Well-honed business processes are the key to success in modern business. For a company to become a leader, it has to have clearly defined internal processes. And the most convenient way to achieve this is to hand off routine processes to outsourcing providers. But how does this work in practice? Are companies really prepared to transfer human resources and payroll to outsiders? Here are the results of a survey from E-xecutive.
The economic downturn has been cited so often as the cause for nearly everything, but it’s key for understanding the sharp changes in the Russian outsourcing market. With mass layoffs and budget tightening, companies have given serious thought to eliminating in-house specialists in favor of outsourcing providers to make the process cheaper, smoother, and more efficient. Top management and business owners have come to the conclusion that burdensome administrative tasks and non-core business activities can be easily outsourced to save money, stay focused, and maintain more flexibility. Payroll accounting, for example, has been an ever-increasing source of business for outsourcers in the last few years: more and more often, companies are hiring providers to take care of employee payroll, vacation and sick leave pay, separation pay, bonuses, and more.
Е-xecutive worked on research together with the UCMS Group to learn how prepared companies are today to outsource HR management, what advantages these businesses see in outsourcing, and what obstacles are holding outsourcing back. E-xecutive performed a similar study at the end of 2007, offering the backdrop on which the state of the market in 2007 and 2011 is compared below.
HR outsourcing refers to the use of external resources (companies) that specialize in human resource management and have the corresponding experience, knowledge, and equipment for performing some or all HR management functions. The client simply sets the goals for the outsourcing provider. Monitoring, selection of job methods, and responsibility for the final result are all placed with the provider.
Our survey of the Russian HR outsourcing market received 293 responses. Respondents were grouped based on their professional specialization. The following groups were most active: senior management, HR management, finance, and information technologies – those at a company who are most directly involved with outsourcing, by either deciding on or implementing outsourcing.
Fig. 1. Specializations of respondents
The survey covered almost all regions of Russia. As can be expected, Moscow and St. Petersburg accounted for most of the respondents since most corporate headquarters are located in the country’s two largest cities.
Most respondents (77%) work at Russian companies, with 13% working at foreign companies and 10% at joint ventures. As far as company size, 33% of respondents work at companies with fewer than 50 employees; 26% at companies with 100 to 500 employees, 17% at companies with 50 to 100 employees, 11% at companies with 500 to 1,000 employees, at 13% at companies with more than 1,000 employees.
Since most respondents work at companies that represent Russian small and medium-sized business, it is fair to say that these respondents are at the forefront of outsourcing demand. While outsourcing in 2008 was most common at companies with a geographically distributed structure, today there is no steep differentiation by corporate structure. All the same, branches are more likely to use outsourcing than locally based companies. 56% of respondents work at geographically distributed companies while 44% work at locally based companies.
Overview of the outsourcing market
Fig. 2 Types of outsourcing used by the respondent companies (Click chart to enlarge)
The market has been rapidly growing at a 15–20% clip over the last few years, booming by 30% in 2010 alone. According to 2009 data, accounting outsourcers had total earnings of RUB 3.2 billion. This speaks to the growing demand for outsourcing on the Russian market.
Fig. 3 Business processes that are outsourced (Click chart to enlarge)
As shown by the data, the most widespread type of outsourcing today is staff selection and hiring, followed by staff development and training. Payroll accounting and HR recordkeeping tasks fall far behind. The latter in particular is relatively new in Russia and has not taken off yet. Payroll accounting, by contrast, is a rather in-demand service although its growth is hamstrung by the complexity and opaqueness of Russian labor legislation. But the benefits of this type of outsourcing – better company operations and lower expenses – contribute to its enduring popularity. Why spend time and money on hiring new employees and getting them up to speed, when it is simpler and more efficient to hire professionals for the same amount of money? The main customers for this service are Western companies, which already are used to outsourcing non-core and administrative processes.
Industry insiders say that economic turbulence has not stopped growth in the outsourcing market. “The main trend in 2010 was the rising growth in interest in outsourcing business processes, especially by Russian companies,” according to Andrei Shabanov, Vice President for Corporate Services and Technologies, EMEA, at the UCMS Group. “In 2008 and 2009, the main customers for our services were the Russian offices of foreign companies. Today we are receiving more and more inquiries from Russian businesses, in particular innovative and quickly growing ones. And as our audience changes, we can see changes in the inquiries as well. They are coming to us with their dilemma of either hiring a person in-house or outsourcing those functions.”
The popularity and demand for outsourcing are underscored by the growing number of players on the market as well. Russian outsourcing companies are appearing, while international companies are actively opening new offices in Russia. Of course, most Russian companies are not ready yet to battle with the market leaders. Although large tenders may still have not more than five outsourcers, what this means is that this is a nascent business with ample room for outsourcing to blossom and succeed.
Recent research by Finansovaya Gazeta compared the cost of payroll outsourcing vs. keeping it in-house. Interesting, for most companies (those with fewer than 1,500 employees), payroll outsourcing begins to bring profits one year after the start of the project. And for small companies, the benefits of outsourcing are inversely proportional to the size of the company: the smaller the company, the greater the savings it enjoys thanks to outsourcing. Return on investment (ROI) from outsourcing for small companies of fewer than 100 employees is approximately 60% over the first year of outsourcing. This is a strong number that clearly indicates the advantages of outsourcing. With today’s tough economy, any company could benefit from savings of this scale.
Fig. 4 Comparison of outsourcing use by Russian and international companies
Staff selection and training are the most in-demand types of outsourcing today, as the study showed. This can be explained by several causes: first, these tasks are time-intensive and are expensive for most companies. A flood of resumes has overwhelmed corporate hiring managers, with up to 400 responses per day for a single position thanks to the current economic situation! To crunch through this massive amount of information, recruiting and HR specialists are critical – the very same specialists who were subjected to mass layoffs and still have not been restored to their previous number. This makes it much more efficient to entrust employee selection to an experienced provider. In addition, an agency contract is cheaper than retaining in-house hiring staff. The second cause of the popularity of this kind of outsourcing is the rather high level of the Russian human resources market. This type of outsourcing is relatively old and time-tested, with a multitude of options available on the market from diverse providers, spanning the range from small Russian agencies to international behemoths. The market is well regulated and this type of outsourcing is very low-risk for client companies.
Almost the same can be said for outsourcing of staff training and development. This service is a customary and rather necessary one for companies, since only major Western companies and some Russian giants have their own corporate universities. For other companies – most companies on the market – the expenses would simply be too much to bear. This has caused the rise of training companies, and while the lesser interest in outsourcing of staff training and development (compared to hiring) can be explained by the 2009 economic mayhem, this type of outsourcing is sure to continue growing.
Many companies also prefer to outsourcing bookkeeping and tax accounting, which is the most popular type of non-HR outsourcing.
Demand for this type of outsourcing is a function of company size as well: our survey found that payroll outsourcing is most popular with companies of fewer than 50 employees and companies with 100 to 500 employees. For the other categories – companies with 50 to 100, 500 to 1,000, or more than 1,000 employees – the most popular services are those related to personnel, with the clear lead held by personnel selection and hiring.
Fig. 5 Comparison of outsourcing types by company size
Financial pros – head accountants and finance directors – were the most interested in outsourcing in 2008. But today, business owners are taking a keen look. Before, owners needed to be convinced of whether a particular solution is necessary. Now they are independently looking for solutions to improve their business processes and control costs. The recession is certainly part of the reason for this, although business owners had the final say over decisions previously as well.
Use of outside providers has also been encouraged by the internal situation at companies. According to PricewaterhouseCoopers, financial fraud (misreporting) became more common in 2009. Many instances of this kind of fraud are due to shortfalls in monitoring due to budget cuts. Pressure to meet targets in ever-trickier situations is part of the reason as well. As shown by PricewaterhouseCoopers, 34% of fraud in 2009 was committed by insiders, compared to 38% in 2007 and 13% in 2005. Hiring new employees and granting them access to key business processes causes new risks that cannot be eliminated by simply adjusting the labor contract. Outside providers, by definition, are isolated from the internal machinations of individual employees and are always dedicated to providing the most honest and complete reports possible in order to retain their reputation and customers. There is also the ability to sign supplemental agreements with the provider so that the client can determine the duration of the contract as well as allow the client to terminate the contract quickly and without negative consequences.
Fig. 6 People showing the greatest interest in having payroll and HR recordkeeping outsourced
The biggest advantage of outsourcing is efficiency – a provider can perform certain processes better, faster, and cheaper than the company itself can. But the advantages of outsourcing don’t end there. For outsourcing of salary and HR recordkeeping, a key plus is reduced staffing levels for corporate finance and HR departments. In the recession in 2008 and 2009, companies were forced to cut expenses and review their business processes, eventually finding that the expenses of hiring in-house were worse than signing an agreement with an outside service provider. Outsourcing also reduces the workload on in-house teams, taking care of repetitive work without needing to hire more staff. But surprisingly and unlike the pre-recession years, many respondents admitted that outsourcing is a good way to reduce dependence on their company’s employees.
Even more surprising perhaps, the advantages that industry professionals put at the head of the list – greater confidentiality, greater transparency in business processes, and financial efficiency – are the last-cited advantages by outsourcing users themselves. With outsourcing, companies are generally resolving urgent problems without a particular long-term plan or business strategy.
Fig. 7. Advantages of outsourcing of payroll and HR recordkeeping (Click link to view)
In selecting an outsourcing partner, companies are often driven by price. For companies that have been spooked by the recession into counting every expense and reducing costs at every turn, this is to be expected. All the same, companies want to have the greatest possible guarantees of their partner’s reliability, thus placing great weight on past experience and market reputation, recommendations from past customers, and additional guarantees from the outsourcers themselves as to the service level. Knowledge of the client company and industry give a provider a substantial leg up in the selection process.
In the view of respondents, knowledge of business specifics is one of the biggest points of concern in the outsourcing process. The specifics of Russian business and particular industries force customers to be skeptical of standard, one-size-fits-all offers from outsourcers. Even the very best product, if not sufficiently targeted, will fail to win popularity on the Russian market.
Fig. 8 Decisive factors in the outsourcer selection process (Click chart to enlarge)
The main reasons impeding the growth of outsourcing on the Russian market, according to respondents, are:
§ psychological reasons – fear of information leaks, hesitancy by senior management, and internal organizational resistance to change
§ external reasons – insufficient information about this service on the market, underdeveloped Russian legislation for regulation of taxation and bookkeeping, and high cost of services
As in 2008, the main consideration blocking the growth of outsourcing, as stated by respondents, was fear of information leaks. Even though practice shows that this fear is baseless – all possible adverse events can be taken into account in the contract and providers will do anything to retain their reputation and customers – companies are afraid to let “outsiders” have access to internal business information that is a commercial secret. But as shown above, commercial secrets and confidential information are leaked for the most part not by external partners, not even ones with access to private information, but by insiders who abuse the system.
Judging by the persistence of this fear of leaks, spanning several years, outsourcing providers must do more to combat this misconception. All the same, a large educational campaign by outsourcers in 2008 on the purpose and benefits of outsourcing succeeded in moving “Insufficient information about the service” from second to sixth place in the list of obstacles to outsourcing.
The reply “high service cost,” however, jumped up the list from sixth place to third place. So as outsourcing has become more popular, the prices for it have grown as well.
Fig. 9 Obstacles to outsourcing of business processes (Click chart to enlarge)
An unfortunate market trend has become pronounced as well: since 2008, the number of complaints about outsourcing quality has grown. Today this issue is the foremost problem in the outsourcing communication process.
As the survey results show, one of the main issues for customers and outsourcing providers is clearly defining and coordinating the work that is performed by outsourcers. This issue can be resolved by clearly delineating and limiting the responsibilities of the parties ahead of time and laying out, in clear language, all of the procedures for communication and coordination. This brings us back to the previous issue of one-size-fits-all offers from providers and poor awareness by customers of outsourcing options.
One of the unique characteristics of the situation in Russia is the traditional popularity of “gray salaries,” which are paid under the table. The scale of the problem has even attracted the attention of the government. The Russian Federal Tax Service has stated that for January to September 2007, the shadow market in Russia for payments was equal to 26.9% of total salaries. There are no official statistics on gray salaries even today, but independent experts estimate that up to 30 to 40% of employee pay is received in envelopes or other unofficial means. Expert predict that the situation will become only worse, with companies driven by the desire to evade tax changes. As of January 1, 2011, the regressive three-tier Single Social Tax will be replaced by contributions to three funds: the Pension Fund, Social Insurance Fund, and Mandatory Medical Insurance Fund. The tax burden from these payments will increase immediately from 26.5% to 34.5%. Specialists believe that increased taxes will affect small and mid-sized businesses first and foremost, forcing entrepreneurs to search for methods to ease this burden. “Gray” methods are the obvious method for accomplishing this.
Experts also believe that many employees do not want to be receiving all-official salaries either, since this reduces the payments employees receive. With the recession-related fall in salaries in 2007 and 2008, which has still not been reversed, they are afraid to lose even more and go along with their employers’ gray payment methods. Some employees may even lose loyalty if all gray payments are eliminated in favor of full honest declaration. These factors clearly impede the growth and development of payroll outsourcing. Even if the economic situation improves and companies can allow themselves to pay salaries in full compliance with the law, it will be hard to voluntarily give up additional money, which will take time to do. Many companies employ similar payment methods even with their business partners. So it is fair to say that “under the table” payment methods both with employees and with company partners create an unfavorable situation for outsourcing in Russia.
Fig. 10 Complaints about outsourcing providers
In spite of the obstacles and occasional frustrations though, companies are turning to outsourcers more and more often. The total earnings of accounting outsourcer companies, according to analyst reports, were RUB 3.2 billion in 2009. Market players are confident that Russian demand for outsourcing will continue to increase. A simple example: in 2006, payroll outsourcing represented 9% of the total Russian market for outsourcing of business processes, but by 2009 it had grown to 22%, according to RAEXPERT. Survey respondents said that outsourcing demand will only grow in the near future, which is consistent with long-term forecasts from Gartner. There is little room for doubt: outsourcing is an outstanding, efficient solution for many of the thorniest problems that companies face.
Fig. 11 Types of outsourcing that respondents believe will be most in demand in the next five years
The recession has provided a powerful impetus for the growth of HR outsourcing in Russia. The most popular types of outsourcing are related directly to staffing: hiring, development and training. Also popular is payroll outsourcing, with recordkeeping still underrepresented on the market.
Forced to cut expenses, many companies have realized the benefits of hiring outside providers compared to hiring in-house staff to perform a narrow range of tasks. The main customers for outsourcing services are small Russian companies and large Western companies.
But this boom in the popularity of outsourcing has had a few blemishes, too, for providers: complaints of high service cost and quality are perhaps the side effect of market growth, and must be dealt with more carefully.