Making the HR Outsourcing Decision

Outsourcing has become increasingly attractive for many organizations. In such relationships, a company contracts with a vendor that rents its skills, knowledge, technology, service and manpower for an agreed-upon price and period to perform functions the client no longer wants to do. Much attention has focused recently on the outsourcing of staffing, including temporary and contract workers, and IT professionals. A much less noticed, though growing, business has been that for human-resources business-process outsourcing, or HR-BPO.1 Starting with humble payroll processing, outsourcers now offer to take over virtually any HR activity — or even the entire function. In 2000, the HR outsourcing industry had revenues of $21.7 billion, accounting for more than 8% of total HR spending.2

Some observers see outsourcing as a key trend (perhaps even the key trend) shaping the future of HR. They envision HR departments focused entirely on strategic activities, all performed with an in-house staff consisting of a small number of high-level contributors, perhaps only internal consultants, HR systems designers and HR executives — leaving all the transactional and administrative activities to vendors for which those processes are core.3 But others doubt that the strategic and operational aspects of HR can be separated so cleanly. Ralph Kimmich, director of compensation and benefits at Southwest Airlines Co., for example, is skeptical about HR outsourcing. “It seems to me,” he says, “that once you do that, you’re abdicating your role as an employer to lead your people.” Consequently, Southwest Airlines has instead been beefing up its in-house HR capabilities.4

Indeed, outsourcing any business activity creates potential risks as well as benefits: Companies can find themselves overly dependent on suppliers, and they can lose strength in strategically core competencies. Interestingly, given the importance of the outsourcing decision and the amount of academic and practitioner literature on it, there is surprisingly little consensus about the topic, probably because of the multiplicity and complexity of the factors involved. This article synthesizes the strongest of the available research and identifies the six key factors that companies should consider when making important outsourcing decisions. The framework, which helps assess the pros and cons of outsourcing, can be applied specifically to HR functions. In particular, it can help explicate the managerial issues of outsourcing agreements such as the recent landmark deal between BP Plc and Exult Inc.

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References

1. R. Scholl, “Business Process Outsourcing at the Crossroads,” white paper, Gartner Group, Stamford, Connecticut, Jan. 31, 2002, reports the following: In a survey of 77 midsize and larger companies that outsource at least one process, the most commonly outsourced processes were administrative, 30% (most typically, claims processing); HR, 28%; payment services, 26%; supply-chain management, 25%; and finance and accounting, 23%.

2. See “HR Outsourcing: Time To Deliver Results,” white paper, Gartner Group, Stamford, Connecticut, March 26, 2001. Robert W. Baird & Co. divides the overall human-capital-management industry into administrative services — essentially HR-BPO — and professional services, which include HR consulting (total revenue of $10.9 billion, according to International Data Corp.) and the various segments of the staffing industry. The latter, according to Staffing Industry Analysts Inc., encompass temporary help ($80.2 billion in 2001), place-and-search companies ($13.8 billion), professional-employer-organizations/staff-leasing companies ($42.8 billion) and outplacement ($1.3 billion). HR consulting is arguably at the intersection of administrative and professional services, and this article includes it under HR-BPO because a growing number of HR consultants offer stand-alone BPO services. But this article excludes professional employer organizations (PEOs), which are also arguably at this same intersection. PEOs provide both personnel and many of the associated HR processes; unlike other staffing organizations, however, PEOs also assume the associated insurance and legal liabilities. None currently offer stand-alone BPO services.

3. E. Lawler and S. Mohrman, “Human Resources Management: New Consulting Opportunities,” in F. Poulfelt and L. Greiner, eds., “Advanced Management Consulting” (Palo Alto, California: Stanford University Press, in press).

4. J. Kochaniec, “BP Amoco Outsourcing,” Business Insurance, Dec. 13, 1999, p. 1.

5. See, for example, M. Cook, “Outsourcing Human Resource Functions” (New York: AMACOM, 1998).

6. “Demand Analysis of Integrated Multiprocess HR Outsourcing,” white paper, Gartner Group, Stamford, Connecticut, Sept. 20, 1999, p. 6.

7. “The Internet and HR Outsourcing,” white paper, Robert W. Baird & Co., Milwaukee, Wisconsin, February 2000, p. 11.

8. C. Greer, S. Youngblood and D. Gray, “Human Resources Management Outsourcing: The Make or Buy Decision,” Academy of Management Executive 13, no. 3 (1999): 85–96.

9. Scholl, “Business Process Outsourcing at the Crossroads.”

10. E.E. Lawler III and S.A. Mohrman, “Creating a Strategic Human Resources Organization” (Palo Alto, California: Stanford University Press, 2003). See also J. Laabs, “The Dark Side of Outsourcing,” Workforce (September 1998): 42–46. Laabs lists the biggest reasons for outsourcing failures as vendor’s failure to be proactive, turnover in the vendor team, vendor errors and mistakes, incompatibility of client and vendor cultures, data-transmission errors, technological inefficiencies and contract ambiguities. In particular, she highlights the costs associated with the lack of transaction standardization. M. Useem and J. Harder, “Leading Laterally in Company Outsourcing,” Sloan Management Review 41 (winter 2000): 25–36, describe the new leadership capabilities required in firms that engage in outsourcing.

11. S. Lever, “An Analysis of Managerial Motivations Behind Outsourcing Practices in Human Resources,” Human Resource Planning 20, no. 2 (1997): 37–47; “HR Outsourcing: Time To Deliver Results,” Gartner Group; and “Business Process Outsourcing Popularity Grows in SMB Market,” white paper, Gartner Group, Stamford, Connecticut, January 2003.

12. This framework integrates ideas from industrial-economics analysis of the value chain (M.E. Porter, “Competitive Advantage: Creating and Sustaining Superior Performance” [New York: Free Press, 1985]) and transaction-cost economics (O.E. Williamson, “Markets and Hierarchies: Analysis and Antitrust Implications” [New York: Free Press, 1975] and “The Economic Institutions of Capitalism” [New York: Free Press, 1985]) with three other strands of theory: social exchange theory, organization theory and business strategy. On social exchange theory, see, for example, T. Kern and L. Willcocks, “The Relationship Advantage: Information Technologies, Sourcing and Management” (New York: Oxford University Press, 2001), chap. 2. On organizational theory, see, for example, J. Baron and D. Kreps, “Strategic Human Resources: Frameworks for General Managers” (New York: John Wiley & Sons, 1999), chap. 18. On business strategy, see, for example, J. Barney, “Gaining and Sustaining Competitive Advantage,” 2nd ed. (Upper Saddle River, New Jersey: Prentice Hall, 2002), chap. 6; R. Hayes, S. Wheelwright and G. Pisano, “Vertical Integration and Supply Chain Strategies,” working paper, Harvard Business School, Boston, 2002; J.B. Quinn and F. Hilmer, “Strategic Outsourcing,” Sloan Management Review 35 (summer 1994): 43–55; and J.B. Quinn, “Strategic Outsourcing: Leveraging Knowledge Capabilities,” Sloan Management Review 40 (summer 1999): 9–21. The decision criteria presented in this article also reflect concerns actually encountered in industry practice. On HR outsourcing, see M. Cook, “Outsourcing Human Resource Functions” (New York: AMACOM, 1998); T. Gainey and B. Klaas, “The Outsourcing of Training and Development: Factors Impacting Client Satisfaction,” Journal of Management 29, no. 2 (2003): 207–229. On IT outsourcing, see Kern, “The Relationship Advantage”; L. Willcocks and M. Lacity, eds., “Strategic Sourcing of Information Systems: Perspectives and Practices” (New York: John Wiley & Sons, 1999); M. Greaver, “Strategic Outsourcing: A Structured Approach to Outsourcing Decisions and Initiatives” (New York: AMA-COM, 1999); M. Lacity and R. Hirschheim, “Information Systems Out-sourcing: Myths, Metaphors and Realities” (New York: John Wiley & Sons, 1995); R. Klepper and W. Jones, “Outsourcing Information Technology, Systems and Services” (Englewood Cliffs, New Jersey: Prentice Hall, 1997); F. McFarlan and R. Nolan, “How To Manage an IT Outsourcing Alliance,” Sloan Management Review 36 (winter 1995): 9–23; K. Ripin and L. Sayles, “Insider Strategies for Outsourcing Information Systems: Building Productive Partnerships, Avoiding Seductive Traps” (New York: Oxford University Press, 1999); C. Saunders, M. Gebelt and Q. Hu, “Achieving Success in Information Systems Out-sourcing,” California Management Review 39 (winter 1997): 63–79; and L. Poppo and T. Zenger, “Testing Alternative Theories of the Firm: Transaction Cost, Knowledge-Based, and Measurement Explanations for Make-or-Buy Decisions in Information Services,” Strategic Management Journal (1998): 853–877.

13. A. Afuah, “Redefining Firm Boundaries in the Face of the Internet: Are Firms Really Shrinking?” Academy of Management Review 28, no. 1 (2003): 34–53; K. Mayer, “Managing Buyer-Supplier Relationships in High Technology Industries” (Ph.D. diss., University of California, Berkeley, 1999); and K. Mayer and J. Nickerson, “Antecedents and Performance Implications of Contracting for Knowledge Workers: Evidence From Information Technology Services,” unpublished, 2002.

14. J. Barthélemy, “The Hidden Costs of IT Outsourcing,” MIT Sloan Management Review 42 (spring 2001): 60–69.

15. K. Artz and T. Brush, “Asset Specificity, Uncertainty, and Relational Norms: An Examination of Coordination Costs in Collaborative Strategic Alliances,” Journal of Economic Behavior and Organization 41, no. 4 (2000): 337–362.

16. Baron, “Strategic Human Resources,” chap. 18.

17. Gainey, “The Outsourcing of Training and Development.”

18. P. Ghemawat, “Commitment: The Dynamic of Strategy” (New York: Free Press, 1991); D. Besanko, D. Dranove and M. Shanley, “Economics of Strategy,” 2nd ed. (New York: John Wiley & Sons, 2000); and T.A. Luehrman, “Strategy as a Portfolio of Real Options,” Harvard Business Review 76 (September–October 1998): 89–98.

19. In November of that same year, BP signed a $1.1 billion agreement with PricewaterhouseCoopers to outsource all its finance, accounting and MIS-applications work in the United States. See F. Hansen, “Global BPO: Reshaping Credit Management,” Business Credit 102 (April 2000): 18–20.

20. Unless otherwise indicated, quotations and descriptive material are drawn from interviews conducted by the author in spring 2002.

21. G. Donnelly, “Do It Yourself: Browser-Based Technology Gives Rise to True Self-Service HR,” CFOEurope, April 15, 2000, http://www.cfoeurope.com/displayStory.cfm/1741270.

22. See A. Maitland, “Giant Leap for Human Resources,” Financial Times, March 27, 2002, p. 12.

23. See B.E. Rosenthal, “Strategic Alliance Provides Missing Piece,” http://www.outsourcing-hr.com/strategic.html, for a description of Exult’s partnership with Deloitte & Touche (now Deloitte-ToucheTohmatsu) to integrate Deloitte’s GlobalAdvantage expatriate-administration software into its suite.

24. Exult does not merely contract with the client to manage existing HR-BPO vendor services. Instead, Exult becomes the party responsible for providing those services, and Exult’s providers are paid by Exult rather than by the client.

Acknowledgments

The author is grateful for the time and help of Nick Starritt, former group vice president for HR for BP, and Bruce Ferguson, vice president and chief people officer for Exult. Research assistance was provided by Jill Benner, Maryann Gonzalez, Natasha Jones, Jason McFarland, Koji Takano and Michelle Sippl. Invaluable comments on early drafts of this article were offered by Nick Argyres, Bob Hayes, Sue Helper, Ed Lawler, Arturs Kalnins and Kyle Mayer. Gartner/Dataquest, International Data Corp. and Robert W. Baird & Co. Inc. were generous with their data and time.

2 Comments On: Making the HR Outsourcing Decision

  • Mike Smith | July 16, 2014

    HR outsourcing will remain the future direction of the business world. For as long as the principals of “ecomomies of scale” and “specialization” are still true, HRM will continue to trend towards outsourced specialists.

    Mike Smith
    Vice President
    http://eagleemployerservices.com/

  • Tim Johnson | October 29, 2014

    I agree with Mike. This article was written in 2003, we can now see Paul Adler was very right. Outsourcing should have been viewed as much more than a “trend”. Great article, and thanks to MIT for publishing.

    Tim Johnson
    President
    http://classcodes.net/

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