The HRO Price Drop

Multi-process HRO prices are dropping like a rock. Heres how you can reap the benefits.

by Michel Janssen

In last months issue, I talked about the explosive growth in multi-process HRO transactions. During the past five quarters, the total number of deals grew 92 percent compared with the total number of all deals since 1998. Thats 98 deals as of March 2005, compared to 51 as of December 2003. Total contract values (TCVs) also increased, but only by 33 percent over the same period ($14.3 billion in TCV compared with $10.7). The discrepancy in the growth rates can be explained by two primary factors: 1) the emergence of a viable HRO market for smaller-sized companies; and 2) a significant increase in the competitiveness of the HRO market causing price points to drop dramatically.

The Everest Research Institutes recent HRO Market Analysis reported a dramatic decrease in the average price per employee for deals signed during the past five quarters compared to deals signed during the past six years. There was a 50 percent price decline for companies with fewer than 25,000 active employees, with cost falling from $1,082 to $540 per employee. There was a corresponding decrease in price for companies with more than 25,000 active employees, which experienced a cost reduction of $538 to $358 per employee (Figure 1). Why? The answer is complicated and primarily attributed to the lack of standardization across the industry. For example:
Few standards for scope. The per-employee cost comparison can be dangerous due to the wide degree of variation in what is included in a deal.
Differing service levels. Every company’s needs are different varied service levels translate into varied costs. 
Accounting for revenues varies by supplier. Some suppliers are more aggressive and include pass-through costs to existing subcontractors as revenues, creating a broader scope agreement with higher associated price.

While I have already confessed to several inadequacies in the data, I believe the underlying trends are representative of the industry. These include:
Increased competition. Despite some industry consolidation, the level of competition has become intense as suppliers vie for early market-share positioning.
Expansion of scale as suppliers gather more clients. There are significant opportunities for leverage, especially against investments made on technology platforms.
Improved delivery models that create process efficiencies. Practice makes perfect and suppliers are definitely learning to deploy best-of-breed operating practices.

Despite the noise in the actual price point data, there is little doubt that prices are dropping in multi-process HRO. The year-over-year price declines of comparable situations are probably closer to mid-single digits, but that too will vary by situation depending on the mix of HR services being outsourced.

Keep the contract short and provide yourself exit options. While the supplier prefers a long-term commitment to amortize up-front investments, it is very important for buyers to negotiate an early out clause.
Expect further price reductions. Buyers should ask the supplier up front for a commitment to build in predetermined price reductions.
Ensure there is flexibility to make adjustments in pricing if the market shifts suddenly. While benchmarking clauses are far from perfect, they do provide the buyer leverage in forcing an examination of what is currently a fair market price.

The contract is the groundwork for your relationship with your selected supplier. Without sounding too self-promoting, this is an area in which a professional advisor can be of valuable assistance. Dramatic price changes are a way of life in outsourcing. Having the proper structure in place at the beginning will prevent much heartache down the road, as your relationship with your HRO supplier matures and changes over time.

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