Outsourcing Payroll – What’s The Business Value?
The value of everything
When it comes to making a decision on outsourcing, cost-per-payslip is just the tip of the iceberg. Payroll has to be the subject of strategic consideration and a deep understanding of both cost and added value. Philip Whiteley reports.
Traditionally, the choice between whether to outsource your payroll function rested primarily on assessment of the cost per payslip. If such a straightforward, easily defined, business-critical process as payroll could be sourced cheaper externally, from wherever in the world, it made business sense to do so.
In recent years, however, a more three-dimensional approach has developed. Cost is not the only consideration; and even the term ‘cost’ is more complex than it at first appears. The transactional expense of producing the gross-to-net calculations, payments, payslips and essential reports is only part of the story. Also of crucial consideration are: the reputational and operational costs associated with errors; hidden costs that some outsource providers levy, and even currency risks and fluctuating labour costs, in the case of offshoring.
Payroll is the most important internal business function, so the benefits of accurate and punctual delivery outweigh other considerations most of the time. The wider costs of frequent payroll errors can be devastating for any organisation.
Outsourcing payroll services has been around for around 20 years now, so the collective experience is considerable. There is no excuse for repeating the more naïve errors that characterised payroll’s early years.
Richard Bishop-Laggett, HR operations director at facilities services company ISS, outsourced payroll a few years ago – for strategic and risk-management reasons, not cost. Minimising cost is not a strategic choice, he says, but simply prudent management. “Strategy is about creating value, and strategic outsourcing is a decision to focus on those processes that add the most value to your customers. If there are other support processes that can add more value by outsourcing to a partner, that is a strategic choice, and the task is to select the partner that best aligns to your goals,” he explains.
Long-term management has to be about “managing risk; the right ethics and values; creating long-term relationships, and evolving with your changing business needs,” adds Bishop-Laggett. “Outsourcing driven by cost-cutting alone rarely delivers this.”
Making the opposite decision, but following the same broad principles, is Jason Jones, head of employee services at Warrington Borough Council. After a thorough analysis of the strengths and costs of the in-house payroll operation, he realized that it offered excellent value for money, and that the outsourcing operation had hidden costs.
“We went back to look at the real costs of providing the service. There were a lot of assumptions that our accountants were making, based on the fact that they didn’t know about all the services we were providing, in addition to core payroll services. We were also looking after recruitment advertising; all of the transactional HR matters – pensions administration, system support. We manage document storage.”
Payroll was also assisting line managers with crucial management information. Jones says: “Very often managers want to look at the sickness report, and look for trends. Information you would normally get from HR was coming from our service.”
This meant that a superficially unflattering comparison with an outsource provider was actually a case of not comparing like with like. In addition, there were matters such as exception reports and ad hoc employee advances for which the outsourcer would charge a £40 fee, but for which the in-house service did not charge – thus costing the department less once overall costs were calculated.
From the provider side, Stuart Stephen – ex-IBM and an outsourcing veteran of 20 years, who is now director of solutions at Ceridian – agrees that direct transactional costs are but a small part of the calculation. Stephen says, “In the case of one hotel chain, they said that they hadn’t done the [financial] modelling; maybe [they] could do it for the same amount or cheaper, but they just didn’t want that risk.”
One source of risk with an in-house operation is the loss of skills, which can be problematic in smaller payroll teams. This risk is heightened with the greater knowledge and skill requirements in the age of Real Time Information and auto-enrolment into pensions schemes – two major reforms which have begun to be implemented.
A small team may have only three or four experienced payrollers, so if one is sick, or on maternity leave, or leaves for another company, the problems can be considerable. By contrast, a bureau or other outsource provider will have a larger team working on dozens of contracts. They can therefore handle fluctuations in demand and staff turnover more comfortably.
In addition, matters such as the technology, technical updates, storage and disaster recovery become the provider’s responsibility. In the case of the hotel firm referred to, they are happy to transfer these matters to a specialist, even at a slightly higher cost. It allows them to concentrate on their strengths.
A spokesman for the provider Equiniti makes a similar point – about value as well as cost: “The payroll service must be competitive and perform, but that is a given. Better access to information – and unlocking that information easily – is an area which can add value around the service. This information can be used to analyse issues such as spiralling overtime or absence costs, and this information access and analysis can be shared with business.”
Equiniti also notes that the move from paper to electronic information – towards more self-service – is continuing. This is significant, as the need to modernize technology is obviously a point at which to consider whether to make that investment internally or go down the outsourcing route.
As for hidden fees, Stephen of Ceridian argues that it’s not in the provider’s interest to annoy their customers in this way. “I would like to think we’re extremely up-front about that… It’s a very short-termist view [to add surcharges or hidden costs]. Having spent 10 years at IBM, they wouldn’t play that game – it’s not sustainable even over the medium term, never mind the longer term, to go hiding costs. You might survive the first five years of the contract, but not the next five years.”
The industry is moving towards engaging in deeper conversations, and earlier, to help potential providers understand the business processes, and be in a better position both to advise and to deliver the right service. Over-optimistic assumptions that the newest kit can magically improve efficiency have been re-thought: it’s better to understand the processes first, and build the IT to suit that, rather than the other way around.
That said, an element of standardisation can help improve services, says Stephen: “The outsourcer keeps it generic enough so that they can transfer services from one client to another, because if they’re too different there’s no economy. That consulting conversation goes something like: ‘I know you do it this way, but we think there’s a more efficient way.’”
Where the old mistakes do still get made is in over-optimism in seeking quick gains from outsourcing – sometimes through a sense of urgency, or over-promises by providers in a competitive marketplace. Due diligence is important, but it can be tempting to take short cuts.
What is important is that making the case against outsourcing is done on the basis of sound understanding, not resistance for its own sake. Payroll managers have to develop business analysis skills as a core part of their ability, not an optional extra. Only they know their function well, but if they can’t communicate this to the rest of the business, finance may impose the wrong choice.
Payroll managers must also develop the self-confidence to push back against finance or other departments, says Jason Jones. “Payroll people need to step up,” he says.
“In the old days it was just calculating the payroll; now we have systems to do that.
We have to be a more valuable asset to an organisation. We need to be knowledgeable about the cost of our product. It was quite amazing when I spoke to our accountants; they hadn’t seen any of this before.
Every action is a product – it’s basic cost accounting.”
An implication for the payroll profession is clear: it has to be a full business partner, with an understanding of the business impact and full cost of the service provided. It is part of an exciting journey from the back office to a managerial role.
Top five reasons to consider outsourcing
1 You have a small payroll function, and recruitment of skills has been a problem
2 Your business has as a strategic priority concentration on its core expertise
3 You have a legacy system and suspect that your business processes are not the smartest
4 You would rather prioritize investment than the skills and capabilities necessary for Real Time Information (RTI) and auto-enrolment (AE); or for modernising an in-house payroll system
5 You do not want to take on all associated risks such as disaster recovery
Top five reasons to keep payroll in house
1 You have a highly experienced, efficient payroll team
2 The services provided go beyond pure payroll. Separating a discrete ‘payroll’ function is difficult and may disrupt other services
3 The level of services is sufficiently efficient and up-to-date that you could potentially offer outsource services to small companies yourself, creating a new revenue stream
4 You have skilled business management personnel within the HR and payroll function who work closely with line managers on absence reports or other human capital analysis, generating ROI for the company
5 You have good back-up, and few recruitment difficulties for the payroll team
The indicators listed are intended as general guides that signal whether a service is likely to be better in-house or outsourced.
No single reason should be considered definitive, however. In all cases the strengths, weaknesses, costs and risks of the decision should be considered as part of a comprehensive analysis of business processes. It may also be advisable to review periodically.
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