Providers are responding to buyers’ scepticism with consolidation. Will it work?
By Russ Banham
Consolidation is inevitable in every nascent service industry. As companies grow organically, they reach their limits. Future growth, expertise, reach, and scale are achieved by acquiring competitors.
In the HRO world, the above applies, but so does something else—the failure of many providers to deliver global, multi-tower services. While the end-to-end offerings sold to Fortune 100 clients such as DuPont, Johnson & Johnson, Motorola, Goodyear, BP, and Unilever had much to recommend them, delivering on them profitably proved an uphill climb for the providers. And that made selling more of them problematical.
With such deals virtually nonexistent these days, many providers’ growth engines have stalled. Fueling the rest of the uphill climb, they’re hoping, is the extraordinary M&A activity that has reshaped the HRO market. The news in July that Aon Corporation agreed to buy Hewitt Associates for $4.9 billion in cash was just the latest in a parade of big business alignments, beginning with Hewlett-Packard and EDS, though more recently exemplified by NorthgateArinso and Convergys, Xerox and ACS, ADP and Workspace, and ACS and ExcellerateHRO.
While these deals generally draw praise from HRO consultants, the Aon-Hewitt acquisition has its share of detractors. Nevertheless, all the consolidations seem predicated on the realization that the HRO market has matured and needs a kick-start to get it going again. Certainly, big money-making deals are few and far between today, and with the economy as shaky as it is, growth was becoming ever more elusive. “Firms are distracted with everything else going on,” says Stan Lepeak, managing director for global research at sourcing advisory firm EquaTerra. “As they go forward, they’re becoming smarter about what kinds of deals can be done safely.”
The mega-deals of yesteryear, in terms of multiple processes, people, and geographies, are being de-emphasized by HRO providers. At least, adds Lepeak, for the time being. “I think buyers want to get to that place eventually,” he says, “but they’re exercising caution, inking smaller, more iterative deals, versus going out and doing the big bang.”
Blame provider caution on buyer’s remorse, adds Lepeak: “Expectations ran ahead of the ability of providers to deliver, creating issues for firms like Convergys, Hewitt, and even ACS, IBM, and Accenture. Providers recalibrated their approaches a couple of years ago, realizing that internally it was too hard to deliver multiple processes to 50 countries and that a more iterative approach might be better. Then, the economy tanked eroding what little appetite was left to do the mega-deals.”
End-to-End to End?
Had the big, global end-to-end outsourcing solutions delivered expected profits, rather than becoming a drag on the rest of the enterprise, more deals might have been struck. But this wasn’t the case. “Service providers that had these high growth expectations struggled to deliver service to their clients, and as a result they had neither highly referenceable clients, nor solid success stories to tell,” explains Jeff Croyle, a partner at Houston-based sourcing advisory firm TPI.
“For example, here’s Convergys five years ago pounding its chest that they just got Johnson & Johnson as a billion-dollar client, and then three years later they were in deep woe because they had J&J and another billion-dollar client, DuPont, and were struggling with them both,” Croyle adds. “Before long, they’re announcing $500 million in losses from just those two implementations. It was a disaster.”
Obviously, this is not the best way to advertise the merits of future large global deals to the marketplace. “Prospective buyers are sitting on the sidelines waiting to hear bona fide success stories in these big global service offerings,” Croyle says. “Instead, they hear all this noise about contracts getting re-scoped, the providers asking for more money, and the clients’ shortcomings with regard to their willingness to standardize processes. It’s not like the buyers are sitting on a burning platform and have to do something now. Instead, they’re waiting for the market to stabilize.”
Convergys wasn’t alone in discovering the trials of delivering top-notch service across a spectrum of processes, much less move multiple clients to a shared IT platform. No provider was, indeed, a jack-of-all-trades, despite protestations to the contrary. “The key players in the HRO space are now centering their offerings on three pivotal processes—payroll, benefits administration, and recruiting,” says Phil Fersht, CEO of HFS Research, a Boston-based global outsourcing research firm. “With the exception of maybe ADP and Ceridian, most players are focused on business areas where they can create some scale, building a platform they can then replicate across multiple clients.”
Mergers and acquisitions enhance the ability to acquire this scale. “If the providers know what they’re doing and have profitable contracts, they’re able to start having common resources across multiple clients,” Fersht says. “Filling in geographic holes is another benefit.”
Each of the recent consolidations—leaving aside Aon and Hewitt for the moment—stick to this theme. Take NorthgateArinso and Convergys. The former itself is the consequence of a merger between U.K.-based Northgate and Belgium-based Arinso. Northgate was a major player in developing HR software and wanted to expand into HR outsourcing. Arinso was in the game of HR systems integration and consulting, essentially implementing SAP HR systems. The combination allied their respective strengths, while boosting market presence across Europe and Asia. This was abetted by the combined entity’s recent acquisitions of some German HRO assets shed by HP-EDS, and the payroll outsourcing business of Randstad in the Netherlands. Other deals were struck to boost its presence in Australia and New Zealand.
North America service capabilities remained wanting, however. That’s where the $100 million deal to acquire the HR management division of Convergys made terrific sense. “It’s our biggest acquisition after the Arinso deal, and it was predicated in large part on Convergys’ footprint in North America,” says Michael Custers, vice president of marketing at NorthgateArinso. “We also were coming from the payroll and HR consulting space, and they bring us expertise in learning and benefits administration. Finally, their global delivery capability maps very nicely with ours. For instance, they have a service center in Budapest, which at some point is a region for expansion for us. We had only a limited presence in Poland and were looking at expanding in Eastern Europe—so it’s not strictly a North American story.”
The combined entity gives each provider’s customers a broader HR process scope and one that is equally represented around the world, Custers says. “Perhaps best of all, we’re no longer sitting in the middle space—we’re in the top tier of players now,” he adds. “We no longer have to work through partnerships or local, small vendors to provide a fuller scope of services. We can offer them now on our own. We’ve got plenty of delivery capability, from Newfoundland to Florida to London.”
Consultants are bullish on the merger. “NorthgateArinso wanted to get bigger in HRO, and now they are,” says Lepeak. “Convergys, on the other hand, just wanted to get out of the business and stick to its core customer care work. HRO was a distraction to management and a drag on profits. Now that NorthgateArinso has Convergys’ HRO business, it can take a longer-term perspective and make investments to improve the situation. That’s good news obviously for customers of Convergys—like J&J and DuPont.”
Still, Lepeak believes that both providers and buyers in the really big deals will have to make concessions down the line. “Services in small global markets that are inherently unprofitable may have to be pulled back, or to continue to provide this the buyer might have to pay more,” he explains. “Another concession might be a situation where the provider is permitted by the client to take more work offshore.”
Croyle says Convergys’ $250 million in recurring revenue from the HRO business was tantalizing to NorthgateArinso. “Convergys was stuck with realizing its implementation failures had pretty much set its destiny—they were not about to win another client,” he says. “Their chances were less than zero. Now, as part of NorthgateArinso, they’re in a winnable position.”
He explains that NorthgateArinso is a buyer with an optimistic view of the market and confidence in the ability to stabilize existing clients. “They have a strong heritage in the payroll space and hovered on the cusp of being a tier-one HRO provider,” Croyle says. “They’re now that, and have improved their market position in North America. It was a hard deal to pass up, and a great deal for the marketplace.”
NorthgateArinso now jumps into second place in the number of HRO contracts bound and the number of client employees serviced, just a notch behind Hewitt. “If you’re Johnson & Johnson or another Convergys client, you at least now have the knowledge that you’re being serviced by a company that is stable and has a strong technology background,” says Croyle. “The combined entity is prepared to handle the pent-up demand for services and service enhancements from existing clients.”
The Xerox-ACS deal also earns hurrahs. Like Convergys, ACS was struggling to implement promised services to the large global clients it had signed up like GlaxoSmithKline. Consequently, the firm had essentially stopped chasing other large and complicated global deals. “ACS also had suffered from some boardroom drama and was trying desperately to pretty up its balance sheet,” says Croyle. “All of this took time away from its implementation work. Now that is has been purchased by Xerox and has that company’s strong financial backing, it is out there again in the marketplace pursuing large deals more aggressively.”
Lepeak says the acquisition was “complementary,” since the type of outsourcing services that Xerox provided didn’t overlap with ACS’ service provisions. “ACS expands their services footprint faster than they would have organically,” he adds. “ACS also had a nice-sized operation in the U.S., but they were not a major player in places like Asia.”
Another touted benefit of the deal is that ACS now has its foot in the door to scout out business with current Xerox clients. “If you’re a Xerox customer, you now have ACS, and there could be some value in that. And if you’re an ACS customer, you’re getting a more viable, stable provider with greater global reach,” Lepeak adds.
Certainly, Xerox sees its $6 billion acquisition of ACS as a powerful combination. “We’ve created an organization that owns the entire value chain,” boasts Rohail Khan, executive managing director of total benefits outsourcing services at what is now called ACS, a Xerox Company. “We’ve now got the IT infrastructure and domain infrastructure with workflow and fulfillment. While ACS’ customer base was historically U.S.-centric, we can now offer customers a global delivery environment north of 70 countries, given that more than half of Xerox’s revenue comes from outside the U.S.”
ACS’ subsequent acquisition of ExcellerateHRO, a global benefits administration and relocation services provider, affirms Xerox’s commitment to the HRO market, Khan says. “It broadens our access to new industries and markets, allowing us to introduce our proprietary technology platform and business processes to an expanding marketplace,” he notes. “We also pick up 1,000 employees globally with deep expertise in health and pension services, and gain broader depth of services in the UK, Canada, Brazil, and the Netherlands. Finally, there was very little overlap in our respective client bases, opening up service opportunities in each other’s client base.”
The various deals certainly seem prudent, given the pronounced difficulties that players were experiencing going it alone. Clients seem better off—none have bailed out of the combined enterprises since the deals’ announcements. As Lepeak notes, “Had not the mergers occurred, you’d likely see more of a rush for the exits. This isn’t to say some of the deals going forward aren’t going to be restructured, however.”
The Aon-Hewitt deal, at $4.9 billion in cash almost as big as the Xerox-ACS acquisition, is a different case in point. Although it nearly triples the size of Aon’s consulting business, some people believe the insurance brokerage firm might have overpaid for Hewitt. Fersht raises other issues. “I’m concerned with the impact on Hewitt's culture and brand, which has been steeped in HR consulting for more than four decades,” he says. “While on paper I can see some minor synergies in terms of scale, geographic presence, and financial offerings, one has to question their two very different cultures and the potential impact on Hewitt’s consulting and managed services offerings, once the Aon corporate machine gets its claws into them.”
Fersht would have preferred that a “true” HRO provider, “one with global HR offerings, especially pan-European” had acquired Hewitt, he says. “A provider with deep technology integration expertise would have been hugely beneficial. Aon will not provide that, unless it hasn’t finished its shopping excursion.”
Of course, if past is prologue, Aon might indeed continue its acquisition spree. The firm has made dozens of purchases in recent years, aimed at reorganizing its menu of business services in the face of soft insurance pricing and weak economic growth. Aon previously was in the multi-process HRO space, netting AT&T as a client, and had entered into an IT-integration partnership with CSC, before exiting the business. “This time around,” says Fersht, “they need to figure out their HR technology services strategy. There are several willing participants out there with real HR IT acumen, including Deloitte, which might be looking at new HRO partners since Convergys’ HRO business was acquired. Others include Indian providers with deepening HR IT capabilities like Infosys, TCS and Wipro.”
Aon’s chief spokesperson, David Prosperi, touts the deal’s benefits even absent any further acquisitions. “What it means for Aon’s consulting, risk, and reinsurance clients is that they will be the beneficiaries of a more complementary product portfolio across consulting, benefits outsourcing, and HR business process outsourcing,” he says. “Clients of Hewitt Associates will benefit from access to Aon’s analytics capabilities, our deeper footprint in healthcare brokerage, and access to our McLagan and Radford brands. McLagan provides advice to Aon consulting clients on market pay and performance information, and Radford is the leading provider of compensation market intelligence and services for the technology and life sciences industries.”
While declining to comment on the prospect of any future acquisitions by the new entity, Kristi Savacool, Hewitt’s senior vice president of large markets benefits outsourcing, likewise extols the merger’s synergies. “There really aren’t large hurdles or challenges to overcome,” she says. “In fact, the complementary nature of the markets that are served—Hewitt being largely focused on the large market, and Aon focused on the mid-market—and the complementary geographies—Aon being highly present in the international markets more-so than the domestic and, in turn, Hewitt having a large North American presence and a smaller European and international presence—when you bring those together, you have a highly complementary set of circumstances.”
Savacool does acknowledge that existing clients of each firm have been “anxious to learn more.” But she also says that the reaction has been generally positive. “Our message to our clients,” she says, “has been this is good for you. . . . Your client teams are intact, they are not distracted they are staying focused on you. This is additive in terms of resources and footprint.”
What Does It All Bode?
With the HRO competitive landscape markedly different from what it was just two years ago, will there be a return to the industry’s heyday of large, global end-to-end deals? Khan says no. “I think the days of the galactic HRO deals are gone,” he explains. “Expectations didn’t match reality and providers suffered. We’ve learned the hard lessons of doing too much, and we’ll see more of a shift to best-of-breed combinations—like eight or 10 facets of HR in a multi-tower, but not 45 of them.”
Custers has a slightly different view. “I think end-to-end and single-point solutions will both be around,” he says. “Sure, there’s going to continue to be nervousness about the big HRO deals, but standardizing the processes and letting technology do the rest of the work will make them more feasible.”
For now, though, companies involved in the spate of recent acquisitions will be looking more inward—toward integrating their respective organizations—than outward to customers. As Lepeak puts it, “Back-office issues will get all the attention for the time being.”