Jay Whitehead04.10.06
Cap-ex: Common Driver for Outsourcing
Jay Whitehead
Recent trends in human resource outsourcing (HRO) in many ways reflect practices in medical device manufacturing. Leveraging a vendor’s best-practice knowledge, reducing costs through external services and getting access to technology are all drivers in the decision to outsource.
But one benefit garnering much attention these days is the expenditure of capital, or cap-ex. Just as some medical OEMs have opted to outsource so they can earmark capital for use in more value-added ways, HR departments in a number of industries are realizing that buying services makes more sense than building them.
This is occurring in a number of areas.
For instance, as automation and employee self-service make greater inroads into HR, many companies lacking the IT tools to implement these services are at a crossroads.
Do they invest in IT and manage Web portals themselves or do they outsource to a vendor already set up to offer these services?
Similarly, when companies are faced with making a sizable investment such as an Enterprise Resource Planning (ERP) system in HR, is the expenditure justified or can outside vendors deliver the same functionality through their system?
When it comes to software for HR, employers are also faced with whether to license the software in-house, select a hosted model, or pay an integrated service provider whose bundled services include a software solution. In many instances, the most cost-efficient answer lies outside the organization’s four walls.
Just as many OEMs have come to the realization that outsourcing manufacturing to a qualified vendor is a more efficient use of cap-ex—the contract manufacturer often boasts a more robust and efficient plant, has invested extensively in its quality system and is experienced with a variety of products—HR departments have arrived at the same conclusion all around the world.
Take the example of the Royal Mail, the United Kingdom’s largest postal carrier. This year, the organization is expected to announce one of the largest public-sector outsourcing HR deals ever, covering nearly 200,000 workers.
The decision to outsource HR on such a broad scale is very much driven by what the Royal Mail lacks—funds to shore up its Infinium HR system. Its group director of people and organization, Tony McCarthy, estimated that it would cost the organization approximately $50 million to replace the system—dollars that the Royal Mail needs for other important initiatives.
“If we could find that amount of money, it would go for sorting machines or a new mail center, not for an HRIS [human resource information system] installation,” he told me last year.
Similarly, Motorola—in its landmark outsourcing deal to provider ACS in 2003—was very much a cap-ex play, with the buyer actually selling assets to its provider. A number of others also have followed suit since then, preferring to buy and not build.
Similar to Asset Sales
This approach is not unlike asset sales that have taken place in the medical device industry. For instance, Medtronic has divested a number of plants to vendors such as ATEK, The Tech Group and TriVirix. Similarly, last year Hospira sold its Salt Lake City plant to ICU Medical for $35 million in exchange for a long-term outsourcing contract. These companies are not alone, as a growing number of medical device manufacturers look for ways to get an infusion of cash while offloading manufacturing burdens.
In HR, cap-ex is increasingly a consideration in the outsourcing decision-making process. That’s because companies of all sizes—from large organizations in need of standardization because of acquisitions to small and medium employers looking to expand and streamline their HR service—realize that they can achieve internal alignment of business processes without the traditional costs attached to such an effort.
Turning to Outsourcing
Others are turning to outsourcing after being spun off from a parent company and must quickly erect an HR infrastructure. In those situations, outsourcing buyers can immediately deliver HR services without investing significant capital.
That was the case with the American Stock Exchange (AMEX). The New York City-based AMEX, which in 2002 was spun off from the NASD, had little more than three months to establish a payroll system when management decided to make the split. Catherine Casey, the VP of HR, told HRO Today that a frantic search helped the exchange, which has nearly 500 employees, find a payroll provider (CheckPoint HR in Edison, NJ).
Within months, the AMEX was outsourcing payroll services and giving employees an expanded suite of services, such as electronic time cards, Web self-service and other value-added tools.
Casey acknowledged that to set up its own payroll system would have been both costly and a distraction for her. Contending with the spin-off was hard enough, but to further make a wise capital expenditure for payroll would have been an added burden for which she did not have time or energy. In the end, she said, the exchange’s service provider rolled out all the services the AMEX needed and more without the cap-ex encumbrance.
Another way companies are burning through cap-ex is the establishment of a shared-services center. These centralized, integrated centers are internal captive facilities that process high-volume transactions for various departments within an organization. Often, companies view shared-services centers as a “baby step” before outsourcing; they learn how to realign business processes and then turn over the operation to an outsourced vendor, who acquires the center as part of its agreement with the client. The shared-service center can be a comfort for employers not fully sure of outsourcing but who still want to reap the benefits. Many outsourcing buyers have taken this intermediate step.
The problem with this approach is that providers increasingly frown on acquiring these assets. They want to leverage their existing facilities so they can achieve true cost savings and deliver HR services on a one-to-many platform.
In other words, instead of serving each client through a dedicated facility, the outsourcing provider wants to serve several clients through one facility. Simply inheriting another asset doesn’t result in savings. For the client, investing capital in a shared-services center also diverts important corporate resources from its core activities.
Furthermore, as any medical device plant manager knows, cap-ex isn’t limited to the initial price tag.
To ensure optimal performance from a facility, a constant stream of investments is needed. Contract manufacturers do it, and HR service providers do as well. Buyers of outsourced HR services demand from their providers not only compliance with contracted service level agreements, but also continuous improvements. These improvements are commonly tied to cap-ex.
Finally, many companies simply don’t have a choice when it comes to buy or build. It’s difficult for organizations undergoing restructuring to pony up a few million dollars for an ERP installation. In those instances, the choice is clear. Of course, outsourcing HR has to make a business case as well.
What is the ROI on cap-ex compared with using a third-party provider?
Can the vendor truly deliver strategic alignment of business processes while saving the client money?
In the end, buyers want to feel good not only about cap-ex savings, but also with the choice to outsource. Not all HR outsourcing relationships succeed, so despite the promise of cost savings and cap-ex reduction, carefully consider outsourcing as a strategy.
If the costs of outsourcing are clear and the delivery of services is assured, cap-ex savings is indeed a powerful argument for using a third party. After all, it seems these are the same drivers behind outsourced manufacturing, and the proof of success has long been established in the medical device industry.