framework to understand issues and challenges of HR HRO and to suggest
what organizations should do to taste success from HRO.

Key words : human resources, outsourcing

1. Introduction
The productive capacity of all business depends on three factors: the capital resource,
the physical resource and the human resource” -(Peter.F.Ducker)
This statement holds a lot of significance because of the fact that of all the three
resources, only the human resources possess the productive capacity for which the upper
limits are not defined. So in order to utilize the true worth of the employees to its fullest, one
need to outsource the non-core activities of the organization.
Outsourcing can be defined as the situation where an external vendor or service pro-
vider provides, on a recurring basis, services that would normally be performed in-house by
the organization. In other words it can said that, outsourcing is a process where in organiza-
tions concentrate on those aspects of their business processes, which gives them a competi-
tive advantage (called as corebusiness) and contract out or shell out the noncore aspects of
their business processes. With the increasing global competition, organizations are looking
outsourcing as a means of gaining a comparative advantage over other competitors.
Outsourcing is thought to benefit a business by allowing an organization to focus on its
“core competencies” or “core processes.” In this way, an organization can divert its energy
away from peripheral or non-core activities of the business which lies outside of its “true”
area of expertise, and instead of that concenterating more energy and focus on what it can
does well in order to differentiate itself from other competitors. By outsourcing their noncore
activities, organizations would be able to reduce their operating costs too. This is possible
by reaping the benefits of a supplier’s lower cost structure, which could result from econo-
mies of scale or other advantages associated with specialisation available with the outsourcing
service provider. One very fine example of this is the BP-Exult deal where Exult handled
the administrative elements of compensation, benefits, payroll, organizational development,
performance management, employee development, training, recruitment and relocation with
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 Human Resource Outsourcing: Issues and Challenges

its web based software and left British Petroleum responsible for HR policy, strategy, pro-
fessional resources and labor relations. It was observed through literature survey that around
85 per cent of companies have realized that outsourcing critical support services can en-
hance their competitive edge, without the need to invest in infrastructure.
Some of the companies are outsourcing entire activities where as some of them are
outsourcing partially. If we look at the history of HR outsourcing (HRO) industry, it can be
traced back to more than five decades, when ADP (Automatic Data Processing) set up its
payroll processing services in the US. Today, the company has annual revenues of $7 bil-
lion and 40,000 associates.(www.citehr.com/information-about-hrbpo-vt7351.html)
Survey conducted by The Conference Board reported that more than three-quarters of com-
panies are either outsourcing their major Human Resource functions or are planning to do
so in the near future. Also two-third of the US companies accepted that they fully or par-
tially outsource five or more HR functions.( www.conference-board.org). It is believed
that with in five to six years, HR BPO (HRO) companies will employ half of all HR profes-
sionals.
Human Resource Outsourcing market is growing vary rapidly. Though for the last
three years HRO market remained flat, but in the coming days it will regain momentum and
is expected to grow very fast as compared to other functional outsourcing businesses. The
global HR outsourcing industry is estimated to reach $31 billion in 2007 and $50 billion by
2010, representing a compound annual growth rate (CAGR) of 12% during the 2007-2010
period. [Hewitt Associates, LLC SWOT Analysis, Jun2007, p1, 8p; (AN 25629859)]
India too is witnessing the growth of HRO. The good news for India is that nearly
50% of HRO business has an offshore component, so a lot of it is actual coming to India.
The latent size of HR outsourcing in India is about $2 billion with a current market of more
than $27 million and it is growing at a rate of about 50 per cent (www.Hewitt .com). The
first HR BPO in India was started by Secova eServices in Chennai on December 2003,
having 50 – seater facility.
Experts believe that in present times HRO is undergoing a transition phase. It is
moving out from the realm of bigger companies to small and mid-sized organizations. There
has also been a transition in its user acceptance, where it is moving from a corporate domain
to PSUs’ and the Government sector. All this reflects on the growth of this sector. (http://
www.expressitpeople.com/20030428/cover.shtml).
Another major issue in HRO process is to decide which HR function need to be
offloaded and also which firm to outsource. This is one of the biggest challenges, because it
may adversely affect company’s performance if selected wrongly. Before going for offloading
any in-house HR related activity to external agency; one need to be sure about the pros and
cons of outsourcing it. Though ther are several benefits of outsourcing HR related activi-
ties, there are some shortcomings too.
In a survey of 129 large companies representing nearly 2 million employees it was
observed that organizations are satisfied with their HR outsourcing decisions and plan to
outsource more HR services by 2008.(findarticles.com/p/articles/mi_m3495/is_6_50/
ai_n13826255). In another survey slightly more than 50 percent of survey respondents re-
ported that they had fully achieved their outsourcing objectives, 42 percent had partially
achieved them, and less than 1 percent of outsourced human capital functions had been

39
The Journal of Nepalese Business Studies

brought back in-house.( http://www.gao.gov/htext/d04679.html)

This paper highlights the various issues and challenges of HRO including the pros
and cons of it and recommending what organizations need to take precautions while going
of HRO.

2. Functions of HR outsourcing
HR outsourcing generally happens in the areas like payroll, employee benefits ad-
ministration, network, fixed assets administration, receivable and logistics management,
hardware maintenance, telemarketing, call centers and database management. In India, the
common processes which are outsourced are generally related to training and development,
payroll processing, surveys, benchmark studies and statutory compliance.
HR outsourcing continues to grow in the future. More and more HR functions will be
outsourced. As per the survey conducted in 2005 by Hewitt Associates, a global human
resource services firm on 129 large companies found that 94% respondents outsource at
least one HR function. Further their study highlights that the most commonly almost fully
outsourced HR functions are:
Exhibit 1: Functions of HR outsourcing
HR Functions % of Respondents
1. Outplacement Services 91%
2. Employee Assistance Programs 89%
3. Defined Contributions 401(K) 84%
4. COBRA administration 77%
5. Defined (Pension) 68%
6. Health benefits 69%
Source www.hewitt.com (Suzanne Zagate & Jennifer, 2005)
By 2008, companies plan to expand outsourcing into the following areas, listed in
order: leave management, learning and development, payroll, recruiting, health and wel-
fare, and global mobility. (findarticles.com/p/articles/mi_m3495/is_6_50/ai_n13826255)

3. HR outsourcing Suppliers:
There are three types of HRO suppliers :( According to Phil Fersht, Senior Analyst,
Business Process Outsourcing for the Yankee Group)
• Specialists in discrete sub processes of HR like payroll, benefits, hiring and recruiting,
and training and education. For exampl; Hewitt Associates and Automatic Data Pro-
cessing (ADP)
• One-stop-shops that aggregate multiple HR functions into one HRO offering. For ex-
ample; Exult and Fidelity Employer Services
• Super-suppliers with worldwide processing facilities offering full service at lower cost.
They take advantage of economies of scale. For example IBM Business Consulting
Services, and Accenture. (http://www.outsourcing-offshore.com/go.html)
Where Hewitt and ADP continue to serve the mid-market buyers with 500 to 2000 employ-
ees, one-stop-shop and super-suppliers will focus on buyers with 10,000 or more employ-
ees. (http://www.outsourcing-journal.com/feb2004adpstudy.html?email004956)

40
 Human Resource Outsourcing: Issues and Challenges

4. Drivers of Human Resource Outsourcing

Much of the literature available on outsourcing in general has examined the rationale
behind such decisions. The key considerations behind HRO being the need for increased
focus on core business, cost reductions; greater business flexibility and need for specialized
expertise (Jennings 1996, Bettis et.al. 1992, Quinn et.al. 1990).
HR outsourcing is sometimes driven by the evolution of the HR function within the
organizations (Greer et al., 1999). The literature suggests extensive use of outsourcing be-
cause of the relatively underdeveloped HR function in their organization or where it is
being restructured. But outsourcing in such organizations is confined to administering com-
pensation and benefits, record keeping, and applicant screening. (NICOM, 2005) Further
literature review highlights that there are three main motivators for HR outsourcing, they
are reduce overall HR service delivery costs (37%, free time for strategic HR (23%), and
improve service quality (14%). Other reasons are highlighted in exhibit 7 given below.
Exhibit: 7
Why Companies Outsource
37% Reduce Overall Hr Service
and delivery costs
23% Free time for strategic HR
14% Improve service quality
7% Free HR time for better
technical solutions
7% Standardize processes
5% Broaden overall
outsourcing strategy
4% Improve HRIS/self-service
1% M&E
1% Improve IT support
1% Other

Source: HR Outsourcing: New Realities, New Expectations (2005 HR Outsourcing Effec-

tiveness Survey Report) www.towersperrin.com
Cost reduction has been the predominant motive for outsourcing (Hoek, 1999). As
per one of the survey conducted in 2005, around 37% of the respondents accepted that cost
reduction is one of the prime factors as compared to 32 % in 2004 (www.towersperrin.com).
Outsourcing decisions commonly target a minimum of 15 per cent cost saving and some-
times in the range of 20-25 per cent (Jennings, 2002; Bounfour, 1999).
Third important reason as cited in the survey (exhibit 7) is improving service quality.
Not only external customers need to be satisfied for successful business operations but
internal customers too play a vital role and thus they also need to taken care of. By improv-
ing service quality, HR professionals can help organization to satisfy their employees as

41
The Journal of Nepalese Business Studies

well their customers. There are other reasons too as cited by the survey. Though none of the
rest of the issues crossed 10%, but will definitely be the important issues in the future.
These issues are; free HR time for better technical solutions (7%), standardize processes
(7%), improves HRIS (4%), etc.

5. Benefits and Satisfaction With HRO:

The biggest contribution is in converting fixed cost to variable cost, and reducing
additional processing cost, ongoing expenditures and capital outlay. Infact the savings in
the capital outlay has been of main concern in the government organizations that have been
operating with decades-old legacy mainframe systems and now want to upgrade their ser-
vices that can provide a better work environment for employees, especially the younger,
technically-savvy employees who are working for the government and are demanding Web-
enabled HR services. (http://www.outsourcing-hr.com/private.html)
Credit Suisse First Boston estimates that it has saved $115 millon since 1994 by
outsourcing most of its transactional human resource functions. Don Packham, vice Presi-
dent of Human Resources for BP Amco’s US operations, reports savings of $ 50 million in
the first two and half years of BP’s outsourcing contract. Similarly Cydney Kilduff, Direc-
tor of Recruiting and staffing at Kellogg, mentioned that the outsourcing had reduced the
time it took to fill vacancies at Kellogg from 67 days to 39 days, and the cost per hire was
reduced from $ 7905 to $ 3784. (www.aon.com)
Let us look at the satisfaction level of those companies who have outsourced their
HR functions, as mentioned in various studies:

Exhibit 8: Benefits of HR outsourcing

Satisfaction level % of respondents
1. Fully Satisfied 89%
2. Achieved hope for benefits 85%
3. Unexpected benefits 20%
4. Achieving Cost Savings 45%
5. Outsourcing transaction smoothly 81%
6. Outsourcing function brought back in-house 23%
7. Continue with the same vendor 70%
Source (www.aon.com, www.towersperrin.com and www.hewitt.com)
If we look at the above mentioned exhibit, it clearly indicates the benefits of HR
outsourcing. The overall satisfaction level has gone up from 51% in 2002 to 89% in 2005.
Another issue is of outsourcing function brought back in-house, which has been mentioned
by 23% respondents. Actually out of this 23%, 68% of the companies have brought back
their outsourced function because of poor services provided by the vendor, whereas only 32
% of the companies said that they brought back because they did not achieved anticipated
cost savings. (www.aon.com, www.towersperrin.com and www.hewitt.com)

6. Drawbacks or problems of HRO:

One of the problems with HRO is difficulty in accepting the change by the employ-
ees of the organization. There is also anxiety about losing control over the process and lay

42
 Human Resource Outsourcing: Issues and Challenges

off. Such employees reactions generally create difficulty in outsourcing. This resistance
will be higher when more scope is added later. Effective communications and change man-
agement programs (OD initiatives) are especially crucial at this stage when the new scope
involves implementing a self-service platform. Actually such systems are not intuitively
obvious. Employees need to be helped to adopt to this the new system.
Also there are various risks associated with HRO. One of such risk is the business
risk which may arise due to cheap outsourcing contracts. There is also spillover risk, i.e.
exposing of confidential matters to competitors. Political risks is another issue in outsourcing.
One such example of this is the controversial issue in the US during the time of elections
when opposition blamed outsourcing for unemployment and wanted it to be banned. An-
other problem in HRO is that sometiimes it brings threat to the organization culture and it
gets totally out of control if gone into the hands of unsympathetic outsourcers. Also vendor
organization should be well aware with the laws and should act in compliance with laws of
his and client’s country otherwise legal issues may crop up and may adversly affect organi-
zation.
One more problem that arises is the loss of personal touch with the employees. Be-
cause an in-house HR person interacts daily with your employees, they will likely have
more of an interest in your employees. This is the reason why Morgan and Stanley decided
to provide retirement planning services in-house. The loss of talent generated internally,
potential redundancies, fear of service provider ceasing the trade, loss of concentration on
customer and more focus on the product are other drawbacks or challenges of HRO.
Also when an organization is using a PEO, giving up the right to hire and fire thier
employees, may not be desirable for their particular business. Mostly PEOs insist that they
should have the final right to hire, fire, and to discipline employees. This may not be healthy
for an organization in the long run. And if an organization decide to use an E-service, the
same issues would remain with any ASP. When everything is stored and handled online,
there might be concerns about the security as well as the potential crashes, both of which
can be detrimental to any business organization. Common complaints about HR outsourcing
range from payroll mix-ups to payroll not being deposited on time to denied medical claims.
(www.entrepreneur.com/humanresources/employmentlaw/article58222.html)
Vendor selection is another major issue in outsourcing HR. If we select the wrong
vendor, then we won’t be able to enjoy the fruits as expected from HRO. Companies say
that one of the important requirements while selecting vendor for outsourcing HR is vendor’s
demonstrated HR process expertise, which has been responded by 95% respondents as
mentioned in the survey conducted by Hewitt associates in the year 2005. (www.Hewitt
.com).

7. What Companies Should Do To Have Successful HR Outsourcing?

Drawbacks can be compensated if an organization takes necessary precautions of
paying more attention to process redesign and details, and at the same time keeps strategic
parts of HR like Human Resource Planning in-house, as it revolves around critical activities
and core capabilities and thus provides sustainable lead in the long run. This is the reason
why HR activities like payroll processing is generally outsourced since it provides less
competitive advantage and is a non-core activity for any organization. Thus there is need to

43
The Journal of Nepalese Business Studies

create a balance between external service providers and internal operatorsOrganizations

need to outsource thier HR activities as per their size. Small and mid sized organizations
should outsource HR activities like payroll because they may lack economies of scale to
perform that function efficiently. Large companies should outsource HR activities like ben-
efit processing because then broader range of benefits are offered which reduce the econo-
mies of scale of handling the activity in-house.
In case of multi-supplier situation, good governance, change management, and ef-
fective dispute resolution structure need to be in place. It should be ensured by the organi-
zations that all the parties should work together nicely. However long-term contracts can be
avoided as things are changing rapidly.
Since outsourcers are the third party, communication travels three ways rather than
two ways involving organization, vendor and employees, giving room for mistakes. In such
case communication plays a very vital role. Sears, Roebuck and Co., retail giant was aware
of this issue. Hence it selected Hewitt Associates as their HR service provider to take over
the work and both companies ranked communications and commitment to mutual goals as
the top two keys to their success. This is also the foundation for their ability to adapt to
change quickly and to innovate in order to achieve the desired objectives. (http://
www.outsourcing-hr.com/reaping.html)

8. Conclusion
This article tried to highlight the overll concept of HRO and identify the main issues
and and challenges relating to outsourcing HR. The reviews of literature, as well as of
recent surveys by various organizations, show that HRO market is growing and will grow
faster than the current rate. Mike Christie, HR Outsourcing Consultant with Hewitt Associ-
ates, says Hewitt posted a 15 percent increase in overall revenues last year. Most of the
increased activity was in its core business i.e. benefits, workforce administration, and pay-
roll. (http://www.outsourcing-offshore.com/go.html). HRO is of most interest in those sec-
tors of economy which are experiencing the margin pressure.
Though there are many benefits of HRO, which can not be denied but at the same
time we need to address various challenges of HRO. One has to take lot of precaution while
planning for ooutsourcing their HR activities. It was also oberved that in the recent times
outsourcing has undergone lot of advancement due to increased data security because of
new technology and changing perception of what can and cannot be outsourced but secu-
rity issue still demands attention i.e. how comfortable are buyers with having their propri-
etary data being transmitted offshore.
Also suppliers need to evolve additional metrics that aren't transactional in nature
and that measure more strategic value like workforce productivity, absenteeism rates, and
employee turnover.
Offshoring HRO is booming and this is good sign for country like India, but suppli-
ers need to address several issues to maintain this momentum. Offshore employees which
are hired to do simple manual process work can't be expected to demonstrate advanced
expertise such as understanding different health care plans in different countries or answer-
ing policy-based questions.
HRO is also becoming more self-service. Company personnel are forced to perform

44
 Human Resource Outsourcing: Issues and Challenges

HR activities like withdrawing money from their 401 (k) plans using self-service over the
Web. This requires employees to be more proactive, and suppliers have not yet defined the
self-service line beyond which buyers' personnel are hesitant to go. (http://www.outsourcing-
offshore.com/go.html).
HR Outsourcing must also be carefully evaluated and weighed against issues such as
control, the strategic value of technology to the organization, staffing, responsiveness/ ac-
countability, and, of course, overall costs.
If organizations have a broader perspective and are taking corrective measures be-
fore going for HRO then outsourcing will certainly help in coping with the peaks and troughs
of the business. Properly applied, including concerns, outsourcing offers many benefits;
otherwise, it offers even greater risks.Like most everything in life, HRO has come a long
way. But there's still a long way to go.

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HR Outsourcing? By Peter Bendor-Samuel, CEO, Everest Group)

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The Journal of Nepalese Business Studies

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