With the benefit of hindsight, buyers and providers head into the next generation of HRO with clearer goals and expectations regarding their enterprise engagements.
Sequels are never as good as the original, unless you’re referring to HRO contracts. A lot of buyers find at renewal time that the follow-up is actually better than the first deal.
First-generation deals, spanning from as early as 1998 to as late as 2005, were often shot-gun marriages. HR organizations lured by the promise of significant cost savings—some were told as much as 40 percent in the early years of the industry—signed with a provider for 7 to 10 years, despite an unproven track record for both the vendor and the practice. At the same time, providers who thought they could serve numerous clients through an existing infrastructure and platform mistook scale for efficiencies and often priced their offering badly, leading to serious profit difficulties. This was the first generation of HRO deals.
Fast-forward to today. As a number of those original deals come up for renewal, much has changed. Buyers and providers are wiser, HR’s goals for outsourcing have shifted, and processes and technology have improved. The lessons learned from the industry’s Wild West days resonate loud and clear in the minds of all stakeholders as the life of many first-generation original contracts winds down. For all these reasons, second-generation (G2) contracts are developing into accords that offer a sharp contrast to their predecessors.
“In a second-generation deal, the providers know what they got themselves into. The client also knows what the provider can do and has done, and they are on a much more even footing,” said Debora Card, director of HR advisory services at sourcing consultant TPI. “The providers are pushing hard on standardization, and they are much less willing to customize unless the client pays for it.”
Card and other industry observers point out that in deals executed three or four years ago, both buyer and provider experienced a rocky start in their HRO relationships. That’s because many first-generation deals were fraught with problems that typically occur during the genesis of any new industry. As buyer and vendor struggled with how HRO could be delivered across a broad spectrum of industries, employer sizes, and geographies, many poor assumptions were made that later disrupted the relationships. These missteps exacted a toll on the market’s development, resulting in two phenomena: a pullback among new buyers engaging in end-to-end enterprise HRO, and a reluctance among providers to take on clients whose needs did not fit well with the provider’s business model.
This retrenching of the industry was clearly reflected in deal signings over the past two years. HRO Today in last month’s issue reported that only four large enterprise contracts in 2007 were signed and maintained (a fifth one involving Starbucks was terminated just eight months after its announcement). This followed a record number of enterprise deals executed in 2005.
While both sides have clearly made mistakes in the past, they are also leveraging the lessons learned as they enter into negotiations for their G2 accords. Infused with this knowledge, companies are more concisely demarcating the responsibilities of the providers versus those of the buyer, a required step that was poorly performed in the past, increasing tension in HRO relationships. Vendor management and governance were skills that buyers learned on the job.
Furthermore, buyers today have a better understanding of which processes should be included in scope and which should be retained; four or five years ago, they tended to lump everything into the deal without considering the impact on HR effectiveness. As a result, services such as recruitment were later brought back in-house after an initial unsuccessful effort to shift it externally.
“The clients have gotten smarter. That’s common sense. As they go through the lifecycle, they’ve gotten better,” said Sreeni Kutam, senior director of HR operations at pharmacy benefits giant Medco in Franklin Lakes, NJ. A practitioner of HRO since 2003, the company outsources myriad services to Hewitt, as well as payroll to ADP. In 2006, it renewed with Hewitt through 2013.
Kutam, who had worked for Hewitt prior to joining his current employer, pointed out that as a buyer, Medco has learned to effectively integrate HRO into its operations. That means planning with the provider for future capital needs, establishing a framework for governance, and clearly voicing its needs for value creation as the deal progresses.
“The key for providers is how to assure the value addition. Clients are not going to talk about transactions anymore,” he explained. “Another thing that will help providers is what I call the business intelligence aspect. As part of that second-generation deal, you have to say, ‘These are part of the common metrics we can deliver as part of the deal.’ The clients love it as part of the dashboard. If the providers spend some time and think that through, no client would not renew with the provider.”
Indeed, G2 deals will be shaped by a different set of goals and expectations, as well as past experiences. Because Medco was a spin-off from pharmaceutical giant Merck, it suffered few of the legacy pitfalls a number of other buyers faced. That may partially explain why the company was so satisfied with its contract with Hewitt, which it decided to renew just three years into the five-year accord.
Lack of Understanding
But not every deal unfolded as smoothly as Medco’s, and providers themselves concede that they might have fumbled around in the dark during the early days of the industry. From their perspective, second-generation deals offer an opportunity to correct past sins and make outsourcing a better experience for all parties involved.
“In the first round, all the providers were focused on building capabilities, infrastructure, and market share. The deals reflected that,” said Mike Wright, HRO sales leader at enterprise HRO market leader Hewitt. “We didn’t have experience in understanding the process, technology, and complexity. There was a complexity not well understood. We weren’t as clear on how that was going to occur. The pricing and SLAs were generally vague and somewhat aggressive in anticipation of what we could create in the business. The contracts reflected a general understanding, but they weren’t all that specific.”
Wright said what has changed since those early days is providers now better understand their core competencies and the requirements needed for ensuring that they can successfully meet client expectations while generating a profit for themselves. Leaving behind the old business model in which they provided highly customized solutions and, in some instances, bought the shared-services assets of clients, providers today are clearly setting limits for customizing service delivery. They are again striving to achieve their original goal of establishing a one-to-many service model, an effort that was disrupted by their pursuit of market share in the first generation. That’s why deal signings in the past few years have slowed—hampered by supplier capacity constraints because enterprise providers such as Hewitt, Accenture, Convergys, IBM, ACS, and others are only willing to take on new clients if they makes business sense.
While this stance has had a chilling effect on new engagements, it also signals the industry’s efforts to stabilize itself, which in the long run would be beneficial to buyers, as well. After all, if a Tier One provider withdraws from the enterprise market because of profitability problems, it could further tighten capacity and seriously shake up buyer confidence.
Industry observers point out that, with a large number of contracts nearing renewal in the next two years—most of those signed in the early part of the decade were five- or seven-year accords—emerging trends reveal some distinct departures from past practice. From a decrease in the length of contracts to a narrowing of service scope to potentially higher per-employee pricing, these shifts reflect a return to market equilibrium.
One of the benefits of hindsight for buyers is understanding which services should be in scope and which should be kept out. Buyers are also more cognizant of the fact that one provider, no matter how large, usually can’t serve all of their needs—or at least serve all of them well. So for some processes, buyers are either asking the provider of record to partner with another vendor, or they are simply parsing out a set of services to another third-party supplier. Clearly, HR organizations no longer believe that one vendor can do it all.
LeAnne Andersen, senior director of HR operations at electronics retailer Best Buy and chairwoman of the HR BPO Buyers Group Leadership Committee, said when she took on oversight of the company’s HRO deal with Accenture, she thought she would be managing just one provider. The reality, she added, is a number of vendors are sometimes at work on the same contract, whether they are brought on by the enterprise provider or simply managed by it.
“You are assuming you’re working with one big providers, but all of us buyers are managing multiple providers,” she said, adding that even when providers compete to win a contract, they may find themselves partnering on the same account because the winner might not have all service lines in place.
“There is no one provider that’s good at everything. You need to look at who has what capabilities and decide which capabilities are the ones you really need. That’s absolutely critical,” said Neil McEwen, managing consultant at PA Consulting.
For instance, he said, systems integration specialists such as IBM or Accenture might be selected for their expertise in this area, but a client may look to outsource payroll to another vendor such as ARINSO or ADP. Benefits might be handled by an expert such as Hewitt, while Cartus may be called in to administer relocation and Kenexa is charged with recruitment services. McEwen said the problem in first-generation deals was that buyers assumed providers were highly competent in all of the services offered, only to be surprised later on when they couldn’t deliver more effectively than the internal organization or as well as best-of-breed vendors.
In some cases, providers’ inability to deliver high-quality service directly affected high-level executives, who then made their dissatisfaction clear to HR. For instance, with relocation services, typically it’s the executives who experience the shortcomings in service. Similarly, a lapse in executive recruitment capabilities may directly affect C-level management. TPI’s Card said she most often sees recruiting and learning functions pulled out of first-generation deals simply because buyers are unhappy with service delivery.
It’s All about quality
That’s not surprising. According to Towers Perrin, which helps to manage the Buyers Group and conducts regular surveys on buyer satisfaction, staffing and learning functions scored the lowest satisfaction scores among outsourced processes in its 2006 survey of enterprise buyers (see figure at right).
Glenn Nevill, managing principal for Towers Perrin’s Dallas office, explained that the survey clearly indicates buyer preference in the second generation is leaning toward getting better outcomes.
“It’s all about quality. The buyers are less interested in the short-term cost savings. They are more interested in how well you can deliver,” he added. “The period of time they give vendors to get up to speed is very short now.”
According to Towers’ survey, which involved 17 “pioneer” buyers that had signed first-generation contracts, cost remained the most critical factor in vendor selection, but its importance is declining. In 2005, 37 percent of those surveyed said cost was the primary selection criteria; by 2006, that number had fallen to 23 percent. Other concerns such as supplier flexibility, cultural fit, financial stability, geographic reach, and even risk management were all cited as reasons for choosing a particular provider.
Nevill added that the survey indicates that buyers negotiating G2 contracts will be more selective about what they initially outsource. They might over time expand on the engagement, but they are quite clear about which services they want to include initially within scope, he added. And the results fall in line with the maturity of the process being outsourced, according to survey results.
“The more mature a process is for outsourcing, the higher the satisfaction level. It’s crystal clear,” he added.
So as buyers negotiate their second-generation contracts, they are looking to narrow the scope of engagement to services in which providers have demonstrated a clear competency, a trend that is mirrored on the provider side. However, one development that might dismay buyers is pricing—some could be shocked by the numbers they see when they renew their contracts.
Although incumbent suppliers are likely to win renewals for most deals—Card said she was aware of only two enterprise contracts where they did not—they are not likely to slash prices to do so. Even though they won’t need to invest as much in renewed deals as they did on the original contract, many providers will look to recoup their losses the second time around.
Furthermore, according to EquaTerra Chairman Mark Hodges, many providers incorrectly priced their offerings in the first contract because they weren’t clear on their own costs. In the second go-round, don’t expect them to make the same mistake.
“There are a couple of myths, one of which is many buyers assume prices will go down if they renegotiate. They don’t realize that in 2001 or 2002, they may have gotten a really good deal,” he pointed out, adding that prices increased slightly last year and are expected to rise a little again this year—but not by more than five percent.
On the other hand, buyers can expect to renegotiate for a shorter term because the initial implementation required a longer period of time to justify the provider’s return on investment. With fewer upfront costs on a renewal, providers are more willing to sign 5-year renewals instead of the typical 7-or 10-year year terms inked in many first-generation deals.
Still, these trade-offs are indicative of the give and take buyers and providers can expect as they move into a new market environment, one in which each side has a better grasp of its goals and expectations. Even as a number of renewals call for scaling back on scope, the net result, say industry observers, should be happier clients and more profitable providers. In addition, innovations will likely accompany re-signings as value-added services will be key to new contract talks.
“Any time you are an early adopter in outsourcing, both the client and vendor suffer one way or another,” said EquaTerra’s Hodges. “A renewal really allows the parties to be stronger and the contract to be stronger.”