As another year comes to a close, we decided to take a pulse-check of the industry by inviting some of the most knowledgeable observers of HRO. Here’s what you can expect to see in the new year.

by HROT Staff

Robert Brown (RB) is a principal analyst in Gartner Research, responsible for the firm’s coverage of BPO for North America. His specialization includes human resources outsourcing, BPO vendor selection, mid-market outsourcing adoption, and global delivery capabilities.

Mark Hodges (MH) is the chairman and founder of EquaTerra, a global sourcing advisory firm that specializies in aiding organizations in their HRO engagements. Hodges has assisted dozens of companies in the assessment and improvement of their SG&A functions via BPO, HRO, and shared services.

Marc Pramuk (MP) currently directs the HRO research practice for the Everest Research Institute. He builds and maintains trusted relationships with HRO providers, buyers of HRO services, and Wall Street analysts following the HRO market.

Lisa Rowan (LR) serves as IDC’s program manager for HR and talent management services research. In this role, she provides expert analysis focused on both business services addressing HR and talent-related process issues such as human resource consulting, processing services, and business process outsourcing services, and HR IT services such as systems integration and IT consulting.

When it comes to forecasting 2007 HRO trends, few industry observers are as astute as the members invited to participate on this panel. These heavyweights of the HRO community—Rob Brown, Mark Hodges, Marc Pramuk, and Lisa Rowan—have decades of expert insight, have worked with scores of buyers and providers, and are arguably the most prescient when it comes to future trends. They have broad knowledge and hands-on experience like no others. That’s why HRO Today sought out their thoughts on the following questions. And if you’re prepared to accept what they predicts as gospel, you’ll get a glimpse of what will be forthcoming in the new year.

HRO Today: We’ve been hearing for months now that enterprise HRO adoption is slowing and that TCV for all of 2006 will be lower than in 2005. Has the industry plateaued or is this a temporary glitch that we’ll see corrected in 2007? What do you see in the pipeline?

RB: We see it as a temporary slowdown in the market, most pronounced in the U.S. through 2006-2007. It is not a contraction or negative growth.  Likely improvement will be seen in market growth in 2008, with further acceleration in 2009-2010. Europe is to an extent propping up the global growth rates while the U.S. experiences largely supply-constrained growth. But, even at 3.8-percent growth—significantly down from years’ past—the market will still grow over $500 million this year. Also, remember that “comprehensive HRO (or end-to-end HRO) is not a synonym for HR BPO at large. There is still significant room for growth in the largely mature payroll and benefits administration markets. Vendors report decent pipelines, but I would expect a moderately low number of major  deals in 2007.

MH: There has been a slowdown, but it is temporary and will not last. The pause in signings of major enterprise deals is not attributable to a lack of demand. On the contrary, demand for assessments and evaluations of savings opportunities has grown across the board in 2006 and notably in Europe for the first time in this industry.

What is retarding actual deal conclusion are provider capacity and global HRO complexity. Some leading HRO providers such as Convergys, Hewitt, and Accenture are slowing sales pursuits due to major global commitments with new clients and a lack of forward-delivery capacity. In addition to provider capacity constraints, the geographic complexity of contracts has increased, with many more organizations now looking to buy global services and fewer buying services for the U.S. alone.

MP: At Everest, we see continued strong buyer interest in HRO, as evidenced by the significant volume of requests we are receiving for informational sessions and the RFPs for sourcing advisory work. Organizations are demonstrating a much greater—and more mature— knowledge of HRO and the desired scope and service delivery models they are considering, and are much more precise with the goals they are seeking. New deal flow has been inhibited by lack of supplier capacity: 57 percent of all HRO contracts have been signed in the past two years and many suppliers have been distracted by implementations.    

There will be an expansion of supplier capacity shortly as Hewitt and Convergys approach completion of the implementations related to the strong win records they had in ’05. The solid year that Accenture and IBM are having in ’06 has the potential to drag on them in ’07 for similar talent capacity reasons, but the depth of their internal resources will likely mitigate this as compared to the impact their peers have felt.

It isn’t really a case of plateau but more of a return to a realistic level of activity; 2005 was a breakthrough year in terms of contracts, and so it is not surprising that 2006 won’t match it for numbers of deals. The providers that signed all of those 2005 contracts are still resource-constrained as they work through implementations. So, the market can only progress as quickly as supply can meet the demand. As an industry analyst rather than advisor, I have less visibility into pipelines, but based on discussions with buyers and suppliers, demand seems to be holding steady at the large end of the market and building in the mid-market.

HRO Today: How will engagements today differ from those signed three, two, and even a year ago? Will integration and comprehensive HRO continue to be the way to go, or will a growing number of companies prefer to selectively engage in HRO or choose best-of-breed solutions? Do you see pricing fluctuating much in 2007?

RB: Integration and comprehensive deals are still the minority of deals we see in the market today; accounting for approximately 15 percent to 20 percent of HR BPO deals in the marketplace. Despite growing pains, companies’ interest in comprehensive, single-source suppliers is growing because of greater choice of vendors in the market, difficulty in coordinating multiple best-of-breed HR specialists, greater regional requirements, and the cost savings associated with keeping the HR domain together through integration. Pricing will continue to fluctuate in the market. There is no “normalcy” in pricing, but metrics that calculate pricing norms seem to be getting more clear.

MH: Many prior engagements reflected the early growth pattern of the industry, which was to provide services in a process without emphasis on integration or a focus on the employee experience. Newer transactions are focused on quality of employee interaction and on lifecycle events driving multiple services across processes. New clients, and those revisiting their up-for-renewal service agreements, are focusing on integration. For example, a performance review should populate a training plan, succession planning, and an employee development plan. This will inevitably lead to integrated pricing of multiple services. Best practice will still be to unit price within bundles of processes.

MP: The emerging trend toward integrated workforce management capabilities within HRO deal scope is the most dramatic difference in HRO deals signed recently versus those from just a few short years ago. There is far greater clarity in the desired role for the retained HR organization and the path by which that role will be realized. At present, we’re seeing recruiting and learning in scope in deals more than 80 percent of the time, and performance management also is dramatically increasing in the frequency that it is included. But unlike earlier deals, in particular those that were more “lift and shift” in nature with a large amount of staff re-badging, the nature of the scope of these processes is limited to technology provisioning and administrative execution rather than more comprehensive service delivery.

LR: The obvious difference is in how the provider implements and supports the client. Three years ago, most vendors supported the lift-and-shift approach in a rush to win business. This less-profitable way of supporting clients is going the way of the buggy whip, and in its place is “transform then transition.” In the latter engagement, the buyer and seller together rationalize processes for best practices prior to transferring them to the seller for management. Vendors are also gaining expertise in various ERP offerings in an effort to lower the costs of supporting clients. Prices dipped during the past three years but appear to be stabilizing for the most part. Comprehensive, end-to-end services will stay popular while there will be new interest in some areas of best-of-breed services.

HRO Today: Consolidation activity was minimal in 2006. What will happen in 2007? Who will most likely be acquired and who will do the acquiring? Will we see further emergence of the offshore provider?

I don’t see the emergence of “the offshore provider” in a significant way in HRO yet. Likely, there will be additional consolidation in 2007 and that will be heralded by the exit of the HRO line of business by at least one of the major providers. What will be interesting to see is if such a sell-off is to one of the offshore heritage players as a suitor. Whatever happens, there is a bifurcation among the main players in the HR BPO market.  

On the one hand are many of the pure-plays in the payroll and benefits arena that have loads of transactional scale, repeatability, automation, and profits. But they have limited visibility with the CEO-level buyer.

On the other hand are the comprehensive HRO vendors, hailing from the ranks of the IT services providers in large part, with plenty of CEO-level visibility and with massive contract value but very little leverage and profitability. Tension exists between the desire to standardize comprehensive offerings and the need to feed short-term revenue growth through major contract signings.

MH: We did not see true consolidation in 2006. Exult-Hewitt and ACS-Mellon were transactions that occurred in 2005, not 2006. In addition, three new players entered the marketplace in 2006: ExcellerateHRO (the joint venture between EDS and Towers Perrin) entered the HRO market, signing its first major commercial HRO client since CIBC. Accenture’s acquisition and endorsement of Savista meant there was a potential servicer of middle-market clients for an integrated HRO service. And Fidelity has successfully digested its Bank of America HRO relationship and is actively pursuing new business.

In 2007, the market will witness some acquisition activity. In addition to acquisitions or mergers, some HRO contracts will be sold to other providers—not a true acquisition but a contract novation and purchase.

There will be additional M&A activity in ’07, much of it as Tier 1 providers add needed capabilities. However, there will be at least one major event to make you stop and go “wow.”

Look for HRO services suppliers to acquire software solutions and other providers that offer niche HR services. As an example of software acquisition, a few months ago ADP acquired Employease in an effort to both expand its software-as-a-service (SaaS) capabilities and give them a robust, newer platform on which to support traditional outsourcing services. In terms of niche services, suppliers of end-to-end services will likely be looking to build out their talent  management services portfolios so as to minimize the complexities of partnering for such services. Notably among these will be recruiting and learning.

HRO Today: By tower, RPO is one of the hottest HRO activities these days. What other areas do you see gaining momentum (learning, payroll, HRMS, screening, etc.)? Will we see enterprise HRO providers make large-scale investments in these areas? Will buyers outsource functions that have traditionally remained internal?

RB: We won’t see investments in the point solutions in and of themselves, but rather in where they meet as a holistic approach to business problems. Specifically, take talent management for example. It’s important; buyers are asking about it with greater intensity, but there is no “point solution” for it. Instead effective TM will require a combination of services traditionally offered by HCM consultants, recruitment providers, and personnel administration outsourcing. 

In terms of the major towers, education & training and recruitment will enjoy the highest growth rate between now and the end of the decade. However, they are among the least likely functions to be outsourced in their entirety—especially true of E&T.

HRO Today: Some buyers still remain dissatisfied with service delivery, time to reach steady state, and lack of innovation by providers. Will these problems ever get fixed?  What must providers do to truly make HRO an irresistible buy?

MH: To date, sales development has outdistanced quality HR service delivery in the U.S. and European markets in many areas. Providers are beginning to cannibalize each others’ delivery resources, and executive-level delivery people are in short supply everywhere. The value “promise” made by providers needs to become the value premise, i.e., demonstrable quality service delivery needs to be the central reality in 2007. If this happens, providers can reduce their sales and marketing budgets because word of mouth and competition within industries will drive future sales.

Quality service experience requires careful transition of services to the provider; scaleable technology to service the client; trained and experienced service people in both call centers and production centers; a strategic vision by the provider about how to deliver services; and an ongoing dedication to a quality employee experience.

Much of the dissatisfaction you cite (which I also am hearing) stems from weak supplier profits in the short term. Were that it, this would correct itself over time. However, another factor intervenes—namely, the relative youth and newness of HRO as an industry and as a “product.” The journey toward establishing generally expected services has taken longer than expected. With implementation typically taking 24 months, and with that solution having been frozen before implementation due to assumptions made by both sides in the assessment and selection process, we are facing very long cycles. This time horizon, in an environment of rapid solution evolotion, is leading to the complaints you cite. Again, this will correct itself over time.

LR: Moving to HR BPO is a radical shift, and so it takes some time for the retained organization to settle into its new role. Being taken out of one’s comfort zone breeds some of the buyer dissatisfaction. On the vendor side, providers need to bring more leading practices skills and experience to the transition in order to set proper and realistic expectations. Only by offering a radically better, not just cheaper, way of approaching HR and talent issues will they build the best mousetrap.

HRO Today: The mid-market appears ready for HRO. Will this be the next big segment for the providers?

RB: The mid-market has long depended on selective outsourcing in areas such as payroll, benefits administration, background screening, and other services. They have been more reluctant in engaging in end-to-end HRO for reasons such as loss of control, the stability of vendors, and standardized offerings not fitting their model. Vendors must invest for the long term to be successful in this segment. The ability of the marketplace to draw mid-market buyers into HRO will depend on how effectively they manage their cost structure.

MH: Yes, the industry is beginning to develop service capacity for the middle market, and there is already the beginning of a mid-market provider group that includes Arinso, Savista (Accenture), Ceridian, Aon, Logica CMG, and ADP. More entrants in this service area will come from point-solution providers who try to scale into servicing companies with less than 10,000 employees in the U.S. No one has a lock on this marketplace, but the race will go to those companies that provide at least core payroll, benefits, HRIT, call center, and self-service offerings.

Advisors will need to productize and train their clients on how to use advisory services in a setting that is productive and cost effective.  The total contract value (TCV) of these deals will be much smaller than many HRO deals today and may be on the order of an average of $3 million to $5 million per year.

MP: The mid-market is emerging as a “hidden gem” within HRO. Mid-size buyers represent just over half (52 percent) of the HRO contracts announced thus far, a point lost in the media attention on the marquee name buyers. For buyers, there is significant opportunity for cost savings and value creation among mid-size organizations as suppliers can offer greater functionality and services than they otherwise might have access to on their own. Further, new suppliers focus solely on mid-market HRO, such as Empagio, while long-time leaders are making significant investments in both process and geographic capabilities—Accenture through its acquisition of Savista earlier this year and ADP through a number of acquisitions and alliances throughout the year.

The mid-market has been underserved a bit up to now but this is changing with new focus on it by both traditional SMB players moving up and large market players moving down. Not being an advisor, I can say that advisors can build practices around the mid-market by creating off-the-shelf RFIs and RFPs and by examining and accounting for the unique needs of key industry segments. IDC’s research on the mid-market indicates that these buyers value industry experience and knowledge above all. So, those HRO suppliers and advisors that can build capabilities that resonate at the vertical segment level will succeed. Both suppliers and advisors need also to bear in mind that mid-market firms have very little grasp on their HR costs today and so education will be key to success. 

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