Making the decision to outsource human resources

Jean Woodall Business School, Oxford Brookes University, Oxford, UK

William Scott-Jackson Centre for Applied HR Research, Oxford Brookes University, Oxford, UK

Timothy Newham Think Associates, Bristol, UK, and

Melanie Gurney Erinaceous Group, Croydon, UK

Abstract

Purpose – The purpose of this paper is to explore and describe how the decision to outsource human resources was made by 12 large and five small organisations.

Design/methodology/approach – Desk research and key informant interviews with senior HR staff who lead the decision to outsource human resources in a purposive sample of organisations identified through an initial search of the professional literature and nomination by an expert panel.

Findings – The research identifies a number of drivers that lead organisations to consider outsourcing their HR. In large organisations cost considerations are dominant, but other factors arise out of the organisational history and context, and very often, senior managers from outside the HR function are very influential. For most organisations, paradoxically, the decision to outsource appears not to be made on the basis of a thorough analysis of costs, with consequences for the quality of HR service offered to line managers, and also for the career paths and skill sets required from HR staff.

Research limitations/implications – This study focuses upon the perceptions and experiences of senior HR managers, but excludes the perceptions and experiences of all staff employed in the HR function. Also, while the use of a qualitative research design makes it possible to uncover the individual perceptions and motivations of the key informants in the sample, there are obvious limitations in respect of statistical generalisation.

Practical implications – The findings relate mainly to the future shape of the HR function in organisations where HR activity is outsourced, with consequent implications for the skill sets and career paths for HR professionals.

Originality/value – The views of HR directors and senior managers have provided a valuable insight into the strategic decision to outsource HR activity and will be of interest to those involved in the same field.

Keywords Subcontracting, Human resource management, Outsourcing, United Kingdom

Paper type Research paper

The current issue and full text archive of this journal is available at

www.emeraldinsight.com/0048-3486.htm

In addition to the thoughtful and constructive criticism provided by the anonymous reviewers, the authors would like to thank Professor Mark Saunders, Assistant Dean Business Research at Oxford Brookes University Business School, for his helpful feedback on earlier drafts of this paper.

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Received 27 February 2007 Revised March 2007 Accepted 14 March 2008

Personnel Review Vol. 38 No. 3, 2009 pp. 236-252 q Emerald Group Publishing Limited 0048-3486 DOI 10.1108/00483480910943313

Introduction Research into the management of the human resource function within organisations is based upon the assumption that it is a unitary function, operating in a single workplace or in a uniform manner across multiple workplaces within the organisation. How human resources might be managed and delivered strategically in a multidivisional company has been considered elsewhere (Purcell and Ahlstrand, 2004), but the discussion has assumed that all aspects of HR activity were controlled and delivered in-house. However, it has become increasingly common for organisations to subcontract specific services, including human resource activities. This is evident from the findings of the 2004 UK Workplace Employment Relations Survey (WERS) which revealed that 86 per cent of all workplaces employing ten or more employees had arrangements for subcontracting some activity, including (in descending order of importance) building maintenance and cleaning, computing services, security, payroll, transport and training, temporary employment, printing, catering, and general recruitment (Kersley et al., 2006, pp. 105-107). So, a number of HR activities (such as payroll, training and recruitment) have for some time been delivered by other agencies and consultancies for a number of organisations. That the professional human resource activity for an organisation might also be controlled and delivered elsewhere has only recently been considered.

This study seeks to explore the implications of this step change in arrangements to subcontract HR activity: HR outsourcing. It aims to identify the main drivers of the decision to outsource HRM, and to describe and analyse the outsourcing solutions adopted, and explore the implications for the management and delivery of HRM within 12 large and five small organisations drawn from a wide range of industries in the UK. A review of the existing literature on outsourcing will be followed by a consideration of the findings from an exploratory and descriptive study based upon desk research and interviews with a sample of HR directors and senior HR staff.

The shift from HR subcontracting to outsourcing A significant finding of the WERS survey (Kersley et al., 2006, pp. 105-7) was that a similar proportion of public (86 per cent) and private (85 per cent) sector workplaces in the UK had subcontracted services, and that 19 per cent of these reported that such services had been carried out by employees of the workplace or organisation five years previously – that is, they had been outsourced. The main difference between the public and the private sectors was that the public sector was more likely to employ former employees as subcontractors (38 per cent) than private sector workplaces (13 per cent). So, subcontracting is extensive, and a significant growth appears to have occurred as a consequence of employees being transferred to the contractor, namely the outsourcing of staff. For the majority of organisations and the majority of employees affected, this relates to work in low skilled occupations such as building maintenance, cleaning and catering. So, we have evidence of a significant growth in outsourced employment in the UK.

However, in addition to such low-skilled work, since the early 1990s large organisations, particularly in the USA and the UK, have begun to move from subcontracting to outsourcing various management functions (Kakabadse and Kakabadse, 2002). Starting initially with IT outsourcing, the practice has spread to include core business functions such as finance, marketing and human resources (Logan et al., 2004). Until recently, IT outsourcing (Lacity et al., 1995; Murray and

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Kotabe, 1999) received most attention. By contrast, HR outsourcing (Lever, 1997; Shaw and Fairhurst, 1997; Switser, 1997; Woodall and Gourlay, 2002; Dickman and Tyson, 2005; Kosnik et al., 2006), has only recently received attention, and has been approached from a variety of perspectives, including employee relations in outsourced call centres (Kessler et al., 1999; Kinnie et al., 2000; Purcell and Purcell, 1998) and the impact of inter-organisational contracting on employee relationships (Rubery et al., 2002, 2003; Grugulis et al., 2003; Benson, 1998; Logan et al., 2004, and, on trust, Gainey and Klaas, 2005).

However, the definitions of outsourcing employed by such studies are often implicit, or where explicit, they are fairly elastic, stretching from the rather minimalist long-term subcontracting of HR service delivery to an external provider, to “spin-off” joint ventures or shared services, and finally a contract with a fully independent service organisation. More recently, the model of Business Process Outsourcing (Lacity et al., 2004) where the client organisation participates in a partnership with key suppliers to deliver “back office” services, adds further complication to any definition of outsourcing. Several authors have attempted to provide typologies of outsourcing (Adams, 1991; Elfring and Baven, 1994; Fitzgerald and Wilcocks, Reilly, 2000; Walton, 1999). Nonetheless, there is a lack of consensus on what is meant by “outsourcing” which can have implications for the validity of findings from the various surveys and case study analyses that form the basis of the research alluded to above. For the purpose of this research, we have taken the following definition:

The delegation of one or more business processes to an external provider, who then owns, manages, and administers the selected processes based on defined and measurable performance metrics (Gartner, 1995).

We have taken this definition of outsourcing because of its clarity, and because it distinguishes outsourcing from simple sub-contracting: the focus is upon “process” (rather than simple tasks) and upon pre-defined performance metrics. But even if we can arrive at such a simple definition, what actually happens in practice when a decision is taken to outsource human resource management?

The justification for outsourcing HR – a review of the literature Superficially, it would seem that the most obvious reason for outsourcing would be to make cost savings. However, the “make or buy” decision at the heart of outsourcing is often quite complex. While short-term cost savings are usually seen as the major reason for outsourcing, recent research has shown that they are not the only one. A desire to achieve “best practice”, to improve service quality, to focus upon the “core competences” of an organisation, and to utilise new technology are also prominent reasons offered by organisations (Kakabadse and Kakabadse, 2002). With respect to the outsourcing of HR activity, earlier studies (Klaas et al., 1999; Lever, 1997) have shown that organisations undertake outsourcing to reduce costs, gain access to HR expertise, achieve workforce flexibility, focus managerial resources on strategic matters and also to keep up with workplace regulation. So the first research question is to identify the main drivers for HR outsourcing.

The rationale for different drivers has received strong theoretical underpinning from economic theories of the firm – especially transaction cost economics (Williamson, 1975), and the resource based theory of the firm (Barney, 1991). Transaction cost

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economics was applied initially to analyse the outsourcing of information technology, and only more recently to HR outsourcing (Klaas et al., 1999, 2001; Woodall and Gourlay, 2002). According to this, the human resource activity most likely to be outsourced, was that which was most unlikely to incur high costs due to uncertainty, the threat of opportunism, asset specificity, frequency, and ease of measurement.

Turning to the resource based view (RBV) of the firm, this provides another perspective on what HR activities might be considered for outsourcing, and also whether outsourcing is necessarily of advantage to an organisation. According to the RBV, only those HR activities that could not meet the criteria of deliverability, inimitability, durability and non-substitutability should be outsourced (Barney, 1991; Boxall, 1998; Priem and Butler, 2001). The argument hinges upon the identification of what are called “core competences” that are intrinsic to that organisation. These attributes or qualities are to be nurtured and retained in-house. Lepak and Snell (1999) argue that externalisation can be a way of providing internal coherence, by allowing a concentration upon core competences. But by implication, this would mean that the selection of HR activity for outsourcing would be contingent upon sustaining the “core competences” of the organisation and in certain circumstances this might preclude a consideration of outsourcing.

Recent research (Dickman and Tyson, 2005) has summarised the empirical evidence from both Europe and the USA, and the activities most likely to be outsourced were outplacement, pre-employment testing, training, payroll administration, employee assistance, counselling and pension plans. The implication is that activities such as strategic HR policymaking, succession planning for key staff, employee relations, or diversity management would be less likely to be outsourced. This gives rise to the second research question: are the HR activities that are outsourced those which involve routine, clearly defined tasks which do not leave the organisation strategically vulnerable to a loss of control or uncertainty and confusion about responsibilities for managing specific HR activity?

However, it has been argued that if an organisation adopted a distinctive approach to the management of some or all of its HR activity, then it would be ill-advised to consider outsourcing (Klaas et al., 2001). In a similar vein Ulrich (1996) and Pfeffer (1997) have also expressed scepticism about HR outsourcing, arguing that it can limit the ability of firms to develop distinctive competencies within the workforce, and that it will also create inefficiencies because contractors are often unfamiliar with client organisation strategies and cultures. This is backed up by some evidence that outsourcing can change the nature of work, especially among professionals who lose discretion over their tasks as their work becomes deskilled in order to facilitate monitoring of output (Grugulis et al., 2003). Other research (Lawler and Mohrman, 2003) has shown that HR outsourcing can lead to problems of poor service, vendors with insufficient knowledge of the business, and therefore higher costs than anticipated. So as well as reinforcing the previous research questions, this argument leads to a third research question: do organisations encounter any potential inefficiency and ineffectiveness as a consequence of outsourcing?

The decision to outsource HR, also has implications for the way in which the HRM function is organised. Ulrich’s (1996) argument that in the changing business climate there are four ways of delivering HR “excellence” (as a strategic partner to the business, as a change agent, as a champion for employees, and as an administrative

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expert) is relevant to outsourcing. The implication is that the delivery of the HR service can not be conducted in a uniform manner. There may well be “back office” activities, such as pay and benefits, recruitment and selection, that should be outsourced in order to concentrate “administrative expertise” in one place. The remaining HR staff could divide between those “embedded” in business units tasked with overseeing the delivery of the HR service as “champions for employees”, and those who could work as internal consultants or “change agents”, engaged in trouble shooting, and providing a range of development interventions. The senior HR team could then become “strategic partners” by integrating all these activities, but above all, by aligning themselves with general business needs. Again this raises a fourth research question: can the HR function neatly segment its activity following the implementation of HR outsourcing, and what does this mean for career paths in HR?

To summarise, this review of the literature has generated four research questions:

RQ1. What were the main drivers for outsourcing?

RQ2. What were the main HR activities outsourced, and were they principally those which involved routine, clearly defined tasks which did not leave the organisation’s “core competences” vulnerable to uncertainty and a loss of control?

RQ3. Were there any instances of the implementation of outsourcing leading to inefficiencies and ineffectiveness in the delivery of the HR service?

RQ4. What were the consequences for the organisation of the HR function and HR career paths?

The research design The research design adopted for this study was essentially exploratory and descriptive. As it was felt that there was little research that had examined how the decision to outsource was approached in specific organisational contexts, this provided the starting point for addressing the above research questions. The study was carried out while conducting an externally commissioned applied research project. The research design comprised three stages. The first involved desk research leading to the identification of a sample of around 80 organisations that were known to have considered outsourcing HR activity since 2000 (some of whom who had subsequently rejected it as an option, or have subsequently ceased to outsource HR)RH. This sample was arrived at by scrutinising reports and articles published in People Management (the professional journal of the Chartered Institute of Personnel and Development) in order to identify organisations that had considered HR outsourcing. In addition, members of the Project Steering Group (a panel of experts drawn from a range of organisations that had adopted outsourcing, as well as a sample of major outsourcing providers) recommended other organisations to approach. Organisations were identified which represented a wide range of sectors, including ICT and telecommunications, financial services, engineering, energy, utilities, public services, retail, health, and general business services. Most employed over 500 staff, but a smaller number of organisations employing less than that were also considered.

This desk research was followed by telephone interviews with half the sample to make contact with the HR Director or senior HR managers involved in the decision to

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outsource human resources, and to assess their suitability for further interview. Finally on-site interviews were held with these and other key informants in a total of 17 organisations, twelve of which were large organisations. Two of the large organisations had decided not to outsource their HR, and a further one had revoked an outsourcing contract after three years). All the key informants were involved in making and implementing the decision to outsource HR activity, and most were HR Directors or else a senior member of the HR Team with responsibility for overseeing HR outsourcing. In some cases more than one interview was conducted, but all were tape recorded and transcribed. Informants were sent briefings in advance explaining the project, and the semi-structured interviews followed a schedule that explored a number of themes, addressing the main research questions. The transcripts were analysed thematically, and the key patterns of response, principally in respect of the larger organisations are reported on here.

Main findings The main drivers for outsourcing HR activity The research revealed that there were five major drivers. Earlier research (Kakabadse and Kakabadse, 2002; Klaas et al., 1999; Lever, 1997) had identified cost reduction, reducing risk and maintaining quality (including increasing the effectiveness of HR service delivery), and moving HR up the value chain. This project identified new drivers. These included pressure from elsewhere in the business and the prior experience of HR directors, and the management of overall HR capacity in response to organisational change. These will now be considered in turn.

1. Influence from elsewhere in the business and the prior experience of HR directors. It is, perhaps, unsurprising that the impetus to consider HR outsourcing, usually came from elsewhere in the business. It therefore follows that in most organisations there were other parties to the decision to outsource HRM besides the HR director. In the larger organisations this was usually a board level decision involving several members of the senior management team. The finance director and head of procurement (for example at Telecoms2 and EnergyCo2) often played a key role alongside the HR director. In the SMEs, the CEO or the finance director played a key role.

Second, a number of organisations had a US parent company which was extremely influential in the decision to outsource:

We were also part acquired by a US company who advised us to outsource HR (Managing Director, FinanceCo4).

We were purchased by a US organisation and we were their first acquisition outside the USA. They were very insistent that we have an HR function and that this be outsourced (Chief Executive, FinanceCo5).

Thus, the decision to outsource was not a discrete strategic decision made by the HR team alone, and there appeared to be a certain amount of path dependence in terms of how it was approached. This is because the option of outsourcing HR did not usually come as a “bolt out of the blue”. Several organisations had already experienced outsourcing of some other business function, most frequently ICT services, facilities management, or even financial services, and most had also already subcontracted some aspects of HR (often recruitment and selection, executive search, pay and benefits – but also substantial aspects of the design, development and delivery of training and

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development). This applied to County Council, EnergyCo1, EngineeringCo, ITCo, FinanceCo3, and Telecom1. Furthermore, with EnergyCo2 where the incoming HR Director had come from running a regional financial service which had outsourced the back office, and County Council, where the incoming HR Director had previously been involved in compulsory competitive tendering, the prior experience of the HR director appeared to be very influential on the final decision.

So what does this tell us? While the HR Directors and other senior HR managers justified the decision to outsource HR in a strong strategic rhetoric, the overall impression is that the decision on whether and what to outsource was not driven by the HR teams. It certainly indicates that few HR directors had approached the decision to outsource HR activity unencumbered by pressure and influence from elsewhere in the business.

2. Reducing cost. Cost considerations appeared to be paramount with a desire for drastic reduction in the HR staff overhead and to move them from a fixed to a variable cost. Almost all the large organisations wished to cut their HR headcount. For example, EngineeringCo faced the need to integrate two separate HR teams after a merger, and ended up transferring 70 per cent of its HR staff to the outsourcing provider:

It was a necessary business decision as the company had recently merged with another, and there was a key driver to reduce costs and eliminate duplication of departments and roles, whilst maintaining levels of service (HR Director, EngineeringCo).

The global reach of its banking business also promoted FinanceCo3 to consider the cost implications:

We needed to cut costs by 50 per cent, deliver the service proposition, and e-enable HR (HR Director, FinanceCo3).

However, as mentioned earlier, the sample included organisations which, after reviewing the options available, had made an explicit decision not to outsource their HR activity as they did not anticipate there would be cost savings. One of these was a large energy company:

We have a growing feeling from both informal and formal benchmarking that outsourcing provides a quick win – whereas we are in it for the longer-term and would rather get it right internally, take longer, and hang on to the savings that we make ourselves (HR Director EnergyCo3).

Cost savings were made most frequently by means of component outsourcing. Component outsourcing to different suppliers was selected by most organisations, and a good example is CountyCouncil (on the grounds that the two-tiered nature of local government required different types of personnel service). Telecom2 also adopted a component outsourcing approach, which they continually adjusted on an incremental basis, and claimed to monitor regularly since they had started outsourcing in 2000. Next, internal shared service functions were set up nationally by RetailCo, and regionally by FinanceCo3. ITCo also outsourced recruitment and also set up their own shared service centre for pay and HR administration. FinanceCo2 bought into the wider group central services in 2004.

3. Moving HR up the value chain and gaining a commercial return from HR resources. A desire to “move HR up the value chain” was prominent for several organisations (with the inevitable rider of cost savings): For CountyCouncil,

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outsourcing of HR arose out of a need to review and improve HR provision, as a direct result of UK government insistence on providing best value to the tax payer:

We wanted to free up HR staff to work at a more strategic level, providing added value to the organisation (HR Director CountyCouncil).

Although they already had 30 per cent of recruitment and over 50 per cent of training and development externally supplied, CountyCouncil decided to move these areas to a more complete outsourced arrangement. A similar motivation applied to FinanceCo1 and Telecom2:

We want to concentrate on “core” business activities (HR Director FinanceCo1).

We started looking at it because of what other [leading] companies were doing. . .it would remove distractions and allow strategic thinking and direction. There would also be cost savings (Head of HR Operations Telecom2).

Business Process Outsourcing (BPO) was adopted by EngineeringCo through their joint venture with a major outsourcing consultancy in 2000. BPO involves transforming “high cost, low performing back offices into commercial enterprises by partnering with key suppliers [. . .] [who] typically centralise, standardise and web-enable.” (Lacity et al., 2004). In this case the HR service charged organisational business units for its services.

4. Reducing risk and maintaining quality. While cost reduction and the commercial performance of HR were important for most organisations, there were also other considerations. The reduction of risk and the improvement of quality were important for a major IT services company providing consulting, systems integration, and managed services to organisations across different industry sectors. The complex UK legislation on the employment of IT contractors (the IR35 regulation) meant that in this case outsourcing was a reassuring way of buying in expertise and minimising risk:

We also want to get better quality of service and service level agreements [. . .] There are also reasons now around risk [. . .] employment law IR35 agency and conduct regulations and contractor regulations – a specialist supplier will have better capability and knowledge, be more innovative, have better management information and bring cost savings (Procurement Manager ITCo).

Similarly, Telecom2 wanted to cut risks around contractor recruitment, and a small company, FinanceCo5, decided to outsource the entire UK HR function so as to avoid having to train them in employment law. Unsurprisingly, ensuring the provision of a full higher quality HR service, was also a common reason among the small organisations:

After a management buy out we were left with 70 people and no HR function(Managing Director, FinanceCo4).

There was a strong legal requirement to have a robust function as we are ourselves an outsourced company and have to engage with TUPE requirements (IT Director, IT FacilitiesCo).

5. HR capacity management in response to organisational change. Outsourcing HR was also considered in the context of managing both organisational contraction and growth. Telecom1 was a global organisation that found the nature of its business had changed so much that it had shrunk drastically in size:

Cost was, of course, a consideration and we really wanted to standardise and reduce duplication after a series of acquisitions. However, our focus was on transformation and

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e-enabling the organisation [. . .] Cost pressures on our business were accelerating and

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