By Zac Ma – Associate Director, SEA Sales, Links International Singapore
*Disclaimer: This blog article is my own perception of an approach which I think is suitable for small to mid-sized organisations.
I’m sure that there are more sophisticated analytical methods to ROI considerations, but the approach described here would at the very least help stakeholders who are unaware as to how to begin calculating their Payroll Outsourcing ROI from a basic understanding of a concept that they can dive into with their steering committee.
NelsonHall predicted in 2016 that the payroll outsourcing sector in Asia Pacific is estimated to grow at twice the rate of the total global market, with multi-country outsourcing demands quadrupling the current take-up rate. The report attributes the significant growth potential to the relative immaturity of the market, an increase in demand for multi-country payroll solutions and compliance driven requirements.
Although cost may not always be the top driver for payroll outsourcing in Asia, 90% of buyers, including mid-market organisations, tend to outsource their payroll in order to reduce costs.
Getting the Basics Right is Important
This brings us to the question of cost comparison; comparing the total cost of ownership (TCO) of in-house payroll management and payroll outsourcing of single country or regional requirements.
I have come across many organisations, small to mid-sized especially, misrepresenting the true TCO of in-house payroll management. According to IBM in 2016, one in three business leaders doesn’t trust the information they use to make decisions, with poor data quality/analysis costing $3.1 trillion annually, in the US alone. Stakeholders end up looking at misunderstood numbers and make poor business decision in the process.
With this in mind, I thought it would be useful to share my experiences on the different considerations that organisations should be aware of when performing their own internal crunching, to see if there’s an opportunity to reduce costs if they outsource their payroll.
Over time, I see many payroll service and software providers offering their own interpretation on Payroll Management ROI. However, it is very seldom that I see vendors flagging considerations that are difficult to measure and how to cost them (I will list a couple of examples in the next sub-section).
To a huge extent, most forms of ROI methodology follow the fundamentals of Gartner’s TCO framework, while adding payroll specific considerations as a basis of analysis.
Many veterans of the consulting industry might be aware of this approach, but I believe this is not the case for the many HR/Finance Managers and their payroll teams who are often tasked with performing the ROI analysis by their higher management.
The Guide to Payroll Outsourcing ROI Calculation
The general concept of Gartner’s framework is to generate a “chart of accounts” that lists all of the cost elements taken into consideration. The definition of cost elements is broken down into “direct cost” and “indirect cost”.
Below is a listing of the “direct” costing elements, which is not exhaustive, but should be a good comprehensive guide that most organisations should consider in their evaluation.
Payroll Management Direct Cost
The “chart of accounts” on all costing elements (direct and indirect) should be represented as an annual view, so that certain elements with depreciation factors such as server, laptops, etc. can be properly costed.
- Payroll software implementation, customisation, licensing and related support costs
- Payroll software maintenance and development costs
- Payroll software/compliance training costs
- Client/server, storage and all peripheral costs, if applicable
- Cloud infrastructure, hosting, backup costs, if applicable
- Bandwidth, networking and communication costs
- Audit and compliance, e.g. penetrative testing, information security framework audits etc
- Payroll employee salary cost by FTE spent on payroll processing (should include time getting and waiting for support from vendor etc.)
- Non-payroll employee salary cost by FTE on payroll processing support
- Finance, IT operations support costs
An Example of Assessing Direct Cost of Payroll Management
The tedious part (nobody says that this is easy!) of the analysis is getting input from various stakeholders on their involvement in the payroll process and “calculating” employee costing and FTEs spent on the process.
Below is a simplified example of a few screenshots showing how you can use a simple spreadsheet to gather employee information for your analysis.
Usually, I would suggest to start with identifying the direct payroll processing employees involved (finance and/or HR) and map the time on each activity.
The salary cost of the employees can then be analysed by the amount of FTEs spent by each role. See below for further illustration.
Again, this is a simplified version, but it should give a good idea as to how this would work when gathering third party and IT cost information. Gathering the total direct cost of payroll management would then form the baseline TCO.
Payroll Management Indirect Cost
Most people would understand “direct cost” consideration with ease, but the difficult part relates mostly to assessing “indirect cost” elements. From my observation, most organisations fail to assess this cost impact correctly in their analysis.
In the context of payroll management, below are some examples of “indirect cost” that are difficult to measure and cost.
- Measuring payroll complexity and its cost
- Measuring cost of compliance and the risk association and its costs
- Measuring operational key-man risks and its costs
Payroll complexity, compliance management (e.g. data privacy, information security etc.) and operational key-man risks represent some of the key elements of “indirect cost” that even the most robust and well-run businesses often fail to comprehend.
Further to this, there will be added complexity when cogitating the dynamics of multi-country payroll requirements, i.e. different languages, time zones, payroll systems, pay rules, culture, etc.
An example of how complex assessing these elements and its cost impact would be is that Gartner’s best practice stipulates that organisations should monitor the total cost of compliance relative to its effectiveness and that higher spending will not necessarily mean a higher level of compliance or reduction of risk.
The key objective here is to understand, categorise and communicate the complexity and risks of non-compliance to the business and have a consensus agreement on the preferred profile, while designing a framework to measure its cost impact.
This is also why each organisation is unique and not one “payroll ROI calculator in the market” is able to truly represent the process landscape for business decisions. For instance, recently in 2016, MAS in Singapore issued new guidelines on outsourcing risk management to all financial institutions, and organisations are encouraged to prudently adopt best practices to ensure they perform their due diligence when outsourcing tasks to third party suppliers.
Setting Up a Complexity Factor
One of the easiest ways to establish a factor to adjust the baseline TCO calculation is to create a complexity profile via a series of weighted questions regarding the payroll environment.
For example, on a scale from 1-10, the internal subject matter experts can help rank the complexity of the payroll processes. A complexity score index can be created using the average result to determine a factor that is used to adjust the TCO baseline. A complexity score index of 5 can represent average complexity and no adjustment is applied, while an increment/decrement of 1 represents 20% adjustments.
Some questions for reference (on ranking 1-10 on complexity, with 1 “as no effort required” and 10 “as the most time-consuming to understand”):
- How complex are social insurance contribution calculations in the country?
- How complex is social insurance contribution lodgements process in the country?
- How complex is time-attendance management to payroll in the country?
- How complex is year-end tax preparation in the country?
- How complex is year-end tax lodgements process in the country?
- How complex is expat payroll in the country?
- How complex is expat tax lodgements process in the country?
- How complex is severance calculation management in the country?
A similar approach can be used for compliance and operational risk concerns and an index can be created for the same purpose of adjusting the baseline TCO. However, to precisely identify key risks and the correct weightage for each risk item, we can add an extra layer of scoring mechanism using a simple risk analysis method such as FMEA (failure modes and effects analysis).
“What If” TCO Simulation
An alternate way to assess cost of compliance, operational risk and other indirect cost concerns that are difficult to measure would be to gather benchmarks or perform an internal study on “what-if” scenarios. These processes would of course be more intensive but more accurate as compared to the former “index” methodology.
Organisations can engage benchmark readings with the help of consulting/research firms to generate a “what-if” TCO simulation. For example, if compliance is managed in-house, what would be the estimated annual spending, if a payroll employee was to resign, and what would be the estimated cost of hiring and training a replacement?
An important factor to remember when comparing the TCO of in-house payroll management and payroll outsourcing is that some time is also retained in-house, e.g. providing data, checking, approvals, etc.
Calculating Return on Investment (ROI) on any topic can be taunting, complicated and time consuming, but it’s necessary to get the basics right in order to set precedence on forming a solid foundation for current and future needs assessments.
Links International is a leading payroll outsourcing provider in Asia and supports 15 countries across Asia-Pacific. If you’re interested to explore the idea of payroll outsourcing, please do not hesitate to contact us.