A theoretical model is presented that identifies environmental and
organizational characteristics that affect human resource (HR)
performance in an organization, Specifically, we address the issue of
when and under what circumstances does HR outsourcing contribute value
to the firm by attempting to identify environmental and organizational
characteristics that affect HR department performance and how HR
outsourcing mediates that relationship. We propose that supplier
competition in the HR provider market has a direct effect on the amount
of HR outsourcing which in turn has a direct effect on HR performance.
Environmental uncertainty (primary, competitive, and supplier) is
proposed to moderate the relationship between amount of HR outsourcing
and HR performance while asset specificity is proposed to moderate the
relationship between supplier competition and amount of HR outsourcing.
An earlier version of this paper was presented at the Southwest Academy
of Management meeting in Houston, Texas, March, 2003, and received the
2003 Irwin/McGraw-Hill Distinguished Paper Award.
Human resource outsourcing has become a major part of human
resource (HR) operations for the last few years. A 2004 joint study
conducted by the Society for Human Resource Management (SHRM) and the
Bureau of National Affairs (BNA) found that two-thirds of HR executives
surveyed say their HR departments outsource at least one HR activity
(Bureau of National Affairs, 2004), with this activity expected to
increase. Proctor & Gamble (P&G), for instance, signed an
agreement with IBM that took effect in January 2004 and led to the
outsourcing of P&G's worldwide HR services, valued at $400
million to IBM. Despite the increased activity, however, there is
recognition that careful planning should be employed before making the
decision to outsource. In fact, a separate 2004 SHRM human resource
outsourcing survey found that in some cases HR outsourcing led to a
decrease in customer service (25% of respondents), a less personal
relationship with employees (37% of respondents), and a decrease in
employee morale (6% of respondents). The information contained in these
two recent surveys seems to indicate that a good understanding of the
factors that drive HR outsourcing and a good understanding of the
expected outcomes is necessary to ensure that organizations fulfill
their HR functions in a manner that allows them to remain competitive in
their respective industries.
In many studies that discuss outsourcing, cost benefits appear to
be a compelling argument for contracting out services previously
performed internally (e.g., Anderson & Weitz, 1986; Belous, 1989;
Greer, Youngblood, & Gray, 1999; Gupta & Gupta, 1992; Kakabadse
& Kakabadse, 2002; Lever, 1997), and Vining & Globerman (1999)
note that empirical data from government agencies outsourcing to private
suppliers generated savings in the range of 20-30% in production costs.
However, some of these same studies caution that cost should not be the
only factor considered in the decision to outsource. Other factors to
consider include vendor expertise, customer and employee satisfaction
(Barthelemy, 2003; Greer, Youngblood & Gray, 1999; Gupta &
Gupta, 1992), and loss of strategic advantage (Anderson & Weitz,
1986; Greer, Youngblood & Gray, 1999, Gupta & Gupta, 1992;
Lever, 1997). In a more recent study, Adler (2003) notes that a review
by the Gartner group listed six factors that are important in
outsourcing decisions: dependency risk, spillover risk, trust, relative
proficiency, strategic capabilities, and flexibility. The first four of
these are classified as short-term factors, whereas the last two can be
considered more long-term or strategic. However, no clear formula exists
that identifies when outsourcing is most efficient and effective. There
are also very few empirical studies that examine the performance
implications of make or buy decisions (e.g. Leiblein, Reuer, &
Dalsace, 2002). Rather, studies seem to concentrate on the reasons
organizations outsource, how to outsource, or the impact of outsourcing
on the organization and its employees.
Notably absent from the literature is the question of when
outsourcing is most appropriate or under what circumstances an
organization should outsource to increase human resources (HR)
performance. In other words, are there internal and external forces that
are conducive to HR outsourcing? If these forces can be identified, they
may provide some clues concerning the appropriate action to take when
outsourcing is being considered. This is especially important since 67%
of HR departments outsourced one or more functions in 2004 (Bureau of
National Affairs, 2004). We specifically address the issue of when and
under what circumstances does HR outsourcing contribute value to the
firm by attempting to identify environmental and organizational
characteristics that affect HR performance and how HR outsourcing
mediates that relationship.
A separate issue concerning the current outsourcing research is the
absence of studies looking at the HR function in organizations. Although
there are numerous theoretical and empirical articles on outsourcing
organizational functions such as information systems and accounting, the
academic literature on outsourcing the HR function is almost
non-existent. Although Klaas (2003) developed a framework that helps
analyze HR outsourcing factors in small and medium-sized enterprises
(SMEs) by explicating on the relationship between SMEs and the
professional employer organizations and Gainey and Klaas (2003) analyze
HR outsourcing specifically in the context of training and development,
these studies are the exception rather than the rule. This fact is
surprising given that many HR functions such as payroll, benefits,
training, and recruiting are often outsourced by organizations (Gilley,
Greer & Rasheed, 2004; Lever, 1997).
The SHRM Human Resource Outsourcing Survey Report, released in June
2004, found that HR functions that are entirely outsourced are generally
background checking, employee assistance/counseling, and Flexible
Spending Account (FSA) administration. The functions that are partially
outsourced include administration of health care benefits, pension
benefits administration, and payroll. Despite this increase in HR
outsourcing activity, to date, the empirical articles on outsourcing HR
functions focus on the impact of organizational characteristics (Klaas,
McClendon & Gainey, 2001), the role of transaction costs (Gainey
& Klaas, 2003; Klaas, 2003; Klaas, McClendon & Gainey, 1999),
the relationship between HR department size and outsourcing activity
(Pommerenke & Stout, 1996), and the rationale and consequences of HR
outsourcing (Greer, Youngblood & Gray, 1999; Lever, 1997). The
question concerning when to outsource HR practices based on the internal
and external forces driving the firm to consider outsourcing, however,
is not directly addressed, although Klaas, McClendon & Gainey (1999)
come close in their analysis of moderator variables in the relationship
between amount of HR outsourcing and perceived benefits from
outsourcing. A separate article by Klaas, McClendon and Gainey (2001)
also touches on certain organizational characteristics that lead firms
to outsource HR activities, but does not consider HR performance as a
dependent variable. As such, it is necessary to address the question of
when to outsource the HR function by looking into the theoretical issues
of outsourcing in the literature representing disciplines other than HR
to form a basis for HR outsourcing. However, a brief discussion of
definitions and HR activities is presented first.
In this paper, the term outsourcing will refer to the action of
allowing external vendors to perform an entire HR activity (such as
training, payroll, etc.) for an organization. The term insourcing will
refer to the action of the organization performing the entire HR
activity in-house, and the term co-sourcing will refer to the action of
allowing an organization's HR generalist to work with external
vendors on some activities, or to the action of allowing HR specialists
to work as consultants to line managers who actually perform HR duties.
The HR Value Chain
The HR functions performed in an organization can be thought of as
a chain of events or tasks that start with the planning of the
organization's staffing needs and end with an employee's exit
from the organization. Figure 1 illustrates the chain of events as they
occur in an organization. These events form the basis of the HR function
and serve as a guide for determining which specific HR functions may be
eligible for outsourcing. It is important to distinguish between those
functions that are a core element of the organization/employee
relationship (those that create value for the organization) and those
that are not. Two typologies are used to illustrate this point.
[FIGURE 1 OMITTED]
Gilley, Greer, and Rasheed (2004) discuss a strategic typology of
HR activities developed by Alan Speaker (Greer, 2001) in which HR
activities are classified as having either high or low strategic value
and as being either transactional or relationship-oriented in nature.
Their resulting typology shows the quadrant containing
relationship-oriented activities with high strategic value to the firm
to include several HR activities related to training and performance
evaluation. In addition, the quadrant containing transactional
activities with high strategic value includes activities related to
staffing, benefits planning, and compliance. Their article suggests that
high strategic value activities and relationship-oriented activities
might not be good candidates for outsourcing activity. Rather, they
suggest that low strategic value activities that are transactional in
nature such as payroll, benefits administration, employee records, and
relocation administration are the best candidates for outsourcing.
A separate, but similar, typology is Lepak and Shell's (1998)
model of virtual HR in which HR activities are classified as either high
or low in uniqueness and high or low in value. A high value activity is
one that is directly instrumental for achieving organizational
objectives, while a low value activity is one that is primarily
administrative or transactional in nature. An activity that is low in
uniqueness is one that is routine, while an activity high in uniqueness
is considered idiosyncratic. Lepak and Snell (1998) argue that the
quadrant representing high value and high uniqueness contains core HR
activities that are most likely to be carried out internally to obtain a
competitive advantage. Thus, these activities should not typically be
outsourced, but other routine administrative activities located in other
quadrants might be outsourced to the growing supply of external vendors
specializing in these activities.
When the HR activities listed by Gilley, et al. (2004) are located
in the HR value chain, it becomes obvious that portions of each major HR
function are potential candidates for outsourcing. However, three
functions in particular, training, performance planning and evaluation,
and compensation, deal specifically with an organization's current
relationship with its employees. As soon as the employee is hired, he or
she receives some type of training, is informed of job performance
evaluation processes, and is informed of compensation issues related to
pay and benefits. If an employee stays with the organization, the cycle
of training, performance, and compensation repeats itself many times
throughout the course of the employee's tenure with the
organization. The professionalism and fairness with which an
organization performs these activities is directly related to how
employees feel about the organization. Thus, these three functions
comprise an organizational career management system and are crucial in
developing corporate strategies concerning employee retention, employee
value to the organization, and employee productivity. As such,
outsourcing in these three major HR functions should be considered
carefully before any final decisions are made.
The Proposed Model
Because HR outsourcing has received such scant attention in the
literature, it is necessary to address the question of when and under
what circumstances HR outsourcing contributes to firm performance by
looking at the literature representing disciplines other than HR. in
particular, theory from economics, organizations, and strategy will be
used to develop the proposed framework. Figure 2 depicts the proposed
model of the relationship between competition, amount of HR outsourcing
and HR performance. Moderator variables, asset specificity and three
types of environmental uncertainty, are also used to help determine the
conditions under which HR outsourcing may affect HR performance.
[FIGURE 2 OMITTED]
Supplier Competition and Outsourcing
When people and organizations agree to conduct business together, a
process emerges that helps determine demand, supply, and prices for
particular goods and services. As the number of people and organizations
involved in business transactions increases, the potential for
competition between these groups also increases. For instance, when the
number of sellers in a particular market increase, buyers have more
freedom to pick and choose the organizations with whom they want to
conduct business than they do if there are few sellers. Because large
numbers of sellers are trying to capture the same market share, the
sellers will compete with one another in an attempt to obtain as much
market share as possible. The resulting competition may cause the
sellers to differentiate their services in terms of price, quality, or
When competition is limited, a decreased quantity of goods and
services is available, and the prices of those goods and services tend
to increase. For example, Lynk (1995) found that mergers between
hospitals led to significantly higher prices in health care service,
indicating an exploitation of market power created by a reduction of
competition. In contrast, as competition increases (with more firms
entering the market) the quantity of goods and services available to
potential buyers should also increase. Because neoclassical economic
theory assumes the buyer to be rational and informed, buyers should
choose the product that best meets their needs and price concerns,
thereby choosing the alternative that is most efficient. Therefore, as
competition between external HR provider firms increases, the quantity
of goods and services available to corporate buyers should also increase
with buyers choosing the most efficient alternative.
In the five forces model of competition (Porter, 1980), five
competitive forces determine the state of competition in an industry.
Three of these forces, potential new entrants into a market, substitute
products, and rivalry among competing sellers in a market, often lead to
new technology, improved products, and lower prices. Thus, a firm
wishing to outsource HR functions in a strong competitive vendor
environment is likely to benefit from a strong bargaining position.
An organization performing a particular HR activity in-house may
not be able to compete effectively with firms offering the same service
externally, particularly if an external provider has a competitive
advantage unavailable to others. In this situation, marginal analysis
would help determine if the HR activity is costing more than the worth
of the HR activity's contribution to total organization output.
Marginal analysis looks at the changes in costs and benefits that occur
when changes from the status quo are proposed. These marginal changes in
the costs and benefits are the basis for rational economic choice
(Ekelund & Tollison, 1991). In a competitive situation concerning
employee wages, for example, marginal analysis would determine if an
employee is worth keeping. If the employee being analyzed is paid more
than the worth of his or her contribution to total output, it is
economically unsound to keep the employee on the payroll. In the same
vein, if an insourced human resource activity costs more to operate than
it is contributing to total output of the organization, it is
economically unsound to continue operating the HR activity internally.
Transaction cost theory (Coase, 1937) helps explain this idea
further. Transaction cost refers to the cost of organizing information,
protecting the interests of all parties in the transaction, monitoring
the transactions, and other similar costs involved in a transaction
(Aubert, Rivard & Patry, 1996). In a discussion of transaction
costs, Coase (1937) noted that "a firm will tend to expand until
the costs of organizing an extra transaction within the firm become
equal to the costs of carrying out the same transaction by means of
exchange on the open market or the costs of organizing in another
firm," (Coase, 1937, p. 341). In other words, when internal
transaction costs equal the cost of purchasing the same good or service
on the open market, the organization will tend to stop producing
internally and purchase from the open market.
Williamson (1975) suggests that a buyer who is dependent upon one
supplier for goods will be less able to resist or avoid opportunism by
the supplier than a buyer who has several suppliers from whom to
purchase goods. The lack of alternative suppliers may create a small
numbers bargaining problem for the buyer, thus creating an incentive for
the buyer to vertically integrate (Levy, 1985). From an outsourcing
perspective, when competition for suppliers of a particular good or
service increases, the number of choices increase, and the ability of a
supplier to engage in opportunistic behavior decreases. The increased
level of competition creates an environment that is more favorable to
the buyer in terms of choice and the ability to use alternate suppliers
if necessary. Without several alternatives, it is doubtful that
outsourcing would occur at all since firms would be hesitant to place
themselves in a situation that forces them to be dependent upon a single
This concept of transaction cost falls in line with theories of
competition, cost leadership and differentiation strategy (Porter 1980).
An organization cannot afford to compete effectively when it pays more
for services or goods than its competitors unless it differentiates
itself clearly from other market providers, If business competitors use
a less expensive but equal method to operate their HR activities, the
organization that continues to pay more for the same service may be at a
competitive disadvantage by not utilizing a cost strategy. Additionally,
as external HR provider firms increase in number, competition among
these contract providers will likely lead to new technology, improved
products, and economies of scale not available to organizations not
specializing in the HR activity. External HR provider firms that exploit
either cost advantages or special differentiated services through
improved technology and products may entice many organizations to
outsource. Indeed, in a study of semiconductor firms, Leiblen, et al.
(2002) found that number of suppliers correlated with greater
In summary, increased HR vendor competition may create positive
benefits for organizations purchasing their services. From a
neoclassical economic perspective, increased levels of external supplier
competition should lower the costs of externally produced goods causing
the rational consumer to purchase the goods externally rather than
producing them internally at a higher cost. Therefore:
Proposition I: There is a positive relationship between supplier
competition in the external HR provider market and amount of HR
The Relationship Between Outsourcing and HR Performance
Because firms outsource to increase performance, HR outsourcing
should lead to increased HR performance such that H R outsourcing acts
as a mediator between supplier competition and HR performance. The
decision to make or buy is based on a number of elements in the internal
and external environment (White, 2000), and the idea of competing based
on the amount of hard assets owned has shifted to competing on the basis
of intangible assets and capabilities (Gottfredson, Puryear &
Phillips, 2005). As a result, the amount of outsourcing in areas such as
production and information processing has increased tremendously in the
last several years in an attempt to compete by using the most attractive
opportunities inside and outside the organization. Outsourcing is
attractive to upper management because it improves some of the metrics
used to judge company performance. For instance, "shedding specific
assets allows a company to increase return on assets (ROA) and return on
investment (ROI), and decreasing the head count increases revenue per
employee," (Rossetti & Choi, 2005, pp. 48-49). Another benefit
of outsourcing includes reducing prices of goods provided, which in turn
leads to higher price to earning ratios. In summary, firms that
outsource any function do so with the idea that the firm's
performance will increase. Several sources indicate that this is indeed
the case (Ellram & Carr, 1994; Smeltzer, Manship & Rossetti,
2003; Velocci, 2001), and thus we expect that an increase in HR
outsourcing will result in an increase in HR performance.
Proposition 2: There is a significant mediating effect of amount of
HR outsourcing on the relationship between supplier competition and HR
Williamson's (1985, 1986) work on transaction costs expands
Coase's (1937) original theory by defining key aspects of a
transaction cost framework. One key aspect is that of asset specificity,
or the investment in assets that are specific to the requirements of a
particular exchange relationship. Research has shown that asset
specificity reduces the degree of outsourcing (Jensen & Rothwell,
1998; Monteverde & Teece, 1982). For example, in an HR context,
asset specificity is high in a transaction where software is designed to
perform a specific HR task for a specific organization. Transaction
costs are likely to be high in this instance since the software cannot
be used in other organizations. Both purchaser and vendor will desire
protections from each other if something goes wrong, thus increasing
costs of the transaction, If asset specificity is low, however, market
transaction costs are likely to be lower and many suppliers should then
effectively compete (Vining & Globerman, 1999). In this scenario, as
the number of external HR provider firms offering basic, non-specific
service that all organizations need (e.g. payroll administration)
increases, external vendor competition should increase and cause
internally produced services to be more costly to administer. The key is
to determine which activities in the HR value chain have low asset
specificity and can be outsourced without damaging the
The specific HR tasks or services being outsourced can have an
impact on the relationship proposed in proposition one, particularly if
an HR service that creates a competitive advantage for the firm is
outsourced. The concept of asset specificity is very similar to Klaas,
McClendon and Gainey's (2001) concept of idiosyncratic practices
developed by firms to create a strategic HR advantage. These
idiosyncratic practices are often firm-specific, based on tacit firm
knowledge, and can limit the ability of an external HR provider firm to
provide the same level of service as an internal HR department. As such,
asset specificity should be accounted for in the competition/amount of
HR outsourcing relationship.
Since prior research has shown that asset specificity reduces the
amount of outsourcing (Jensen & Rothwell, 1998; Monteverde &
Teece, 1982), we propose that asset specificity moderates the
relationship between supplier competition and amount of HR outsourcing.
Proposition 3: There is a negative moderating effect of HR task
asset specificity on the relationship between supplier competition and
amount of HR outsourcing.
Environmental Uncertainty and Outsourcing
Seminal works in the area of environmental uncertainty suggest that
the most effective firms tend to use mechanistic or bureaucratic designs
in stable, predictable environments while organic designs are used by
effective firms in unstable, turbulent environments (Bums & Stalker,
1961; Lawrence & Lorsch, 1967; Thompson, 1967). In other words, the
type of organizational design used should match the organization's
environment. Although much has been written about the relationship
between environmental uncertainty and organizational design, some
scholars have looked specifically at the role information processing
plays in this relationship (Daft & Lengei, 1986; Galbraith, 1974;
Huber, 1991). Arguments have been made suggesting that the level of
analysis for information processing should be the subunit or
departmental level rather than the organizational level because
organizations are composed of subunits which are interdependent (e.g.
Tushman & Nadler, 1978). Information processing is important because
an organization's ability to process information is tied to
environmental uncertainty. The more uncertain the environment, the more
difficult information processing becomes, and the more likely it is that
an organization developing better methods for processing information
will obtain a competitive advantage.
Considering the HR department as a subunit in an organization, it
is appropriate to analyze the structure and process of the HR function
in the theoretical vein suggested by the studies mentioned previously.
Seminal research clearly suggests that in stable, predictable
environments, a bureaucratic structure is the most effective design to
use. Therefore, when labor demand and supply are stable and predictable,
outsourcing the HR function, even a bureaucratic one, seems unnecessary
since all market competitors have fairly complete information in an
unchanging market. It would be difficult to obtain a competitive
advantage for HR under these conditions since the resource in question
(labor market information) is not limited to one organization. Indeed,
such information is often compiled by government agencies and dispensed
publicly to all interested parties.
A more recent view of environmental uncertainty suggests that
uncertainty is divided into three distinct components--primary,
competitive, and supplier (Sutcliffe & Zaheer, 1998). The first
component, primary uncertaintya refers to "uncertainty arising from
exogenous sources, such as natural events, from changes in preferences,
as well as from regulatory changes, such as those involving standards or
tariffs," (Sutcliffe & Zaheer, 1998, p. 3). Competitive
uncertainty is defined as "the uncertainty arising from the actions
of potential or actual competitors ...," (Sutcliffe & Zaheer,
1998, p 4). These two forms of uncertainty are somewhat similar in an HR
outsourcing context in that a firm must deal with the effects of these
types of uncertainty after they occur. For instance, changes in
Department of Labor regulations concerning the status of exempt versus
nonexempt employees and the calculation of overtime have caused many HR
departments to recreate the entire timekeeping process to avoid
potential legal problems. When competitors raise or lower the average
wage level for a particular area, HR departments must decide if they
should or should not match the competitor's wage and the impact
that will have on their workforce. Because primary and competitive
uncertainty create a situation in which the firm must react after the
event has occurred, it is expected that high levels of primary and
competitive uncertainty will enhance the ability of firms specializing
in HR outsourcing to outperform internal HR departments. The reasoning
for this assumption is based on the idea that firms specializing in HR
services will have more ability to focus on specific HR issues and will
be able to respond more quickly when changes occur.
Proposition 4: There is a positive moderating effect of primary
uncertainty on the relationship between amount of HR outsourcing and HR
Proposition 5: There is a positive moderating effect of competitive
uncertainty on the relationship between amount of HR outsourcing and HR
The third type of uncertainty proposed by Sutcliff and Zaheer
(1998) is supplier uncertainty, defined as the behavioral uncertainty of
an exchange partner firm. Supplier uncertainty is related to possible
opportunism by the supplier, and is expected to have a negative
moderating effect on the relationship between HR outsourcing and HR
performance. In an HR outsourcing context, an increase in supplier
uncertainty would suggest that the external HR provider firms are in a
position to act in self-serving ways at the expense of the contracting
organization. Thus, an increase in the ability of external HR provider
firms to engage in opportunism could lead to a decrease in HR
Proposition 6: There is a negative moderating effect of supplier
uncertainty on the relationship between amount of HR outsourcing and HR
The propositions presented are intended to give some solid
theoretical background for determining when the HR function should or
should not be outsourced. It is well and good to discuss competitive
advantages and employee reactions concerning outsourcing, but defining
the appropriate situation in which to act to increase HR performance has
not yet been established. The proposed model is a starting point for
connecting outsourcing activities to HR performance.
A potential difficulty with the model, however, is adequately
defining and measuring what is meant by HR performance. In firm-level
studies of outsourcing, profitability and earnings per share may be
appropriate measures of performance, but performance in the HR function
is more difficult to quantify in dollar amounts, although some authors
have made progress in this regard (Becker, Huselid & Ulrich, 2001).
Basic operating cost comparisons can be made easily, but intangible
functions such as creating the appropriate organizational culture or
ensuring that employees feel valued and supported by the organization
are difficult to measure and difficult to translate into dollar amounts.
These intangible factors, however, need to be quantified in order to
obtain a valid measure of HR performance. If the goal of outsourcing is
to improve the function being outsourced, valid measures must be
available to determine whether the outsourcing is successful. Perhaps
each component in the HR value chain can be analyzed to determine
specific measures for each function that can then be compiled into an
overall measure of HR performance. The measures might include both
operating costs and behavioral components translated into dollar
In addition, since the dependent variable is HR performance, the
knowledge, skills, and abilities (KSAs) of individuals performing the
work are most likely part of the HR performance measure. The model,
however, does not account for individual contributions to HR
performance. Just as HR performance is difficult to measure, individual
KSA contributions to an organization are also difficult to measure. For
instance, the labor relations manager who convinces the local union to
avert a strike certainly has KSAs that contribute value to the firm, but
how should the manager's KSAs be measured? Perhaps colleagues,
subordinates, and supervisors could give a reasonable measure of the
manager's KSAs as some 360-degree performance evaluations require,
but obtaining 360-degree feedback for all HR department employees can be
impractical, and performance ratings are often inflated and inaccurate.
Thus, although HR performance is likely to be a function of
employees' skills and abilities, employee KSAs are not included in
Another limitation concerns other functions and departments within
the organization. Because HR performance often depends upon the
willingness of other departments to follow organizational policy and
procedure, individuals outside of the HR function may have an impact on
HR performance. For example, assume the HR department adequately
conducts sexual harassment workshops and has tried without success to
discipline a vice-president who informs his managers to ignore all
complaints from female employees. The vice-president is a personal
friend of the CEO, and simply refuses to take sexual harassment
seriously. Lawsuits resulting from sexual harassment complaints may
count against HR performance even though HR employees have done
everything possible to stop sexual harassment.
The factors discussed above and others are likely to contribute to
HR performance that are not considered in the proposed model, and any
test of the model will most likely yield a small r-square value because
of the missing variables. Despite this limitation, the model is adequate
as a starting point for determining how outsourcing affects the
relationship between external forces of competition and HR performance.
If the model is significant, it would indicate that the amount of HR
outsourcing does have an impact on HR performance under certain
conditions. Since the goal of outsourcing any task is to reduce costs,
gain expertise and control over processes, and improve quality of
service (Shelgren, 2004), knowing that HR outsourcing may add value to
the firm is a positive step in determining ways to capitalize on any
potential benefits of outsourcing.
A number of organizations have begun to outsource the HR function,
and it would be helpful to understand the impact of outsourcing on firm
performance. Electronic Data Systems will combine forces with Towers
Perrin to create an HR outsourcing company that is expected to bring in
$600 million in annual revenues (Fuquay, 2005), and consulting firm
Nelson-Hall says the worldwide market for HR outsourcing services is
expected to grow 21% annually to $7 billion by 2008 (McDougall, 2005).
The sheer size of the market for HR outsourcing suggests that firms
should be aware of the forces that indicate outsourcing to be beneficial
or detrimental to the organization. The research to date on HR
outsourcing has not yet determined the circumstances under which HR
outsourcing would be most beneficial, and part of the problem lies with
the inability of researchers and firms to grasp an overall, widely
accepted measure of HR performance.
Many HR functions may not lend themselves to outsourcing, and
changing the dependent variable from HR performance to HR function
performance for specific functions such as payroll or employee
development may help determine which functions should or should not be
outsourced. The HR value chain illustrates in a timeline fashion how
certain HR activities become tied to an employee's value to the
organization. Training leads to better performance which leads to higher
compensation, and the cycle of training, performance and compensation
repeats itself throughout the life of the employee in the organization.
Because an organization has invested time and money in training
employees, the decision to outsource should not be made lightly. If
conditions in the environment and in the organization are conducive to
outsourcing, the amount of time and money invested in the HR
professional employees who are to be downsized should be considered for
the sake of the organization as well as for the sake of the employee.
Unlike an outsourced manufacturing process, where the cost of goods
and quality metrics can clearly show if the outsourced process is
successful in meeting numeric goals of production, HR practices are
typically intertwined together to form a coherent overall strategy that
is more difficult to tease apart and measure individually. The
literature on HR bundles illustrates this point (see Macduffie, 1995,
for a specific manufacturing example). For instance, an overall strategy
that claims, "People are our most important asset," would
suggest that all HR practices from recruiting to retirement focus on the
individual employee to make them feel like a valued part of the
organization, If a specific HR function such as benefits administration
is outsourced to an external provider, however, the employee may feel
more like a number than like a valued employee. At this point, there is
a potential breakdown in the overall strategy, and metrics showing the
amount of money saved by outsourcing benefits administration may look
promising, but employees themselves may feel less committed to the
organization. As a result, other HR performance measures that are
typically not calculated in benefits administration, such as turnover or
absenteeism, may increase. HR management is concerned with the
management of people in an organization throughout all phases of the
employment process, and improving one part at the expense of another
part makes little sense. Thus, the emphasis earlier in this paper on
core HR activities with high strategic value is not misplaced, and the
authors who caution that cost should not be the only factor in the
decision to outsource have good reason for their arguments (Anderson
& Weitz, 1986; Greer, Youngblood & Gray, 1999; Lever, 1997).
The field of HR management has transformed over the past few
decades from being primarily a record-keeping function to a strategic
function that helps develop strategies for fitting HR practices with the
overall organization's strategy. The old record-keeping functions
tend to be routine, bureaucratic, and have low strategic value; thus,
they can probably be outsourced with little effect on the individual
employees of the organization. However, some people do not see the value
of "new" and strategic HR departments because they see all of
the HR function as a bureaucratic, record-keeping function that adds
nothing to the firm's bottom line. Thomas Stewart (1996), for
example, suggests that most HR departments are 80 percent routine
administration with no value-added, so the entire HR department should
be abolished; not improved, but completely eliminated. The problem with
Stewart's suggestion is that many researchers have decided that the
acquisition and management of human capital can become a strong
competitive advantage for an organization if handled appropriately
(Barney, 1995; Barney & Wright, 1998; Brockbank, 1999). Since most
managers are kept busy with typical tasks such as production or sales,
few have extra time to devote to the human resource component of the
business. This situation means that someone needs to develop the HR
practices that are critical to creating and sustaining a competitive
advantage with human capital. It also means that decisions to outsource
the HR function must be made with the appropriate information, and the
research in this area needs more development and clarity.
Future research should focus on other organizational
characteristics or environmental characteristics that affect HR
performance based on the amount of outsourcing. Other organizational
characteristics might include organization structure and design,
particularly in the HR department itself, or the size of the
organization. Other environmental characteristics might include boundary
spanning capabilities of the organization or the level of resource
dependence the firm experiences. Learning more about the conditions
under which HR outsourcing affects specific HR functions would help HR
departments plan accordingly when making decisions to outsource.
Although the purpose of this paper is to identify characteristics of the
organization or environment that determine when to outsource HR and
subsequent performance, another valuable component of determining
whether outsourcing is successful concerns the individuals performing
the work. A more complete model would include organizational,
environmental, and individual employee characteristics that all work in
concert to determine the appropriate situation in which to outsource.
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Juliana D. Lilly
Sam Houston State University
David A. Gray
The University of Texas at Arlington
Meghna Virick is a visiting assistant professor at the University
of Texas at Arlington. She joined the faculty in 2003, after she
completed her doctorate in business administration from the University
of Texas at Arlington, specializing in Human Resource Management and
Organizational Behavior. She earned her Masters in Industrial Relations
and Personnel Management from XLRI, India, and an MBA from Texas
Christian University. Since January, 2003, Dr. Virick has been serving
as Research Director of the North Texas Technology Council (NTTC), a
non-profit organization that promotes North Texas as a leading and
varied technology region. Her research interests are in the area of job
loss, diversity, and work family conflict. She has published in journals
such as Journal of Applied Psychology and Human Resource Management
Review. She has made numerous presentations at the Academy of Management
and Society of Industrial and Organizational Psychology.
David A. Gray is Associate Dean of the College of Business and
Professor of Management. He was awarded the Ph.D. in Business
Administration from the School of Management at the University of
Massachusetts in 1974. His research interests have focused on aspects of
human resource management and the labor relations process. More
specifically, he has researched strategic and operational rationales of
human resource outsourcing; the linkage of the HR value chain to the
employee-employer psychological contract and the performance impact of
various HR practices; and union management conflict and cooperation
before and after labor-management relations by objectives, or RBO. The
results of these and other research efforts have been published in the
Academy of Management Review, Academy of Management Executive,
California Management Review, OMEGA: The International Journal of
Management Journal of Labor Research, Journal of Collective Negotiations
in the Public Sector, Journal of Business Research, and national
proceedings of the Academy of Management and Industrial Relations
Juliana Lilly is an Assistant Professor of Management at Sam
Houston State University. She was awarded the Ph.D. in Business
Administration from The University of Texas at Arlington in 2001. Dr.
Lilly's research interests include organizational justice,
psychological contract violations, outsourcing, and layoffs. She has
published in journals such as Journal of Business and Public Affairs,
Managerial Finance, and Journal of Applied School Psychology, and has
made numerous presentations at the Academy of Management and regional