The Empirical Case Against In-house HR Software: Uncovering the Hidden Costs in Your HRIS

Transcription

1 The Empirical Case Against In-house HR Software: Uncovering the Hidden Costs in Your HRIS By Greg Secord INTRODUCTION Executives are increasingly focused on the total cost of ownership (TCO) associated with their internal systems. A recent PricewaterhouseCoopers (PwC) study on payroll and HR practices indicates that this increased focus is warranted. The study determined that the costs of in-house systems are dramatically higher than previously thought, and most of this difference is attributed to hidden costs. More and more companies are looking to outsourcing to eliminate hidden costs, increase productivity, and lower their total cost of ownership. This article examines the key findings of the study and discusses ways to reduce those costs and dispel some common misconceptions about in-house systems. 1 TOTAL COST OF OWNERSHIP (TCO) TCO is more than just cost. Gartner first introduced TCO in the 1990s to analyze the direct and indirect (with emphasis) costs of owning and using hardware and software. Bill Kirwin, vice president and research director at Gartner Research, says, "TCO is really about process improvement and best practices that result in lower costs and improved service levels." 2 TCO is a management issue, not a technology issue. In other words, you can t expect to buy technology and lower your costs. New functionality or technology on its own won t automatically result in operational efficiencies or improved service levels. Managing TCO requires a partnership between all parties involved: IS, HR and Finance. It is a form of process improvement that recommends reviewing key processes and reducing/removing non-value-adding activities or even the processes themselves. Many firms are not aware just how much a focus on TCO might save them over the course of a year. This quote from Jeanne Ross and Peter Weill in the Harvard Business Review supports the value of knowing your TCO: "Companies that manage their IT investments most successfully generate returns that are as much as 40 percent higher than those of their competitors." 3 THE TCO STUDY PricewaterhouseCoopers and ADP recently 3 conducted and extensive study to measure the Total Cost of Ownership associated with in-house payroll and human resource information systems (HRIS). Invitations to participate were sent via letter and to Controllers, CFOs and financial VPs of over 20,000 companies with more than 1,000 employees. With 181 responses, this study is one of the most extensive of its kind. The respondents represent many industries and sizes, with an average company size of 6,500 employees. At the time of the survey, 44 percent of the participating companies were using a major ERP system, and 56 percent were using other systems. In order to compare TCO across such diverse companies and systems, base data was collected so that the individual pieces could be used to build the components of total cost. The initial surveys were followed by more than 400 s and phone calls to clarify responses. The study brings many surprising facts to light facts that lead to questions about the overall value of in-house and ERP systems. The major findings offer evidence that in-house HRIS systems are more expensive and less strategic than buyers may have realized. In fact, responses from financial executives revealed that in-house systems have consistently failed to deliver the promise of high productivity and low total cost of ownership. 4 Five key findings were uncovered and are outlined in more detail below: Hidden Costs, No Economic Value Added (EVA), Upgrade Treadmill, HR Shelfware, and Shifting Costs. HIDDEN COSTS The study reveals that the mean annual payroll TCO per paycheck for inhouse systems in the U.S. is now at US$16, which averages to US$459 per employee per year and does not decrease significantly over the life of the system. This average cost of US$16, and not US$5-6 per paycheck as indicated by previous studies, was a surprise. When identifying the cost components associated with payroll systems and processing, many previous studies appear to have overlooked a substantial portion of costs. The current survey contacted senior financial executives, who were able to take a broader perspective on costs than payroll departments generally have. Hidden costs are a key target that most senior financial executives focus on (see Figure 1). The most common hidden costs identified in this study included the following: Initial system costs implementation, hardware and license costs amortized over three years; Upgrade system costs recurring cost of new hardware, internal and external labor; Processing labor costs salaries in the actual payroll department plus 34 March/April 2004 IHRIM Journal

2 FEATURE Figure 1. Average Annual TCO Components of In-house Payroll. all labor costs related to printing and distribution, as well as reconciliation, year-end and tax filing, employee data maintenance, etc.; Processing non-labor corporate overhead, facilities, third-party fees, etc.; Labor costs incurred for maintaining systems maintenance time, database administration, IT help desk support, etc.; Non-labor costs incurred for maintaining systems overhead, facilities, maintenance contracts, hosting, network costs, etc.; and TLM labor costs cost (outside the payroll department) of all the remote workers who spend time entering and collecting time data. The average payroll system TCO for participants in the study was US$2.5 million per year, ranging from US$1 million to more than US$12 million depending on company size. Putting aside the hidden cost of TLM (Time and Labor Management), this number would be roughly US$1.2 million per year, ranging from US$400k per year to over US$7 million per year depending on company size (see Figure 2). Figure 2. Average Annual TCO Components for HRIS. The study measured the TCO for inhouse payroll and the system cost for HRIS. Measuring the labor costs related to HR administration was not feasible given the wide variance in scope of HR systems and practices. The costs measured were again ones that would likely appear in a budget outside of the HR department or that might not be considered in an annual expenditure analysis, i.e., the hidden costs. The average HRIS system cost for firms in the study was an additional US$487,000 per year or about US$88 per paycheck, ranging from US$170,000 to US$2M depending on organization size. NO ECONOMIC VALUE ADDED (EVA) The survey shows that 52 percent of in-house users plan on upgrading or installing a new system in the next two years. Yet the study also found that only 25 percent of executives expect to decrease costs or add value as a result (see Figure 3). Put another way, of those senior executives looking at a new installation or an upgrade of in-house software, 75 percent expected no economic value added (EVA), no price decrease, and no productivity gains! This low expectation may be largely due to costs that were hidden during the original purchase process many of which are ongoing rather than one-time. What was regarded as a one-time investment one that would realize efficiencies and savings with time and a growing employee base turns into an ongoing series of upgrade, maintenance and processing expenses. So why upgrade? Fear of non-compliance of falling behind seems to be a primary driver. UPGRADE TREADMILL The average in-house upgrade occurs every 18 months, and firms are amortizing about US$470,000 in upgrade costs per year for larger software systems. As we ve already seen, little expectation of EVA accompanies these upgrades. The continuous cycle of upgrades becomes an expensive treadmill that is ultimately contributing to a decline in the useful life of in-house systems. Two-thirds of companies made a change within the last five years, and only 15 percent of companies surveyed are using systems installed more than 10 years ago. Over 50 percent of firms in the study had installed their system since The rate of new system installations in the last three years has maintained the same trends as we saw right before the year It has not leveled off. Traditional system life was always pegged between seven and 10 years, and this was often used as a basis of comparison. Now system life has moved into the four to seven year range. Why? An upgrade every 18 months is a very expensive exercise. Sooner or later companies tend to go out to the market to compare the options with new alternatives. In many cases, there is little difference in the price to upgrade or install new. hence the shorter life (see Figure 4). While some companies avoid the upgrade treadmill by continuing to rely on outdated, often non-compliant systems, they are essentially delaying hard costs, as well as incurring risk and foregoing new functionality, such as employee self-service. Many find it so expensive to catch up after having fallen behind by more than two upgrades, that the proposition of moving to an entirely new platform and (new functionality) IHRIM Journal March/April

3 FEATURE Figure 3. Anticipated Change in Total Payroll Processing Costs. becomes an attractive alternative once the system is fully depreciated. For some this means a new cycle of implementation, and the associated costs begin over again. Others explore alternatives such as outsourcing that remove the burden of system maintenance and upgrades. HR SHELFWARE Enterprise resource planning (ERP) systems cater to a market in which they need to be a little bit of everything for everyone. It s a great strategy for multifunctional decision teams, because everyone gets a little something of what they need. So companies write the big check for all the modules. Yet, in actuality, they end up only implementing the core functionality as part of their original implementation. While they have the best intentions of going back and implementing the rest of the functionality when financial and human resources become available, more often than not it never happens. The respondents in the current study reported that a high percentage of purchased HR functionality (roughly 30 percent) never gets implemented (see Figure 5). In addition, more often than not, annual maintenance continues to be paid on modules that are never implemented. What if the unused functionality was removed from the initial return on investment (ROI) calculations? In that case, the financial cost of the inhouse solution would be considerably more, and the opportunity cost even higher. Many of the HR modules that fall into the 30 percent that constitute shelfware have to do with human capital management, such as self-service, recruitment, career development, etc. All too often, we find companies are using their expensive in-house ERP systems merely as data repositories, rather than as strategic management tools as they were intended. SHIFTING COSTS The current study also provides evidence that large in-house applications do not offer TCO advantages over other software packages, including smaller Figure 4. Number of Months Since Last Payroll System Upgrade. vendors and home-grown systems. They simply redistribute the costs across different budget centers. The average TCO per paycheck for major and other ERP systems was roughly the same at US$16. Initially, there are increases in efficiency as firms grow larger, but once the 5,000 employee threshold is reached, cost savings level off, and a "floor" begins to set in for larger firms. This is due to the disproportionately higher costs in the labor behind time collection and to the initial systems costs with the larger firms in the study. The study also found that TCO is roughly the same for in-house systems whether you evaluate older platforms versus newer ones or platforms from major vendors versus niche players. The study results strongly suggest that moving from one platform to another may just lead to shifting costs from one department to another, such as from payroll to IT and/or to field operations. While newer software may increase employee productivity, the IT costs associated with hosting an ERP application are generally much higher than maintaining an old legacy system. This is a key example of the redistribution of costs through in-house software versus the outright elimination of costs that can often be achieved by outsourcing. OUTSOURCING AS AN ALTERNATIVE The current study provides strong evidence that in-house systems are more expensive and less strategic than buyers have been aware of previously. Increasingly, executives are turning to outsourcing as a means to streamline their HR, payroll and benefits operations and to capture a lower total cost of ownership. Companies choosing outsourcing tend to see an average 30 percent decrease in TCO. With an outsourced solution, a substantial portion of the hidden costs associated with labor and non-labor processing in each paycheck are eliminated. Numerous studies by the Gartner Group and others have pointed out other key advantages that outsourcing can bring, such as: elimination of upgrade costs through hosted services, increased compliance and functionality, without shelfware, 36 March/April 2004 IHRIM Journal

4 FEATURE Figure 5. HRIS Modules Owned But Not Deployed. 3 Ross, Jeanne W. and Peter Weill Six IT Decisions Your IT People Shouldn t Make. Harvard Business Review. November 2002, pp The Total Cost of Ownership: Warning Signs of Hidden In-House Systems Costs, Pricewaterhouse- Coopers. August reduction of labor and redeployment of IT professionals, reduction in IT costs associated with system and infrastructure maintenance, and fixed costs become variable, creating financial flexibility. CONCLUSION The study reveals that the cost of owning HR and payroll systems, as well as administering payroll in-house, resides in multiple cost centers and is not easy to measure for the purpose of managing costs. Overall, given the complexity of in-house systems on the market today and the increased frequency of system upgrades, the study suggests that executives need to re-evaluate their methods of calculating total cost of ownership, re-examine the useful life of their systems, and evaluate the alternatives. ENDNOTES 1 Additional survey results and a white paper from the ADP-PwC study on the TCO study entitled, The Total Cost of Ownership: Warning Signs of Hidden In-House Systems Costs are available at 2 Gartenberg, Michael and Bill Kirwin Common Myths of Total Cost of Ownership Exposed. Gartner Research. 23 February T Greg Secord is vice president of marketing and business development for Automatic Data Processing s National Account Services, a division focused on delivering integrated business outsourcing solutions to companies with more than 1,000 employees. Mr. Secord has 20 years of experience in high technology sales and marketing, including area sales management for National Account Services. His current responsibilities include strategic planning, product marketing and strategic alliances. He is responsible for establishing key marketing initiatives, ensuring market-driven development within R&D, and driving company growth with go-tomarket support. He is charged with accelerating the company s track record of sustained profitability by supporting the efforts of a global sales and marketing force. Mr. Secord holds a BA from the University of Western Ontario and an MBA from Duke University s Fuqua School of Business. In his current role, he is often quoted in the media and invited to speak on technology industry issues. He can be reached at greg_secord@adp.com. IHRIM Journal March/April

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