Outsourcing Payroll

What Are the Advantages and Disadvantages of Outsourcing Our Payroll Function?

[Workforce Management | August 05, 2010]

 

'Takeover outsourcing' has profound effects on the organization and the affected employees.

 

Q: We have been approached by a nationally known payroll company that has proposed to hire our 50 employees and lease them back to us. The major benefit for us would be dramatic savings in health insurance costs, due to the employees being part of a larger pool. What are the possible downsides of an arrangement like this for us?

 

- Both Pro and Con, retail trade, Grand Junction, Colorado

 

A: History actually provides some great lessons on the potential impact of a decision such as this.The health insurance savings benefit is only one potential value of this arrangement. The reduction in overall administrative costs stemming from having 50 fewer employees also would be sizable. Organizations that have outsourced employees, along with services, can realize cost savings and potentially some enhancement in services through expanded service capabilities - but you asked about possible downsides.

 

This particular outsourcing model, often referred to as "takeover outsourcing," would have a profound effect on both the organization and the employees personally involved  in this transition for several reasons. First, this type of transaction would normally require that you terminate these employees in order to "move" them to the new organization. Invariably when employees "lose" their identity as part of the company, there is a significant change effort for all parties. Even in the most benign "co-employment" scenarios, payroll staff must make the mental shift from being part of the organization to becoming service providers for the organization.

 

Second, many organizations that expect significant changes in performance often find deterioration due to the transition of people and a variety of factors that affect employee performance during this time. The following summarizes many of these benefits and potential risks.

 

1. Pros - Benefit cost savings

 

Cons

Risk of the rebadged employee leaving and a reduction in service potential and institutional knowledge. Two immediate factors drive this deterioration: employees who leave because of the transition event, and future efforts of the outsourced payroll organization to reduce headcount.

 

2. Pros - Familiarity with client payroll

 

Cons

Risk of losing the personal touch and "ownership" of employees versus contractors over the course of time.

 

3. G&A cost reduction (reduced headcount, facilities, overhead tied to 50 payroll people) - Pros

 

Cons

a) What happens to the cost over time? Will the outsourcing fees increase to minimize the savings? Have service-level agreements, or SLAs, been established to guarantee similar levels of staffing, response time and interaction/resolution quality?

 

b) Are there any contractual limitations that allow the vendor to change delivery locations? Many vendors are looking to move back-office calculations and processing offshore to realize additional cost savings. What provisions do you have that would restrict this type of additional transition and potential future reduction in headcount?

 

c) What is the retained work that your own organization will still have to own? It is important to include the cost of retaining some expertise in your organization to manage the outsourcing relationship and governance process.

 

d) Remember that additional services outside of the "normal" payroll operations will likely carry with it a transaction fee or project cost. This often includes such items as:

 

Mass salary changes

Exception processing

Special projects

Off-cycle adjustments

New-hire reporting

CPI adjustments

Volume (population) changes 

 

As you consider potential savings, it is very important to carefully consider the potential out-of-scope costs that typically alter the value proposition significantly.

 

At their worst, "lift and shift" transitions move problems and inefficiencies from one organization to another. Although time (and turnover) may fix some of those things, the challenge here is determining the real value proposition. What is it that the outsourcer will be able to do that your company could not do, other than the removal of some overhead costs? Are your organization's processes and policies ready for outsourcing? Generally it is advisable to consider the people, process and technology opportunities that your organization can realize as part of making your organization "outsource ready" - and then evaluate any potential gains that can only be realized by actually transitioning to an external vendor.

 

 

[Source: Daniel Vander Hey, Towers Watson & Co., Houston, June 3, 2010]