Gartner’s Bill Kirwin first introduced the TCO concept in the early 90’s as a method to analyze both the direct and indirect costs of owning and using hardware and software. Essentially, TCO can be looked at as a tool to help a company determine whether it benefits financially from the use of a specific technology.
Since it was introduced, TCO studies have proliferated in many industries, including HR and Payroll. However, many of these studies do not encompass all of the costs involved. For example, most payroll TCO studies came up with $2-4 TCO per paycheck. These payroll TCO studies don’t account for “hidden costs” or those that were shifted to other budgets.
Clearly a new approach to TCO was needed. To fulfill this need, ADP commissioned PricewaterhouseCoopers (PwC) to conduct two studies on Total Cost of Ownership for in-house payroll and human resources systems (2003) and for outsourced solutions (2004).
The two studies conducted by PricewaterhouseCoopers offer valuable points of comparison. The 2003 study provided strong evidence that in-house systems are more expensive and less strategic than buyers predicted. Then, in 2004, PwC showed that outsourcing with ADP offers an average 35-50% improvement in TCO as well as numerous cost advantages.
TCO Study - Part I
In early 2003, PwC sent invitations to controllers, CFOs and financial VPs of companies with more than 1,000 employees. With 181 companies participating that had average size of 6,500 employees, this study is one of the most extensive of its kind. At the time of the survey, 44 percent of the participating companies were using a major ERP system, and 56 percent were using other in-house or legacy systems. To accurately compare TCO across diverse companies and systems, PwC collected base data so that individual pieces could then be used to build the components of total cost.In an effort to precisely measure the total cost of ownership, PwC collected data on the following TCO components - many of which other studies have overlooked or have been unable to quantify:
- Initial System Costs – implementation, hardware and license costs amortized over 3 years
- Upgrade System Costs – cost of new hardware, internal and external labor
- Maintenance System Costs – maintenance fees, hosting, network costs, databases administration, IT help desk support
- Processing Labor Costs – Full Time Equivalents (FTEs) in the actual payroll department – also includes all labor costs related to print and distribution as well as reconciliation, year-end and tax filing, employee data maintenance
- Processing Non-Labor Costs – includes facility, General & Administrative (G– includes facility, General & Administrative (G&A), and corporate overhead
- Time and Labor Management (TLM) Labor Costs – the total cost of all the remote workers who spend time entering and collecting time data
Supported by a number of findings, the key conclusion from TCO Part 1 is that in-house systems are more expensive and less strategic than buyers may have realized. Of particular note is the finding that, when all costs are considered, the average in-house payroll system TCO is $2.5 million per year – or $16 per paycheck – and the average annual HRIS system cost for firms in the study was an additional $500K, or $88 per employee.
TCO Study - Part II
In 2004, PwC conducted a follow-up study to determine how outsourcing payroll and HR systems to ADP impacts Total Cost of Ownership. The goal was to make “apples to apples” comparisons to the 2003 study’s findings, and verify that ADP outsourcing clients have a lower TCO than in-house users.PwC’s invitation to participate in the 2004 study was accepted by financial executives from 46 ADP client companies with more than 1,000 employees. As with the 2003 study, respondents represent many industries and company sizes, with an average size of 6,700 employees. All participating companies outsource their payroll to ADP, with some also using ADP’s HR and Time and Labor Management (TLM) solutions. To accurately compare TCO across such diverse companies and industries, PwC collected base data that was used to build a consistent picture of total cost.
The key result from TCO Part II, again supported by a number of findings, is that outsourcing with ADP means an average 35% improvement in payroll TCO and more than 50% savings for HRIS, plus many other benefits associated with outsourcing. The mean annual payroll TCO per paycheck for ADP clients is $10 compared to the $16 cost for in-house systems, and the TCO for ADP Clients is $40 per employee versus $88 for in-house companies.
Best Practices in TCO
The PwC studies point to a number of ideas to consider when looking at calculating your TCO and making future payroll and HR system purchasing decisions.Understand Your True Costs
Accurately measuring and managing your TCO requires fully understanding your true costs. These means recognizing where your hidden costs lie, and avoiding shifting them to other budgets. Moving costs does not remove them – they are simply accounted for somewhere else, and this may actually cost the company more in the long run. When used effectively, knowledge of your TCO becomes a tool for achieving process improvement and best practices. According to Peter Weill and Jeanne Ross of MIT, “Companies that manage their IT investments most successfully generate returns that are as much as 40% higher than those of their competitors.”( “Six IT Decisions Your IT People Shouldn’t Make,” Jeanne W. Ross and Peter Weill, Harvard Business Review: November 2002, pp 86-91.)Step Off the Technology Treadmill
Only 25% of financial executives expect to reduce their costs as a result of upgrading or installing a new system, yet they continue to run on the technology treadmill. For some, fear of non-compliance may be driving their decisions to continuously upgrade an in-house system. As the studies explain, this may be a factor in the steady decline of the in-house system lifecycle. Conversely, aided by a lower TCO, the average tenure of ADP clients has steadily increased.Automate and Control Your Time and Labor Management Process
The studies showed that hidden costs associated with time and labor activities average out to a considerable percentage of TCO, are often not attributed to payroll department budgets. By automating and controlling these costs, companies can substantially affect their TCO. As noted in Part 2 of the PwC study, TCO savings increased when the payroll system was paired with an automated Time and Labor Management system.Maintaining system compliance is an ongoing process that adds considerable costs to a system’s TCO. When part of the system goes unused as “shelfware”, financial resources that could be channeled into your core business are wasted on unnecessary maintenance. Companies that choose to outsource transfer all of the responsibilities and costs associated with maintaining and upgrading systems to the service provider. In addition, they pay only for the functionality used, allowing resources to be allocated to other business areas.
Get Synergistic
Partnering with an outsourcing service provider can make your company stronger by tapping into synergies. ADP clients enjoy economies of scale that bring TCO down as company size increases. Clients using more than one outsourced solution can achieve both system and service synergies, which lead to cost savings in a number of areas, as well as time savings.Partner With A Trusted Outsourcing Service Provider
The two studies conducted by PricewaterhouseCoopers offer valuable points of comparison. If your company is still managing payroll and HR in-house, a close examination of the 2003 and 2004 results will point to best practices for decreasing your Total Cost of Ownership. Additional survey results and both PwC white papers are available at tco.nas.adp.com.