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Don’t Burst That Bubble! The Effects of Irrational Exuberance

Now that the HRO honeymoon is over, what’s next?

by Michel Janssen

By 2001, the dotcom boom became the dotcom bust. Now Robert Shiller, who correctly predicted the stock market run-up and bust in his book Irrational Exuberance, says the current housing mania may be the biggest bubble in U.S. history.

In the outsourcing world, I see a similar level of irrational exuberance surrounding HR BPO. Now that we are well into 2005, I looked at the facts to determine whether HR BPO is an outsourcing bubble or a real phenomenon that is building a foundation for solid, future growth.

Since the first HRO transaction in 1998, the industry has shown strong year-over-year growth, with a 34-percent growth rate in total contract value over the last five quarters. The number of new deal signings from January 2004 to March 2005 grew from 51 to 98, a 92-percent growth rate, and the number of employees served by these transactions grew from 2.4 million to 3.7 million, a 56-percent jump. These numbers indicate bubble.

HOW BIG IS THIS BUBBLE?
But there are many mitigating factors. First, how much of the market have we tapped? Answer: very little. Only 3.5 percent of U.S. companies with annual revenues of $500 million or more and more than 25,000 employees have outsourced, and 0.9 percent of companies with less than 25,000 employees have outsourced. If 30 percent is a conservative target level of penetration, there remains significant room to grow, thus reducing the pressure on the bubble.

Second, there have been no deal failures. Some customers have selected to take the HR function back in-house due to a change in their business scenarios, but not because the outsourcing didnt work out. I have found no deals where buyers decided to return their outsourced functions back into the corporate fold. And there have been no supplier failures yet.

In fact, we are now beginning to see second generation deals. For example, Bank of America renewed its contract with Hewitt. This indicates buyers are remaining confident in what the industry is offering, even after real-life experiences have passed and the rose-colored glasses are gone. A further affirmation is the fact that these repeat buyers are adding additional services to their offerings the second time around.

Hewitt Associates released a new study in April that found that corporations plan to outsource more HR services by 2008. The expanded services include leave management, learning and development, recruiting, health and welfare, and global mobility. The supplier surveyed 129 of its largest buyers, who represent nearly two million employees.

DOES HR BPO HAVE THE LEGS TO TRAVEL ANY FURTHER?
As I see it, the value proposition of HR BPO is sound. HR executives are moving away from a transactional focus and becoming more strategic. They have discovered suppliers can reduce costs while providing similar or better service than the company can internally. Additionally, the ongoing cost of the ERP upgrades has always presented a financial challenge; outsourcing solves this dilemma. Given these facts, I feel assured that HR BPO does have legslong ones, in my book.

However this being said, I do see two dark clouds on the horizon:
1. Little visibility into supplier profitability. It is difficult to discern who is losing money and who is making it.
2. Government and regulatory changes. While there are no discussions affecting HRO at the moment, Congress could pass a law that alters the current landscape.

During the next 12 to 24 months, I believe we will see a sharper division between the transaction engine players, like ADP and Fidelity, and the HR value players, such as Hewitt and Accenture. I think most suppliers will concentrate on building their global capabilities so they can meaningfully service multinational corporations HR needs across the globe, not just in North America. This will likely lead to suppliers increasing their use of offshore resources. Finally, I predict well hear more noise from the ERP vendors, who are taking a serious look at how they can work with outsourcing suppliers and deliver a one-to-many model.





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