Consequences of Outsourcing Human Resources

This essay will attempt to highlight the issues pertaining to the effects of outsourcing human resource management. The essay will be structured as follows:

• An Overview on Outsourcing of HRM
• The Rationale of Outsourcing
• The advantages of Outsourcing
• The disadvantages of Outsourcing
• An analysis on effect of Outsourcing

An Overview on Outsourcing of HRM-The HRO

The “Outsourcing” is the new management mantra which came into existence during the turbulent times of 90s, where it was seen as an effective tool for cost cutting. Outsourcing basically means hiring of the relevant business function from a third party. This phenomenon made rapid advancement and very soon engulfed nearly all area of the business. The function of Human Resource management has also been affected by it. Although in HRM outsourcing is a relatively newer term but the economic crisis of global meltdown has helped it to a stage where more and more organisations and businesses are opting for it. Following are main findings of the survey carried out by CIPD (2009) in the UK-

HR outsourcing (HRO) is used by 29% of the survey respondents.

Most organisations are increasing their use of HRO. Over the last five years, 20% reported significant increases in HRO activity, and 44% reported a slight increase in HRO activity. Only 11% have reduced their reliance on HRO.

Only 44% of those organisations that outsource other business functions also outsource HR.

HR outsourcing is used predominantly in private sector organisations, with 69% of those outsourcing HR working in this sector. HRO is pursued by 25% of public sector organisations in this sample.

The private service industry dominates the use of HRO, with 50% currently undertaking HRO activities. Twenty-four per cent of HRO activity is in manufacturing, 22% in public services, and 4% in voluntary and charitable organisations

The top drivers for HRO include access to skills and knowledge (71%), quality (64%) and cost reduction (61%). Organisations stressing clear objectives and targets in these areas are also more likely to have achieved them.

The top three wholly outsourced areas include legal activity (69%), payroll (66%) and pensions (64%). The areas partially outsourced the most include training (49%) and recruitment and selection (47%).

HRO is not relieving pressure for the internal HR team, with 43% confirming HRO failure in this case.

Source- CIPD survey 2009

Introduction to HRO

HRO is often confused with the two more associated terms -HR shared services and HR expert leasing. To begin, it is necessary to distinguish HRO from HR shared services and HR expert leasing. The main reason for this confusion is the complexity involved in Shared Services and HR expert leasing. HR shared services are also known as ‘co-sourcing’ (Shen et al. 2003). The shared service has two forms.

First, there is a shared service set up by large organizations to provide assistance and services not only to their own departments or subsidiaries, but also to external client organizations as an outsourcing business.

Second, the other type of shared service refers to those set up, again by large and often multinational or multi-establishment organizations, aimed at restructuring their service provision through recentralization and of a creation of an internal market system. This is very popular in large enterprises, such as Motorola, Fuji, HSBC, IBM and Nokia.

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HR expert Leasing refers to the concept used by some professional employer organizations of leasing HR experts to clients (Laabs 1996) due to the fact that when the option of leasing employees is used, HR is more likely to be kept in-house, thus HR expert leasing should not be regarded as HRO. Similarly the shared services which are designed at providing services to internal and external clients cannot be in strict sense be regarded as HRO. Thus we see that in both the cases, i.e. HR expert leasing and the Shared services, there is no significance of the third party, which as per the definition of HRO is an prerequisite for them to be classified as Outsourcing. Hence we see that there is a clear demarcation between all the three services being used to provide HR support to the organisation.

The commencement of Outsourcing in HR functions commenced primarily with the field of Recruitment. The Business organisations felt the need for recruitment as an independent function which could be transferred to third party for a measure of cost cutting and bettered shared service. Soon the functions such as Pay roll management, benefits and legal advice, were also outsourced. If we analyse the key decision for whether the particular function is outsource or not is based on the fact that whether the function is a core function or not?

The rationale behind the Outsourcing

The five competitive forces (Charles R Greer; Stuart A Youngblood; David A Gray, 1999) that can be called as the driving force for the companies to outsource some or all of their HR activities are: downsizing, rapid growth or decline, globalization, increased competition, and restructuring.

Downsizing: The inevitable restructuring of entire industries has recast HR departments as formulators and implementers of downsizing. The pressure of ‘reducing costs’ has now made HR themselves as targets of downsizing due to the overwhelming demands for reduced costs for HR services.

Rapid Growth or Decline: Again the ‘Costs’ as a major factor, the retrenched firms, or those in decline, face incredible pressures to reduce costs, while high-growth firms face similar pressures to monitor costs. HR outsourcing presents the option of cost reduction

Globalization: Due to this, the companies now staff comprising of host country or third party nationals, this required harmonizing pay and benefit packages in accordance with the local laws demands specialized expertise. Larger vendors that focus on compensation and benefits offer these specialized services and deliver expertise built on experience and concentration in particular regions of the world.

Increased Competition: Increased competition, both on domestic and international front, emphasizes the value-added role of products and services. Firms that subscribe to the balanced scorecard approach to measure effectiveness look not only at financial measures of firm success, but also at customer and employee measures of service quality. As per General Electric’s CEO Jack Welch- He pays attention to only three measures of firm effectiveness-cash flow, customer satisfaction, and employee satisfaction. If HR departments are to be responsive to both internal and external customers, they must look for ways to improve the quality and responsiveness of their services. Proponents argue that outsourcing offers HR an option to satisfy competing demands for improved service and responsiveness at a reasonable cost.

Structuring: Firms that redeploy HR generalists to serve key divisions or business units of the organization can transform HR into a service role. Such a transformation serves as a source of competitive advantage for the firm. These new, service-quality cultures are not easy to build and sustain, particularly among established, traditional, or entrenched HR departments. Strategically, HR outsourcing decisions can potentially be part of a larger pattern of responses designed to deliver hard-to-imitate, hard-to-substitute, value-added services that enhance the value and quality of the firm’s products and services.

After having seen the driving force behind the HRO we will now try to analyse various models of HRO as conceptualised by the resource-based view (RBV) (e.g. Barney 1991; Ulrich 1996); that suggests that the resources of a firm are rare and valuable and cannot easily be substitutable, are more likely to achieve sustained competitive advantage. According to the RBV, a firm should only outsource those resources which are replaceable or imitable not its core functions. This concept is in line with the ‘core’ and ‘periphery’ concept (Atkinson 1984), which can be applied to evaluate what HR activities are more likely to be outsourced. According to Atkinson, the core is defined as a ‘numerically stable core group which will conduct the organization’s key, firm-specific activities’ (Atkinson 1984: 29). The core can be redeployed easily between activities and tasks and has functional flexibility. All other function which support the core are known as the periphery, this provides the organization with an advantage to vary the numbers with fluctuation in labour demand (known as numerical flexibility). Ulrich (1998) suggested that core activities creates unique value to employees, customers and investors and are transformational in nature. Non-core activities are easily duplicated and replicated and are of transactional nature. Thus we find that HR ‘core’ activities include top-level strategy, HR policies, employee relations, and line management responsibilities (e.g. appraisal and discipline) and the ‘peripheral’ activities include specialist activities (e.g. recruitment and outplacement), routine personnel administration (e.g. payroll and pensions), relocation, and professional HR advice (e.g. legal advice related to employment regulations) {Finn (1999) and Lepak and Snell (1998)}. Thus according to the core and periphery theory, while the administrative and transactional functions (periphery) can be outsourced, it is in the interest of the firm to keep the strategic parts of HR (core) remain in-house. However, in practise, the core and periphery concept is difficult to distinguish as some HR activities appear to be purely administrative, but actually are not. For instance, recruitment is often seen as suitable for outsourcing, but it’s a key function that should stay in-house. To ascertain these arguments, we next shall analyse the advantages and the disadvantages of Outsourcing of HR functions.

The advantages of Outsourcing

As mentioned above one of the major benefits of HR outsourcing is Cost Saving but is not the only advantages of the Outsourcing. It provides a wide array of advantages specially to the small and rapidly growing businesses with limited resources, to achieve the same level of efficiency and service consistency in their HR functions as larger companies, without having to invest in large amounts of capital. The advantages of outsourcing can be enumerated as follows:-

Cost Savings. Companies can realise substantial cost savings by outsourcing HR activities and functions. Torode (2000: 2) reported a success story about cost reduction about Trident Inc. reducing its HR administrative burden by 65 per cent and uncovering US$40,000 in overpayments for insurance premiums by using Employease Inc.’s web-based human-resources application. The same is also supported by Gilley et al. (2004) that outsourcing training and payroll could lower administrative and overhead costs of training staff.

Greater Focus on Core Business Activities. Due to globalisation companies face aggressive competition both locally and from abroad and thus can incur a tremendous amount in terms of lost business and loss of competitive advantage by spending more than required time and resources in non-core or administrative functions. Outsourcing enables companies to focus on their core competencies and to direct their full attention towards market dynamics and business strategy.

Greater Participation by HR in Value-Adding Activities. Outsourcing certain HR administrative tasks enables the HR department to free themselves of time-consuming administrative tasks and direct their attention towards helping to improve their company’s business performance thus fulfilling there roles as that of a strategic partner.

Greater Efficiency. Due to the vertical specialisation and intense competition the outsourcing providers can usually perform the task more efficiently than the internal HR department. This is also due to the fact that service provider has a specialised team and since provides wide array of services to various outsourcer, hence at times can have more resources as well as experience to deal with any situation. This is specially true for medium and small firm which have a smaller HR department.

Greater Flexibility of a Decentralized Structure. The business environment is very volatile, presenting newer challenges to companies. Outsourcing provides flexibility by removing those responsibilities and constraints that make it difficult to react effectively to changing conditions and issues. A leaner, more focused company engaged in fewer activities, is better able to react to environmental changes.

Risk Reduction. Risk reduction is a major benefit of HR outsourcing. As the outsourced tasks are the outsourcing provider’s core competency, they are unlikely to make lesser mistakes as compared with the client’s internal HR staff. Furthermore in case of eventuality of mistakes, the service provider can be held accountable for losses to its client thus lowering the level of risk. More so ever the firms can enjoy the benefits of the HR functions without having to invest heavily in those HR functions, at the same time also keeping the option to change the outsourcing supplier if required.

More Objective Process. Outsourcing provides a certain degree of objectivity to the functions of HR department as service providers are not affected by political, cultural and bureaucratic conflicts intrinsic to the firm, which prevents the department from being fully productive and aligned with the strategic goals of the organisation. Outsourcing HR functions brings the objectivity of a third party into the process.

Disadvantages of Outsourcing

Cost-Savings Not Always Achieved. Laabs (1996) argued that HRO in fact leads to increasing costs because it may be less expensive to administer HR functions in-house, the same is also supported by Friel (2003),who argues that one major reason for higher costs of HR outsourcing is that HRO is still in its infancy. For example, software products must be tailored to organizations’ requirements, pushing up development costs. The following are examples showing increasing costs as a result of HRO.

• BP Amoco’s international contract with Exult increased costs by one third in 2001 (Broad 2002).
• BT admitted that costs were on the rise in its contract for HR service provision with Accenture HR Services in 2002 (Broad 2002).
• The September 2002 audit revealed that Federal Energy Regulatory Commission (FERC) in the United States paid up US$2.6 million to VA sytems well above the original estimate of US$1.2 million.(Friel 2003).
• Transportation Security Administration (TSA) of America paid NCS Pearson, US$700 million as against originally estimate of US$103 million,by the end of 2002. (Friel 2003).

Greer et al. (1999) found in their study that specialized vendors were unable to achieve greater economies of scale and cost savings due to the magnitude of the internal HR operations of some large companies,. More importantly, as Greer et al. (1999) warned, outsourcing produced no cost savings when only two or three vendors dominate a specialized market. Caulkin (2002: 10) has supported Greer et al. by arguing that ‘the argument of economies of scale and specialization is self-serving, benefiting providers, not purchasers’.

People Issues. This is one of the most debatable aspects of Outsourcing. An extensive study by Hackett Benchmarking & Research revealed that companies consider the greatest obstacles to outsourcing to be cultural and political factors. The services being outsourced to an outside entity poses a threat to the employee trust in the system. Further more the vendor working environment and ethics might not be commiserating with the firms’ which would bring out contention of issues. For example (Broad 2002), when Bank of America formed an alliance with Exult which included a major outsourcing arrangement, employees were worried about the implications of the deal for their positions. It is only when they understood that it was Exult, and not Bank of America, that would make the required investments, that they became reassured and accepted the alliance

Problems with the Outsourcing Provider. The providers might be faced with issue where he is forced to cover up for any mistakes for which the service provider can be held liable. Further more the organisational culture of the provider would also be a binding factor as they can be a cause low service standardsr, a lack of attention to regulatory and business requirements, or unmet objectives and timeframes by the outsourcing provider.

Loss of Control. Outsourcing HR functions can lead to a loss of control by the buying company. According to recent study by Accenture, 48% of executives surveyed stated that the fear of a loss of operational control was the greatest impediment to expanding their use of outsourcing. Their can be a fundamental mismatch of hierarchy in the firm as the line manager and the service provider might not be able to synchronise their working.

Consequences of outsourcing

Major implication, both in terms of their (changing) roles and their experience of the HR services of Outsourcing have been felt by HR professionals, line managers, employees who receive the services, and outsourced HR staff who provide the services.

In-house HR Professionals. Most noticeable impact on in-house HR professionals will be in terms of the nature of their work and their career patterns, although due to scarce literature, the extent is difficult to predict. Ulrich (1998) proposes four new roles for HR; among those he recommends sharing of HR work in varying proportions among the line management, employees, external consultants, and other groups. But he does not really discuss the rationale by which this distribution of work would be determined (Procter & Currie, 1999). Nor have the implications for their career prospects been contemplated. Greer et al.’s (1999) study suggests that as a consequence of outsourcing of HR activities, the user company would mandatorily have to deploy in-house HR generalists who know can manage the outsourcing relationships. However, this also poses a threat of work intensification for these HR professionals, as they might still be relied by their colleagues to provide the service because they may be used to it or are unfamiliar with the new system. For example, Shen et al.’s study (2004) indicates that the job content for the NHS maintenance manager of National Health Services (NHS) trust hospital in the United Kingdom has undergone severe work intensification and radical change ever since the outsourcing of maintenance. The same can also happen to the HR managers when outsourcing HR takes place, since both functions require intimate knowledge of the organization and a relatively high level of relationship management. HR outsourcing also raises concerns about the career prospects of the HR staff. One of the significant changes to career prospect would be – Availability of fewer career development options for specialists as compared to generalist. At the same time, as there would be only a limited activities being performed in-house, general HR experience would be hard to gain. This will also raise question about the type of training to be provided to HR professionals that existing training for the HR profession is generalist-oriented, while in future the service provider would need specialists. Therefore, outsourcing HR could affect the in-house HR staff in ways such as job intensification, change in job content, reduction of career development opportunity, and increased levels of stress, especially when the relationship with the service provider is strained and the quality of services unsatisfactory. More broadly, the role that HR professionals play will be dependent upon their interaction with other groups both within and outside the organization (Procter & Currie, 1999). Communication can be more difficult, especially when there is geographical, as well as organizational, separation. But if the onward march of HR outsourcing is a given, then the HR professionals will need to learn how to play the game (Turnbull, 2002).

Line Managers. One of the apparent rationales of Outsourcing has been to delegate the softer aspects of the HR function to the line management ie involvement in and ownership of HR decisions. For example, Vernon et al. (2000) found that in Europe it is a common practise for sharing responsibilities between the HR specialists and the line management, in regard to the policy making: “About a third of senior HR specialists reported an increase in line management responsibility for HR issues over the last three years” (Vernon et al.,2000, p. 7). The role of line managers in executing HR policies and shaping HR practices has long been acknowledged (e.g., Currie & Procter, 2001; Marchington & Parker,1990; McConville & Holden, 1999; Procter & Currie, 1999). This has resulted in line managers taking on additional responsibilities, thus intensifying their role. This can at times all draw away or cloud the focus of line manager from their primary role. Also in reality, some of the smaller tasks may take longer to explain via electronic devices and are easier for the line managers to do themselves. The lack of HR support on-site seemed to have caused work intensification for the line managers, since they no longer have easy access to the HR staff. Another aspect which is pertinent to mention here is the competence of line manager. Line managers in the United Kingdom have been criticized for their lack of HR skills and competence, especially on legal matters such as discipline, dismissal, redundancy, and equal opportunities (e.g., Currie & Procter, 2001; Hall & Torrington, 1998; Mc-Conville & Holden, 1999). They have also been criticized for their lack of interest in managing human resources, as HRM tends to be low down in their operational priority. In addition, they tend to focus on the hard, rather than soft, aspects of the HRM issues.

Employees Receiving HR Services. The most significant outcome of this has been on the employees as they find difficulty in divulging confidential or private information with unknown HR person over the phone or online. This can also be termed as loss of ‘Human touch’ from the term Human Resources. Research carried out by Feng Lee Cook (2006) about the employees’ response in Consult-Corp UK also indicates the same. Number of employees felt loss of emotional aspect as they felt that staff in the services centre, provide answers by reading off the screen or the manual and the entire process is mechanical. Another consequence of the outsourcing has been the lack of clarity of ownership of problems that may occur in HR services. With no HR department, at times the employees could find a void for issues such as grievance against their line manager itself especially when the grievance concerned the line manager or if the line manager responsible for their performance appraisal. All these changes may cause some fear and resistance among the workforce. BP Amoco’s outsourcing of HR is a case in point (see Higginbottom, 2001). As a result, it may actually be more costly for the organization to acquire the HR services from the external provider when all the indirect costs (both financial and emotional) that may incur in-house are calculated. This is especially true for large organizations in which employees are highly professional and highly paid.

Outsourced HR Staff. Traditionally, skilled and knowledge-intensive work such as HR activities has been provided by workers of “status.” Employers tend to have an employment relationship with these employees that is characterized by relatively high levels of trust in order to elicit greater commitment and effort from the workers (Streeck, 1987). It has been argued that the tacit knowledge possessed by these workers is vital for the organizational competitiveness (Cooke, 2002; Manwaring, 1984; Pavitt, 1991; Polanyi, 1966; Willman, 1997). Outsourcing of this type of work replaces the status approach by a (short-term) contractual relationship of tight specifications of all aspects as a predominant mechanism of control. This mode of employment relationship does not encourage workers to provide “extra-functional” contribution to enhance the firm’s competitiveness (Fox, 1974). In fact, the potential problem of gaining commitment from the nonemployee workers is well recognized by organizations and academics (Cooke, Hebson, & Carroll, 2005). For the employees of the service provider, job security may be low and firm-specific knowledge may be lacking as a result of multiclient services and the standardization of work processes. Indeed, lack of critical expertise and a customer service focus, or failure to take the interests of their client into account when delivering their HR services, have been found to be some of the main reasons for the failure of the HR outsourcing relationships (Greer et al., 1999). Additional complications in the employment relationships may occur where the HR outsourcing decision involves the transfer of existing HR staff to the external service provider (see Table 1). For the employees concerned, the transferred HR staff are likely to be protected, at least in principle, by some sort of employment regulation of the specific country (e.g., the Transfer of Undertaking Protection of Employment [TUPE] regulations in the United Kingdom). In theory, the employment contract of the transferred workers is preserved intact under TUPE regulations. In reality, however, their terms and conditions and other experience of work may change significantly, albeit incrementally (Cooke et al., 2004), since the impact of TUPE has proven to be only marginal to date (Colling, 1999; Wenlock & Purcell, 1990). As Domberger pointed out, “the principal effect of TUPE is to ensure minimum standards are maintained in negotiated transfers. The legislation is designed merely to assure the continuity of employment” (Domberger, 1998, p. 143). For example, Cooke et al.’s (2004) study of outsourcing in the public sector reveals that work intensification and increased performance monitoring are common features of post-transfer working life. Outsourcing offers the new employers opportunities to improve organizational performance by creating change through reducing staff numbers; introducing new skills and working practices; and by modifying individual incentives, employment terms and conditions, and attitudes to the workplace Domberger, 1998). None of these changes can be prevented effectively by TUPE, although not all of these changes necessarily point to a worsening scenario to the disadvantage of the workers (Cooke et al., 2004). However, this raises a question as to the extent to which the client organization can expect their ex-employees to (continue to) demonstrate loyalty and commitment in providing their services. These employees may be resentful that they are being “dumped” by their former employer and/or may have taken on their new employer’s organizational values that are not necessarily in line with those of their former employer. These issues may be exacerbated if the new employer has also taken on staff from other client organizations, thus creating a work environment with multiple cultures, multiple identities, and competing demands for preferential treatment from client organizations (Rubery et al., 2003). These issues also present a serious challenge for the new employer. The outsourcing firm has to manage a fragmented workforce, one where employees have different employment packages. At the same time, the outsourcing firm is trying to implement a coherent HR strategy and a consistent organizational culture while delivering customized HR services to its client organizations.

Conclusions

The aim of this article has been to provide an overview of the various aspects of HR outsourcing with a combination of empirical evidence and academic debate. The intention has been to provide a critical review of the state of affairs in the practice of HR outsourcing and to raise issues that require further academic research and attention from organizations interested in HR outsourcing. Existing literature on HR outsourcing appears to be rather limited in general. This is perhaps due to both research and practice in HR outsourcing being in its early stages of development. There is a longer tradition of firms outsourcing discretional aspects of HR (e.g., payroll, training, health and safety, legal advice), areas in which they lack inhouse expertise and that are deemed noncost- effective to develop and maintain inhouse. Existing evidence suggests that HR outsourcing has increased substantially over the last decade, although some authors remain cautious about the future growth of HR outsourcing. Training and payroll appear to be the favorite aspects of HR outsourcing. In addition, recruitment, taxation, and legal compliance are often outsourced. However, employee relations, HR planning, career management, and performance appraisal are less likely to be outsourced, as they are more likely to be seen as core competencies or activities. Even so, there are no clear patterns of the types of HR activities that are outsourced. Existing evidence also suggests that the primary motives for HR outsourcing are to reduce cost, to gain external expertise, to enhance strategic focus of the in-house HR function, and to improve service quality. Cost reduction and “sell-out strategy” are also important factors for making decisions. While the overwhelming objective for outsourcing appears to be cost reduction, both the transaction-cost economics model (Williamson, 1985) and the resource-based view of the firm (Barney, 1991) seem to influence firms’ HR outsourcing decisions. The diverse evidence as to whether the HR outsourcing trend is set to grow or not and/or at what rate implies pragmatic decision making by firms when considering whether to outsource HR activities. Due to the limited number of empirical studies on various aspects of HR outsourcing and the fragmented and inconclusive evidence they have yielded, it is difficult to draw clear conclusions on the types of HR activities that should be outsourced and the effectiveness of HR outsourcing. In fact, evidence seems to suggest that organizations’ decisions in outsourcing are not always rational (Vernon et al., 2000), nor is their process successful or the outcome effective. It is possible, however, to identify a number of research issues and practical implications that require further attention from academics and practitioners.

Conclusion

The resource-based view (RBV) (e.g. Barney 1991; Ulrich 1996) suggests that a firm’s resources that are valuable, rare, and not easily imitable or substitutable are more likely to achieve sustained competitive advantage.

According to the RBV, a firm should focus on its core competencies and outsource those not valuable, and imitable or substitutable resources. The RBV is consistent with the ‘core’ and ‘periphery’ concept (Atkinson 1984), which can be applied to analysing what HR activities are more likely to be outsourced. According to Atkinson, the core is defined as a ‘numerically stable core group which will conduct the organization’s key, firm-specific activities’ (Atkinson 1984: 29). The core can be redeployed easily between activities and tasks, by means of multiskilling or through flexible career structures, known as functional flexibility. The periphery, however, provides the organization with the ability to increase or decrease the organization’s headcount in response to every fluctuation in demand for labour (known as