As 2007 winds down, the HRO market is reassessing outsourcing strategies and opportunities. Signs of a louder 2008 are in the works.
For observers of the HRO landscape who had their ears pressed to the ground in 2007, the most likely sound they heard was a dull thud. By dull I mean the pace of deal making, which was clearly off the mark, even compared with the anemic picture witnessed in 2006. With one notable exception during the year, enterprise HRO deals were harder to come by during the past 12 months than bankers handing out sub-prime mortgages.
There were numerous signs pointing to a slowdown leading up to the first of the year, but even with lowered expectations, some industry insiders say they were caught off guard by how few enterprise deals were inked in 2007. While outsourcing activities showed a healthy spike across the Atlantic in the U.K. and continental Europe, in the U.S. only the $1 billion contract executed by healthcare giant Johnson & Johnson with provider Convergys stood out in what was mostly an unremarkable year of new signings. A number of smaller deals were reached during the year, including those involving American Airlines, Kimberly Clark, Starbucks, GlaxoSmithKline, and others, but clearly the volume had dropped off.
Consider these numbers: in the Americas, the total contract value of BPO deals worth at least $25 million through the first three quarters fell to $6.5 billion this year from $9.1 billion last year, according to sourcing advisory firm TPI. In Europe, the decline was less notable, and Asia actually recorded a gain.
Advisory firm EquaTerra also reported similar trends through its Pulse Survey, which indicated that service providers themselves were less optimistic in the third quarter than at the same time a year ago. The Everest Group estimated that the market this year will reach $2.85 billion.
“The pace was a little surprising. I had expected it to be a little more fast and furious,” said Richard Crespin, who heads up the HRO Association. “It became pretty clear by the first quarter that buyers were taking more time.”
Buyers were indeed taking more time, and providers were none too eager to urge them on. Following a number of deals that had veered off course and led many buyers to re-examine the wisdom of outsourcing HR and providers to rethink their business model, both sides appeared to have taken a break from the negotiations table this year. Even providers readily admitted they had grown more selective in their choice of clients as profitability emerged as a central issue. It was clear that 2005’s frenetic pace of signings resulted in providers this year shifting their focus from making new deal to stabilizing the ones they already had.
“I think the key drivers are the deals cut in 2005, and many [providers] are struggling with them,” said Rosemary Collins, partner and HR services leader at TPI. “That woke some people up to be a little more cautious in going after the big mega deals.”
So in 2007, Collins contended, providers as well as buyers changed the nature of their HRO engagements. For one, the contracts were smaller, more measured in scope, and less complicated. A return to best-of-breed services emerged in the market, with recruitment process outsourcing, total benefits outsourcing, and integrated learning all gathering steam. At the same time, enterprise deals grew more transformational in nature, which added to the bottom line of providers, who had moved away from lift-and-shift arrangements.
“What the providers are learning is a real focus on transformation instead of saying to clients ‘We’ll give you whatever you want.’ They are looking for rationalization and standardization,” she added.
Lisa Rowan, program director, HR and talent management services, at analyst firm IDC, remarked that following the industry’s high-watermark year in 2005, when a record number of contracts were signed, providers have taken the past two years to implement those deals. Providers such as Hewitt, Fidelity, and other brand names have struggled with implementation and profitability along the way, but she said it appears they may be ready to make a push in 2008 to sign more customers.
“ I think it’s good for those in the provider space to step back and figure out where they are, to figure out what they want to handle,” she added.
A Few Notable Deals
The market didn’t completely dry up this year, especially considering that at the end of May J&J entered into a 10-year, $1 billion deal for comprehensive HR services delivered by Convergys. Although few details were disclosed publicly, J&J was said to have considered outsourcing HR services for a number of years before entering into the contract. A company with a strong culture of outsourcing manufacturing of its pharmaceuticals and medical devices, J&J did surprise some with the size of its engagement.
Aside from this big contract, providers such as ACS, Northgate, and even Hewitt added new clients to their portfolios. In February, GlaxoSmithKline committed to a 10-year, $171 million contract with ACS. IBM grabbed a $217 million, 7.5-year contract from American Airlines a month later. ARINSO, acquired by Northgate, secured a 10-year deal with Agilent in August, and parent company Northgate in October announced a seven-year deal with Cadbury Schweppes. Accenture also grabbed more market share with a seven-year accord from Kimberly Clark.
Although fewer new deals were announced, one analyst noted that there were plenty of negotiations that took place—around renewals of existing contracts. With the industry having reached the second generation of contracts, some providers were distracted by retaining their existing clients, according to Stan Lepeak, managing director of research for EquaTerra. He said some renewals took place quietly and slipped under the radar screens of industry observers. These were either contracts that were soon to expire or highly satisfactory relationships that prompted buyers to renew long before their due dates.
This may be good news, he noted, because it indicates that buyer satisfaction has risen from the early days of the industry. While some big buyers still grumble about the speed of implementation, Lepeak said many other HR leaders have adjusted their outlook after their deals failed to meet initial expectations. But it also reflects a greater effort by providers to patch up delivery shortcomings and to respond to customer concerns.
Another bright spot for the outsourcing industry in 2007 was the rapid adoption of recruitment process outsourcing, which continued to grow by double digits during the year. With more enterprise buyers now engaging in RPO in a standalone, best-of-breed approach, independent providers are winning the lion’s share of recruitment contracts. With two-thirds of RPO contracts being awarded to point-solution providers and the rest bundled in large, end-to-end HRO accords, buyers are clear in their strategy.
Why are point-solution providers preferred? According to some buyers, enterprise vendors lack the same degree of competency and maturation when it comes to delivering recruitment services. Because they’ve spent much of their development efforts in areas such as payroll, benefits administration, HR administration, and other transactional functions, they’ve placed less emphasis on developing the high-touch skills needed to effectively manage recruitment. IDC’s Rowan said enterprise HRO vendors have not leveraged their existing HRO relationships to capture market share and have failed to ramp up compelling offerings.
“I don’t think they are especially well-positioned for it,” she said of the end-to-end providers. “They could be if they really wanted to be. At this point, I’m giving the nod to the specialists.”
While providers such as ACS, IBM, Accenture, and Aon all offer RPO services, independents such as The RightThing, Spherion, Kenexa, and others are winning many more deals. And with the market still expanding rapidly, more providers are being drawn into the fray. In fact, traditional staffing firms such as Adecco, Manpower, and Kelly Services are aggressively ramping up their offerings, which will further challenge HRO provider’s bid to envelope recruitment services within larger deals.
Buyers’ preference for standalone RPO deals reflected the market’s changing headwinds as contract sizes fell, deal scope contracted, and the work being split up among multiple vendors. This change clearly speaks to HR leaders’ desire to reduce complexity of outsourcing, but they may pay a price for this. By multi-sourcing services, buyers must develop better vendor management skills or face more chaos. Additionally, from a technology perspective, more integration headaches could result. Still, if this means faster implementation, improved service delivery, and acquiring deeper domain knowledge, HR organizations may be willing to make sacrifices.
As the industry approaches its 10th anniversary, it’s clear that service offerings are still evolving. At the same time, the provider landscape has changed little during the past few years—2007 saw only one major merger, the acquisition of ARINSO by Northgate IS. All other major HRO players remained in the marketplace, if not quiet about their activities. However, a number of India-based providers appear ready to make a bigger push into the U.S. market. TCS, Infosys, and Wipro recently signed HRO clients and may try to further leverage its IT and F&A expertise in the HR domain.
So with little fanfare, 2007 has passed by quietly for the HRO market. As buyers and providers lick their wounds from past mistakes, they are also staging themselves for possibly stronger growth in the new year. And if that happens look for the dull thud to be drown out by loud bang in a year of