HR Outsourcing in the UK

Peter Reilly
Helen Wolfe
Published by:

INSTITUTE FOR EMPLOYMENT STUDIES

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Copyright 2004 Institute for Employment Studies

No part of this publication may be reproduced or used in any form by any meansgraphic,
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Studies.
Contents

1. Introduction 1

2. What is HR Outsourcing? 2

3. The Extent of HR Outsourcing and its Coverage 3

3.1 Extent 3
3.2 Content coverage 3
3.3 The effect of organisation size and sector 4

4. Drivers Towards HR Outsourcing 6

4.1 General reasons for outsourcing 6
4.2 Specific reasons for HR outsourcing 7

5. Theories and Models of Outsourcing 17

5.2 From theory to practice 20

6. Cost/Benefit Analysis of HR Outsourcing 22

6.1 Why not outsource? 23

7. The Future of HR Outsourcing 25

7.1 Influences in HR outsourcing trends 26

8. References 30

v
vi
1. Introduction
The subject of HR outsourcing has attracted considerable attention
during recent years and there is a lot of talk in the personnel press
about the subject. However, there exists rather less detail on its
extent and the strategic intent that underpins it. Is there really a
shift towards a greater and deeper outsourcing of HR activities?
This review seeks to address these questions and also to look at:

z defining outsourcing with respect to the HR function

z the nature and prevalence of HR outsourcing in the UK
z key drivers behind outsourcing
z theories and models of HR outsourcing
z assessing cost and benefits what are the considerations?
z likely future trends and developments.

The effects of outsourcing on employee attitudes and behaviour

will be reported in other IES research.

HR Outsourcing in the UK 1
2. What is HR Outsourcing?
The basic premise of Business Process Outsourcing (BPO) is the
move of some set of activities from within the organisation to an
external supplier or vendor. Most HR outsourcing would be seen
as BPO. This fits with IDSs (2000) view of outsourcing:

outsourcing involves suppliers taking on a wide range of

administrative and/or transactional tasks across the HR function with
the aim of providing these more cost effectively through investment in
technology to automate and standardise process.

Reilly and Tamkin (1996) offered an alternative definition:

where an organisation passes the provision of a service, or the

execution of a task previously undertaken in-house to a third party to
perform on their behalf.

As you can see, this second definition offers the possibility of a

broader range of tasks as candidates for outsourcing than was
provided by IDS version. It also leaves open the reasoning behind
the decision to outsource.

In this report we will include any form of HR outsourcing, be it of

transactional services or transformational contribution. The
assumption behind the IDS definition is that HR activities beyond
the administrative or transactional would not be outsourced. In
fact, this is a key question we hope to address.

2 Institute for Employment Studies

3. The Extent of HR Outsourcing and its Coverage
3.1 Extent
It had been hoped to offer our own view on the extent of HR
outsourcing in the UK. This has not proved possible. Instead, we
have to rely on a variety of sources of mixed value. Some accounts
are compromised by being undertaken by those selling outsourcing
services. Others are limited by poor quality survey results a
small or skewed sample. Further studies cover outsourcing issues,
but not as the main part of their focus. To complicate matters,
some descriptions concentrate on the financial value of HR
outsourcing, others, more helpfully, present the proportion of
organisations that outsource. Then there is the problem of
geographic focus: the UK is rarely isolated on its own in the
results produced.

To give a flavour of this data, here are some figures reported in

recent months:

z BPO research and consultancy firm, Nelson Hall reports UK

outsourcing contracts currently value in excess of 10bn, with
1.5bn being attributable to HR functions.
z The Work Foundation (with only a 2 per cent response rate to
their survey) found that 42 per cent of organisations outsource
at least one area of their HR function.
z Three-quarters of US and European companies surveyed by
The Conference Board outsource at least one HR activity.

3.2 Content coverage

So what areas of HR are included in outsourcing deals? Again the
data suffers from the limitations described above, although it
might be argued that the figures on the content of outsourcing are
more likely to be reliable than the quantum.
The Work Foundations survey reported that the most common
HR activities outsourced were:

z occupational health services 54 per cent

z pensions administration 44 per cent

HR Outsourcing in the UK 3
 z training 37 per cent
z payroll 32 per cent.

Salary and benefits administration was the area least often

outsourced by respondents (2 per cent). No organisations reported
outsourcing strategic activities and only a few indicated that
policy work was done externally.

In the Workplace Employee Relations Survey (WERS), training (36

per cent) was by far the most common HR activity to be
undertaken externally. Payroll was outsourced by one-fifth of
respondents and recruitment by only 11 per cent. Note though
that these results are from 1998.

RebusHR (now Northgate IS)s 2001 survey of the UK market

revealed that outsourcing payroll was the first step along the
contracting out road for most companies.

A joint study conducted by Accenture and The Conference Board

(2002), based on the responses of 165 top HR executives in the
USA, UK, and Europe, reported the following on the content of
HR outsourcing programmes:

z 70 per cent outsource health benefits management

z 69 per cent outsource pensions and benefits administration
z employee communications (standardised offer letters,
contracts of employment etc.) was least frequently outsourced.

A more recent survey conducted in 2003 added to the above list,

in declining order of frequency:

z training and development

z salary and benefits management
z payroll
z recruitment services, and
z assessment services.

The context of this study needs to be considered, as a large

percentage of respondents were US based, where the
administration of health and other related benefits is notoriously
complex, and indeed outsourcing in this way has been considered
somewhat commonplace for a number of years.

3.3 The effect of organisation size and sector

The Work Foundations report highlighted some interesting
differences in the outsourcing practices of organisations in
different sectors and of different sizes. It found that, where
outsourcing was used, it was more likely in professional and

4 Institute for Employment Studies

 financial services companies, or IT organisations, than in
manufacturing organisations.

The nature of outsourcing (ie the particular item of activity) seems

also to differ by sector. According to The Work Foundation (2003),
the financial services is the most likely to seek external support for
payroll administration (67 per cent did so), compared to only 25
per cent of manufacturers using this type of service. Within the
public sector, the most popular outsourcing activities were
occupational health at 59 per cent of respondents, and pensions
administration, which was outsourced by 45 per cent of the
sample.

Organisational size also appears to affect the choice of outsourced

services, with the smaller companies opting for suppliers who
could assist with both transactional and administrative tasks,
probably a reflection of the potential cost benefits associated with
using a single vendor. They are also more likely to extend HR
outsourcing into more transformational activities, policy work or
strategic advice. Indeed, for organisations of less than a 750 staff
they may use the supplier as in effect their HR department.

The management team head of Capital Incentives had two choices

when it split off from the Bank of Scotland. It could either employ an
HR manager or it could outsource its HR department to a service
provider. Both options were examined closely, and a decision was
taken to outsource. Debbie Rees, marketing director, explained: When
we first considered employing an in-house HR team, we realised that
we only really needed one HR staff member to look after our relatively
small company. This would mean that the HR manager would need to
carry out routine administration tasks, as well as working strategically
with the board. We wondered if we would actually find an HR
professional at a senior enough level to work strategically, who would
also be willing to undertake a large proportion of administrative tasks
too.

In order to meet an objective of maintaining low overheads whilst still

effectively supporting the staff and managers, Wizard Inns decided to
take out a contract with a HR service provider, rather than employ an
in-house HR manager.

Howard Spode, Director of HR Outsourcing, Northgate IS

There are also variations by country in HR outsourcing activity

that have been widely described. For example, the Accenture and
Conference Board (2002) research found that US companies were
twice as likely as their European counterparts to outsource major
parts of the HR function. This information is very important in
two respects. It suggests that US owned companies, located
overseas, might be more inclined to outsource than their locally
owned equivalents in Europe. It also though suggests that we
should be cautious in understanding the current extent and likely
future growth of HR outsourcing in the UK, if viewed only
through American eyes (be they those of clients or suppliers).

HR Outsourcing in the UK 5
4. Drivers Towards HR Outsourcing
In this section we question whether the drivers for HR
outsourcing are the same as for outsourcing in general. To what
extent is the same as for outsourcing in general.

4.1 General reasons for outsourcing

Reilly and Tamkin (1996) proposed that organisations outsource
for the following main reasons:

z Cost reduction
achieving economies of scale
higher labour productivity
more efficient deployment of labour
numbers reduction through attrition
erosion of old terms and conditions
z Shift from fixed to variable costs
z Improved service
access to specialist skills
access to up to date technology
advantages in size or geographic spread
product or market knowledge
avoidance of internal controls
z Focus on core business
z Reduced exposure. Protection against:
the costs of downsizing
adverse publicity
changes in regulation and legal requirements
changing career expectations
z Avoidance of headcount based manpower controls
z Flexibility to meet fluctuating supply and demand

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 The 1998 WERS survey supported the view that cost saving is the
principal driver for outsourcing. It found that nearly half of its
respondents contracted out to save money. The focus on service
improvement also featured 20 per cent of the respondents
outsourced in order to improve the quality of service though
perhaps less strongly than one would expect. Some organisations
(a further 20 per cent in WERS) choose to outsource non-essential
activities in order to concentrate on the core business.

4.2 Specific reasons for HR outsourcing

In one of the few surveys specifically looking at why organisations
outsource HR activities, the study conducted by Accenture and
The Conference Board discovered that the three most significant
drivers in HR outsourcing were:

z cost reduction
z improving the quality of HR services provided to employees
z maximising resource availability.

The Work Foundations survey produced the following responses:

z 63 per cent of respondents who outsourced one or more

function did so to harness specialist knowledge
z 44 per cent cited a key reason as maximising resource availability

A survey by IDC (International Data Corporation) in 2003 gave

the top three benefits of HR BPO as:

z cost savings
z technological expertise
z process expertise

The RebusHR 2001 survey, referred to earlier, also put cost as the
principal driver, followed by buying in specific expertise and the
need to comply with employment legislation.

Other reasons advanced for HR outsourcing include

z process standardisation and tidying up (especially after

mergers)
z policy harmonisation, especially in decentralised organisations
z better understanding of costs of service delivery

In the USA, the CIPD equivalent organisation (the Society for

Human Resource Management) found from its survey that:

z 26 per cent outsourced to save money, and

z 17 per cent to provide services they could not offer in-house.

HR Outsourcing in the UK 7
 These surveys seem to produce similar reasons to those described
above that drive outsourcing decisions in general: cost, quality
and expertise considerations predominate. It is interesting to note
that improving services to employees is listed in the Accenture
and The Conference Board report, not to the business, not to line
management.

This begs the question of to what extent is the HR function

following the path of others, like Information Technology, in
undergoing a fundamental shift from an operational function to a
strategic, business-driven group. In this context, outsourcing non-
core activities can allow HR professionals to move away from
routine administration to a more added value role. This shift has
been described by some suppliers as moving from a cost to a
transformational focus in outsourcing HR services.

The answer to the question of whether HR is on a transform-

ational journey is bound up with the creation of a new structural
model for HR delivery, namely shared services.

4.2.1 The importance of HR shared services

The key dimension of a shared service is, as the name implies, that
the activities involved are those which are available to a number
of parties. Moreover, the nature of the services is determined by
both the provider and user. The significance of this is that, unlike
traditional internal service provision, the customer defines the
level of the service and decides which services to take up. Thus, as
it has been more graphically put: the user is the chooser (Ulrich,
1995). A shared services model presupposes central provision.
Shared is not supposed to mean centralised in the traditional sense
of that term, rather services are common to the recipients.

There is no single model of shared services in our study. If you

consider Figure 4.1, organisations commonly distinguish between
strategic, operational and administrative activities. Strategic
governance functions are always excluded from shared services,

Figure 4.1: HR organisation: broad choices

Policy
Strategic
Governance

Centres of excellence
Relationship management
Operational
Project work
Consultancy
Information and advice
Support Administrative
Record keeping

Source: Reilly, 2000

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 as it is seen as a corporate responsibility. Policy development may
or may not be part of the corporate responsibility. It may feature
as part of the role of centres of excellence, described below.

At the other end of the spectrum, administrative tasks are, not

surprisingly, the bread and butter of the shared services function.
Items forming part of the service include:

z payroll changes
z relocation services
z recruitment administration
z benefits administration
z company car provision
z pensions administration
z employee welfare support
z training support
z absence monitoring
z management information.

Information provision either via a call centre or the intranet, or

both, is normally a key feature of shared services models.

The greatest variety in defining the boundaries of shared services

is in the operational middle of Figure 4.1. Here there was a great
deal of variation in what was included. The HR person in a
customer facing role, variously described as business partner,
account manager or relationship manager, is usually, but not
always, separate from the shared services organisation. Sometimes
organisations create a project or consultancy pool of advisers able
to tackle longer-term problems, or case workers to look at short-
term, often individual issues, in more depth than is possible for
the telephone first respondents. Centres of excellence, with
expertise in such areas as resourcing, employee relations, reward
or training, may not only give policy leadership, but also act as
advisers to other HR professionals.

The principal drivers to the introduction of HR shared services

appear to be cost reduction, quality enhancement (including being
more customer focused) and responding to (sometimes leading)
organisational change. Another factor in the equation is technology.
Technology usually seems to be a facilitator rather than a driver of
change, though many delivery models would not have been
possible only a few years ago without technological innovation
(Reilly, 2000).

These reasons are sometimes discrete, eg shared services are

introduced primarily to save money in what is more a case of
producing centralised rather than shared services; more often, the
drivers are seen in combination. So a desire for cost saving and

HR Outsourcing in the UK 9
 quality enhancement frequently both lead to the introduction of
shared services.

What is striking is that the reasons for setting up shared services

are so very similar to those given for outsourcing. However,
introducing shared services does not necessarily lead to
outsourcing all transactional activity. As the IES report (Reilly
2000) on shared services advised:

there was little evidence that the development of shared services was
part of a reorganisation based on a core/periphery model. There was
scarcely any suggestion that such a concept would determine whether
an organisation would make or buy activitiesconcentrating on
executing core activities itself, outsourcing the peripheral ones. There
was discussion about who should provide services, but this was more a
debate about implementation than a question of fundamentals.

The circumstances where outsourcing might be part of the

adoption of shared services seem to include:

z Needing to fund technological improvement, be it a new HRIS

or e-HR facilities. Organisations may not be able to justify the
expenditure on HR systems. Outsourcing might offer the
chance of funding these developments either because use is
made of the suppliers own IT platform or the supplier funds
(or co-funds) the spending on new kit.
z Organisations may feel that there is a cost advantage in using
an external supplier. This may be for smaller organisations
because the supplier provides economies of scale or for larger
companies because their cost base is higher.
z The need for change management expertise and the capability
of building an effective shared services model is another
reason for externalisation.

With the growing interest in outsourcing HR activities, BT decided to

exploit its scale and technology to sell its services externally. So it
established a profit centre based wholly on internal capability. Before
long, BT moved towards greater external positioning. Together with
Accenture it established a completely discrete joint venture company,
called e-peopleserve. Subsequent to that, in 2002, Accenture took full
control of the business (renamed Accenture HR Services). It now
provides services to BT, amongst other customers. (Pickard, 2004)

BAE Systems set up a 10 year joint venture with Xchanging (an

Internet company) called Togethr HR in February 2001 to handle BAEs
HR transactions and professional advisory services. It costs 25m a
year. BAE contributed 500 HR staff and Xchanging supplied the IT
systems, an administrative and call-handling centre and a small
number of experts. This was followed in October 2001 by further
outsourcing, covering BAEs 80m-a-year spending on HR
procurement, such as car fleet management and healthcare provision.

Xchanging guarantees to reduce HR transaction costs by 10 per cent in

the first year and 15 per cent in the second. It also promises to deliver
the same or better quality of service.

10 Institute for Employment Studies

 Meanwhile, the remaining 200 HR staff at BAE Systems have been
expected to become more strategic. (Maitland, 2002a)

Conversely, other organisations have explicitly rejected

outsourcing their shared services operation. Again this might be
for a number of different reasons:

z public relations considerations, especially for some public

sector organisations, might deter outsourcing
z a recognition that the supplier will not find cost savings except
by sacrificing quality
z the belief that improvements to HR services should be sorted
out in-house: you should not pass your problems to a third
party to solve because this will cost you significantly.

A Shell manager at a conference in 2000 explained why Shell People

Services had chosen thus far not to outsource its activities:

z the importance given to internal knowledge

z the ability to develop and circulate staff between shared services
and its customers
z all staff providing services are aligned toward the success of the
whole enterprise
z any benefits from their operation (be they financial, intellectual or
service) stayed within the company
z suppliers and customers being part of the same organisation
allowed for more customer intimacy on the part of the service
deliverers
z their operation acted as a gateway to the outside world: they
were not part of it.

Absa (the Associated Bank of South Africa) has chosen not to

outsource their HR shared services at present. Dennis Farrell, the
manager of the shared services operation has pointed out that the
people management departments headcount had fallen from 571 in
1999 to 356 by late 2003 and spending had fallen by 25 per cent. As
he explained: We have squeezed out all the cost of our HR operation.
There is nothing left for the supplier to find. (Reilly, 2004)

A government agency advanced similar views to Absa. The reason it

gave for not outsourcing in the initial stages of creating a shared
service model was that management felt it could retain more of the
benefits by doing it themselves. As evidence of the pragmatism that
seems to be behind decision making on this subject, the design project
team intends to market test to see if building or buying was more
cost effective.

4.2.2 Service quality

As we noted above, the introduction of shared services might be

driven by the aim of improving service quality. Are there other
specific reasons why outsourcing would raise standards of service

HR Outsourcing in the UK 11
 delivery? One element in organisational calculations is the belief
that external providers may offer expertise not available in house.
For example, recruitment advertising has been long seen as a
specialist activity, but recruitment selection may be viewed likewise
if it involves, say, psychometric testing. The same argument is
given with counselling services with the added argument that it
puts some distance between the service provision and the
organisation, thereby reassuring employees of its independence.

Specialist expertise may also be bound up with technological

infrastructure. The client might want to buy the whole package in
order to deliver a quality service. RBS followed this route with its
benefits provision. Their flexible benefits scheme was outsourced
to Hewitt Associates, (a US domiciled but increasingly global
HR/benefits consultancy and administration company) because
there was no internal capability and little UK knowledge of how
to run these schemes at the time (Reilly and Williams, 2003).

Then there is the argument that by outsourcing the task it gets more
attention. The supplier will concentrate on it and the client can
more clearly specify the deliverables. This was the reasoning
behind RBSs original decision to outsource the management of
the induction process. It is a task that might have a low internal
priority. The contractor, instead, needs to focus on it in order to be
paid.

The more that the organisation feels that to be an employer of

choice in the war for talent the more likely it is to add benefits to
employees, be they child care, flexible benefits, gymnasia, etc., and
the more likely it will draw on outside help. The argument for so
doing might be a mixture of the above reasons. Quality of service
is a prerequisite and is more likely to be obtained from those with
the expertise and facilities to provide it, but also with the
necessary business focus to deliver it.

Maria Persson, Director of Human Resources at Novo Nordisk (Europe

North), said: As a result of a reorganisation during the fall which led to
the creation of the new business area, we had to find a new solution to
the way HR services were provided. We had to find a guaranteed
source of HR expertise in the UK and Ireland that could provide the
same level of service.

Howard Spode, Director of HR Outsourcing, Northgate IS

4.2.3 Scale and cost

Economies of scale are reasons for introducing shared services

and outsourcing. As we remarked earlier, these points may come
together for smaller organisations. They need to use the
economies of scale offered by a service provider because they
cannot obtain them themselves. On their own they cannot justify a
new HRIS, a call centre or case workers. Using the contractors

12 Institute for Employment Studies

 staff and kit, and sharing it with others, may be a cost effective
solution. And if the IT investment is large, passing the
responsibility to a third party may be necessary even for big
companies because they, too, may not win the internal case for
investment in HR technology. This seems, for example, to be one
of the main reasons BP outsourced to Exult (Pickard, 2000).

However, this argument may now start to be applicable even to

big organisations. If they have already gone down the shared
services route, they may have achieved all the cost reduction
possible with an internal solution. The only next step (apart from
getting bigger still as an organisation) is to combine with other
organisations. This might be done via joint ventures, and there has
been some evidence of this kind of partnership working in the
public sector, but in the more competitive commercial sector,
outsourcing might be an easier concept to accept.

4.2.4 Repositioning the HR function

Even before shared services took off as the prime means of

structural reform of HR in large organisations, the HR function
was trying to reposition itself. The aim is to encourage the
function to become more strategic and less bogged down in
administrative activities; to be less of an employee welfare service
and more of a business support function and a facilitator of
change, rather than a guardian of tradition. In other words, HR is
seeking to avoid a low profile, fire-fighting role and seeking to
become an explicit, high profile contributor at the strategic level,
well integrated with the business and demonstrably adding value.

Outsourcing of especially transactional activities may help realise

this ambition. The less HR is involved in administration and the
more it is adding value to business improvement, the greater will
it be respected. There is a recognition that the administrative work
still has to be done to a high standard. The debate then becomes
whether the organisations own HR function can do this better or
worse than an external provider.

4.2.5 Globalisation

Providing cross-national HR services is tricky. There are some

successful of examples where there is in-house provision eg
Shell, Standard Chartered or IBM. However, some companies
might balk at the notion of offering to deliver HR activities across
a number of countries from one or two service centres. Especially
for firms new to trans-national operations and where staff
numbers are small in many locations, the idea of passing over the
responsibility for handling the variety of terms and conditions,
legislative requirements, cultural differences, etc., all in a variety
of languages, to another organisation must be attractive. Of course
the service provider itself needs to be at least as global.

HR Outsourcing in the UK 13
 4.2.6 Mergers and acquisitions

The continuing prevalence of mergers and acquisitions encourages

companies towards structural flexibility. As we have described,
some firms believe that shared services offers the basis for easy
and speedy adjustment to changes in ownership or wider
organisational configuration. Passing out HR activities to a third
party also offers a credible response to business change.

Of course it is not as simple as that. If merging companies have

both already outsourced HR tasks then this might mean greater
rather than lesser difficulty in combining work. Or, if these
companies are using different technological platforms, then
outsourcing will not necessarily be a simple solution.

4.2.7 Externally imposed solutions

In the UK public sector, the drive to outsource functions,

including administrative and transactional HR tasks may come
from outside the organisation. The government imposed Best
Value Initiative, following on from the previous compulsory
competitive tendering process, aims to achieve continuous
improvement in the efficiency and effectiveness of service
delivery in the sector. The legislative aspects of Best Value are set
out in the Local Government Act 1999, and apply to local
government organisations and authorities, with the aim of
continuous improvement in the way in which they exercise their
various functions.

The current Gershon review of civil service HR delivery invites

departments and agencies to look at outsourcing as a means of
achieving economies of scale. It sees value in departments and
agencies banding together to deliver common back office
functions. There is a recognition that this might then logically lead
to asking a third party to act on behalf of this organisational
consortium.

From this perspective outsourcing of HR processes might be seen

as a route to cost savings or to the improvement in service quality.
This view may be driven by the belief that public sector service
provision is inefficient and old fashioned, not as modern as in the
private sector. So, involving private sector service providers may
be as much about effecting cultural change as simply about
financial savings.

4.2.8 Business driven solutions

Whether HR is in the driving seat or other business leaders may

make a difference in what the function is aiming for and what
solutions are chosen. Just as with the creation of HR shared
services, where HR is in the van, quality of service and strategic
reposition of the function may be as least as important as cost

14 Institute for Employment Studies

Figure 4.2: Differentiated drivers
Business Driven Objectives
z provides cost effectiveness and
competitive advantage
z offers economies of scale
z facilitates organisational change
z allows investment in HR
infrastructure
z reduces exposure to externally
driven change
Combination
z allows focus on core activities
z improved productivity
z generates better HR to employee
ratios
z increased cost transparency
z better integration of core
functions to increase control and
efficiency
z shifts costs from fixed to variable
z frees up resources
HR Driven Objectives
z reduce fragmentation of HR
service delivery
z automation and standardisation
of processes
z better service for users
z access to technology, expertise,
and specialist knowledge
z improved management
information
z strategic repositioning of HR
function
z allows new service offerings
z permits internal headcount
reduction

Source: IES

reduction. Where general management is calling the shots,

slashing expenditure might be the primary focus. Which direction
is likely to be taken will depend upon the emerging organisational
structure, corporate culture and the economic climate. HR may be
forced down a particular route by economic exigencies or by
pervasive structural reform. It may be that outsourcing is or has
become the cultural norm, where externalising services is seen as
a good thing that brings managers brownie points.

4.2.9 No single explanation

There is a risk of oversimplification in this account. Decisions

regarding outsourcing may well combine a number of factors;
which predominates depends upon the activity involved. Cost is
likely to be the predominant raison dtre for outsourcing generic
services, whereas quality is going to be a more significant criterion
where higher value added or more bespoke activities are
involved. Internally driven reasons may focus at one point in
organisations development, whereas external considerations (eg
mergers) may be more of an issue at another point in time.

Contrasts in organisational structure, activities, culture and

objectives, and how these in turn affect the outsourcing process,
can be seen at sectoral level. For example, in The Work Foundation
2003 study, harnessing specialist knowledge was the most frequently
cited driver in the move towards outsourcing in professional and
financial services organisation. In the manufacturing sector,
respondents emphasised the importance of maximising resource
availability in their decision making process.

HR Outsourcing in the UK 15
 However, differences between sectors may not be the complete
explanation. As we will see in the next section, there is also the
question of the corporate orientation to outsourcing. This may be
more about a philosophy of how to do business than a calculative,
cost/benefit analysis.

16 Institute for Employment Studies

5. Theories and Models of Outsourcing
This section looks firstly at two key conceptual models of decision
making with respect to outsourcing (core versus peripheral
activities, and transaction cost economics) before moving to models
in practice. Both theories propose a distinct method by which
organisations might may make strategic outsourcing decisions.
They do not seek to provide a prescriptive methodology, or be
universally applicable to this type of choice. Indeed, as we will
show later, elements of one, or both, theories may be more/less
applicable to different organisations. And for some organisations
decisions of this nature will made on an altogether different basis.

5.1.1 Core versus peripheral activities

Atkinson and Meager (1986) proposed in the flexible firm model

that the decision to outsource will depend on the organisation
differentiating between those activities that are considered core to
the business operation, and those which are more peripheral in
nature. The critical question that then arises is on what basis is the
decision made on what constitutes the core and what the
periphery.

Some organisations have merely identified those activities that are

core and those which are not based on implicit criteria. Other
organisations may make a more explicit judgement distinguishing
between those activities that are considered the source of its
competitive advantage and those that are not. Yet this too requires
further analysis, as it is by no means immediately apparent what
provides competitive advantage.

A different method is to look at the processes, to determine what

is critical to successful performance. Techniques such as activity
analysis and business process redesign may help to identify the
key elements. Thus it may be said that strategic or financial
management are core processes, as are the management of external
relations, including supply contracts, or design rather than
production. Another approach is to decide which are the skills
that the organisation above all else needs to control or nurture.

Table 5.1 below offers one view of how you might view the
distinction.

HR Outsourcing in the UK 17
Table 5.1: Core versus peripheral activities

Core v Periphery
skills specific to the firm v generic skill requirements
limited labour supply v minimal supply restrictions
hard to define tasks v well defined or limited tasks
activities which are well integrated v jobs easily separated from other work
easy to fund work v resource intensive (especially in financial terms)
stable work demands v fluctuating work demands
mature technologies v those subject to rapid technological change

Source: IES

Whatever the criteria used, further judgements may be made to

determine whether there is enough of a market to ensure
satisfactory supply and, if activities are to be retained in house,
whether there are sufficient resources to make them competitive.

5.1.2 Transaction cost economics

Transaction cost economics (TCE) provides a theoretical

framework for assessing the option to keep an activity within the
organisation, or to seek an externally provided alternative.
Developed by Williamson, this perspective argues that the
organisation will seek to chose the most economical governance
structure (Williamson, 1979). The theory argues that in
transactions the make versus buy choice are composed of three
key elements:

z degree of uncertainty
z frequency of transaction
z specificity of activity/investment
is the activity bound to a particular location(s)?
how specific is the task (equipment/skills needed etc.)?
how specialised is the human knowledge needed?

Supporters of this perspective argue that using TCE can assist an

organisation in assessing the relative difference and competitive
advantages between market costs and production costs.
Outsourcing decisions based on TCE are likely to focus on the
economies of scale and specialist skills available via vendors,
although the effect of these benefits are likely to diminish as the
level of service becomes more bespoke and frequently produced.
Market arrangements, however, need to be closely monitored
otherwise the supplier will seek to take advantage of the client
because of opportunism (Williamson, 1973). This involves a lack
of honesty in behaviour or self interest seeking guile
(Williamson, 1973). This sort of exploitation is particularly evident
where there are a small number of vendors. Internal management

18 Institute for Employment Studies

Figure 5.1: Williamsons transaction cost analysis (simplified)
investment characteristics

non-specific specific

transaction frequency
occasional outsource outsource?

frequent outsource insource

uncertainty

Source: Reilly and Tamkin,1996

does not have these governance costs because all those employed
should be working for the common purpose of the firms profit
maximisation. There are also advantages in continuity,
communication and control that should lead to better efficiency
and performance.

Research conducted on the determinants of outsourcing in the IT

sector (Nam et al. 1996) suggest that asset specificity and the
potential number of vendors were not significant in the decision
to contract out. However, Williamsons theory seems to borne out
with respect to uncertainty. It significantly affected the decision
to outsource IT activities. This seems quite plausible. To repeat
ourselves, organisations need flexibility in the highly volatile
business climate of the modern world. High levels of uncertainty
in a move to outsourcing, may leave the organisation open to
significant exploitation by the vendor, or with inadequate ability
to plan effectively for the future. In particular, when clients are
contractually locked-in with vendors, vendors opportunistic
behaviour, such as price exploitation, may significantly impair the
organisations interests. Indeed, Lacity and Hirschheim, (1993)
reported that very often clients continue their relationships with
vendors precisely because client firms may have locked-in
relationships with vendors.

TCE provides an interesting framework, with clear links to wider

economic and business theory. The applicability of this approach
has come under significant question by those who do not see
organisational human decision making as based on such logical
approaches: human nature intervenes. TCE also implies
universality of decision processes. This again seems highly
unlikely, given sectoral, geographical and functional differences
and the involvement of individual human beings. The
development of business strategies may also not operate in the
manner suggested by Williamson, with long-term strategies and
goals often evolving as the result of a series of smaller business
decisions, an approach which Mintzburg (1994) identifies as post

HR Outsourcing in the UK 19
 hoc rationalisation. The disparity between the theory and practice
of such decision making has also been highlighted by Pfeffer
(1981), and Johnson (1987), who argued the influence of power-
forces within the organisation and the dominating corporate
culture as key factors in how the decision making process actually
works.

5.2 From theory to practice

The rationale for which activities to outsource, is likely to be as
diverse as the functions affected, options available, and the nature
of the organisation itself. Based on their research, Reilly and
Tamkin (1996) suggested three differing models aim to describe
the considerations that are involved in the move to outsource:

z the rational strategic

z the ad hoc pragmatic
z the ideological purposive.

The rational strategic

There are a number of organisations that base their decision to

contract out on a well considered, rational analysis of their
business position. It is likely to be long-term in focus and strategic
in intent. It might well use the flexible firm model as its
inspiration. It might apply TCE, as described above. It might try to
apply the notion of core competencies. Hamel and Prahalad (1990)
saw the route to achieve business focus through the notion of
defining and protecting core competences.

The ad hoc pragmatic

This view is based on research (eg Hunter et al., 1993; Bresnen, 1994)
that indicates that decisions such as whether to, and how to
outsource functions, including HR, are relatively unlikely to be
made in formulaic manner (such as via a core/periphery analysis).
Instead, outsourcing decisions are often made in connection with
immediate business strategies and needs, and rarely are they part
of an encompassing plan. Objectives may well be short to medium
term, reactive to market conditions and the need to cost cuts.
Moreover, despite the emerging change to a more business
focused HR function, some would still argue that such decisions
are owned and driven by the Finance function.

Ideological purposive

Other organisations have by contrast taken an ideological position

in favour of outsourcing. The basis of this view is that tasks
performed internally are by definition more expensive because
they are not market sensitive; management attention is diverted

20 Institute for Employment Studies

 away from key issues, and unnecessary overexposure and
inflexibility is risked. They believe in-house arrangements generate
work and result in over-staffing. Some have taken this further by
arguing the need to create what have variously been described as
the virtual, modular or minimalist organisation. Size is restricted as
much as possible and the organisation works through a series of
loose and temporary networks assembled to perform specific
tasks as required. It is more of a theoretical than actual construct,
though there are examples such as Nike or Dell computers.

There are examples too of management choosing to outsource as

part of a process of organisational transformation, in order to
change employee attitudes to work. Such cultural change
programmes may be underpinned by a belief that those exposed
to the rigours of the market are, by definition, more productive.

HR Outsourcing in the UK 21
6. Cost/Benefit Analysis of HR Outsourcing
So how successful has HR outsourcing been in meeting business
objectives? The results are mixed, but also limited. Too few
organisations review the success or otherwise of their decisions.
Rather, we are restricted to honeymoon stories at the beginning of
outsourcing ventures or the occasional horror story as things go
wrong.

The Conference Boards research from 2003 would argue that this
is too gloomy a picture. It claims that three-quarters of companies
surveyed monitor the success of outsourcing on cost and just over
half on service quality and customer satisfaction. What we do not
know is whether this is compared with statistics from the pre-
outsourcing period. The truth might well be that these metrics are
only now being properly understood.

Here is a sample of the evidence of more general evaluation of

success or failure:

z The study conducted by Accenture and The Conference Board,

referred to earlier, discovered that only 50 per cent responded
that their objectives had been fully met, although 90 per cent
felt that they would continue to outsource more HR activities
despite the inherent challenges. Of those who did outsource
one or more HR activity, less than one per cent had chosen to
move these back in house, suggesting a high level of
satisfaction with the outsourcing experience. Furthermore, 78
per cent of respondents were in the process of considering
moving to a shared service option, in some cases as a
precursor to outsourcing the entire HR function.
z In contrast, the 1998 WERS research uncovered very mixed
views on whether outsourcing in general had saved money,
despite the fact that nearly half the organisations outsourced
for this reason. Only one-third of respondents reported that
costs had fallen.
z Similarly, the University of Sheffield found that a quarter of
the more than 500 manufacturing companies responding to its
survey said that outsourcing had failed to meet its objectives,
and only one-third were really positive about the benefits
(quoted in Lonsdale and Cox, 1998).

22 Institute for Employment Studies

 z The 1999 Outsourcing World Summit Survey System found
that 40 per cent of respondents were either dissatisfied or
ambivalent about the outcome of their outsourcing decision.

The outsourcing of HR, as with any function, faces significant

challenges. One view is that outsourcing can provide a higher
level of service than might be reasonable to expect from an
internal department. Faster response times, higher compliance,
and convenient access to benefits supports employee loyalty, in
effect minimising liability and turnover costs. Conversely, many
questions and concerns continue to be raised regarding the
security of outsourced services both for the company, and
ultimately employees. The challenge is to clearly demonstrate the
value outsourcing contributes in supporting the overall business
objectives.

6.1 Why not outsource?

We have tended to emphasise the arguments for outsourcing in
this report. Some organisations do their cost/benefit analysis and
conclude that HR outsourcing, other than for specific activities, is
not for them. In section 4.2.1 we gave the examples of Absa and
Shell that in their different ways had rejected systematic
outsourcing. For Absa, it seems to have been purely a cost
equation. Some of The Work Foundations respondents seemed to
share this view. Of the 66 organisations which did not outsource
any HR activities, nearly half were not convinced that a third
party would add value (The Work Foundation, 2003). Shells
arguments went further. They seemed to include fears over a loss
of organisational learning and lack of shared vision. These points
are consistent with two of the objections to outsourcing Reilly and
Tamkin (1996) found. These were:

z an underlying difference in outlook between profit maxi-

misation on the part of the contractor and cost minimisation
for the vendor
z damage to business performance through a loss of control
through being locked into inflexible contracts
z we can perform the work as well in house what value does
the contractor have?

A US HR director made this point more trenchantly: outsourcing

is a sign of lazy management. I can do it faster and cheaper than a
supplier can. It is my core business. (Maitland, 2002b)

These are fundamental problems with the concept, not the day to
day difficulties with the outsourcing process. Here there were
more practical concerns:

z managing the contractor (made harder by the loss of internal

expertise)

HR Outsourcing in the UK 23
 z legal (contractual) disputes
z service difficulties
z customer complaints
z employee relation problems
z poor communication
z unexpected costs.

Again, one can see some of the day to day problems in those major
HR outsourcing contracts that have been let. In connection with
the BT/Accenture deal, Pickard (2004) describes communication
failings, a tendency for customers to blame outsourcing for any
service deficiency and weak account management on the part of
both parties. In the early days of its outsourcing arrangement (late
2001), BP was concerned that Exult had gone too far and too fast
in automating HR activities. Employees seemed reluctant to use
the new e-HR technology. Managers were concerned with the
standardisation of some policies that they did not believe to be
achievable or even desirable. Costs rose because there was
duplication of service electronic and personal (Higginbottom,
2001).

Problems of growing costs, especially of internal HR numbers

growing back after outsourcing, and poor vendor account
management (frequent changes in staffing), are also reported in
The Conference Board survey of 2003.

24 Institute for Employment Studies

7. The Future of HR Outsourcing
The existence of HR outsourcing in a variety of forms is not new,
yet the rate at which this industry is growing and the prevalence
of outsourcing in its various guises is significantly less well
documented. Not surprisingly, vendors see significant growth in
the market. For example, Gartner Dataquest estimate that the
world-wide HR outsourcing market will reach a value of 37bn in
2005, although it is interesting to note that this has been heavily
reduced from a previous estimate of 42bn (Horn, cited in
Personnel Today, 25th March 2003). For the UK, it has been
estimated that the HR outsourcing market is running at a value of
2.3bn in 2000, rising to 4.3bn in 2005 (The Work Foundation,
2003). In the Accenture/Conference Board survey of HR
executives in the USA, UK, and Europe, a majority reported a
strong intention to increase their level of outsourcing, irrespective
of their location. TPI, an outsourcing consultancy that advises
globally on business process outsourcing and IT outsourcing
deals, recently released market statistics indicating that the
outsourcing market within Europe continues to grow, despite
turbulent economic times (November 2003, from HRO Today).
Their research indicates the number of contracts larger than 200
million Euros in Europe increased by 83 percent and surpassed
the total for 2002. Deals valued at more than one billion Euros are
also on the rise in Europe.

By contrast, 37 per cent of The Work Foundation survey

respondents already using outsourcing services commented that
they would not outsource any further HR activities in the
foreseeable future (2003). This can be compared with only 24 per
cent that felt they would make greater use of outsourcing in the
future. A further 34 per cent remain undecided as to whether they
will make more use of outsourcing, with a mere five per cent
responding that they definitely plan to outsource more of their HR
activities. Organisation size appeared to play a role in future
outsourcing decisions with organisations that were either very
small (with less than 100 employees), or very large (with more
than 2,500 staff), being most likely to consider outsourcing HR
functions in the future.

Similarly, only one-third of HR Directors responding to a Capita

survey were considering outsourcing transactional activities
(Rampart, 2003).

HR Outsourcing in the UK 25
 It is also worth noting that survey figures for the potential growth
in outsourcing always seem to exceed what actually happens in
practice. For example, in 2000 Saratoga predicted that 40 per cent
of HR operational and transactional activities would be outsourced
by 2003/5. Has that figure been reached? It seems unlikely.

One difficulty in these debates about the future is separating out

the difference between tactical outsourcing of specific HR
activities (such as payroll or training delivery) and strategic
outsourcing of significant chunks of the HR function. David Dell
of The Conference Board claims that outsourcing has become the
norm amongst large companies (Roberts, 2004). He points out
that their survey shows that three-quarters of respondents
outsource at least one activity. He claims that three or four years
ago, HR outsourcing was dismissed as a fad. This seems a
surprising remark, certainly from a North American perspective.
Subcontracting specific parts of HR delivery has quite a long
history. What is much less certain, even now, is whether many
organisations will follow BP, Cable and Wireless and BAE
Systems in a more complete BPO approach. The suppliers have no
doubts that this will happen I believe we are on the cusp of a
revolution in the way services operate said one (Roberts, 2004).

7.1 Influences in HR outsourcing trends

7.1.1 Further repositioning of the HR function

There is a continuing debate is the way in which the HR function

will evolve over the coming years, and if indeed its role will
further shift from an administration based department to being a
key strategic business contributor. Technology could be the
principal enabler of such change. It may allow both greater
automation of HR processes and increased devolvement to line
managers and employees. However, to fund such investment in e-
HR, organisations may have to accept outsourcing. With the
constant claim on corporate funds, HR might not be able to secure
enough money to build the right IT infrastructure. For smaller
organisations, the need to achieve economies of scale through
linking with other firms (through a common supplier) will be a
further driver.

The growth of the shared service model may also explain interest
in outsourcing. Separating out administrative, transactional or
informational services into one organisational area may encourage
an outsourcing response. It may be easier to test the cost/benefits
of internal provision against external, and decide that it is cheaper
or more effective to hive off the unit. Furthermore, HR processes
have traditionally been outsourced individually rather than on an
integrated basis. This may have been due to the developing nature
of the HR outsourcing market with organisations concentrating on
those processes with the greatest pay back and where there is a

26 Institute for Employment Studies

 choice of suppliers in the market. Shared services bundles up
activities into a form that leads to easier outsourcing.

However, it could be that that there will be some revolt against

these trends:

z e-HR is seen as offering too depersonalised a service

z devolvement of people management administration to line
managers may produce a backlash over the diversion of
managers from their core activities.
z the move towards being a more strategic function may be
challenged by those who think the focus should be more
operational
z shared services may come to be too centralised, insufficiently
customer centric, or over specialised.

In truth, where cost saving is to be achieved, the drivers towards

more automation and centralisation will continue to push
organisations towards outsourcing. But sensitivity on the part of
HR directors to the above complaints will make them think twice
and move more cautiously. Their own instinct to get their own
houses in order themselves before looking outside may be
reinforced. Moreover, in some organisations, there will be a fear of
relinquishing control and threatening the intellectual capital of the
organisation.

7.1.2 What the service providers offer

The service providers believe that at least 80 per cent of HR

activities could be outsourced. This would follow the IT and
accounting patterns. The only activities that would need to be
retained in house, according to one supplier, are those tasks which
have a high face-to-face content or require organisational
judgement.

The immature nature of the market and perhaps some degree of

conservatism are holding back HR outsourcing, according to
suppliers. What is clear is that outsourcing will begin at the
bottom of the HR value chain and work its way up. The choice for
vendors is between using specialist suppliers for discrete pieces of
work (eg recruitment or payroll) or asking one contractor to
provide a full range of services.

The future of HR outsourcing may well be largely market driven

by the service offerings of major suppliers. There is a clear need
for alignment between organisations and vendors, not only
technically, but also in terms of organisations aims, corporate
culture and values. Achieving cross organisational savings on IT
spend may drive organisations towards outsourcing in order to
use a common platform. An HR shared service to cover multiple

HR Outsourcing in the UK 27
 organisations is not going to work where each of the constituent
bodies has a different IT infrastructure.

7.1.3 The move to offshoring

Offshoring business process activities refers to the movement of

tasks or business functions to locations overseas. The prime driver
is to achieve significant cost savings, through access to lower
labour and accommodation costs. Newspaper headlines have
screamed explosive growth in offshoring, and business research
firms have predicted continued expansion over the coming years.
In December 2003, the UK government launched a study to
address growing concerns regarding the usage of offshore call
centre facilities. The impetus for this may be associated with the
recent revelations of several high profile organisations regarding
their intention to transfer a significant number of jobs to overseas
locations, including National Rail Enquiries, Prudential, and
Lloyds TSB.

The IT service sector has led the way towards offshoring. Since
1998, governments in countries such as India, the Philippines,
Canada, Ireland, Czech Republic, Hungary, Poland, Brazil,
Guatemala, Mexico, and Ghana have promoted new offshore BPO
processing centres. For example, the South African minister for
trade and industry expressed the hope that his country will
become the back office to the world. Companies have been able
to access a large pool of skilled, English speaking workers and
advanced telecom/networking infrastructures.

Despite competition, India has emerged as the dominant offshore

BPO provider. Only the Philippines is a near-term market share
competitor (Dalal, 2003). Indias BPO prominence is based on
several factors:

z India led in offshore IT services for applications development,

maintenance, support, upgrades, and staff augmentation.
z Indias client relationships through its Y2K conversion work
with North American and European vendors and global
organisations.
z BPO back-office processes leverage Indias human resource
cost advantage and skills profile in call centres, accounts
receivable/payable, customer billing, claims administration.
z India benefited from the marketing buzz of favourable reports
by NASSCOM, Gartner Group, International Data Corporation
(IDC), McKinsey & Company, and PWC.

Will HR services follow the IT lead and get involved in offshoring,

perhaps with India a prime location? According to some observers
(eg Dalal, 2003), there are very similar patterns to those found in
relation to outsourcing within the same country. These include:

28 Institute for Employment Studies

 z the search for lower operational costs
z aiming for higher productivity levels, resulting in further cost
reductions
z seeking quality improvement in operational processes
z enabling more strategic focus on key issues/activities
z using it as a tool for evoking culture change
z searching for product/service improvement.

There are some advantages that may be peculiar to offshoring:

z tax incentives on offer in some developing countries

z labour subsidies (eg as available in Ireland and parts of Canada)
z a follow the sun model of service delivery
z access to skilled and available labour pools.

What is likely to be the case, is that some HR activities are deemed

more suitable for offshoring than others. Clearly those that require
deep local knowledge or face-to-face contact are ruled out. More
appropriate would be back office processing or employee help
desk facilities.

Thus far there has been limited HR offshoring. Why might this be
so? Is it just that HR is, as ever, behind IT, in developments that will
come in due course? Is it the conservatism of the HR function that
suppliers complain about? Is it that there are too many risks
involved (see Figure 7.1) political instability, technological
breakdowns, customer resistance, public relations objections that
deter HR directors? Or are they not convinced by the cost savings
or quality improvements? This is despite evidence from a recent
survey conducted by PWC with 45 organisations who currently
operate some business process function offshore. This indicated
that 42 per cent of respondent organisations have realised a cost
saving between 10 and 30 per cent on their operational overheads,
whilst 44 per cent felt that they had seen some improvement in the
quality of service provision since moving the activity overseas.

Figure 7.1: Outsourcing risks

Strategic Operational Transactional

Challenges/Risks Challenges/Risks
1. significant cultural 1. people related (retained
differences and outsourced staff)
2. potential geographical, and 2. integration with core
political impacts processes
3. loss of control 3. service delivery
4. loss of knowledge 4. regulation/legislation
compliance
Challenges/Risks
1. potential liability issues
2. asset transfer and
valuation
3. ownership of Intellectual
Capital
4. termination issues

Source: IES

HR Outsourcing in the UK 29
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