The Impact of Consolidation in Human Resources Outsourcing

Does the recent wave of mergers and partnerships in human resources outsourcing (HRO) herald industry consolidation, or are we too early in the industry maturation cycle to draw such conclusions?

Snapshots of an industry undergoing change are especially valuable to customers in helping them predict the implications for their businesses. If, for instance, human resources outsourcing is in the early adoption phase, more cautious customers will hesitate to commit to an as yet unproven strategy.

If consolidation is underway, they will want to know how mergers will affect suppliers’ ability to deliver broader capabilities and greater geographical reach. A discussion of HRO, then, benefits from analyzing these issues and coming to instructive conclusions about industry maturity and consolidation.

Supplier Saturation

Philip Fersht, Senior Analyst, Business Process Outsourcing, Yankee Group, thinks the entry of new players into human resources outsourcing will probably saturate the market in the next year. “There’s still a lot of opportunity out there,” he explains, “but there are simply too many players in the market with new entrants coming in.” Michel Janssen, President, Supplier Solutions Practice, Everest Group, concurs with this assessment. “Saturation by suppliers is there,” he says. “What you need in this marketplace is five to ten suppliers for each market segment, not 15 or 20 generic HRO suppliers. Ultimately, suppliers will have to find a way to carve out unique niches in each of those market segments by creating unique value propositions.”

Fersht also sees the global orientation of many of the new entrants having a distinct impact. “Some new players are moving into the market that are a lot bigger and have more global delivery capability than some of the other players who may have deep domain knowledge.”

Suppliers like Hewlett Packard and CSC number in this group. HP has bid on some big human resources outsourcing contracts in the last year but has yet to win one. Companies like this and, say, IBM who’s relatively new to HRO but has won some key contracts, may come to exert dominance over the industry because they offer end-to-end services and are developing deeper consulting expertise to complement their experience with IT infrastructure.

Other companies to watch, notes Marc Pramuk, Program Manager for HR Management and Staffing Services, IDC, are traditional IT outsourcers that have specialized in managing or hosting ERP systems. Acquiring HR expertise gives them a lot of leverage in the HRO market. Companies with a broader reach such as these may become the obvious choice for servicing the biggest HRO contracts and that would relegate specialist firms to smaller ones in focused niches.

Buyer Saturation?

Saturation of the market by suppliers should not be confused with saturation of the market by buyers. In that respect, says Janssen, “saturation of deals is just starting.” Pramuk comes to the same conclusion. “The market is still not mature,” he explains. “There are only 40 to 50 publicly announced HRO contracts among large organizations,” he continues, “so it’s a low percentage.” Even if all of those were in the Fortune 500, he goes on, that’s not even a 10% penetration rate in just the Fortune 500, typically the province of early adopters.

Another way to gauge the remaining potential customer base is to examine how many buyers’ employees the major HRO suppliers are supporting. Exult, the leader in HRO market share, supports about 600,000 employees, Pramuk explains. But, he says, there are about 120 million non-government workers. That means the largest HRO provider supports less than 1 million, out of a possible 120 million. Looking at the market in those terms, Pramuk contends that “the buyer penetration rate is very low.”

As a result, Pramuk and Janssen judge the market to be at the tail end of its early adoption phase or just moving into its mainstream phase.

What’s the Impact of These Mergers?

If that’s the case, then how does one account for the mergers and partnerships among HRO suppliers outlined in Tables 1 and 2? Such activity suggests a tendency toward supplier consolidation. After all, if the number of suppliers the market can support has reached its peak, mergers and partnerships would seem inevitable.

Pramuk views the activity as suppliers making opportunistic moves to consolidate their processes. This has to do with how HRO has evolved. “HRO has been sectionalized and siloed,” he explains. Somebody in HR did payroll, someone else did health and welfare benefits, someone else did 401(k) and pension. “Over time the supplier community aligned their services with these areas,” he continues, “so you have payroll service bureaus doing one piece, health and welfare benefits consultancies and outsourcers doing another, pension and actuarial consultants and outsourcers doing another piece, and so on.” Pramuk says these processes have evolved into very efficient ones, so much so that changing them might do more harm than good. Instead, he thinks the way to gain more value from them will be by connecting them together.

Pramuk also notes that with technologies changing as rapidly as they are, buyers also can cut costs by “standardizing on a common platform and integrating data together in a meaningful way.” If buyers hire suppliers that can offer more processes on a common platform, they get the cost savings of connecting together disparate processes while simultaneously gaining access to common technology that’s easier to manage and administer. So mergers to gain these capabilities make the suppliers more competitive.

Acquiring broader capabilities also help suppliers remain or become tier-one suppliers with more control over the buyer contracts. According to Pramuk, a tier-one supplier owns the primary contract relationship with the customer, though they may still subcontract to a tier-two. He says Exult, for example, might own a buyer relationship but still work with Towers Perrin to do the benefits administration work on the contract. Where a supplier may lose leverage, however, is if it is doing one HR activity like benefits administration with a buyer, for example, and then the buyer outsources all its HRO to another supplier. The first supplier might retain benefits administration, but its customer now becomes the other HRO supplier and it loses more control over the direct buyer-supplier relationship. The supplier “can get relegated to a tier-two,” says Pramuk. Those kinds of situations, he concludes, are “creating further urgency to obtain the ability to remain that tier-one prime provider and that’s what’s driving some of these acquisitions.”

In general, though, Pramuk thinks suppliers “are making acquisitions to allow them to evolve from what they were doing to what they need to be doing — so Hewitt buys Cyborg for the ability to do payroll because it didn’t do payroll administration before.” Janssen is of the same opinion. He says suppliers “are picking up spot solutions and missing pieces of their solutions that will enable them to have a robust offering” as in the cases of Mercer and Synhrgy and Fidelity and IBM’s HR Access.

Fersht views the merger activity in terms of globalization. “Suppliers have to consolidate if they’re going to have a full-service HR capability,” he believes. “If you’re a multinational, you’re going to want to have a supplier that has global trans-boundary capabilities to deliver all the services you need.” Such capabilities, he continues, might even include strategic elements such as performance management, regulatory compliance, and information management. So this merger activity will result “with potentially big players with very large capabilities that start to deliver HR services that you didn’t have before.” Larger, merged companies also can take advantage of economies of scale. “You need bodies on the ground in different parts of the world that have different laws, employee practices, regulations, so you’ve got to have the scale to be able to do that,” he says.

Human Resources Outsourcing: Implications for Customers

As mergers and partnerships continue, most experts see the prospects for customers as excellent. While buyers will have to deal with some disgruntled IT and HR employees who resent outsourcing, says Fersht, C-level executives will see nice improvements in their bottom lines.

Janssen also concedes that there will be temporary disruption of management teams and services, but “that’s probably good news over the long term because these suppliers need positive client references. They will work extremely hard to resolve any issues. In the end this will give them more sophisticated capabilities and will induce them to pay more attention to their customers.”

Lessons from the Outsourcing Journal:

• The next level of value from siloed HR processes will come from connecting them together through mergers and partnerships.
• Rapidly changing technologies are dictating that buyers standardize on common human resources outsourcing platforms resulting from mergers to cut costs in IT administration and management.
• Acquiring broader capabilities through mergers also helps suppliers remain or become tier-one suppliers with more control over the buyer contracts.
• The right mergers allow certain suppliers to obtain global, full-service HR capabilities to be able to service large, multinational buyers.
• Larger, merged companies also can take advantage of economies of scale needed to service global buyers.