2006 Nugget - HRO Market Concerns

Many people are asking me what the big sourcing stories of 2006 were. Rather than discuss the obvious - like huge profits for service providers in India - I enjoy talking about the less-prominent developments, which may well become the big stories of 2007.

Here's one such development: The slowdown in companies opting to send their human-resource operations offshore was caused by a host of factors, and the problems plaguing so-called HR outsourcing (HRO) may not get better anytime soon. In fact, they could get worse, and the wholesale outsourcing of HR departments could be on hold for the near term.

The culprits behind the HRO slowdown include management changes at Hewitt (the market leader); the well-publicized earnings problems of a few notable providers and the failure of several providers to provide good service on large deals they've done in the past.

Management changes are a matter of course for any business, and Hewitt handled its management changes well. They wouldn't even be noteworthy except they seemed to contribute to taking the company off its torrid pace from the prior year, 2005, when Hewitt won almost 30 percent of the HR contracts awarded globally. Some clients seemed concerned about the HR outsourcing business model when Hewitt's new leadership acknowledged having some hard choices ahead.

Elsewhere, another provider, ACS, has admitted to "growing pains" and has also taken accounting charges on two of its HR contracts. And Convergys is still struggling to achieve the scale required to leverage its solution. While it is difficult to assess just how EDS (ExcellerateHRO), Accenture and IBM have performed financially, we can make a rough estimate of how much business they've won. The answer is: probably less than they'd hoped.

Some of the challenges the HR business faces today are the result of an immature market: providers that over-commit and clients that under-weigh the changes required for substantial benefits through outsourcing. Some are also attributed to poorly designed deals.  Some are just related to poor execution.

Are the HRO industry's issues really going to be solved by greater volume? We don't think so.

Instead, the market is already showing a bit of retrenchment, with clients opting to contract for discrete parts of their HR functions, such as recruiting, payroll, or training. The market appetite for wholesale HRO relationships seems to have waned a bit, opting to wait out the service delivery issues that are affecting several of the leading providers.

This situation may be the proverbial self-fulfilling prophesy: If the providers require scale to grow out of their problems, and clients are unwilling to sign up until the problems are settled, we're in a deadly embrace.

The industry's biggest deal of 2006, Unilever's award to Accenture, may be the critical relationship to watch. If Accenture can show that the demanding needs of a company like Unilever can be met, perhaps there's a way forward for others through large-scale HRO. In the mean time, look for greater use of function-specific sourcing within the HR domain.