Human Resources Outsourcing and Its Effect on the U.S. Economy

Pros and Cons

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Human resources outsourcing involves hiring companies to manage personnel functions, including the administration of health benefits, retirement plans, and workers’ compensation insurance. It also includes hiring, training, and legal expertise.

Smaller companies hire outside firms to administer payroll, pay employment taxes, and manage risk. The average size of a company that uses HR outsourcing is 19 employees. HR firms pool thousands of businesses together, and the economy of scale lowers the cost of their services.

Advantages

HR outsourcing reduces the fixed cost of managing employees. HR firms can be more efficient because the talent and infrastructure are already in place. Small businesses save money and time by hiring HR firms and are better able to offer a wider range of benefits:

  • Health insurance plans, including health maintenance organizations (HMOs), preferred provider organizations (PPOs), and health savings accounts (HSAs)
  • Dental and vision plans
  • 401(k), retirement plans, and credit unions
  • Voluntary benefits, such as cancer, travel, and long-term disability plans

Small businesses are more likely to outsource other human resource functions such as payroll administration and recruitment. Few outsource everything and usually keep HR staff to communicate with employees in core business areas.

A 2012 study found that businesses that outsourced grew 7-9% faster than firms that didn't, but that also could be because fast-growing companies are more likely to need HR outsourcing. They also had 10-14% lower employee turnover and were 50% less likely to go out of business. Their administrative costs were $450 lower per employee.

One study showed that companies saved 24-32% of the cost of hiring an HR staff in-house. Shell Oil cut its HR budget by 40% in four years. It combined outsourcing with other strategies to lower departmental costs. A 2011 report revealed a 32% savings from HR outsourcing.

Companies that expand overseas look for HR firms with global expertise.

Disadvantages

The most significant drawback to outsourcing HR functions is poor internal communication because the outsourcing company is not on-site and doesn't have a good sense of the company's culture. Employees can't just drop into the HR office if it's off-campus. As a result, they may feel disenfranchised.

Outsourcing HR functions could greatly hinder organizational learning. Being off-site and disconnected means they are unable to adequately facilitate organizational learning by providing a continuing thread that supports corporate identity.

Employees may start to mistrust management as other departments may wonder if they, too, will be outsourced. If employees liked the old HR department, they might resent the new company. Even if they didn't like the old department, they might transfer those feelings to the new firm.

A poorly-run outsourcing company could create disasters by accidentally leaking sensitive company information, not delivering adequate services, or going bankrupt and leaving a client without any HR services.

How HR Outsourcing Affects the U.S. Economy

Human resources outsourcing has a positive effect on the U.S. economy. First, it helps small businesses compete, allowing them to take advantage of sophisticated HR firms instead of building that expertise in-house. They can focus on their core businesses and maintain their competitive advantage. A company's leaders don't have to get distracted by HR issues.

Second, it lowers business costs for all corporations. They can use lower costs to drop their prices, helping consumers. It also makes them more profitable, benefiting stockholders.

Third, higher profitability allows firms to increase skilled positions in their core competencies. Although many HR jobs could be lost to overseas companies, they could be offset by the jobs added by fast-growing firms.