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TCO in the Context of Risk

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Many regular readers of SystematicHR know that I conducted a Total Cost of Ownership study to determine the cost of benefits administration. The results were released last December. Double Dubs commented on it here, and it is how I originally came to find his great blog.

Generally, TCO is a means at getting at hidden costs. It is a way to determine the full and total cost of manufacturing, maintaining, administering, etc. a widget or function. Unfortunately, there is something TCO can’t do: measure and calculate risk or factor in quality.

The TCO studies I have conducted demonstrate that within the study groups, there is considerable variance in the bottom line cost for administration. In the case of the benefits administration and payroll studies I conducted, cost variance is consistently greater among the in-house administration group.

I would contend that the reason for this is that quality and service level is much more likely to differ widely among companies administering in-house. When a function is outsourced, the outsource provider will generally offer the same level of service and quality to all clients. Cost variance among the outsourced group comes as a result of the combination of the costs associated with the retained organization and the deal that a client cut with the outsourcer during contracting.

What does this mean, then, for a company that benchmarks costs against a peer group of companies who insource, and finds they are an outlier in that its costs are TOO LOW? Anecdotally, when I have seen this exact situation, I find that there comes a point in which cost containment and reduction clearly increases the risks associated with administration. We will more likely see fines or penalties related to non-compliance or, in the case of benefits administration, see errors in claims payments due to eligibility problems.

I wonder if the line managers that try to understate cost ever thought about how costs that are too low might be interpreted.

As companies evaluate their sourcing options for payroll, HR and benefits, this should be carefully considered. A financial business case that does not consider risk mitigation is not a complete business case. Some would counter that risk mitigation is a non-financial benefit of outsourcing. I believe it is integral to the financial case.

To begin, one can add up the total cost of error experienced over the past 3-5 years. How much in penalties has been paid for tax reporting errors, for example? In an in-house versus outsourced business case, how could assumptions be made that future in-house administration would experience greater quality so as to avoid future penalties?

Ultimately, companies will behave much as individuals do. Some will be willing to take on more risk than others. The risk of speeding is a speeding ticket and financial loss. Certainly, I wouldn’t expect continued speeding to cost me less in the future, but I will consider it when determining how fast I drive. The past experience of getting caught will impact the likelihood of speeding in the future. Get enough speeding tickets, and eventually I will outsource the driving (talk to David Letterman about that).

If I run afoul of the IRS often enough for a big enough price, eventually I will outsource payroll. Small business owners probably know that lesson better than anyone else. They also are probably more risk adverse as life savings are tied up in the business.

Next week I will write more specifically about measuring risk related to group benefit plans and techniques on evidence based cost avoidance.

About the author – Donald Glade is President and Founder of Sourcing Analytics, Inc. , an independent consulting firm specializing in helping companies optimize their HR / benefits / payroll service partnerships through relationship management, financial analysis, and process improvement.

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3 responses to “TCO in the Context of Risk”

  1. […] In a prior post I wrote about the Total Cost of Ownership (“TCO”) in the context of risk.  Today I would like to write about techniques to measure the cost of risk, particularly in the case of administering benefit plans. […]

  2. […] Last week I promised to write about measuring risk related to group benefit plans and techniques on evidence based cost avoidance (when I put it that way, it sounds so boring!)  I’m sorry, but some other news broke last week that I felt compelled to comment on.  I’ll get back to measuring risk next week. […]

  3. […] Measuring Risk In a prior post I wrote about the Total Cost of Ownership (“TCO”) in the context of risk. Today I would […]