Solution Selection: Software vs. Sourcing

Risk management should be part of the equation of weighing insourcing through software against outsourcing services.

by William B. Bierce

The marketplace for HR “solutions” pits software vendors against service providers. Let’s compare and contrast software licensing and outsourcing, particularly at the lower level where the “service” is a commodity (unlike pension fund management and administration).

Why outsource when you can insource using robust software for virtually any HR function? Proponents of the software solution argue that a good software program in the hands of well-trained HR practitioners, supported by knowledgeable IT staff, can manage an HR process as well as anyone else. Proponents of HR sourcing solutions respond that in-house operations achieve limited efficiency. The crux is whether a sourcing solution in which the service provider uses the same software commercially adds value on a long-term basis, reduces or mitigates risks, and enables the strategic growth of the enterprise.

ERP software providers market software on the basis of completeness and, by implication, full compliance with all applicable legal and accounting principles. However, most software licenses are not legally supported. In contrast, service providers are responsible for the process that they design. Their marketing approach relies on a stalwart process.

Business process management (BPM) tools have emerged to fill the gap. This puts the control and the liability for erroneous logic or design back in the hands of the business manager. BPM tools, therefore, are the solution for HR administration, at least at the transactional levels.

Outsourcing is probably a better solution than software licensing when it comes to the general duty of compliance. While sophisticated lawyers can negotiate some protective measures, the typical software warranty disclaimers deprive the employer-licensee of any legal remedy.

In contrast, service providers agree to comply with the laws applicable to the performance of their services. The provider’s contractual commitments are akin to those in an insurance contract, where the employer cedes risk as if it were a re-insurer.

The laws will certainly change, and interpretation of the laws (both today’s and tomorrow’s) will require legal analysis and advice. In turn, that advice will need to be implemented into the HR systems. By hiring a service provider, the enterprise customer appears to be getting a better risk management profile by shifting the risks and costs of current and future legal compliance to a service provider. In such cases, the service provider delivers not just transaction processing but a financial guarantee of legal compliance across the full term.

Let’s consider audit and control functions. Well-managed service providers probably offer better auditability and control functions than an employer running third-party software.

Developers do not provide warranties of compliance with any audit or control policies for which the enterprise is responsible under the Sarbanes-Oxley Act. Auditors typically will consider an employer (client) software in opining on auditability and control of operations, but the auditing standards are lower for audits of service providers.

Service providers operating their own proprietary software have greater control and greater liability. As a result, auditing the outsourced operations managed by SAP or Oracle might need to include an analysis of their software, and auditing the operations of a service provider managing “industry standard” software would include a caveat that the audit does not cover the software.

Security and privacy issues have gained traction since the personally identifiable information (PII) of thousands of individuals has been lost or stolen. Carelessness occurs everywhere. Identity theft not only hurts business, but it may become subject to direct lawsuits by data subjects.

HR outsourcing does not insulate the employer from such liability. Unlike a simple software license, HRO gives new meaning to “misery loves company.” Hosted applications should provide the same high level of comfort as that of a managed sourcing solution provider.

For Global 1000 companies, a well-designed and monitored HRO solution offers an opportunity to share risk. For mid-market companies that have no ability to manage risk, HR outsourcing can provide significant benefits beyond cost savings by reducing uncertainty and increasing transparency of process, auditability, and compliance with law. This explains the difference in pricing models between software licensing (and maintenance) and outsourcing.

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