I've been asked a lot lately what events in outsourcing occurred in 2006 that really were worthy of note. Rather than state the obvious, such as the astronomical revenue and profit performance of India-based service providers, I thought I'd share a few observations about an issue that's a bit more obscure: the slowdown in HR outsourcing, or HRO.

The decline in HRO last year was driven in large part by three things: management changes at Hewitt (the market leader); the well-publicized profitability problems of a few notable HRO providers; and service delivery issues on several large first-generation HRO deals.

Now management changes are just a normal matter of course for any business. And Hewitt did a good job managing the transition that they endured. This wouldn't even be noteworthy if it weren't for Hewitt's tremendous performance in 2005 in winning HRO relationships - almost 30% of the HRO contract value awarded globally in 2005 went to Hewitt.

The other two issues are worthy of attention. Under the covers one will see that clients developed a concern over the HRO business model when Hewitt's new leadership acknowledged having some hard choices ahead; ACS has admitted to "growing pains" and has also taken accounting charges on two of its HR BPO contracts; and Convergys is still struggling to achieve the scale required to leverage its solution. While it is difficult to assess just how EDS (ExcellerateHRO), Accenture and IBM have performed financially, we can make a rough estimate of how much business they've won. But contract signings as Hewitt has shown are not everything.

Some of the challenges being experienced today are the result of immature marketplace dynamics providers that overcommit and clients that underweigh the changes required for substantial benefits through outsourcing. Some are also attributed to poor deal design, with inexperienced architects rushing into relationships that lack the balance or rigor of well-considered win-win models. Some of the issues are just related to poor execution.

Can the HRO industry's issues really be solved by greater volume? We don't think so.

The activity in the market is already showing a bit of retrenchment, with clients opting to contract for discrete aspects of the HR service cycle, such as recruiting, payroll or learning services. The market appetite for wholesale HRO relationships seems to have waned a bit, opting to wait out the service delivery issues that are affecting several of the leading providers.

This situation may be the proverbial self-fulfilling prophecy. If the providers require scale to grow out of their problems, and clients are unwilling to sign up until the problems are settled, we're in a deadly embrace.

The industry's biggest deal of 2006, Unilever's award to Accenture, may be the critical relationship to watch. If Accenture can show that the demanding needs of a company like Unilever can be met, perhaps there's a way forward for others through large-scale HRO. In the meantime, look for greater use of function-specific sourcing within the HR domain. — Peter Allen

Peter Allen is a partner and managing director for market development with the sourcing advisory firm Technology Partners International. You can reach him at peter.allen@tpi.net.

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