Outsourcing HR: The Impact of Organizational Characteristics 125

OUTSOURCING HR: THE IMPACT OF

ORGANIZATIONAL CHARACTERISTICS

Brian S. Klaas, John A. McClendon, and Thomas W. Gainey

This study investigates the relationship between a number of organizational characteristics and
the decision to outsource HR. Determinants of the outsourcing of four categories of HR are
examined: HR generalists activities (e.g., performance appraisal), transactional activities (e.g.,
payroll), human capital activities (e.g., training), and recruiting and selection. HR executives in
432 organizations provided data on outsourcing levels and organizational characteristics. Reli-
ance on HR outsourcing was associated with idiosyncratic HR practices, strategic HR involve-
ment, positive HR outcomes, promotional opportunities, demand uncertainty, and pay level. As
predicted, however, the impact of organizational characteristics varied among the different types
of HR activities outsourced. 2001 John Wiley & Sons, Inc.

Introduction (Huselid, 1995; Becker & Gerhart, 1996),

While HR activities have traditionally been
performed in-house, advocacy for the
outsourcing of HR is increasing (Stewart,
1996; Jamrog, Groe, & Pyle, 1997). Some ar-
gue that HR outsourcing can reduce costs,
increase service quality by producing greater
economies of scale, increase incentives and
accountability for service providers, and in-
crease access to experts in specialized areas
(Csoko, 1995). Others, however, argue that
outsourcing exposes organizations to oppor-
tunistic behavior by contractors, that HR
outsourcing will limit the ability of firms to
develop distinctive competencies within its
workforce, and that outsourcing will create
inefficiencies because contractors are often
unfamiliar with their clients strategy and cul-
ture (Ulrich, 1996). As a result, while research
has shown the importance of effective HR
management to organizational performance
there has been considerable controversy about
who should perform HR activities (Wright,
Gerhart, Snell, & McMahan, 1997). While HR
Although HR outsourcing may be increas- activities have
traditionally
ing, there is substantial variation in how firms
been performed
are responding to this controversy (Csoko, in-house,
1995). While some firms may make little use advocacy for the
of HR outsourcing, others rely heavily on the outsourcing of
use of outside vendors to provide HR activi- HR is increasing.
ties, ranging from routine administrative tasks
(Jamrog et al., 1997) to heavy reliance on
outsourcing of major portions of the HR func-
tion (BNA, 1996; Corporate Leadership Coun-
cil, 1996; Goldfarb & Naasz, 1995). Given that
HR outsourcing has important consequences
for the quality and cost of HR as well as for the
HR profession (Ulrich, 1996), it is important
to better understand why firms differ in the use
of this increasingly important practice. Our
study attempts to shed light on this issue by
examining how organizational characteristics

Human Resource Management, Summer 2001, Vol. 40, No. 2, Pp. 125138
2001 John Wiley & Sons, Inc.
126 HUMAN RESOURCE MANAGEMENT, Summer 2001
are associated with different forms and levels
of HR outsourcing.
In a previous article (Klaas, McClendon,
& Gainey, 1999) we surveyed HR executives
to investigate the perceived benefits of
outsourcing a broad array of HR activities. The
outsourced activities surveyed were, in turn,
factor analyzed to classify four types of HR
outsourcing: HR generalist activities (e.g., HR
planning, performance appraisal), transac-
tional activities (e.g., payroll), human capital
HR outsourcing,
however, can
activities (e.g., training), and recruiting and
take many forms, selection. We found that the relationship be-
ranging from tween the degree of HR outsourcing and its
routine payroll perceived benefits were moderated by reliance
administration to on idiosyncratic HR practices, uncertainty,
training program
firm size, and cost pressures. While our previ-
delivery to HR
planning. ous article dealt with the perceived benefits
of HR outsourcing, perhaps a more funda-
mental question concerns why firms differ in
their reliance on outside vendors. Given that
organizations have unique competitive envi-
ronments, cultures, practices, and strategies,
organizational differences are likely to affect
the advantages and disadvantages associated
with outsourcing HR. As such, factors unique
to the organization are likely to influence the
decision to acquire HR services from external
vendors. In this study we attempt to build on
our previous article by examining how organi-
zational characteristics are associated with HR
outsourcing levels.
HR outsourcing, however, can take many
forms, ranging from routine payroll adminis-
tration to training program delivery to HR
planning. While some HR outsourcing may
involve routine administrative tasks, other
functions may involve the design of HR sys-
tems that are likely to have a fundamental in-
fluence on organization culture and
performance. Given these distinctions among
HR activities, various organizational charac-
teristics may impact the feasibility of
outsourcing some forms of HR activities more
than others, resulting in different determi-
nants for various forms of HR outsourcing.
Consistent with the idea that different types
of HR outsourcing may have different deter-
minants, we examine how organizational char-
acteristics are associated with choices
regarding the outsourcing of a range of differ-
ent HR activities. In doing so, we assess the
outsourcing of HR activities that are classi-
fied among the same four categories of HR
activities examined in our previous study
(Klaas, et al., 1999): HR generalist activities,
HR transactional activities, human capital ac-
tivities, and recruiting and selection.
The Determinants of HR Outsourcing
Questions about HR outsourcing relate to
many of the broader make or buy issues
addressed in Transaction Costs Economics
(TCE) (Williamson, 1996). According to TCE,
HR outsourcing may be viewed as relying on
market contracting as a form of organization
structure as opposed to relying on organiza-
tional hierarchy. Given that an organizations
characteristics will likely affect the costs and
benefits associated with market contracting
(Williamson, 1991), we use a TCE perspec-
tive to develop hypotheses that predict rela-
tionships between organizational
characteristics and the outsourcing of four
categories of HR activities.
Idiosyncratic HR Practices
Where organizations utilize a distinctive ap-
proach to managing its workforce (Barney,
1991), HR outsourcing is likely to require up-
front investment in understanding the particu-
lar needs of the organization. This up-front
investment is likely to be substantial in that
HR processes cannot always be codified and
often are based on tacit knowledge (Conner
& Prahalad, 1996; Barney, 1991). As a result,
this increased cost will likely be reflected in
the price charged for services provided
(Williamson, 1996). In addition, where firms
emphasize distinctive practices, they will likely
limit the ability of the contractor to provide
satisfactory services. Beyond this, outsourcing
is argued to result in greater economies of
scale due to availability of multiple clients with
similar needs (Abraham & Taylor, 1996); how-
ever, economies of scale will decline when id-
iosyncratic practices require specific
investments. The reduction of economies of
scale will, in turn, adversely impact the cost
advantage of HR outsourcing.
Although relying on unique practices
may change the advantages associated with

outsourcing, the impact of idiosyncratic
practices may depend on the type of HR ac-
tivity outsourced. For example, practices
such as performance appraisal, training, and
selection involve either strategic or special-
ist activities and, thus, may directly reflect
the organizations unique culture. As such,
to the degree the organization develops id-
iosyncratic practices, these strategic related
and specialist HR activities may depend
heavily on tacit knowledge. Conversely, more
routine administrative tasks such as payroll
administration may rely less on organization
specific tacit knowledge. As a result, we pre-
dict that to the degree the organization de-
velops idiosyncratic practices, there will be
less reliance on outsourcing for HR gener-
alist activities, human capital activities, and
recruiting and selection activities, but not
transactional activities.
Hypothesis 1: Where decision-makers be-
lieve their firms approach to managing
HR is idiosyncratic, reliance on outsourcing
of generalist, human capital, and recruit-
ing and selection activities will be lower.
HR Strategic Involvement
In recent years there have been repeated calls
for HR to become more of a business part-
ner or play more of a strategic role that fo-
cuses on organization-level performance
(Wright, Gerhart, Snell, & McMahan, 1997).
To the degree this occurs, HR managers be-
come more strategic, business oriented, and
broad in perspectiveall changes that re-
quire substantial knowledge regarding the
firms business processes and strategic direc-
tion (Ulrich, 1996).
For HR managers who are more strategi-
cally involved, it is likely that they will direct
more attention toward HR activities that have
strategic relevance, are central to organization
performance, and require a deep understand-
ing of the firms practices and culture. Con-
versely, strategically focused managers may
become less focused on the execution of rou-
tine activities such as payroll and specialist
activities such as training, reducing the feasi-
bility of conducting less strategic activities in-
house. As a result, a more strategic focus will
Outsourcing HR: The Impact of Organizational Characteristics 127
likely result in lower perceived benefits asso-
ciated with in-house delivery, increasing the
perceived advantages of outsourcing. HR man-
agers, however, who continue to play less stra-
tegically oriented HR roles will likely continue
to emphasize in-house HR delivery of all HR
activities. In fact, given that these managers
have few alternatives, continued emphasis on
in-house HR management will be consistent
with the self-interest of these managers. We HR managers,
however, who
predict, therefore, that to the degree that HR continue to play
is a strategic player in the firm, there will be less strategically
greater tendency to outsource HR. oriented HR
Again, however, the impact of strategic roles will likely
emphasis will likely vary with the type of HR continue to
emphasize in-
outsourcing used. For firms emphasizing the house HR
influence of HR in strategic initiatives, gen- delivery of all
eralist activities will likely require a high level HR activities.
of understanding of the firms strategic plan-
ning, increasing the costs and risks associ-
ated with the use of outside vendors. In
contrast, more routine transaction and spe-
cialist activities will likely have less to do with
organization strategy and, thus, these func-
tions may require little direct involvement of
strategic decision makers. As a result, strate-
gic oriented HR managers may be motivated
to outsource transaction, human capital, and
staffing activities for two reasons. First, with
respect to human capital activities and re-
cruitment and selection, focusing on strate-
gic involvement may lead these managers to
acquire specialized expertise from well estab-
lished vendors. Second, because transac-
tional activities require little strategic
involvement, strategic oriented managers will
be attracted to the potential cost savings as-
sociated with greater economies of scale for
these administrative activities.
Hypothesis 2: Reliance on the
outsourcing of transactional, human capi-
tal, and recruiting and selection activi-
ties will be higher in firms where HR is
seen as being involved with strategic con-
cerns within the business.
Positive HR Outcomes
According to the resource-based view of the
firm, achieving positive HR outcomes is often
dependent on tacit knowledge (i.e., knowledge
128 HUMAN RESOURCE MANAGEMENT, Summer 2001
acquired via experience without being reduced
to formal decision rules or programmable rou-
tines) (Wernerfelt, 1995; Barney, 1991). With
in-house management of HR, managers pos-
sessing tacit knowledge can accomplish posi-
tive outcomes by directing subordinate activity
even where subordinates may not fully under-
stand the basis for their directions (Conner &
Prahalad, 1996). Over time, the leadership and
direction by managers possessing tacit knowl-
edge results in this knowledge being internal-
ized by subordinates. With HR outsourcing,
while objectives can be contractually speci-
fied, methods and processes are difficult to
incorporate if they are based on tacit knowl-
edge (Masten, 1988).
Tacit knowledge is the result of an accu-
With in-house mulation of experiences and, as such, may be
HR, costs may be difficult to communicate to those without
incurred by equivalent experience (Barney, 1991). Since
employees contractors control work processes, unless
pursuing sub- they share the required tacit knowledge, they
unit goals at the
expense of may choose suboptimal processes (Conner &
organizational Prahalad, 1996). Addressing this limitation
goals. may require intense day-to-day involvement
by organizational managers with the HR con-
tractor until the contractor acquires the tacit
knowledge. Inefficiencies are likely to result,
however, because managers may lack specific
authority to direct work processes of contrac-
tors. Thus, because many positive HR out-
comes depend on tacit knowledge (Barney,
1991), firms which believe they have achieved
such outcomes with in-house HR manage-
ment are less likely to rely on HR outsourcing.
Once again, while tacit knowledge may be
important for all HR functions, its instrumen-
tality may be less apparent with some activi-
ties. For example, while tacit knowledge of
specific work processes and organizational
culture may have important utility for gener-
alist activities such as employee relations pro-
gram design, tacit knowledge may have little
relevance to transactional activities such as
payroll. Compared to activities that generate
salient performance outcomes, vendors may
be able to develop standardized procedures for
routine activities that require little understand-
ing of the organizations culture, and
outsourcing transactional activities may pose
little threat to the positive outcomes associ-
ated with in-house HR management. We pre-
dict, therefore, that having achieved positive
HR outcomes will be associated with less reli-
ance on outsourcing of generalist activities,
human capital activities, and recruiting and
selection, but will not be related to the
outsourcing of transactional activities.
Hypothesis 3: Reliance on outsourcing of
generalist, human capital, and recruiting
and selection activities will be lower in
firms where decision-makers believe they
have achieved positive HR outcomes.
Promotional Opportunities
With in-house HR, costs may be incurred by
employees pursuing sub-unit goals at the ex-
pense of organizational goals. Such costs are
likely to depend, however, on the extent to
which control devices exist (Dow, 1987). The
internal labor market is considered one such
control mechanism (Lazeor & Rosen, 1981).
Emphasizing internal promotion creates paths
and training for career advancement. As such,
where emphasis is given to providing promo-
tional opportunities, the likelihood that sus-
tained contributions are rewarded by
promotion increases and the cost associated
with relying on in-house HR decreases
(Doeringer & Piore, 1971). Thus, where an
organization is seen as emphasizing promo-
tional opportunities for its HR staff, reliance
on HR outsourcing will likely be reduced
among all HR activities.
Hypothesis 4: Reliance on HR outsourcing
will be lower where the HR staff is seen by
decision-makers as having superior promo-
tional opportunities.
Demand Uncertainty
Uncertainty about the demand for labor has
the potential to affect the costs associated with
HR outsourcing (Williamson, 1996). When
tasks are performed in-house, it is often diffi-
cult to reallocate activities across employees
in response to demand shifts. As such, demand
shifts often require costly adjustments. While
staffing increases require investments in the
hiring and training of new employees, staff-
ing decreases involve forfeiting these human

capital investments as well as incurring costs
associated with terminating permanent em-
ployees. Given that contractors can reallocate
work across their client base when there is a
shift in demand from any particular client
(Abraham & Taylor, 1996), relying on outside
vendors allows staffing levels to be adjusted
without significant costs. As such, where the
organization is seen as facing demand uncer-
tainty, increased reliance on HR outsourcing
is likely to be observed.
Hypothesis 5: Reliance on HR outsourcing
will be higher where the firm is seen by
decision-makers as facing substantial de-
mand uncertainty.
Pay Level
Due to variation in pay level policies (Gerhart
& Milkovich, 1990; Martocchio, 1998), the
cost of providing in-house HR varies across
organizations and is likely to affect the costs
and benefits associated with internal man-
agement. For organizations that follow a pay
lead strategy, in-house HR is likely to be more
costly, thus increasing the attractiveness of
HR outsourcing.
Some HR outsourcing activities are more
likely than others to be impacted by a pay lead
policy. Being a pay leader may be associated
with attracting and retaining high quality
employees (Rynes & Barber, 1990). As a re-
sult, outsourcing activities that involve high
quality employees could adversely effect or-
ganization performance, resulting in a barrier
to HR outsourcing; however, conducting rou-
tine and specialist activities such as payroll
and training in-house as opposed to
outsourcing these functions may have little
impact on organization performance, regard-
less of the firms human capital quality. For
such positions, the gap between the cost of
providing services in-house and the costs as-
sociated with HR outsourcing may be suffi-
cient to motivate decision-makers to rely on
outsourcing. In addition, in contrast to some
generalist functions, the wide availability of
quality vendors for specialist functions such
as training and selection may facilitate greater
outsourcing of staffing when the cost of in-
house performance is high. As such, while the
Outsourcing HR: The Impact of Organizational Characteristics 129
cost associated with pay leadership will pro-
vide an incentive to outsource transactional
activities, human capital activities, and recruit-
ing and selection, generalist functions are
likely to be more difficult to replace with out-
side vendors.
Hypothesis 6: Increased reliance on HR
outsourcing will be observed for transac-
tional activities, human capital activities,
and recruiting and selection where deci-
sion-makers believe their firm follows a pay
lead strategy.
Firm Size
in contrast to
Firm size is likely to affect the costs associ-
some generalist
ated with outsourcing because of its impact functions, the
on economies of scale (Abraham & Taylor, wide availability
1996). Many HR services require specialized of quality
expertise and, thus, substantial training vendors for
specialist
(Ulrich, 1996); however, a firm is only occa-
functions such
sionally likely to need such services. As a re- as training and
sult, in small firms many specialized HR selection may
activities will be infrequently performed and facilitate greater
because of the high costs associated with ac- outsourcing of
quiring the expertise to perform these activi- staffing when
the cost of in-
ties, the per unit cost associated with providing house
such HR services will be relatively high. By performance is
contrast, in larger firms the per unit cost will high.
be substantially lower due to greater econo-
mies of scale. Because of the larger employee
group, even specialized activities will be per-
formed more frequently, thus spreading the
cost of acquiring expertise across a larger num-
ber of activities. Due to differences in econo-
mies of scale, the costs associated with
in-house delivery of HR is likely to be greater
for smaller firms (Abraham & Taylor, 1996;
Williamson, 1996), resulting in greater reli-
ance on HR outsourcing.
Hypothesis 7: There will be a negative re-
lationship between firm size and reliance
on HR outsourcing.
Outsourcing By Competitors
Decisions to outsource are made in the con-
text of bounded rationality (Simon, 1991;
Williamson, 1975). As such, choices about
HR outsourcing may be biased by patterns of
130 HUMAN RESOURCE MANAGEMENT, Summer 2001
behavior within the existing environment
(Mansfield, 1977). The patterns of behavior
in a firms institutional environment may serve
as signals to the efficiencies associated with
outsourcing choices. Consistent with this, we
argue that willingness to rely on HR
outsourcing is likely to be affected by the de-
gree to which major competitors are seen as
outsourcing HR.
Hypothesis 8: HR outsourcing in a firm will
be positively related to the degree to which
that firms major competitors are seen as
relying on HR outsourcing.
Industry Affiliation
Given that HR outsourcing could potentially
be associated with industry affiliation, we gather
and analyze data on industry. No hypotheses
are made, however, regarding industry effect.
Methods
Sample and Procedure
The sample for this study consisted of 2,000
participants randomly selected members of the Society of
rated the degree
of outsourcing in Human Resource Management (SHRM) who
twenty different had the job title of Vice President or Director
areas of HR of Human Resources. Each of the SHRM mem-
bers solicited to participate were asked to com-
plete a questionnaire and mail the completed
questionnaire directly to the researchers.
Of the 2,000 surveys mailed, 98 were re-
turned, uncompleted, because of incorrect ad-
dresses. Thus, 1,902 of the originally selected
SHRM members received the questionnaire.
Of these 1,902 surveys, 432 were completed
and returned to the researchers. This resulted
in a 22.7% response rate. This response rate is
comparable to other recent firm-level surveys
(Terpstra & Rozell, 1993). We excluded from
our sample 41 respondents who indicated that
they were not involved in HR outsourcing de-
cisions in their organization.
Dependent Variables: Amount of Outsourcing
Reliance
Participants were asked to indicate the degree
to which their organization currently relies on
HR outsourcing. Using a seven point scale,
with percentages as anchors, participants rated
the degree of outsourcing in twenty different
areas of HR for (a) the design of programs
and policies, and (b) the administration of
programs and policies. Responses to the items
were factor analyzed using principal compo-
nent analysis with promax rotation. Skree plot
analysis and examination of eigenvalues sug-
gested a four-factor solution. As was the case
in our previous study on which this article
builds (Klaas, et al., 1999), the following four
factors serve as dependent measures of level
of outsourcing. First, factor one represents HR
generalist activities (alpha = .87) such as HR
planning, employee relations, performance
appraisal, safety, and EEO/diversity. Second,
factor two consists of transactional activities
(alpha = .80) concerning routine administra-
tive functions (e.g., payroll, benefits, and
HRIS). Third, human capital activities (alpha
= .73) consists largely of items concerning
the building and maintaining of human capi-
tal such as training and employee assistance.
Fourth, recruiting and selection (alpha = .72)
represents factor four and includes items re-
lating to staffing activities.
Independent Variables
The following is a brief description of all in-
dependent variables, specific items of which
are presented in Appendix 1. To assess mea-
surement reliability, we computed Cronbach
alphas on all multi-item independent variables.
The results ranged from .77 to .92, indicating
a high level of internal consistency for all
multi-item measures used.
Idiosyncratic HR practices. The extent to
which the HR practices in a firm are seen as
idiosyncratic or unique was measured by a
four-item scale.
HR strategic involvement. The degree to
which the HR function in a firm is seen as
being involved in the strategic management
of overall business issues was measured by a
scale containing two items.
Positive HR outcomes. A four-item scale
was used to measure the extent to which
the firm has achieved positive outcomes in
employee motivation, cooperation, and per-
formance.

Promotional opportunities. The extent to
which the firm was perceived to offer pro-
motional opportunities to its HR staff was
measured by a four-item scale. Items related
to both the availability of promotional op-
portunities and whether internal candidates
received preferential treatment for higher-
level positions.
Demand uncertainty. Uncertainty about a
firms demand for labor was measured by a
five-item scale. Because uncertainty in de-
mand for labor is determined by broader or-
ganizational conditions, the items examined
the predictability of firm performance and
product demand as well as uncertainty in the
organization as a whole and its environment.
Pay level. Pay level was measured by a
single item regarding whether the firm led the
market in terms of pay for its HR staff. When
a firm was reported to be leading the market,
this variable was coded 1. Otherwise it was
coded 0.
Firm size. This variable was measured by
simply asking respondents to supply the num-
ber of full time equivalent employees that
worked in the organization.
Outsourcing by competitors. Competitor
outsourcing was measured by a two-item scale.
Industry affiliation. Respondents were
asked to indicate their primary industry. Re-
sponses were categorized into the following
classifications: Manufacturing (26%),
Healthcare (22%), Finance services (13%),
Professional services (7%), Other services
(6%), Trade (6%), Information systems (4%),
Utilities (3%), Government (3%), Communi-
cations (3%), Hospitality (3%), Transportation
(2%), Petrochemicals (1%), and Construction
TABLE I Predictions and Results.
Organizational Characteristics
1. Idiosyncratic HR Practices
2. HR Strategic Involvement
3. Positive HR Outcomes
4. Promotional Opportunities
5. Demand Uncertainty
6. Pay Level
7. Firm Size
8. HR Outsourcing by Competitors
Outsourcing HR: The Impact of Organizational Characteristics 131
(1%). These 14 industry classifications were
used as dummy variables with Manufactur-
ing being the omitted category.
Interrater Reliabilities
To assess measurement reliability, among the
2,000 HR executives who were sent surveys,
500 also received a second questionnaire that
they were asked to distribute to another HR
professional in their organization. The addi-
tional respondent was instructed to complete
the survey and mail it to the researchers. Cod-
ing allowed the questionnaires to be matched
upon return. Of the 500 organizations receiv-
ing two surveys, 39 complete sets were re-
ceived. The interrater reliabilities of the
independent variables computed from the
subsample were: .70 for idiosyncratic HR prac-
tices, .65 for HR strategic emphasis, .64 for
positive HR outcomes, .72 for promotional
opportunities, .74 for uncertainty, .89 for pay
level, .94 for firm size, .59 for outsourcing by
competitors. These interrater reliabilities are
consistent with those obtained in other re-
search efforts attempting to assess perceptions
of organizational-level characteristics (Chen,
Farh, & MacMillan, 1993).
Results
Table 1 indicates the relationships observed
between organizational characteristics and HR
outsourcing activity. As shown in Table 1, six
of the eight organization characteristics were
statistically significant in the predicted direc-
tion for at least two forms of outsourcing, re-
sults that provide broad support for the impact
Relationship of Organizational Characteristics
and Form of HR Outsourcing
1. HR Generalist Activities; Human Capital Activities
2. Human Capital Activities; Recruiting and Selection
3. Human Capital Activities; Recruiting and Selection
4. Human Capital Activities; Recruiting and Selection
5. HR Generalist Activities; Transactional Activities
6. Human Capital Activities; Recruiting and Selection
7. No Support
8. No Support
132 HUMAN RESOURCE MANAGEMENT, Summer 2001
of organization characteristics on outsourcing
decisions. In addition, as predicted, the orga-
nizational characteristics impacted some
forms of outsourcing more than others. (Ap-
pendix 2 provides a detailed presentation of
the regression results.)
With respect to Hypothesis 1, the mea-
sure for idiosyncratic HR practices was
negative and significantly related (p < .01)
to outsourcing HR generalist and human
capital activities. As predicted, this suggests
that where the firm was seen as having
no support unique approaches to managing HR, less
was reliance on outside contractors was observed
demonstrated for for key generalist and specialist activities but
the predicted not for more routine transactional activities
negative
relationship
such as payroll.
between As predicted in Hypothesis 2, we found
organization size significant results (p < .01) for outsourcing
and HR human capital and staffing. These findings
outsourcing. suggest that firms with strong HR strate-
gic linkage rely more on outsourcing spe-
cialist activities such as training but not
generalist activities.
In regard to Hypothesis 3, negative and
significant relationships were found between
positive HR outcomes and human capital ac-
tivities (p < .01) and recruiting and selection
(p < .05). However, as predicted, outsourcing
of transactional activities was not lower
among firms that report having achieved posi-
tive HR outcomes.
As predicted in Hypothesis 4, a signifi-
cant negative relationship (p < .01) was
found between promotional opportunities
and the outsourcing of both human capital
as well as recruiting and selection. Orga-
nizations that indicated greater emphasis
on providing promotion opportunities re-
ported making less use of outsourcing for
these activities.
Next, consistent with Hypothesis 5, posi-
tive significant results were observed for gen-
eralist and transactional activities (p < .01),
suggesting that uncertainty facilitates greater
reliance on outsourcing for these HR functions.
Pay level, as predicted in Hypothesis 6,
was significantly related (p < .05) to human
capital (p < .01) and staffing activities (p <
.05). Transaction activities, however, were not
significantly related to pay strategy. This sug-
gests that firms following a pay lead strategy
rely more on outsourcing specialist activities
such as training and staffing, but not routine
administrative activities.
With regard to Hypothesis 7, no support
was demonstrated for the predicted negative
relationship between organization size and
HR outsourcing. Recruiting and selection
was significant (p < .01), but in the opposite
direction predicted, suggesting that larger
firms are more likely to outsource specialist
staffing activities.
Finally, with Hypothesis 8 no form of
outsourcing was significantly related to competi-
tor outsourcing level; thus, no support was found
for the influence of competitor behavior.
No predicted relationships were made for
industry affiliation. There were, however, a few
significant relationships observed. First, finan-
cial services (p < .01) were related to
outsourcing generalist activities. Second, three
industry variables were significantly related (p
< .05) to outsourcing transactional activities:
professional services, trade, and communica-
tions. Third, construction firms were more
likely to outsource human capital activities (p
< .05). Fourth, communications was signifi-
cantly related (P < .05) to the outsourcing of
recruiting and selection.
Discussion
We hypothesized that organizational char-
acteristics would be related to HR
outsourcing because of their impact on the
costs and benefits associated with in-house
delivery. Of the eight predictions examined,
six received support for at least two types of
HR outsourcing examined.
Consistent with Hypothesis 1, we found
that where the firm was seen as utilizing
unique or idiosyncratic approaches to man-
aging HR, levels of outsourcing were lower
for generalist and human capital activities.
Where HR practices are unique, substantial
human capital investment is needed before
outside contractors can perform adequately.
Given the idiosyncratic nature of the HR
practices, any such investment is also likely
to be of value only within the context of that
same contractual relationship. As such, ven-
dors may demand higher prices, making
outsourcing less attractive.

In contrast to less strategic HR oriented
firms, our findings provide support for our
prediction that firms emphasizing the strate-
gic role of HR would rely more on the
outsourcing of human capital activities and
recruiting and selection. Human capital ac-
tivities and staffing include functions that re-
quire specialized expertise; however, these
activities do not represent strategic decision
making activities. As such, these findings sug-
gest that as firms place greater emphasis on
HR strategy, they place less attention on in-
house delivery of these functions by acquir-
ing specialized expertise from outside vendors.
In addition, if one assumes that strategic HR
oriented firms place greater importance on HR
overall, perhaps this value facilitates a propen-
sity to search out possible advantages associ-
ated with acquiring the services of specialized
experts externally.
Another possible explanation for the role
of strategic HR concerns the orientation as
well as the self-interest of decision makers.
Take, for example, a firm that emphasizes stra-
tegic HR. In such a firm the strategic activity
will likely be restricted to high level staff mem-
bers who are unlikely to be the target of
outsourcing, perhaps removing a barrier to
outsourcing and, thus, resulting is a greater
propensity to outsource specialized activities.
As an alternative example, in firms that do not
emphasize strategic HR, outsourcing special-
ized functions related to human capital and
staffing may pose a threat to the role and job
security of HR managers, resulting in an in-
hibiting influence to outsourcing.
In regard to Hypothesis 3, positive HR
outcomes are often highly dependent on tacit
knowledge, and contractual relationships are
often inefficient means by which to ensure
that such knowledge is transmitted. Given that
contractors may be reluctant to adjust their
processes in ad-hoc ways, either substantial
investment in far-sighted contracting or costly
day-to-day involvement with contractors will
likely be required.
The finding for Hypothesis 4 is consistent
with the idea that emphasizing internal pro-
motion increases the probability that sustained
contributions to the organization will be re-
warded over time. For example, a firm that
emphasizes internal promotion opportunities
Outsourcing HR: The Impact of Organizational Characteristics 133
will likely do so to increase incentive intensity
among employees. In such a firm, the deci-
sion to outsource will alter the prevailing re-
ward system and, thus, outsourcing may have
a more deleterious impact on employee moti-
vation and performance.
With respect to Hypothesis 5, our findings
suggest that the nature of the employment re-
lationship makes reliance on in-house systems
more costly for generalist and transactional
activities when a firm faces demand uncertainty
(Abraham & Taylor, 1996). Where substantial
demand uncertainty exists, reliance on in-house emphasizing
HR may require firms to forgo investments in internal
human capital and abrogate commitments promotion
increases the
made to employees. Our results indicate that
probability that
firms respond to demand uncertainty by rely- sustained
ing more on HR outsourcing, at least with re- contributions to
spect to generalist and transactional activities. the organization
Consistent with Hypothesis 6, the reliance will be rewarded
over time.
on HR outsourcing is greater where the firm
offers above-market wages for its HR staff.
This suggests that HR outsourcing is influ-
enced by a desire to reduce the costs of HR
services. Take, for example, a firm that has a
pay lead policy even for jobs that are not in-
dustry-specific roles such as recruiting spe-
cialist. Based on these findings, it appears such
a firm will likely find outsourcing these spe-
cialist functions to be especially attractive
given the additional cost savings that can be
gained with outsourcing. While it might be
argued that a firm employing market leading
pay policies could reduce compensation rather
than outsource, our data suggest that HR
outsourcing is at least sometimes considered
a more attractive means to reduce costs.
While Hypothesis 7 argued that smaller
firms would be more likely to rely on HR
outsourcing because they are likely to benefit
more from the improvements in economies of
scale, we found that size was positively related
to recruiting and selection. Our failure to find
predicted results could be due to a
countervailing effect. Specifically, HR
outsourcing is a relatively recent trend and
experimentation with outsourcing may have
surfaced first among larger firms where the
staff is likely to be more familiar with HR
trends (Ulrich, 1996).
Finally, we had argued that because judg-
ments about the relative efficiency of in-house
134 HUMAN RESOURCE MANAGEMENT, Summer 2001
delivery are difficult, decisions-makers may
search for cues from competitor firms as to
the efficiency of outsourcing. We did not, how-
ever, find support for the prediction that firms
will be influenced by the outsourcing of com-
petitors. Once again, given that HR
outsourcing is a recent trend, perhaps the
prevalence of HR outsourcing has not yet
reached a level that would provide models of
competitor use that would facilitate the adop-
These findings
tion of this emerging practice.
suggest that firms With respect to the different types of
emphasizing outsourcing investigated, an overall assessment
promotional of the analyses indicates that organizational char-
opportunities and acteristics had the greatest impact on the reli-
achieving positive
ance of outsourcing for human capital activities.
HR outcomes rely
less on Five organizational characteristicsidiosyncratic
outsourcing practices, strategic HR, positive HR outcomes,
promotional opportunities, and pay levelwere
significantly related to outsourcing human capi-
tal activities in the predicted direction.
Consistent with our predictions, recruit-
ing and selection was significantly related to
HR strategy, positive HR outcomes, promo-
tional opportunities, and pay level. Recruit-
ing and selection was also positively related
to firm size. These findings suggest that firms
emphasizing promotional opportunities and
achieving positive HR outcomes rely less on
outsourcing, whereas firms characterized as
strategic HR oriented, higher paying, and
larger rely more heavily on the outsourcing of
staffing activities. Transactional activities were
more likely to be outsourced by firms that com-
pete in more uncertain environments. With
respect to HR generalists activities, firms re-
lying on idiosyncratic HR practices were less
likely to outsource, whereas firms that com-
pete in more uncertain environments reported
more reliance on HR outsourcing.
Implications for Organizations
Our findings provide several suggestions for
how organizations should approach HR
outsourcing. First, the significant findings for
two predictorsidiosyncratic practices and
positive HR outcomessuggest that tacit
knowledge is another critical factor that war-
rants consideration when deciding to use HR
outsourcing. If an organizations HR activities
rely to a large extent on tacit knowledge,
outsourcing may result in the loss of advan-
tages associated with distinctive practices.
Given that tacit knowledge dependence may
serve as a barrier to HR outsourcing, it is im-
portant that organizations include assessments
of this factor when deciding to outsource.
Furthermore, assuming that a decision is made
to outsource, tacit knowledge also has impli-
cations for how vendors are selected and how
the relationships are managed. First, to miti-
gate the potential cost associated with loss of
tacit knowledge, it is important that firms re-
lying on tacit knowledge select vendors who
are capable of tailoring activities to the
organizations unique needs. Second, in addi-
tion to the decision on vendor selection, it is
important that such firms manage the rela-
tionships in a manner that facilitates close
partnerships with the service providers; how-
ever, whether such highly developed partner-
ship relationships with contractors can be
developed remains unknown (Gulati, 1995).
Our findings also have implications for
how strategic HR oriented firms may differ
from those that practice traditional HR when
determining the level of HR outsourcing.
While more strategic HR oriented firms may
wish to acquire specialized expertise such as
training and selection from outside vendors,
these firms will likely find the outsourcing of
strategic oriented generalist activities such as
performance management to be an unattrac-
tive option. Conversely, given that less strate-
gic HR managers will likely continue to focus
on the in-house delivery of specialized services,
they will likely make a lower assessment of
the benefits of outsourcing and, thus, the
outsourcing option will be less appealing.
Outsourcing is often motivated by ineffi-
ciencies associated with bureaucratic organi-
zations. Given that internal promotion is one
mechanism that can control such inefficien-
cies, these findings suggest that firms who rely
on promotions may experience greater cost
associated with HR outsourcing, resulting in
an inhibiting influence to outsourcing.
The findings also indicate that demand
uncertainty affects the benefits associated with
HR outsourcing. For firms that compete in
relatively dynamic and unstable environments,
the need for flexibility that avoids the fixed
costs associated with employer commitments
 Outsourcing HR: The Impact of Organizational Characteristics 135

is greater. As a result, firms competing in un-
certain environments may wish to consider
that factor when deciding to outsource. In
addition, our finding that pay leaders are more
likely to outsource suggests that higher pay-
ing firms may find the benefits of outsourcing
to be more attractive.
Finally, an overall assessment of our findings
indicates that the influence of organizational char-
acteristics was highly contingent, suggesting that
organizational characteristics have different ef-
fects on various types of HR activities outsourced.
As such, it appears that many factors should be
considered when deciding to outsource HR.

BRIAN S. KLAAS is Professor of Management in the Darla School of Business at the

University of South Carolina. He is also director of the Riegel and Emory HR Center
and Master of Human Resources program. Brian received his Ph.D. from the Industrial
Relations Research Institute at the University of Wisconsin-Madison. Brian has written
extensively on a number of HR topics, including employee relations and discipline,
compensation, and collective bargaining. He is currently working on a project funded
by the SHRM foundation which examines how outsourcing HR activities to a profes-
sional provider organization affects the performance of client organizations.

JOHN A. MCCLENDON is Associate Professor of Human Resource Administration in the

Fox School of Business and Management at Temple University. He is also director of
the Master of Science in Human Resources program. John received his Ph.D from the
College of Business Administration at the University of South Carolina. He has pub-
lished numerous research articles on a wide-range of HR issues, including compensa-
tion management, organizational citizenship behavior, and labor-management relations.
He is currently working on a SHRM foundation sponsored project dealing with how
HR outsourcing to a professional employer organization impacts the performance of
client organizations.

THOMAS W. GAINEY is an Assistant Professor in the Richards College of Business at the

State University of West Georgia. He received his Ph.D in management from the Col-
lege of Business at the University of South Carolina. His research interests include the
effects of HR outsourcing, employee discipline, and alternative work systems. His re-
search has appeared in Personnel Psychology, Industrial Relations, and Human Resource
Management Review. He is currently working on a SHRM foundation sponsored project
on how HR outsourcing to professional provider organizations impacts the performance
of client organizations.
136 HUMAN RESOURCE MANAGEMENT, Summer 2001
APPENDIX 1
Idiosyncratic HR practices
1. Our HR practices are tailored to fit
the nature of our business operation.
2. Solving HR problems here requires
knowledge of our business strategy.
3. In this firm, you have to understand
the history and culture before you
can help solve HR problems.
4. You cant solve HR problems here
unless you know our business.
HR strategic involvement
1. At my firm, HR is involved in major
strategic decisions.
2. At my firm, HR helps make decisions
about broader business issues.
Positive HR outcomes
1. Our way of managing people has
helped produce superior results.
2. Our way of managing people has
helped to motivate our employees.
3. Because of the way we manage
people, our employees are very coop-
erative.
4. This organization has to find new and
better ways to manage people. (R)
Promotional opportunities
1. In our HR group, we believe in pro-
moting people from within.
2. In this firm, HR managers who excel
will be promoted.
3. HR managers here looking for a pro-
motion have to look outside the firm.
(R)
4. We emphasize training HR staff
members for higher-level positions.
Demand uncertainty
1. The financial performance of this
firm is hard to predict.
2. There is a lot of uncertainty about
the prospects for this firm.
3. The demand for this firms goods or
services is hard to predict.
4. The organization is facing much
change and uncertainty.
5. This organization is relatively stable. (R)
Outsourcing by competitors
1. Our competition has outsourced
many HR activities.
2. Other firms like us have outsourced
a good deal of HR.
 Outsourcing HR: The Impact of Organizational Characteristics 137

APPENDIX 2
Regression Estimates: Determinants of HR Outsourcing
(Standard Errors in Parentheses)

Dependent Variables
Independent HR Generalist Transactional Human Capital Recruiting &
Variable Activities Activities Activities Selection
Idiosyncratic HR Practices 0.16** 0.09 0.33** 0.03
(.04) (.08) (.11) (.04)
HR Strategic Involvement 0.03 0.12 0.22** 0.07**
(.03) (.06) (.08) (.03)
Positive HR Outcomes 0.03 0.02 0.36** 0.07*
(.03) (.06) (.08) (.03)
Promotional Opportunities .01 0.11 0.24** 0.08**
(.04) (.07) (.09) (.03)
Demand Uncertainty 0.09** 0.25** 0.0 0.04
(.04) (.07) (.09) (.03)
Pay Level 0.08 0.2 0.37** 0.10*
(.06) (.11) (.14) (.05)
Firm Size 0.0 0.0 0.0 0.00**
(.00) (.00) (.00) (.00)
Outsourcing by Competitors 0.02 0.1 0.01 0.05
(.03) (.06) (.08) (.03)
Healthcare 0.01 0.01 0.02 0.1
(.08) (.14) (.18) (.07)
Financial Services 0.25** 0.16 0.21 0.02
(.09) (.16) (.20) (.07)
Professional Services 0.08 0.37* 0.23 0.04
(.10) (.19) (.25) (.09)
Other Services 0.14 0.25 0.06 0.06
(.11) (.19) (.25) (.09)
Trade 0.02 0.06 0.19 0.2*
(.12) (.21) (.28) (.10)
Information Systems 0.11 0.55* 0.06 0.02
(.13) (.24) (.31) (.11)
Utilities 0.04 0.36 0.26 0.21
(1.7) (.31) (.40) (.15)
Government 0.03 0.32 0.34 0.21
(.14) (.25) (.32) (.12)
Communications 0.06 0.59* 0.1 0.29*
(.16) (.29) (.38) (.14)
Hospitality 0.17 0.07 0.13 0.08
(.15) (.28) (.36) (.13)
Transportation 0.04 0.22 0.07 0.17
(.19) (.34) (.44) (.16)
Construction 0.65 0.24 2.16* 0.06
(0.48) (.87) (1.14) (.42)
Petrochemical 0.08 0.34 0.52 0.03
(.34) (.62) (.81) (.30)
R2 0.11 0.17 0.17 0.18
F Statistic 1.93 3.4 3.34 3.59
N 366.0 366.0 366.0 366.0

Significance level two-tailed test **=.01, *=.05

138 HUMAN RESOURCE MANAGEMENT, Summer 2001
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