Vital functions: HR outsourcing is booming, as companies send everything from payroll to training outside. But take out too much of the company's core, and you risk losing its heart and soul

Chief Executive, The, March, 2004 by Pamela Mendels

When ComUnity Lending was planning a major expansion into new regions several years ago, company executives realized that employment regulations varied widely state to state, and that mastering them would be no small challenge. To make it easier, the Morgan Hill, Calif-based mortgage lender, which funded $4 billion in loans in 2003 and has about 1,500 employees, turned to someone else to handle everything from payroll to legal guidance on employment matters. "We came to the conclusion that HR was a specialty," says CEO W. Darryl Fry. "It was not one of our core competencies, and our culture is: 'we stick with our core competencies.'"

Fry's way of thinking is far from unusual these days. A growing number of companies in recent years have outsourced part or most of their human resources operations. Indeed, annual revenue for the North American HR outsourcing market grew from about $13 billion in 2000 to $15 billion in 2002, and is projected to reach $23 billion in 2007, according to Rebecca Scholl, an analyst for Gartner, the Stamford, Conn., research firm.

At the same time, however, some executives and human resources experts remain wary of the trend. They argue that a number of HR tasks are so closely entwined with the culture of a company, that letting go of them is dangerous. In outsourcing training, for example, an employer runs the risk of putting generic employee education courses in the place of in-house work-force development programs that are born out of a company's own way of doing things. That's a false step for any enterprise that hopes to differentiate itself, says Patrick Wright, professor of human resources at Cornell University's School of Industrial and Labor Relations.

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A similar problem could emerge with compensation. What had previously been the kind of unique offerings that made an employer stand out to high-quality job recruits could become, instead, "plain vanilla," says Peter Cappelli, professor of management at the Wharton School at the University of Pennsylvania. Further, if anything goes wrong with the outsourced service, it is the employer, not the vendor, who will bear the blame. The very idea of outsourcing, especially when it involves shipping jobs overseas, outrages many employees, to say nothing, in this political season, of many voters.

Even at companies that have embraced the idea of sending more work outside. HR executives warn that with all the options available, outsourcing is increasingly complicated and needs to be handled with care. Telecommunications giant AT & T spent a full year evaluating its HR activities, trying to assess which might naturally lend themselves to outsourcing. After carefully examining proposals from six different vendors, it outsourced a large chunk of its HR operations--benefit plan management, compensation communications and employee relations administration, among other things--to Aon Corp, in June 2002, says Mirian Graddick-Weir, AT & T's executive vice president of human resources. Plotting compensation strategy, however, was determined to be too essential and was kept in house.

BP Amoco, considered one of the trailblazers in HR outsourcing, still holds on to what one executive calls "strategic" tasks, such as performance appraisals, employee discipline and work-force planning, among others. "What stays is what's required to help people build competencies," says Senior Vice President Don E. Packham, a BP human resources executive.

Outsourcing Without Gutting

With the pressure to keep strategic HR functions close to the vest, while maintaining a company that is lean and competitive, CEOs and their HR chiefs face increasingly tough decisions. Having no clear-cut rules to follow, each company must determine how much of the organization's functions can be outsourced without damaging its core.

It's not an entirely new challenge, of course. For years, employers have turned to outside specialists for assistance with HR transactions such as payroll and pension administration. But these days, more and more employers are looking to place as much work as possible in the hands of a single contractor. Plus, the array of HR functions landing outside is going far beyond payroll. Today, the largest outsourcing businesses can assume up to 18 different jobs, everything from employee recruitment, relocation and development to the more conventional administration of pension and health benefits, says Jay Whitehead, president and publisher of the trade magazine Human Resources Outsourcing Today.

It's not hard to see why CEOs would be attracted to the concept. "Companies are under extreme profit pressure," Whitehead says, so HR, which is not a profit center, is a prime target for cost savings. The numbers bear him out. "Cost reduction" was the most popular reason--given by 68 percent of respondents--when 125 companies were asked why they initially considered HR outsourcing, according to a 2002 report by The Conference Board, the New York-based business research group.