Whether on a state or federal level, interest in outsourcing HR functions is growing. Buoyed by a desire to upgrade services and fears of a tax revenue shortfall, government agencies are taking another look at HRO.
There is nothing new about an organization opting to outsource HR functions to a third-party provider to better service its employees and achieve higher cost effectiveness. But when the buyer is a county government, that’s something worth taking notice.
Orange County in California, is a lush place of near-perfect temperatures for its 3.1 million residents—among them 18,000 people who work directly for the county. Five years ago, Orange County broke ranks with many other regional governments and did the unthinkable—fully outsourced benefits administration to Unifi Network, now part of Affiliated Computer Services (ACS).
“Other counties were amazed at the time,” recalled Patti Gilbert, assistant director of HR for Orange County. “People kept asking us why we would want to lose control over something so important. We pointed out that, if anything, we’d actually have more control, dealing with a contracted vendor responsible for detailed performance guarantees. It doesn’t get much better than that.”
Orange County, however, is more the exception than the rule. Few government bodies or the agencies they control outsource HR functions and services. A decade ago, the only public sector HRO deal was across the Atlantic in the U.K., a country that still accounts for the lion’s share of contracts. The U.S., despite having a much larger network of federal, state, and local governments and respective agencies and departments, has been much slower to warm up to the idea of outsourcing, but thanks to a number of factors, this may change in the near future. Although the public sector still lags the private sector by far when it comes to adoption of HRO, the sheer volume of public sector employees makes it an appealing yet underdeveloped market segment that some service providers follow carefully.
Already, growth is evident. According to a report by Everest Research Institute, the HRO market in the government vertical is expanding steadily, reaching $275 million last year from $75 million in 2001. “We’re definitely seeing increased activity and interest,” said Monica Barron, vice president at the Dallas-based research and consulting firm.
Barron said the drivers for adopting HRO are similar to those in the private sector—chief among them a significant reduction in the cost of delivering HR services. Another factor is technology. “A lot of public sector agencies use fairly old technology,” she explained. “For example, they don’t have employee self-service portals that make the delivery of services more efficient. And they are behind when it comes to technology upgrades.”
That said, one would be hard-pressed to call public sector outsourcing a fast-growing phenomenon in the U.S., much less the rest of the planet. Everest has tallied only 10 comprehensive HRO deals globally involving organizations with more than 3,000 employees since 1995. That’s still a leap from where things stood in 2001, when only one deal was on the books—the U.K. government’s contract with EDS to outsource HR services covering employees of the Armed Forces Personnel Administration Agency. Six comprehensive HRO deals have now been signed in the U.K.; four in the U.S.
Forced to Buy
If cost reduction seems to be what’s swaying the public sector to consider HRO, then the recessionary economy in the U.S. could persuade more government agencies to follow suit. A report released in late April by the National Conference of State Legislatures (NCSL) indicates the financial well-being of many states has degraded in recent months. The culprit is the housing crisis and related credit squeeze, compelling consumers to cut back on their spending, which, in turn, hurts treasuries. By mid-April, 16 states had reported shortfalls in their current budgets because tax revenues had dwindled, and 23 states in all are reporting shortfalls of $26 billion for the upcoming fiscal year. NCSL is not alone in these sober findings: the Center on Budget and Policy Priorities in Washington, D.C., reported in April that 27 states are projecting budget shortfalls next year approaching $39 billion.
To compensate, many states are cutting spending or deliberating tax-increase measures. The need to pare government expenses could prod more HRO deals down the line, given the cost savings it produces. “When there is less (tax) revenue arriving in state and local coffers, that’s a driver for considering cost-effective services like HRO,” said Glenn Davidson, managing director of public sector outsourcing at EquaTerra, a sourcing advisory firm.
While the benefits of public sector HRO are recognized by the vast majority of government and public sector HR executives, according to a study by EquaTerra, adoption rates are low for a variety of reasons. Lack of good cost and performance data involving public sector HRO, for example, was an issue for 100 percent of federal HR executives responding to the firm’s survey. It’s not that government is new to the world of outsourcing—after all, roads, sewers, and government buildings tend to be developed by the private sector. It’s more a case of running a tight ship. “Government is not driven by monetary qualifiers or evaluators like earnings per share or EBIDTA (earnings before interest, depreciation, taxes, and amortization), as in the commercial world,” Davidson noted.
“The mission is to provide quality services to stakeholders, in this case citizens,” he explained. “Consequently, there’s been less focus on outsourcing HR functions. Instead, there’s been the continuation of building these organizations without addressing their overall impact on the budget. Nevertheless, this is a new time.”
Davidson pointed to the federal government’s Office of Personnel Management, which he said is leading the charge among federal agencies and departments for government-wide, modern, cost-effective, standardized, and interoperable HR solutions. “Such solutions aim to provide common core functionality to support the strategic management of human capital, as well as remove redundant HR systems and processes across the federal government wherever possible,” he added.
The “O” Word
Nevertheless, movement has been slow in the federal government to embrace HRO since the first deal was signed in 2002—the outsourcing of core HR activities by the federal Transportation Security Administration (TSA) to Accenture. “The federal government is in the forefront of looking for opportunities to outsource because of its makeup—the great number of agencies that can come together with a common cause to effect an end-to-end HR solution,” said Nancy Sabatiel, ACS regional vice president. “But, they’re still building the case.”
Federal agencies such as the Environmental Protection Agency and the Federal Bureau of Investigation remain mired in study mode, trying to determine the cost of their current internal service systems for comparison purposes with outsourced provisions. While others agree that Uncle Sam will eventually be the primary outsourcer of HR functions among domestic governments, much of the recent activity has been at the state and local levels. The states of Florida and Texas, for example, have signed HRO deals with provider Convergys involving different agencies—the Health and Human Services Commission in Texas and Florida’s Department of Management Services.
Why aren’t other states lining up for similar service? Davidson said both states “have had mixed success with the engagements, which suggests that a lot of other states are watching and learning from their experience.”
Barron offered up a different perspective. “The sales cycle in the public sector tends to be very long, not to mention bureaucratic and overly administrative,” she said. “In the federal sector and in many states, administrations change quickly, and vendors suddenly have to start all over again. It’s a big commitment and investment on the part of suppliers to work through a lengthy sales cycle with potentially different stakeholders at different levels. On the plus side, if you win the deal you probably have a client for life.”
Another pothole—and it’s a big one—is that federal and state laws tend to discourage outsourcing. Circular No. A-76 issued by the Office of Management and Budget (OMB) states that the government’s policy is to retain governmental functions in-house to achieve economy and enhance productivity.
“A-76 basically says that you cannot outsource or at least you cannot use the `O’ word,” said Barron. “While government is authorized to turn to commercial suppliers under certain circumstances, a group of 10 or more federal employees are allowed under the law to compete against commercial providers. In such competitions, the federal employees win the contract 90 percent of the time.”
Offshoring is an even more pejorative word than outsourcing. A key cost savings provided by outsourcing service providers is labor arbitrage—driving cost down by accessing cheaper offshore labor. Government, however, is handcuffed to provide as many jobs as possible to the local citizenry. Barron noted that resistance to giving work to people who are not government employees, particularly if they are outside the country, is strong. For example, some states will mandate that a call center be located in a place where unemployment is high to create jobs in that area. These requirements are difficult to work around.
Sabatiel concurred. “The idea of moving work outside the immediate area has been a struggle for many governments,” she said. “This shouldn’t surprise anyone, as offshoring in the corporate sector is also somewhat controversial. The business case becomes more challenging but certainly not insurmountable.”
Indeed, the fact that half of the 10 end-to-end public outsourcing deals were signed from 2005 to 2007 bodes well for more to follow. The carrot is just too enticing to ignore. Everest Research pointed out that the average number of employees covered in government deals is much higher compared with private industries, a scale that also results in lower prices paid by the outsourcer. “The average number of employees covered in an HRO contract with the government is 80,000, which is well above the 30,000 employees covered in the 219 HRO deals in the private sector that we have tallied,” Barron said. “On a comparative price basis, government paid $346 per employee in the 10 contracts, while all other industries paid $426 per employee.”
Still, government has a long way to go to catch up to the sophisticated deals being struck in the private sector. So, the federal government has signed just one comprehensive HRO contract—the aforementioned TSA-Accenture engagement, which is coming up for renewal and is reportedly expected to include additional HR services. For the most part, governments are outsourcing only such transaction-intensive services as benefits administration and payroll.
However, industry observers are sanguine that momentum is in the providers’ favor. “I expect to see more of it,” noted Barron. “Suppliers are becoming more comfortable overcoming the challenges posed by the public sector, which is certainly looking to cut costs, given all the budget shortfalls.”
“We will see much more of this in the future simply because outsourcing provides consistent quality, improved services and cost savings,” Sabatiel asserted. “That message is getting out there now—thanks to the pioneers in government like Orange County that have outsourced and have only good things to say about it.”
Gilbert does not mince words about her employer’s successful outsourcing endeavor. While other counties were amazed back in 2002 about Orange County’s outsourcing decision, few of them are now caught offguard. “Other counties are sure to follow,” she predicted. “It’s just too expensive to have these large staffs that really don’t have the experience managing functions like benefits administration. No one raises his eyebrows these days.”