Mastering the Mid-Market

The segment is small but growing, but can it break out from being an after-thought for the HRO industry? Market research shows it has huge potential ahead.

by Andy Teng

Those who have come along for the ride during the past few years of the HRO industry’s rapid evolution know that demand is rising in the mid-market even as the number of enterprise deals falls. With average HRO deals getting smaller, many industry observers predict that this segment—in which company employee headcount is less than 15,000—will eventually grab a bigger piece of the overall market than the large-market component. If true, this could lead to a whole new landscape for the industry.

Sound dubious? Certainly in today’s environment,seeing the mid-market overtake the large-market segment appears unlikely, especially on the heels of another billion-dollar contract announced recently by Johnson & Johnson and Convergys. And there were billion-dollar contracts signed last year and the year before. The total valuation of just the industry’s three largest deals easily equaled the total contract value of dozens of mid-market accords. Additionally, the large-market could receive another huge boost if the federal government aggressively embraces outsourcing, which some predict could occur as early as later this year. So perhaps the likelihood of the mid-market surpassing the enterprise part of the market is wishful thinking?

Think again. HRO’s mid-market, still raw and underdeveloped, has a huge potential for growth. That’s because the segment is constrained on a number of fronts, but as the market matures and overcomes barriers to adoption, look for a bursting of the dam that will lead to widespread adoption. In fact, the number of mid-market deals is only slightly fewer than the number of enterprise deals; but total contract valuation is vastly different.

According to the Everest Research Institute, of the 170 deals signed until 2006, companies with 3,000 to 15,000 employees accounted for 48 percent of the total, while those with more than 15,000 employees accounted for 52 percent. In total contract value, however, large-market contracts accounted for 88 percent of the market, while the mid-market only tallied 12 percent.

With such a large disparity in valuation, how can the mid-market ever catch up to the enterprise sector?

According to Everest, the mid-market’s potential has barely been tapped. With a base of 15,500 companies (those with annual revenues of at least $500 million), market penetration in this segment is only half of one percent; in the enterprise market, the rate is nearly four percent. Furthermore, when both markets reach mature states, the mid-market could reach a value of $24.9 billion, compared with $21 billion for its larger counterpart.

How quickly will this happen? While it’s not clear when either segment will mature, it appears that new enterprise buyers entering the market may have reached a plateau in 2005, when the industry reported a record number of signings. In his column this month (p. 66), EquaTerra Chairman Mark Hodges points out that the J&J deal may be the last billion-dollar HRO deal signed this year and that contracts are becoming smaller in total value and in scope. Mid-market buyers, on the other hand, are still in an exploratory stage.

“We see no slowdown in demand, and we see continued growth. Demand has not been an issue,” said Jeff Bizzack, CEO of Accenture BPO Services, one of the biggest comprehensive HRO service providers in the U.S.

Bizzack pointed out that it’s clear that the mid-market is growing at a faster rate than enterprise HRO, a segment that Accenture also serves. However, driven by a different set of business dynamics, mid-market buyer demands are uniquely different from those of the large market, and the industry is still trying to figure out how to deliver end-to-end services in a cost-effective manner to draw more buyers.

Of all the requirements that mid-market employers need from HRO, cost efficiency ranks head and shoulders above the rest. More sensitive to costs than enterprise buyers, the mid-market has proven to be especially tricky to service for several reasons. Even though pricing is its No. 1 concern, buyers still want outsourced solutions that are customized to their needs. To deliver low-cost services, providers must offer a one-to-many solution in which clients must accept being on a common platform with others. Furthermore, because the mid-market encompasses such a broad range in company size—companies with 3,000 employees face significantly different challenges than those with 10,000 workers—a solution that works for one might not work for the other. For instance, those at the lower end of the segment may have purely domestic needs, while those in the other range may have an international presence, which would preclude many vendors from serving the segment.

Another challenge for providers is technology integration. Because mid-market companies are often on a fast-growth path—one built through acquisitions—they often don’t have a robust technology backbone supporting HR operations; more likely, they are running a patchwork of systems built through mergers. If they are set on their particular platform, this may become a deal breaker for outsourcing HR services because it will be too costly for providers to operate on a proprietary system.

On the other hand, because they often have a fragmented HRIS, mid-market clients may be more inclined to outsource than to invest in a costly ERP system. In fact, precipitating events such as a broken HRIS can drive buyers to look for an external solution.

Steve Rosenthal, the CEO of CheckPoint HR, a payroll service provider with mid-market clients, pointed out that many of his customers want intelligence tools to help them to better run their organizations. With providers now offering various suites of tools—especially ones to help facilitate self-service—HRO’s appeal is on the rise with this segment. He added that many buyers are able to collect data, but their HRIS are incapable of easily delivering it in a usable format.

“Many companies are data rich and information poor,” he said. “The intelligence tools for reporting and automating are something that’s in high demand, and that’s only going to get higher.”

Technology resources and needs not only differentiate the mid-market from the large market, but they have also helped to carve out market offerings to these buyers. In fact, with automation a cornerstone of just about all mid-market solutions, employers can be assured that any choice they make will include a fairly robust technological platform. For example, a look at leading vendors such as Accenture, ADP, Northgate, and Ceridian shows that each has a strong payroll engine. These companies offer traditional outsourcing and even on-demand services such as ADP’s Employease offerings.

Another solution gaining momentum in the mid-market is software as a service (SaaS), a more cost-effective version of hosted service. SaaS is garnering increasing attention because of its low-cost, scalable features. In theory, because the data from all of a vendor’s customers reside in a single database, costs are minimized; the vendor only needs to make one application update to universally apply changes. Also, because the system is hosted, customers don’t need to invest in technology. And SaaS vendors usually price their solutions based on a per-employee, per-month model, which gives buyers cost predictability as well as scalability when they need it.

What SaaS fails to deliver, however, is the best-practice knowledge that HRO providers offer. So while it can be a cost saver, SaaS is incapable of, say, helping a growing company to improve employee services or reduce internal errors. To gain those benefits, mid-market buyers will still have to consider HRO.

Many already do these days, outsourcing such services as payroll, benefits administration, learning, screening, recruitment, and others. What mid-market buyers haven’t done is to roll all of these services into one end-to-end deal—it seems most still prefer a best-of-breed approach. But that may change in the future, said Accenture’s Bizzack.

Today, “one client might want us to do payroll and HR, but stay with another company to do benefits. The way the mid-market companies are approaching this is they are dividing and conquering,” Bizzack said. “The leaders aren’t always focused on the overall outsourcing strategies, so they are tipping into pieces. Eventually, they get to the whole piece.”

Embracing an integrated buy of HRO—including HR administration, payroll, benefits, training, and other domains—had been a hallmark of enterprise HRO, but more recently larger employers are finding a best-of-breed or even limited engagement more appealing, mostly because of its simplicity. Mid-market buyers, on the other hand, are moving in the opposite direction, preferring to consolidate their vendor base for one point of contact for their HR services. Bizzack noted that 90 percent of his customers buy the entire suite of services from Accenture BPO Services.

But will the pendulum eventually swing the other way? After all, enterprise buyers initially bought broad, integrated services, and now they appear to be pulling back, according to EquaTerra, which reported that fewer HR processes are included in the scope of today’s large-market deals. If the mid-market follows down the same path, will it eventually return to a point-solution market? The answer remains to be seen.

For now, the mid-market is simply enjoying a period of brisk growth, as buyers realize that despite their size, there are cost-effective outsourcing solutions to meet their needs. No longer just for global employers, HRO offers them an alternative to building internal capabilities as they struggle to move into the enterprise market.

Posted July 10, 2007 in Engaged Workforce

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