How to reduce the cost of HR and continue to provide value.(Current Practices)

In a recent survey by Hewitt Associates, (1) 75 percent of HR leaders said they were under pressure to reduce costs. The first step in managing HR costs is to establish a solid baseline; however, taking that first step can unearth unsettling news: True costs may be considerably higher than initially thought. Faced with increasing cost pressures, many HR executives find that a holistic view of HR costs, while shocking at first, is essential to finding cost-effective measures for streamlining HR.

One of the early findings from Hewitt's HR Analyzer[TM] (HRA) benchmarking study is that most organizations initially underestimate the cost of HR by as much as 50 percent. (2) Among companies that conducted a detailed assessment of total HR cost, the median per employee investment was close to $2,955, considerably more than the $1,300 to $1,500 per employee benchmarks commonly accepted as "appropriate" HR expenses. The same holds true for HR staffing levels; the median reported in the first release of HRA findings was 71:1 (company employees to HR employees), which is more than 25 percent less efficient than the 100:1 gold standard.

Companies like Verizon and Southern Company have achieved (or expect to achieve) sustainable cost savings in HR by taking a hard look at their current HR cost structure, and using that information to rethink their approach to delivering HR services. Before walking through some of the steps that these companies and others are taking, let us unbundle the HR cost equation.

Understanding the True Cost of HR

What is behind the higher than expected HR costs? In our experience, there are three drivers:

1. Hidden Costs: Focusing solely on the HR budget instead of taking a holistic view of HR delivery and the related costs.

2. Incomplete Transformation: Going down a path of centralization/shared services or outsourcing, etc., but not doing enough to change the HR organization or the behavior of employees.

3. Poor Alignment with Needs: Continuing to provide "soup-to-nuts" programs instead of focusing on the areas that are most important to the business.

Hidden HR Costs

HR is more than a department: It is a set of broad-reaching activities that support the organization in managing its people. At many companies, some of the costs associated with providing these services do not show up as part of the HR budget, but are still part of the total investment in human capital. To better manage these expenses, HR leadership must capture and quantify all HR costs. Three common hiding places are: the HR budget itself, decentralized HR activities, and HR technology investments.

The HR Budget. Across companies, there are great inconsistencies in HR budgeting practices. Does the company account for both federally mandated (FICA, unemployment) and health benefit costs for the HR staff in its labor loading rate? Is the cost of outsourcing vendors fully captured? Is HR assessed for real estate and office equipment? Is the cost of advertising for open positions and fees for search firms captured? What proportion of training is managed or delivered by HR? Are there expenses that pass through HR (severance costs, disability payments, etc.) that need to be excluded from the HR cost baseline?

Trying to reduce HR costs without first getting a handle on the entire HR expense is like trying to clean the corner of a swimming pool: You will have short-term success but will not change the overall quality of the water. HR may not directly control all the costs associated with HR, but has the responsibility to know what they are and to help provide stewardship for the company. For that reason, the definition of HR baseline costs should be based on objective standards.

Decentralized HR Activities. Thinking about all the activities that HR performs, there is a good chance many of them are not performed by HR professionals. Take something as basic as benefits administration. Employees may receive a summary plan description (SPD) that was drafted by Communications, call Payroll with questions about monthly deductions, gather education about benefits from an HR generalist, enroll through an employee portal developed by IT, and receive a confirmation from a third-party administrator who is paid by the Finance Department. Another common area of oversight is HR generalists who have a solid line reporting relationship to the business and a dotted line, or no, reporting relationship into corporate HR. In doing this type of analysis, a retail company, for example, found that more than a quarter of its HR work was performed by administrative staff in its stores.

If there are opportunities to reduce HR costs by streamlining processes, deploying self-service, outsourcing, or putting in an HR service center, it is absolutely essential to find out where that work is being done today and to factor that information into the summary of current costs.

HR Technology Investment. At most companies, the bulk of the spending on HR technology is made by IT. This amount can be four to six times what the HR department spends--yet HR rarely sees the charges or is involved in directing the service. HR needs to get a handle on this information both to be better consumers of corporate IT support and services, and to incorporate accurate estimates of IT investment and IT savings into any cost savings plans. HRIT costs outside the HR department budget fall into three categories:

1. Unallocated Corporate IT Expense: Vendor and internal costs to maintain software, hardware, and ERP systems.

2. HR Technology Products Purchased and Maintained by the Lines of Business: Investments in software and hardware to fill perceived gaps in the functionality provided by corporate. The two most common examples are organization charting software and sales compensation management systems.

3. Capitalized HR Technology Investments, Including a Portion of IT Labor: Depending on the company's accounting practices, inclusion of a substantial portion of implementation costs, for example. Capital expenses sit outside the operating budget, so they are easily overlooked when cost reduction strategies are being developed. If HR decommissions an application that is still being amortized, the company may be eligible to write off part of the expense and capture additional cost savings.

Incomplete HR Transformation

Many HR organizations are "stuck in the middle" when it comes to implementing new HR organization models. Although steps have been taken to centralize, automate, and, in some cases, outsource the administration of HR programs, a high proportion of HR time is still devoted to the basics. Among the companies in the HRA database:

* HR still devotes 46 percent of its time to routine administration and HR customer service. People may be assigned to roles like "Business Partner" and "Plan Strategist, but their work still entails a high volume of routine work.

* The people doing the routine work are often the wrong people: They are highly paid HR specialists who are supposed to be spending their time consulting to the business and designing programs. On average, HR generalists still devote 42 percent of their time to routine work.

* There is a high degree of fragmentation (many people spending small amounts of time on many activities) instead of in focused areas. Some of the areas with the highest levels of fragmentation include compensation administration, employee relations, and staffing and recruiting.

Despite large dollar investments--sometimes in the millions--to transform the HR function, HR continues to spend a lot of time and money on routine work. More importantly, HR professionals are not able to put the needed time and energy into working with line managers to develop talent strategies or design new programs for compensation and benefits. Inefficient administrative processes both drive up costs and handicap HR's ability to deliver value.

Poor Alignment of HR Programs with Needs

The flip side of focusing too many resources on administration is that many companies do not invest enough in the talent programs that are most important to their businesses. Business leaders assume that HR will deliver the basics, but they also look to HR to provide them with strategies and consulting on business issues. Improving alignment sometimes uncovers hidden costs. The real reason to look at alignment as part of a cost-management exercise is to keep track of the value side of the equation. The high-level checklist for ensuring alignment is:

* Having an HR strategy in place that is linked to business goals.

* Developing--and using--a screening process for evaluating whether new programs meet the needs of the business before funding them

* Measuring the impact of HR strategies and using this feedback to adjust course on an ongoing basis.

Thinking about cost and value together is the cornerstone of an effective HR cost-management strategy.

Achieving Cost Savings in HR: Two Approaches

HR staff salary and benefit costs are between 50 and 60 percent of the total HR budget. (3) It is virtually impossible to achieve significant cost savings without reducing HR headcount. At least 75 percent of the companies Hewitt surveyed are currently looking to reduce staffing levels in HR. The majority are also involved in at least one other effort to shrink HR by cutting programs or delaying implementation of new initiatives or technologies.

At least 60 percent of the companies surveyed are also committed to transforming HR and are undertaking at least two activities to change the way work gets done. (4) Comparing these two approaches, we find the second, transforming HR, is the better way to deliver sustainable cost savings. In both scenarios, gaining a solid understanding of HR costs today is a critical part of delivering value over the long run.