All signs point to strong growth ahead for outsourced HR services in the segment, from more contracts to increased vendor attention to public declarations by industry pundits that the mid-market has arrived. The problem is, we’ve seen this act before, so has anything changed?
You would think with all the attention that major outsourcing buyers such as DuPont and Unilever command, HRO is a singular market. Who really cares about the smaller employers—those with fewer than 10,000 lives—you might also question. After all, conventional wisdom says enterprise deals worth millions are where the money is, and the really innovative, big service providers wouldn’t even bother with a prospect who couldn’t hand over a check with at least six zeros.
If you’re among scores of companies with only a few thousand bodies, your fortunes are about to change. With the HRO market so intensely focused on large buyers during the past eight years, the tide is starting to shift as the elusive mid-market finally gains momentum. Buyers in the segment are buying, providers are ramping up solutions, and myriad signs point to an explosive period of growth ahead. Then again, pundits have prematurely predicted the year of the mid-market before, so has anything changed?
Unquestionably, the mid-market is more active than ever on numerous fronts. Providers who only used to take on large, enterprise customers are now serious about moving downstream. At the same time, small professional employer organizations (PEOs) that traditionally cater to companies with headcounts in the hundreds are eying larger targets.
Mid-market buyers, at the same time, have found confidence in the market as they turn over their HR functions to vendors. After watching from the sidelines for years—as well as being ignored by major providers—they are now taking the plunge like never before. Some are so confident in a mid-market solution that they’ve outsourced entire HR departments, retaining no internal capabilities. The momentum generated by both buyers and vendors is clearly heating up the segment.
“What has been happening in the market is all the hype and attention have been among the larger organizations, but what’s also happening quietly is the mid-market is growing as well,” said Marc Pramuk, vice president of research for HRO at sourcing advisory firm Everest Research Institute.
Pramuk, who has closely followed the mid-market segment, noted that after years of chasing big game, the market has now turned its attention on smaller clients for several reasons. While Fortune 500 HRO buyers are attractive targets, the outsourcing penetration rate among this crowd, while still low, has climbed to about four percent. That means there are fewer potential global, enterprise-scale buyers. The number of potential mid-market buyers, on the other hand, remains high, especially because HRO penetration is only about one percent and because there are significantly higher numbers of uncommitted companies in the market.
At the same time, Everest predicts that at maturity, the mid-market will eventually generate $120 to $145 billion in total contract value, which is comparable to large-scale HRO deals, expected to reach $125 to $150 billion.
Another reason mid-market buyers are attracting greater attention is the high cost of acquiring major accounts. Pramuk noted that in an enterprise deal involving more than 15,000 lives, a vendor may spend $3 to $15 million and up to 18 months of effort to win the contract. Mid-market clients, on the other hand, are cheaper and faster dates because these deals cost vendors a fraction to pursue, and they are usually secured in only a few months.
Furthermore, Everest found that large deals don’t necessarily mean larger profit margins. In fact, enterprise deals signed in 2004 and 2005 showed that mid-market buyers pay significantly higher prices per employee than their large-cap counterparts, and the gap is increasing (see Fig. 1). This is in addition to the fact that mid-market providers can truly leverage the one-to-many instead of the one-to-one model that large buyers require. It’s clear why the allure of this segment is growing.
But before you jump to the conclusion that the mid-market will soon become the new darling of HRO, keep this in mind: these deals presently account for only a small fraction of the overall market value. According to Everest, the 124 mid-market deals signed as of November 2005 only accounted for 12 percent ($17.2 billion) of all HRO sales even though it accounted for 48 percent of the number of executed deals. So even if a growing number of buyers are outsourcing, they haven’t added much to the bottom line of HRO providers. Sure there are more mid-market deals, but vendors know which segment remains their bread and butter.
Revenue contributions aside, the mid-market presents some significant challenges to providers of all sizes, so tapping this segment is no cakewalk. To begin with, there is no broad consensus on even who mid-market buyers are. Defining the mid-market is an ecumenical exercise, and getting key players to agree on the thresholds of the mid-market is not a small task. For instance, Everest defines mid-market as employers with 3,000 to 15,000; Accenture, which recently entered the mid-market race with an acquisition of Savista, claims it’s in the 2,000 to 12,000 range; traditional PEOs suggest this segment ranges 500 to 5,000. With such a large disparity, it’s no wonder the segment remains nebulous.
Beyond organizational size, mid-market companies also have unique needs, and these needs more accurately define mid-market than size alone, according to a number of industry observers.
“The way I look at it is across two dimensions. It’s a function of needs and function of size,” said Steve Lutz, executive vice president of HRO for Chicago-based provider Aon. He pointed out that while Aon defines the segment by size as employers with 1,500 to 15,000 lives, a better indicator is buyer requirements. For instance, global 500 businesses heavily stress ERP requirements while the mid-market is more closely aligned to application service providers (ASP). But the needs also go far beyond HRIS and platform.
“I think there is a belief out there that the mid-market doesn’t require client-specific solution. To do well with the type of clients we’ve served over the years, you need to be able to create solutions that are specific to their needs,” Lutz noted.
His comments echoed the findings of a recent study published by research firm NelsonHall, which found a common misconception that mid-market buyers don’t face unique challenges in their HR operations and that they don’t need customization. On the contrary, said John Wilmott, CEO of NelsonHall, mid-market have a “strong” preference for tailored and locally delivered services and that solutions offered to large buyers simply don’t fit their needs.
“Mid-market organizations insist they want to be treated as real people and have a first-class service and not a second-class service,” Wilmott said, noting that the study included interviews with HR executives at 60 mid-market buyers with 1,000 to 10,000 employees.
Indeed, the growing interest in mid-market HRO may be spurred on by dissatisfaction with internal HR operations. NelsonHall found that the factors leading to outsourcing include poor recruitment capabilities, increasing cost of HR service delivery, compliance challenges, a patchwork of HRIS systems, and lack of knowledge about best practices. Furthermore, compelling events such as a system upgrades or software renewal may drive an employer to look externally for solutions.
According to NelsonHall’s findings, high on the mid-market buyer’s list of service requirements are:
• Local delivery of services;
• The provider to promote employee self-service and offer management self-service functionality; and
• A tailored service.
This short list is often accompanied by the constant question whether an employer should invest in additional capabilities or outsource it, said Keith Strodtman, senior vice president at provider Ceridian. A hallmark among many of Ceridian’s clients is having a need to standardize its HR processes, gain better access to data, require a high touch for its employees, and resolve its capital expenditure dilemma.
“We look for customers who are in flux—trying to make a decision on whether to build out or outsource. It’s usually a company with a compelling event, driving towards best but standardized services, someone who is not looking for purely a cost saving,” Strodtman said. “Human capital management is important to them.”
Firefighting is one of the most common drivers to outsourcing, Strodtman and other industry observers say. For instance, corporate divestures have led many newly established operations scrambling for HR capabilities. In these circumstances, mid-market organizations have very little time and internal knowledge to adequately assemble a top-shelf HR department. As a result, they may outsource some or many domains of HR services such as payroll, benefits, recruiting, training, HRIS, and others.
“They usually have a date that they need to be live, so they are moving pretty rapidly,” Strodtman said.
THE CAP-EX CONCERN
Another driver and differentiator of large enterprises and mid-market organizations is technology investment. Large-scale buyers typically have spent millions in ERP systems and have settled on a HR platform—whether it’s SAP or PeopleSoft. Often, provider-suitors are given preference in the selection process based on the platform they operate (DuPont, for instance, chose Convergys for its support of SAP human capital management software).
Many mid-market buyers, however, have no preference when it comes to an HCM platform because they don’t have one. Some of these companies, through M&A activities, already operate on a hodgepodge of systems that span everything from proprietary software to Microsoft Excel. So when offered an industry-standard platform featuring a cornucopia of functionalities such as report generation and robust, enterprise-wide self-service, these organizations are more than willing to embrace the technology offering.
“Platform is a selling point. It’s a differentiator for us,” said Anthony Marino, vice president of middle market for Bradenton, FL-based Gevity, a traditional PEO that has moved upstream into the mid-market. “We’re educating people [about our platform] and they hear we’re on Oracle and they say ‘We know that works.’”
Marino pointed out that clients feel more assured when their outsourcing service provider operates on a familiar platform. Oracle, which bolstered its market share of the HR software marketplace when it acquired PeopleSoft in 2005, is a household name when it comes to brand recognition. Similarly, software giants such as SAP have made greater inroads into the enterprise HRO market, especially among companies with major ERP investments.
Last year, Gevity announced a landmark deal with office imaging equipment Danka to provide all HR services for the $1 billion St. Petersburg, FL-based reseller. Under the evergreen contract, Danka outsourced and turned over all HR employees to Gevity, which is now responsible for all of the client’s domestic HR functions for its 2,500 employees.
In an interview with HRO Today, Danka CEO Todd Mavis said that one of the reasons for the company to outsource was to tap Gevity’s strong experience on the Oracle platform and to avoid significant cap-ex in bringing self-service to the company.
Indeed the cost of technology has emerged as a major driver for outsourcing in the mid-market. In addition to the initial expenditure, there is concern about ongoing operating costs for those investments. For global 500 employers, those costs are smaller considerations than for mid-market organizations, which are much more sensitive to capital costs. But as Bob Donahue, vice president of product management and marketing for Tampa, FL-based Advantec, explained, there are many headaches in maintaining internal capabilities.
“It’s not just the systems but the people, process, and technology,” he pointed out, adding that companies need to carefully consider the business case for outsourcing versus maintaining internal resources. “It’s less about the emphasis on technology but more about the cost of service.”
PROVIDER LANDSCAPE CHANGING
Advantec, which focuses on HRO services to companies with 500 to 5,000 employees, is among a growing field of providers looking to tap the mid-market space. In the past, it was difficult for smaller buyers to get a large provider to even respond to an RFI let alone an RFP. However, as the mid-market gains momentum, the number of vendors serving it is growing as well.
The clearest example of the rush into the mid-market is the Accenture-Savista marriage. Enterprise HRO providers don’t come larger than Accenture, but its decision to acquire Savista, a specialist in mid-market HRO and FAO, clearly validated the ascendancy of this segment. After unsuccessfully toiling with its own efforts through Accenture BPO Services, the company’s purchase of Savista showed it was serious about smaller clients and that it is making a serious foray into the territory.
But Accenture is not alone. Other large providers are taking notice of the development of this segment. Companies such as IBM are planning to make a greater push into mid-market F&A, while PEO providers that traditionally targeted employers with fewer than 50 workers are moving upstream to win more business. All of this movement is, in the mind of Mike Seckler, co-founder and VP of business development for HRO provider Employease, causing some problems in the marketplace.
“There is confusion in the marketplace on what the options are,” he said, noting that Employease’s web-based HR solutions are used by employers with as many as 50,000 to those with fewer than 1,000. What Seckler consider as the company’s sweet spot, though, is solidly in the mid-market area.
He questions whether larger providers accustomed to serving up one-to-one, customized HRO solutions will be able to survive in the mid-market, especially considering the difficult economics of making money in the mid-market.
“For them to craft the solutions that are the right functional solutions in a way that the economics work will be a really big challenge,” he added. “Certainly some of these folks can make a change, but I haven’t seen it.”
Still, the movement is on, and whether large providers will make significant inroads into this segment and leverage their existing investments remains to be seen. In the meantime, buyers are finding more choices from more vendors every day. With so much attention lavished on the mid-market these days, it begs the original question: Is this really the year of the mid-market HRO? As Aon’s Lutz puts it this way: “I think it says everyone believes this is an attractive market.”