Outsourcing Personnel Functions.

One of the more recent "hot button" issues in our field is that of outsourcing all or some human resource (HR) functions whether by fee for service or contract. Advocates from the field of Public Choice Economics assume and, in many cases, economically substantiate the case for privatization

of governmental functions.[1] Even though these economists demonstrate an underlying anti-government bias, their basic argument with supply of government services is "that agencies should compete to provide citizens with goods and services instead of acting like monopolies under the influence of organized pressure groups."[2] Responsiveness to the needs of individual citizens (or to governmental units to be served by staff agencies, for that matter) is best obtained by competing within markets, with the result of economic choices by clientele between competing services. From this market environment economies in resource allocation and efficiency and effectiveness in operations are said to result. Public Choice Economists would also include simulation of market forces by introducing competition, possibly within the same department, governmental jurisdiction, or between other public, profit or nonprofit providers.[3]

This essay departs from an article by Robert J. Agresta.[4] He argues for an extension of the Public Choice approach from one of "citizen-customers being empowered to select freely among providers of a service--whether it is schools or health care (with vouchers) or groceries (with food stamps)--and have control over the resources needed to acquire the service...",[5] to the same market relationship between central administrative (staff or auxiliary staff) agencies and the line units to which they provide services. While Agresta writes of building choice into any line-staff relationships, this article is concerned with HR service supply alternatives and alternative modes for their delivery.

There are some advantages and disadvantages to outsourcing HR management services. Advantages are really reasons for empowering operating units to buy services from whatever source, based on their perception of satisfaction of important criteria (cost, quality, timeliness, availability, and so forth). Reducing costs was cited as the single most important reason for privatizing services of all types in a survey of America's largest cities.[6] Service delivery was also improved. Seventy percent of respondents to an American Management Association 1996 business survey found cost reduction to be important, 65 percent found quality improvement important, and for 72 percent time savings were important.[7] Avoidance of investment in new technology was also a reason for outsourcing.[8] Another advantage of seeking alternative service suppliers is to confront reduced staffing in HR areas accompanied by increased responsibilities.[9] Overall, personnel occupations lost 20 percent of their work force in the federal government between 1991 and 1996.[10] Another advantage is upgrading the HR management role from provider of services to strategic business partner according to one management consulting firm, based on an executive roundtable it sponsored (The future of HR: Smaller staffs and greater influence, 1995).[11] There are other more general advantages from the Public Choice literature--accountability is forced on the provider because the purchaser can take the business elsewhere,[12] service tends to be more customized for the needs of the purchaser because the latter are not passive receivers of services,[13] costs are reduced because purchasers must commit their resources and can not look upon services as "free,"[14] and providers are more responsive to customer needs because their income is dependent on customer satisfaction.[15]

On the negative side, there are some disadvantages. First, particularly where a former monopolist central personnel agency must now market to provide portions of its budget, there may be some untoward consequences such as: reductions in force of core staff when insufficient revenue is produced; line manager-consumers may do without some services which were formerly in demand; the central agency may not survive the cultural transition organizationally. One author argued that a possible down side risk of contracting out payroll and human resource information system functions is that the customer loses control and responsibility and may have to accept inflexible systems; suppliers may not have kept up with the latest equipment and software.[16]

There does not appear to be a great deal of evaluative information on satisfaction with and effectiveness of contracting or other outsourcing methods for the HR field. Respondents to a survey of America's largest cities were about neutral ("somewhat satisfied" on a five point scale) on privatization of "employment and training."[17] A National Academy of Public Administration study evaluated both franchising and outsourcing in the federal government. Franchising was defined differently than usual (granting a special or exclusive privilege to conduct business within a defined market segment or geographical boundary) as: "components of a business or government agencies that compete to provide services or goods to other organizations--usually within the confines of their respective economic sectors, organizations, and/or jurisdictions."[18] Agencies contracting under this rubric mostly rated services received as "good" on a scale of "good, adequate, poor."[19] Outsourced services with the private sector were rated the same as were franchised services, but with a higher frequency.[20]

The Extent of Outsourcing

Selected sources available in the literature were consulted for data on the extent of outsourcing, both in government and the private sector. Also of interest were data on increase and decrease of the incidence. Findings are summarized in Table 1. As we will see below, the specific tasks or functions outsourced varies considerably. Three modest inferences can be drawn from Table 1. First, functions are being outsourced by both government and business organizations and at all levels of government. Secondly, a significant number of organizations and public jurisdictions report the outsourcing of one or more functions. Thirdly, where change data is reported for more than one year there is growth in the incidence. Thus, it looks like we have a trend that is more than transitory.

Table 1. Incidence of Outsourcing of One or More HR Tasks or Functions

Source                                                %

IPMA[a]
1996 (n=270)                                          24.00
1997 (n=346)                                          72.00
Change                                                40.00

U.S. Largest Cities[b]
(n=66)                                                24.00

ICMA (cities and counties)[c]
1982 (n=1780)                                          0.02
1992 (n=1504)                                          5.30
change                                                 5.28

American Management Association survey of business[d]
1994 (n=619)                                          60.00
1996 (n=619)                                          77.00
Change                                                17.00

NAPA[e]
U.S. Govt (n=22):
Franchising                                           48.00
Outsourcing                                           64.00

Society for Human HR Management[f]
(n=1750)                                              64.00

Sources:

[a] International Personnel Management Association. 1996 and 1997 Personnel
Program Inventory. The Center For Personnel Management Research Series;
1997 Personnel Program Inventory. Parts I & II. Alexandria, VA, IPMA.

[b] Dilger, R. J., R. R. Moffett, and L. Struyk. "Privatization of Municipal
Services in America's Largest Cities." Public Administration Review. 57
(January/February 1997), 21-26.

[c] 1982 data: International City Management Association. Urban Data Service
Report. Washington, D.C.: ICMA, 1982, 14(10), Table 2. 1992 data: Miranda,
R. and K. Andersen. (1994). "Alternative Service Delivery in Local
Government, 1982-1992." The Municipal Year Book 1994. Washington, D.C.:
International City/County Management Association, Appendix. Note: IC/CMA
reports survey findings inconsistently between years--sometimes as numbers or
percents of jurisdictions reporting on an item of data response and other
times as number or percent of total questionnaire responding jurisdictions.
To make comparisons possible percents of all jurisdictions are used,
irrespective of whether they answered the item or not.

[d] "Outsourcing Continues." HR Focus. 74 (March 1997), 2.

[e] National Academy of Public Administration. Alternative Administrative
Services Delivery. Improving the Efficiency and Effectiveness of Human
Resources Services. Implementing Real Change in Human Resources Management.
Phase II: Practical applications. Washington, D.C.: NAPA, 1996, 33-62.

[f] Harkins, P. J., S. M. Brown, and R. Sullivan. (1995). "Shining New Light
on a Growing Trend. HR Magazine. Society for Human Resource Management, 1995,
77.

The data in Table 2 further substantiate the observations about growth in the outsourcing of HR functions in general, and both the single and repeated surveys substantiate it's occurrence at all levels of government and in the private sector. With exception of the training and development cluster of activities, governments mainly outsource functions that are peripheral to core HR management (health and benefits administration, workers compensation administration, employee assistance programs, drug testing, HR information system operations). Private sector organizations outsource most HR functions. The emphasis on "employment" and/or "training" in the first single survey item for largest U.S. cities is not known. Outsourcing of test development probably reflects a common government practice of contracting out technical activities, which are beyond the competence of in-house staff.

Table 2. Outsourcing HR Tasks or Functions by Subject Cluster and
Survey Reported Title: Percent of Change of Repeated Surveys and
Single Survey Frequencies

Cluster and Survey               Repeated Survey      Single Survey
Reported Title                  % Change   Period       %      Year

Staffing

Employment and training                               24.0[b]   95
Recruiting                        57.0[d]  94/96
Recruitment and Staffing
 Franchising                                          13.0[e]   96
 Outsourcing                                           9.0[e]   96
Temporary staffing                44.0[d]  94/96
Test development                  32.4[c]  96/97
Outplacement                                          64.0[a]   95
Relocation                                            13.0[a]   95
Compensation and Benefits
Compensation planning and
 salary surveys                                       30.0[a]   95
Payroll                           38.0[d]  94/96
Benefits administration           30.0[d]  94/96
Health and benefits
 administration
 Franchising                                          13.0[e]   96
 Outsourcing                      34.7[a]  96/97      36.0[e]   96
                                                      95.0[g]   96
Defined contribution plan
 administration                                       91.0[g]   96
Defined benefit plan
 administration                                       68.0[g]   96
Workers Compensation
 Administration                                       50.7[a]   97

Training and Development

Training                          26.8[a]  96/97
                                  60.0[d]  94/96
Management training
 Franchising                                          26.0[e]   96
 Outsourcing                                          77.0[e]   96

Technical training
 Franchising                                           9.0[e]   96
 Outsourcing                                          64.0[e]   96

General skills training
 Franchising                                          17.0[e]   96
 Outsourcing                                          55.0[e]   96

Career transition services
 Franchising                                           0.0[e]   96
 Outsourcing                                          55.0[e]   96

Organization development
 Franchising                                           0.0[e]   96
 Outsourcing                                          32.0[e]   96
Training delivery                                     46.0[f]   95
Training development                                  40.0[f]   95

Other
Employee assistance programs
 Franchising                                          22.0[e]   96
 Outsourcing                      68.3[a]  96/97      64.0[e]   96
Drug testing                      76.6[a]  96/97

HR information system operations
 Franchising                                          26.0[e]   96
 Outsourcing                                           9.0[e]   96

Sources:

[a-f] See Table 1.

[g] Laabs, J. J. "PEOs Make HR Easier With Staff Leasing." Personnel
Journal. 75 (December 1996), Supplement: 64-72.

Decision Making

Decision making about the merits of outsourcing follow a typical rational analytical model. What services or functions are candidates for outsourcing? Are these so-called core HR functions and does that make any difference in the decision? Examples of conditions which might favor outsourcing are: increased numbers of tasks to be performed and reduced budgets for their performance; inability to recruit and retain expert staff; organizational growth or downsizing; reductions in force; and inability to update HR infrastructure for whatever reasons.

Can candidate functions be taken apart so that some parts might be performed by contractors and other parts retained in-house? Process analysis has to be done for each chosen function anyway; so you may find that parts which are deemed critical might be allocated to in-house staff and the rest contracted out. Process analysis allows definition of component tasks, appropriate sequencing, and standards governing performance. An important part of this analysis--the standards--should involve stakeholders, such as customers. Outputs of processes should be able to meet customer expectations in terms of various standards such as quality and timeliness.

Once the process or part of the process to be outsourced is agreed upon, analysis of both direct and indirect costs must be conducted.[21] The existence of cost accounting or interdepartmental service charge systems will greatly facilitate cost analysis of processes and their absence often leads to under estimation of costs.[22] Reliance on budgeted costs should be avoided.[23] Cost of contract administration must also be estimated. For comparative purposes the latter costs are added to bidder proposals.[24]

The analyses of costs of processes will permit decisions about what goes and what stays, the possibility of reengineering functions and retaining all or parts in-house, and standards for performance. Process descriptions, costs, and performance standards will be important in preparing specifications as part of requests for proposals from vendors and for developing a monitoring/contractor management system. They will also be the basis for comparing bid proposals from vendors.

Contractors come in organizational variations, the most fundamental of which is public and private sector organizations. The next section examines several of these organizational possibilities.

Alternative Service Delivery Modes

A distinction is made between service provision and delivery. The difference between these terms is that provision refers to retention of responsibility to produce the service, but not necessarily doing it. Delivery, on the other hand, refers to the production of outputs. Some organizational HR service delivery logical possibilities can be viewed as clusters of traditional and competitive alternatives. Traditional modes reflect a continuum of more to less service provision and delivery monopoly. Competitive alternatives, on the other hand, are organizational variations for service supply in a market of buyers and sellers. Competitive alternatives reflect modes of HR service delivery, which permit the possibility of multiple providers in a competitive market. Multiple providers, in turn, have several advantages. Within the same organization or jurisdiction they allow comparison evaluation of different providers, ensure that the consumer organization is not held hostage by one suppler, and facilitate emergency support in cases such as nonperformance of contractors. Table 3 illustrates some logical alternatives for service supply, both traditionally and competitively.

Table 3. Traditional and Competitive HR Service Delivery Modes

Traditional Alternatives
All centralized mode:          Central personnel agency (CPA) provides
                               most services to departments on a
                               centralized basis.
Semi-decentralized mode:       Some authority is delegated to departmental
                               HR units for some functions, or there is
                               shared responsibility
                               (e.g., both recruit and test).
Mainly decentralized mode:     Most HR operations are decentralized to line
                               departments, sub units, and line management;
                               CPA retains coordinating, evaluation/audit,
                               and general policy areas of authority.
Mix mode:                      Variations on these themes in line departments
                               and their  subordinate units.

Competitive Alternatives
CPA markets services:          Departments purchase all or selected services
                               from CPA and pay by inter-departmental
                               service charge or other transfer;
                               Units of other governments purchase services
                               from CPA under contract or fee for service
                               arrangements.
Departmental units market      Some market services to other departments in
services:                      jurisdiction, to CPA, or outside
                               governments.[*]
CPA and/or Departmental units  All or selected services procured from private
procure services:              sector or other governments by contract or fee
                               for service.
Intergovernmental compact:     Intergovernmental consortium markets services
                               to CPAs and departments.
Mix mode:                      All potential suppliers compete to supply
                               services; mixture of traditional and
                               competitive service supply
                               alternatives in same jurisdiction.

[*] Sometimes described as franchising (NAPA, 1996).

One competitive alternative that does not appear in Table 3 is the use of professional employer organizations (PEOs).[25] PEOs both lease employees and supply a variety of HR services. Thus they might be used as substitutes for government HR staff in various units at different levels, and/or they might supply all or some service as an outsource supplier. Usually they also provide consultative services to the client organization such as information on new labor laws and assuring compliance with existing laws and regulations.

Some Cautions From the Literature on Contracting Out

Finally, there is considerable literature on the subject of contracting out government services. Not all researchers and essayists are fans of alternative service delivery, especially contracting. However, little of the critical literature relates specifically to HR fields. Rather, it is mainly derived from the subject in the abstract and from empirical evaluation of the delivery of physical and human services. What follows is a synthesis of opinion that appears relevant for HR fields. Thus, a subject such as union resistance to contracting may not be of great importance (although let's not forget civil service systems, their rules, appeals potential, and employees), but a government restriction that contractors pay wages equivalent to the public sector might be important inasmuch as direct and indirect compensation paid by private contractors is often less than the public service.[26]

Good results can come from competition in service supply, but if there is not competitive bidding it is argued that a private monopoly can be worse than a government one.[27] The potential for sole source contractors to hold the jurisdiction hostage to price rising was previously mentioned. This can especially be a problem where major capital expenditures are involved, such as HR information systems.[28] A limited pool of potential suppliers may be a block to alternative service supply. Harper and Ferris[29] relate problems of the federal government in finding a contractor large enough to replace the Office of Personnel Management's (OPM) revolving fund financed Federal Training Service, which was rapidly losing money. Ultimately, they were able to contract with the U.S. Department of Agriculture (U.S.D.A.) Graduate School, but not until after a frustrating search.

A related problem is what to do with employees of a contracted function?[30] In the Federal Training Service case the U.S.D.A. Graduate School agreed to hire many of the OPM employees. A similar problem existed with OPM's Investigations Service, which suffered a significant workload decrease. Other solutions failing, the service was transformed into a private company with employee stock ownership.[31] In general, displaced employees are less of a problem for larger governments. For example, Palguta[32] reported that reductions in force resulting from contracting HR between 1991 and 1996 resulted in a decrease in federal classifiers by 44 percent and staffing specialists by 37 percent. However, the inference was that most of these personnel were absorbed as personnel management specialists, which only decreased by three percent. The situation may be more stringent for small local governments, which do not have the absorptive potential of larger units.

Besides morale problems, outsourcing may have immediate impacts on performance. Timmins[33] reported that following a decision to contract, affected employees began using accrued leave for job searches and agency facilities for copying resumes and making long-distance phone calls for their job searches.

Contracting out of a function may result in loss of expertise and know-how.[34] Thus, it can be advantageous for organizations or jurisdictions to elect multiple modes of service supply, as illustrated in the previous section. Also, as discussed earlier, multiple suppliers make sense to avoid problems with price manipulation by sole source suppliers or their failure to perform adequately. Besides, the organization must retain sufficient subject expertise to be able to supervise suppliers.

Finally, as a follow-up to our earlier discussion of the process of contracting, it is noted in the contracting literature that contract price often does not take into account the cost of monitoring the contract.[35] Further, local governments in particular do not do a good job of providing oversight of contractors in any case.[36]

Summary

The central ideas of this essay are summarized in the following general statements, which, though not a set of linear instructions, give a sequential perspective of the subject.

* Decide which core functions should and should not be outsourced. This is where the non-linearity begins. In order to make this decision you may have to undertake the process analysis described in step 3, below. Various considerations are relevant. You may be more concerned with the way a function is performed as much as the quality of the output. For examples, issues of privacy, security and political sensitivity in selection may be as important as the quality of candidates produced by the process; it may be necessary to disaggregate a function into in-house performed and outsourced tasks, such as more complex versus routine (outsourced); or, complete functions might be retained for whatever reason (an HR information system comes to mind).

* Reconnoiter the environment to determine if vendors exist, if there is a competitive market to supply these services, and if there are constraints on this service supply that may be unacceptable to your organization. Regarding the latter point, sometimes it may be reasonable to alter your process expectations in favor of the way vendors provide services if the output is what is wanted. As part of your vendor search also investigate potential suppliers who are not now contractors, but are known to do quality work; they might be induced to contract. Legislative change may be needed to authorize outsourcing, and particularly through some of the alternative service delivery modes that were suggested.

* Assuming you have decided what is to be outsourced and that a competitive service supply environment exists, each candidate function is to be process analyzed into component tasks, flow, costs, time, outputs, and standards for process and outputs. Performance standards may have to be developed or revised in consultation with client agencies and other stakeholders. Also at this time, you may want to reengineer processes for their improvement. This may ultimately lead you to conclude that outsourcing is not needed, perhaps after vendor proposals are compared with present or improved cost and quality of performance.

* Process and performance requirements then become the basis for developing requests for proposals from vendors and a monitoring system for contractors. Monitoring tasks must be visualized and time for their performance estimated; contract monitors must be designated. The system is then cost analyzed function, by function. Potential contractors are solicited for proposals. Resulting proposals are compared with requirements. Monitoring costs are added to vendor proposals. To the extent possible, an environment of competition is sought, using multiple vendors, including in-house sources. An effort is made to avoid sole source suppliers.

Notes

[1] Hilke, J C. Competition in Government-Financed Services. New York: Quorum, 1992.

[2] Chandler, R C. and J. C. Plano. The Public Administration Dictionary. New York: Wiley, 1982, 95.

[3] Niskanen, W A. Bureaucracy and Representative Government. Chicago: Aldine, 1971; Miranda, R. and A. Lerner. "Bureaucracy, Organizational Redundancy, and the Privatization of Public Services." Public Administration Review. 55(March/April 1995), 193-200.

[4] Agresta, R J. "The Service Market Place: Building Choice into Line-Staff Relationships." The Public Manager. 22(Spring 1993), 47-50.

[5] Ibid, 47.

[6] Dilger, R J., R. R. Moffett, and L. Struyk. "Privatization of Municipal Services in America's Largest Cities." Public Administration Review. 57(January/February 1997), 21-26.

[7] "Outsourcing of HR Continues" HR Focus. 74(March 1997), 2.

[8] Spee, J C. "Addition By Subtraction: Outsourcing Strengthens Business Focus." HR Magazine. (March 1995), 38-43.

[9] International Personnel Management Association 1996 and 1997 Personnel Program Inventory (PPI). The Center For Personnel Management, Research Series. Alexandria, VA: IPMA, 1996 and 1997.

[10] Palguta, J M. "Human Resources Issues For 1997 and Beyond." Classifiers' Column. 28(Summer 1997), 6-7, 11.

[11] "The Future of HR: Smaller Staffs and Greater Influence" HR Focus. 70(June 1995), 5.

[12] Chubb, J E. and T. M. Moe. Politics, Markets and America's Schools. Washington, D.C.: The Brookings Institution, 1990, 32.

[13] Agresta, Op Cit., 47.

[14] Osborne, D and T. Gaebler. Reinventing Government. Reading, MA: Addison-Wesley, 1992, 204.

[15] Agresta, Op Cit., 47.

[16] Baker, D "Are You Throwing Money Away By Outsourcing?" Personnel Journal. 75(November 1996), 105-107.

[17] Dilger, Moffett,and Struyk Op. Cit., 23.

[18] National Academy of Public Administration Alternative Administrative Services Delivery. Improving the Efficiency and Effectiveness of Human Resources Services. Implementing Real Change in Human Resources Management. Phase II: Practical Applications. Washington, D.C.: NAPA, 1996, 33.

[19] Ibid, 34.

[20] Ibid, 50.

[21] Wisniewski, S C. "A Framework For Considering the Contracting Out of Government Services." Public Personnel Management. 21(Spring 1992), 101-117.

[22] Coe, C K. and E. O'Sullivan. "Accounting For Hidden Costs: A National Study of Internal Service Funds and Other Indirect Costing Methods in Municipal Governments." Public Administration Review. 53(January/February 1993), 59-64; Holder, W. W. and R. Kerner. Cost Accounting For California Cities. Sacramento: California League of Cities, 1981; Osborne and Gaebler, Op. Cit.; Savas, E. S. "How Much Do Government Services Really Cost?" Urban Affairs Quarterly. 15(September 1979), 23-41; Swiss, J. E. Public Management Systems, Monitoring and Managing Government Performance. Englewood Cliffs, NJ: Prentice-Hall, 1991.

[23] Berenyi, E B. and B. J. Stevens. "Does Privatization Work? A Study of the Delivery of Eight Local Services." State and Local Government Review. 21(Winter 1988), 11-20; Savas, Op. Cit.

[24] Jarell, D A. and Skibniewski. "Cost Comparison Model For Contracting Out Government Services." Journal of Management Engineering. 4(July 1988), 260-271.

[25] Laabs, J J. "PEOs Make HR Easier With Staff Leasing." Personnel Journal. 75(December 1996), 64-72.

[26] Halachmi, A and M. Holzer. "Towards a Competitive Public Administration." International Review of Administrative Sciences. 59(March 1993), 29-45.

[27] Kelley, J T. Costing Government Services: A Guide For Decision Making. Washington, D.C.: Government Finance Officers Association, 1984.

[28] Miranda, R "Privatization and the Budget-Maximizing Bureaucrat." Public Productivity and Management Review. 17(Summer 1994), 355-369.

[29] Harper, K and R. Ferris. "Privatization." Classifiers' Column. 27(July/August 1996), 8.

[30] Jones, M "Four Trends to Reckon With. Here's How Some Major HR Trends Are Taking Shape. HR Focus. 73(July 1996), 22-23.

[31] Harper and Ferris Op. Cit.

[32] Palguta Op. Cit.

[33] Timmins, W M. "Impacts of Privatization Upon Career Public Employees." Public Administration Quarterly. 10(Spring 1986), 50-59.

[34] Halachmi and Holzer Op. Cit.; Wisniewski. Op. Cit.

[35] Miranda Op. Cit.

[36] Dilger, Moffett, Struyk Op. Cit.; Donahue, J. D. The Privatization Decision. New York: Basic Books, 1989; Miranda, R and K. Andersen. "Alternative Service Delivery in Local Government, 1982-1992." Municipal Year Book. Washington, D.C.: International City Management Association, 1994; Savas, E. S. Privatization: The Key to Better Government. Bridgeport, CN: Chatham House, 1987.

Gilbert B. Siegel, Ph.D.
School of Public Administration
University of Southern California
Los Angeles, CA 90089

Gilbert B. Siegel is the C.C. Crawford Distinguished Professor of Public Productivity Improvement, Emeritus, in the School of Public Administration of the University of Southern California. Most of his academic work has been in the fields of public management, with particular emphasis on human resource management. On the latter subject, his work has focused on compensation and performance improvement. His most recent major consulting assignment was concerned with development of a compensation system for the Civil Service of the Palestine National Authority, under World Bank sponsorship. He is the author or editor of seven books, over 60 articles and numerous consulting reports. His most recent book is Mass Interviewing and the Marshaling of Ideas to Improve Performance: The Crawford Slip Method, University Press of America, 1996. He holds Bachelors and Masters degrees in Public Administration from USC and a Ph.D. from the University of Pittsburgh in Political Science.