Outsourcing HR Functions: Key Benefits, Services and Best Practices For Your Business

For several reasons, including cost savings and the freeing of human resource professionals to focus on more strategic efforts, HR functions are among the services organizations are most likely to choose to outsource. As a result, HR professionals are being asked to identify outsourcing solutions for businesses and guide organizations through vendor selection and management of the outsourcing relationship.

This article serves as a roadmap for HR professionals involved in the HR outsourcing process. It explains the types of arrangements prevalent in HR outsourcing, states the business case for HR outsourcing and discusses HR's role in the process. It then examines various HR functions suitable for outsourcing: compensation, workforce administration, external recruitment, relocation, employee rewards and recognition, and benefits administration. The article outlines special considerations for developing an outsourcing agreement and transitioning from in-house to third-party administration of select HR functions. It concludes with the discussion of successful vendor relationship management.

What is HR Outsourcing?

HR outsourcing is a contractual agreement between an employer and an external third-party provider whereby the employer transfers the management of, and responsibility for, certain HR functions to the external provider. Many types of HR outsourcing options are available to employers. The options can be as specific as outsourcing one particular aspect of one HR function—such as applicant tracking for affirmative action purposes—or as broad as outsourcing the entire human resource department. The terms and types of arrangements prevalent in HR outsourcing are outlined below. See Small and Large Employers Outsource HR Duties Differently and HR Advice for a Department of None.

Software-as-a-Service (SaaS)

Software-as-a-service (SAAS) is a software licensing and delivery model in which software applications are hosted remotely by a vendor or service provider and made available to customers via a Web browser. This model of software delivery creates greater organizational agility and provides an opportunity for cost savings. In the HR realm, employers most commonly pay for access to talent management (e.g., applicant tracking and training/performance) and payroll applications.

Business-Process Outsourcing (BPO)

In a business-process outsourcing (BPO) arrangement, an employer contracts a single business task, such as payroll, to a third-party service provider. This contrasts with SAAS outsourcing in that the BPO provider is providing the service as well as the software. A common BPO arrangement is the outsourcing of benefits administration, which removes the administratively burdensome and specialized functions for benefits auditing, processing and reporting to a third-party.

Single-Source Outsourcing

Under this outsourcing arrangement, also called single sourcing, HR professionals access one solution to meet their needs, from welcoming new hires to managing turnover, and all the tracking in between; a single supplier covers the full employee life cycle. This type of human capital management technology starts at talent acquisition, includes time and labor management and payroll, covers talent management, picks up benefits administration, and supports the separation-of-employment process.

Shared Services and Shared-Services Centers

These terms refer to consolidation of a business function within an enterprise to a highly skilled internal department or group. Shared services may also be provided to third parties. When the services offered by the shared services team are combined into a central operation, they are often referred to as shared-services centers.

Broadly defined, shared services are marked by the consolidation of administration or support functions for several departments. Among HR processes that may be folded into a shared-services plan are payroll, procurement, accounts payable and receivable, travel expenses, health benefits enrollment, and pension administration. Under the shared-services model, the administrative functions can be handled in-house or outsourced. Technological advances and increasingly sophisticated use of Internet communications have played a major rule in spurring shared-services arrangements in recent years.

Professional Employer Organizations (PEOs) in HR

A Professional Employer Organization, or PEO, is an organization that provides HR management and benefits to an employers' employees via a co-employer relationship or employee leasing arrangement.

Employment responsibilities are typically shared between the PEO and the employer; the employer retains management control over the work performed by the employees, whereas the PEO assumes co-responsibility for benefits, taxes and payroll. As co-employer, the PEO pays the wages and employment taxes for worksite employees out of its own account, collects and reports taxes to state and federal jurisdictions, maintains a long-term relationship with worksite employees, and in theory retains the right to hire, terminate and reassign employees. The employer reimburses the PEO for these expenses and pays a monthly administration fee based on the number of employees employed.

Although some PEOs offer services to larger clients, the majority of PEO business is conducted with companies with 50 or fewer employees. PEOs are increasingly becoming the service model of choice for smaller organizations.

Building the Business Case for HR Outsourcing

Outsourcing has become increasingly important as HR professionals seek ways to reduce time and resources spent on transactions and administration, so they can concentrate on more strategic activities. This reduction in time and resources also translates to savings for the business. When HR departments decide which functions to retain and which to outsource, many hold on to talent management, recruiting and succession planning, while handing off payroll, benefits administration and other routine tasks to third-party vendors.

Besides giving in-house HR professionals more opportunity to focus on strategy, outsourcing can:

• Provide companies access to specialized HR expertise.
• Help with regulatory compliance.
• Speed up response times on transactional HR functions such as benefits enrollment and payroll.

In addition, there can be technology benefits. For example, through the use of a SAAS provider that provides and maintains software, employers gain the benefits of advanced software systems and avoid possible technical hassles of managing programs onsite.

HR's Strategic Role in the Outsourcing Process

The process of deciding whether to outsource HR functions begins with consideration of how outsourcing could help an organization and includes how well positioned HR would be to help the organization manage a transition to outsourcing. It is important to analyze how the company is currently delivering HR and to identify whatever gaps may exist between the organization's HR needs and HR functions. Employers should also research the outsourcing industry and its trends and analyze how industry trends could affect their organizations.

A key consideration is whether the time is right for the organization to outsource HR functions. Outside advisors can help with that question by analyzing data, financial projections and proposed contract terms. For example, even if outsourcing would ultimately save money for the organization, lost productivity during the transition results in initial costs—costs that must be factored into any financial projections. See How to Make the Case for Investing in HR Technology.

When deciding whether to outsource, an organization should be able to answer questions designed to analyze its HR needs, its current HR processes, its business plan and its outsourcing options such as the following:

• Can HR handle outsourcing without disrupting the current operation?
• Do HR staff members have the time and experience to deal with outsourcing?
• Is the HR department sufficiently staffed to manage the outsourcing relationship?
• Is HR providing excellent service with existing staff and processes? Is HR meeting all the organization's needs?
• Most importantly, will the CEO and top management team support and pay for an outside vendor?
• Does the company have a clear mission and vision? Have company values been established?
• Does the situation merit outsourcing?
• If so, what type of outsourcing solutions would best fit the situation?

In addition, it is important to know the ways in which an outsourcing arrangement can fall short of expectations and to mitigate such risks. The main areas of concern are listed below.

Ensuring Compliance in HR Outsourcing Agreements

It is necessary to determine exactly what compliance services the outsourcing vendor will provide and whether the vendor's services will completely satisfy an employer's legal obligations. This concern is most common when a state requirement is more stringent than a comparable federal requirement.

Defining Service Levels in HR Outsourcing Contracts

Confusion can arise if a vendor provides a service at a level below or above the level of service performed in-house. There must be full understanding of the services to be provided.

Understanding the Processes in HR Outsourcing

In many instances, outsourcing providers carry out tasks in ways that differ from the methods most familiar to the organization. The client business must understand the vendor's processes fully and must know how the organization may play a role in those processes.

How to Choose the Right HR Functions for Outsourcing

U.S. employers are selective in outsourcing certain functions, among them are benefits administration, recruiting and payroll. Selective outsourcing—as opposed to relying exclusively on a single provider—generally means outsourcing routine, transaction-oriented processes and is popular because it can be tailored to meet an organization's exact needs. Following are major areas of HR expertise and the ways in which they can be outsourced.

Outsourcing Compensation

The compensation functions commonly outsourced are payroll, job evaluation systems, salary surveys, executive compensation design and expatriate compensation. Outsourcing to third-party administrators for payroll and related tax duties helps employers meet filing deadlines and deposit requirements. The reasons for outsourcing may include cost savings, a need to improve customer service, the decision not to develop internal expertise, the ability to take advantage of technology not available in-house, or a desire for the HR department to work more strategically and less transactionally.

Third-party services and systems have historically been used to provide or support complex aspects of compensation administration, including job evaluation systems, salary surveys and executive compensation design, whereas actual administration remained an internal function in large organizations.  As outsourcing continues to evolve, marketplace options for truly outsourcing compensation administration are becoming available, including point solutions, single-process outsourcing and integrated HR outsourcing.

Point solutions. In this approach, the vendor provides hosted software to support the compensation administration process, and sometimes also provides a degree of call center support. However, the client retains responsibility for the overall success of the compensation administration function and for any aspects of the administration not performed by the vendor. Point solutions for compensation administration are limited in scope and are usually associated with the adoption of an external portal for employee self-service.

Single-process outsourcing. In this approach the organization selects one vendor to perform all of its compensation administration.

Integrated HR outsourcing. Under this approach—currently the most commonly used—compensation administration is outsourced in conjunction with a larger outsourcing arrangement that includes workforce administration. In fact, compensation administration can be a natural extension of the outsourcing of workforce administration. Most workforce administration vendors have at least salary and bonus administration capabilities that are linked to their employee and manager self-service capabilities. Those tools make them well positioned to take over many of the more routine tasks associated with compensation administration.

Organizations with specific needs in compensation administration should search for more tactical, subprocess outsourcing arrangements to supplement or enhance their current services. An example of this approach would be to outsource expatriate administration, which is a subprocess specialty within compensation administration and has an established vendor community.

Outsourcing Workforce Administration

The term workforce administration refers to the following set of HR functions and activities:

• Development, maintenance and operation of HR information systems.
• Employee and manager policy and procedure support.
• Employee and manager self-service and customer service.
• Employee data management and records retention.

Outsourcing workforce administration is often considered the foundation for the outsourcing of many other functional areas. In fact, many functional areas within HR, such as compensation administration and performance management, are typically outsourced only in conjunction with workforce administration.

Outsourcing External Recruitment

Outsourcing is not a panacea for recruitment, but many organizations are testing it and finding it useful. Success in outsourcing external recruitment depends on defining and deploying an effective talent-sourcing strategy, selecting an appropriate area for testing recruitment outsourcing in the organization, establishing clear performance expectations and measures, and carefully selecting a recruitment partner. The potential benefits include building a strategic partnership focused on obtaining top-quality talent critical for the organization's success.

With recruitment-process outsourcing (RPO), buyers take full advantage of flexible options that turn a fixed expense into a more manageable variable expense—a flexibility that enables the organization to adapt to the ups and downs of a fluctuating marketplace.

Outsourcing Employee Relocation

The need to deal with the unexpected is one reason many HR professionals consider outsourcing various relocation functions. These include claims assistance, audit and payment of invoices, shipment monitoring, expense tracking, reimbursement, and supplementary services. International organizations are much more likely than national companies to outsource relocation services. See Managing Employee Relocation.

Outsourcing Employee Rewards and Recognition Programs

Recognition and rewards programs are taking their place among services better handled by outside specialists. Recognition programs can provide incentives and reinforcement for desired employee behaviors in areas such as productivity, sales, workplace safety, years of service and cooperation with peers. But the programs can be time-consuming to administer. Even a program that simply recognizes employees for years of service involves several tasks for obtaining accoutrements for the program, such as plaques, certificates or gifts. Administrative tasks increase as the program becomes more complex and specialized. Outside vendors can be enlisted to handle many of the routine tasks of rewards programs, freeing HR for other responsibilities. See Managing Employee Recognition.

Outsourcing Benefits Administration

HR managers, who spend an estimated 25 percent to 30 percent of their time managing employee benefits, must protect their organization's bottom line while maintaining employee satisfaction. One way for HR to achieve those purposes can be to partner with a third-party benefits administration provider—a practice known as benefits administration outsourcing. Through negotiated contracts, volume buying and economies of scale, providers deliver program advantages that many individual HR professionals may not be able to secure on their own. Providers can also be enlisted to manage the most challenging part of benefits administration: the annual enrollment process. Among the key services offered by benefits administration providers are:

• Call center support.
• Eligibility management and audits.
• Improved carrier oversight.
• Compliance.

See Employers Use Technology and Outsourcing to Ease Leave Management and Viewpoint: 3 Questions to Ask Wellness Program Providers.

How to Shape a Successful HR Outsourcing Agreement

Negotiating an optimal HR outsourcing agreement requires that HR professionals understand the relevant business issues and settle on a price for clearly defined services.

A business-process outsourcing (BPO) services agreement contains the fundamental deal terms and conditions, and it includes the substantive exhibits. A master services agreement (MSA) is another commonly used outsourcing agreement often used in larger global companies that allows local affiliates to meet country-specific legal requirements and business expectations. But whether using a BPO services agreement or an MSA, the key exhibits should cover scope of services, pricing, service level fundamentals, exit plans and any additional contract terms.

Scope of Services and Base Price

Defining the scope of base services is the first critical decision in an outsourcing contract. The typical contract contains a fixed price for a base amount of work and a variable price for incremental increases or decreases from the base line.

Pricing Methods

Although most outsourcing arrangements contain a number of pricing methods, best practices involve a contract with predominantly unit-based pricing. At a minimum, the pricing model has to achieve the following:

• Predictability: clear and quantifiable prices for a range of services.
• Efficiency: a pricing model that provides vendors an incentive to drive down costs.
• Competitiveness: keeping the price competitive throughout the life of the contract.

An excellent way to test whether the price is competitive throughout the contract term is to use benchmarking. Benchmarking and the ability to move work to other vendors can be important for ensuring that the price organizations pay remains competitive.

Service-Level Fundamentals

HR professionals must understand the vendor's performance commitments and have clear and specific service levels and a method for enforcement. Because service levels need to improve over the life of the contract, HR managers must document the services existing when their contract becomes effective to ensure the vendor has accountability.

Most deals provide for service-level credits payable to the organization as the client if the vendor falls short of meeting service level requirements. Such credits are not remedies, though, and their ultimate purpose is to ensure proper behavior by the vendor.

Exit Plans

Employers should consider including automatic termination rights in the event of mission-critical service-level failures or chronic poor performance. HR professionals should set out a specific set of circumstances in which a termination right automatically comes into play if service levels are not being met or if credits exceed a certain amount.

Additional Contract Terms

Among other topics to include in the contract are the degree of exclusivity of the particular vendor relationship and the customer's ability to take back services ("insourcing") and send them to other providers ("re-sourcing"). Service requirements could change significantly if the organization is affected by acquisitions or divestitures, so the outsourcing contract must contemplate how those changes may be managed.

The contract also needs to address:

• Regulatory compliance, especially if there is an offshoring component to the outsourcing deal.
• Control of personnel, including subcontractors, and which staff members will transition over to the supplier.
• Limits on liability.

Managing the Transition to HR Outsourcing

Transition is the stage of greatest risk in any outsourcing relationship; it is a sustained period during which both the customer and the supplier acknowledge that failure is possible. This execution phase normally consists of three main activities:

• The moving of responsibility for assets and people, leases, contracts, and licenses from one organization to another.
• The moving of processes from one organization to another.
• The change from the current environment to something better, faster or cheaper. It is almost always the driver for outsourcing in the first place.

The key principle of transition is that the employer owns the relationship with the incoming and incumbent service providers, and thus must own the transition process using a dedicated transition management team that controls the scope and deliverables. This is true for newly outsourced services and for transition of services between outsourcing suppliers.

The sole aim of transition is to ensure that the required business benefits of the outsourcing relationship—for both the customer and the supplier—are achieved by thoroughly implementing the terms of the agreements. To accomplish this, organizations must ensure:

• The transfer of services to the supplier is transparent to the end user—that is, the end user experiences little or no disruption, and service levels are at least maintained at current levels.
• The end user sees the new service arrangements as clear, positive and supportive.
• The employees, whether they are being transferred to the supplier or are remaining with the customer (or the incumbent supplier), are not disrupted and remain focused on delivering—and are motivated to deliver—the service. Employees being transferred must be treated with respect and dignity, and it is appropriate for the customer to have significant input into the supplier's internal communication process to ensure that this is so.
• There is no disruption of work on current projects. All projects under way during the transition should be identified, the responsibilities for completion defined and the tasks/scope of work agreed to by all parties involved.
• Working practices and procedures are established.
• Achievable service levels are defined, sensible measurement is in place, and the supplier's ability to meet these levels is verified.

Ownership and Resources

Effective outsourcing relationships are those in which both parties help each other achieve business benefits. Therefore, the customer and the supplier must mutually manage the transition process and work together to ensure successful transition. Most customers will look to the supplier to provide an outline of a transition plan and to support them in constructing their part of the project.

Managing HR Outsourcing Vendor Relationships

Outsourcing HR functions can involve significant costs but outsourcing to a skilled vendor—and using that vendor correctly—can save an organization money in the long run. The key is to manage the relationship well. This involves establishing a collaborative way of working with vendors that builds trust and open communication. It can be accomplished by setting forth all expected benefits in a written business case that includes quantitative and qualitative targets, and by using practices that have been shown to produce successful outcomes.

Vendor governance encompasses much more than just "resolving issues" and approving fees. Organizations that understand how a third-party vendor undertakes the activities it has been hired to perform greatly increase their ability to provide consistent direction, thereby ensuring that vendors meet the contractual and regulatory obligations outlined in the initial contract. If problems emerge, as they inevitably will over time, this understanding can help the organization resolve those issues quickly.

The traditional vendor manager is a technical or subject-matter expert and not necessarily adept at managing contracts, performance or overall relations with a third-party supplier. Under those circumstances, relations between the vendor and the client organization can quickly become adversarial or strained. A structured approach to vendor governance helps organizations build trust and enhance communication so that all parties feel they are being treated fairly.