With big signings nearly disappearing in 2007, is the HRO industry in trouble? Bad news aside, mid-market interest may help prop up contract values this year.
Is the era of big enterprise HRO contracts over? Do last year’s anemic deal-making activities portend a continuing downward spiral in the number of mega-deals? Can HRO still attract the kind of big-name buyers it did just a few years ago?
A look at the top deals in HRO last year shows a paltry five contracts that were estimated to be worth more than $100 million in total contract value each. And of those, one has already fallen apart with the recent announcement by Starbucks that it was terminating its engagement with Convergys just eight months after announcing it. Even buoyed by the $1 billion end-to-end accord that Johnson & Johnson had signed with Convergys in 2007, the market still exhibited all the signs that HR departments have abandoned the outsourcing market.
Or have they? According to industry observers, the steep decline in the number of large enterprise deals reflects temporary setbacks in buyer outlook and supplier capacity, but it doesn’t mean the industry is about to go away. Some of the problems associated with service delivery are being tended to, they pointed out, and employers who last year looked for more favorable deals but simply couldn’t procure the terms they wanted might be idling on the sidelines until more favorable market conditions arrive.
“What has happened in the market is there are a lot of challenges around finding immediate cost savings, and it’s slowed down adoption. It’s taking companies longer to make decisions,” said Phil Fersht, research director, outsourcing and implementation services, enterprise strategies group, at AMR Research. Fersht pointed out that the enterprise market faced significant difficulties last year on two fronts:
supplier constraint and buyer wariness. On one hand, Tier 1 providers who signed a number of clients in past years were still grappling with profitability while meeting service requirements. Even though vendors such as IBM, Accenture, ACS, Hewitt, and others have grown up in the business since its inception around the turn of the decade, they are still working on perfecting the business model. In 2007, in particular, providers pulled back from customer acquisition like they have never done before, and they may still be reluctant to rush into new signings this year, he added.
Similarly, enterprise buyers during the past 18 months have grown more guarded about outsourcing their HR processes. With their enthusiasm dampened in part by capacity constraint, they’ve also seen a number of deals go south or have gotten wind of the implementation struggles some buyers are encountering. Despite outsourcing’s promise of HR transformation, a number of HR leaders still view the complexity and potential downside of HRO as a powerful deterrent.
“Some [buyers] would have moved forward if they could find a provider to move with them. I think there were to a certain extent some who stepped back” because of uncertainty in the market, said Stan Lepeak, director of research for sourcing advisory firm EquaTerra.
Lepeak noted that buying cycles might have lengthened as well because a number of client organizations escalated the decision-making process to the C-suite, which typically will look at a big HR transformation efforts with a more critical eye, delaying execution. He noted that the bigger a deal gets, the more likely executive oversight is involved.
Still, there is no denying that HRO activities were down sharply in 2007. Sourcing advisory firm TPI in its annual look at the state of the outsourcing market (including HR, IT, F&A, procurement, and others), found that total contract value of all HRO deals worth a minimum of $25 million totaled $3.27 billion last year, down 39 percent from the $5.35 billion posted the year before.
The Big Deals
Despite having produced just four big deals last year, the market posted one of its biggest ever with the Johnson & Johnson/Convergys contract: a 10-year, $1 billion, end-to-end behemoth. According to industry sources, the deal had been in development for years, and on an annualized basis it eclipsed even the $1.1 billion, 13-year contract signed in 2005 by DuPont with Convergys. Although J&J declined to release terms of the services, industry observers say it is likely to include everything from payroll to HR administration, benefits, and other HR functions.
The deal was just one of three worth $1 billion or more (the DuPont deal and one involving Unilever and Accenture are the other two), but it is likely to be the last one of its size for some time, some industry observers have predicted. Although Tata Consultancy Services (TCS) also engaged in a $1.2 billion contract last October, only a small portion of it involves HR. Considering the timidity of buyers in today’s market, billion-dollar HRO-only deals are unlikely.
In a deal that involved two providers, American Airlines last March awarded a 7.5-year, $217 million contract to IBM to overhaul its HR functions. Under the terms of the contract, IBM is working with Mercer to standardize the enterprise-wide HR functions of American Airlines and provide a wide range of services. IBM is supporting various HR processes such as training, recruitment, and staffing. In addition, the company will provide HR-related systems as well as call-center support. Mercer is delivering health and wealth benefits and compensation administration services, as well as employee communication consulting services to American Airlines. In announcing the deal, the airline said it sought to improve employee satisfaction, reduce costs, improve operational efficiency, and provide employees access to innovative solutions so it can focus on its core business.
In a 10-year, $171 million deal, GlaxoSmithKline contracted ACS to consolidate a number of services it had received from various providers. Among those covered are payroll processing and benefits administration in the U.S. and employee and manager self-service portals and integrated online tools for several HR processes in the U.S. and U.K. The deal furthered the two companies’ existing IT relationship, which included three other IT and systems-related contracts signed since 2003.
Two other large contracts announced last year included Starbucks and a Rogers Communications deal signed with Hewitt. Although neither company released financial terms of the deal, industry sources estimated that both were significant and possibly worth over $100 million.
The Rogers Communications accord was an expansion of the companies’ relationship, since Hewitt had previously provided compensation and benefits consulting services to Rogers for several years. The multi-year contract called for Hewitt to deliver workforce administration, payroll, and compensation and health and welfare administration services to about 26,000 Rogers employees. It was the provider’s first major win since 2005.
Although Starbucks had the potential to become a global contract for Convergys—when the deal was announced last July, it included HR administration and payroll services for employees in the U.S. and Canada, along with benefits services for Starbucks employees in Canada and a possible extension to additional markets—it came to an abrupt end just eight months after its announcement. Starbucks officials had said the outsourcing effort was to build a single global platform for HR services to support the retailer’s rapid global expansion.
Was this a case of HRO gone bad, and quickly? Although Starbucks declined to state the reasons for its reversal, Fersht believed this was clearly not a case of provider failure. He said the eight-month timeframe wouldn’t have even allowed Convergys to roll out the implementation adequately. Instead, he pointed to the replacement of Jim Donald by Howard Schultz as CEO at Starbucks, signaling a change in company direction that may have led the coffeehouse giant to retain HR services internally.
But will speculations about that decision to terminate hurt future deals in the pipeline? Fersht said it’s not likely, and he emphasized that of all enterprise HRO deals executed since the practice was first taken up, in only three percent of the cases have buyers grown so dissatisfied that they decided to take back services. So with a 97 percent success rate, HRO should be seen as a sure bet, he added, and he discourages buyers from dwelling on the failures. “The market will recover, and we will get it right,” he added.
Will 2008 bring about a rebound in the number of big deal executed? Neither Lepeak nor Fersht said they expected a significant rise in the number of contracts for the year, but they are optimistic that a growing number of mid-market buyers will take on HRO deals involving a handful of processes. Typically covering employers with 3,000 to 15,000 workers, many of these buyers are outsourcing payroll and benefits administration and adding on service components as needed. As for contracts worth more than $100 million, more activity is predicted for the second half of the year, they said.
Lepeak said that the market could get help from new players in the enterprise market. Offshore competitors such as Hexaware, Wipro, Infosys, and TCS could alleviate capacity constraints and give buyers more economic incentive to embrace outsourcing. Similarly, a freshly globalized Northgate IS (ARINSO) flush with the financial backing of private equity giant KKR, could aggressively go after market share both in the U.S. and abroad.
So after a quiet year marked by less than a half-dozen large enterprise deals, the HRO market might see a modest rebound as a result of more supplier capacity and growing interest among mid-market employers. Whether this translates into an increase in total contract value for the year remains to be seen.