Outsourcing payroll: beyond transaction‐cost economics
| DOI | https://doi.org/10.1108/00483480510599770 |
| Published date | 01 August 2005 |
| Date | 01 August 2005 |
| Pages | 451-467 |
| Author | Michael Dickmann,Shaun Tyson |
| Subject Matter | HR & organizational behaviour |
Outsourcing payroll: beyond
transaction-cost economics
Michael Dickmann and Shaun Tyson
Cranfield School of Management, Cranfield, UK
Abstract
Purpose – There are continuing pressures to improve administrative efficiency in human resource
management (HRM). Following the professional and academic literature, proposes “payroll” as an
ideal candidate for outsourcing in order to drive costs down.
Design/methodology/approach – The research uses a transaction-cost-economics perspective to
identify efficiency implications of varying governance decisions. Ten distinct payroll activities that
account for a generic payroll workflow are identified. Then the costs of carrying out these distinct
payroll processes, either market- or hierarchy-based, are analysed in 20 case studies of UK-based
organisations.
Findings – While key payroll activities were more costly when outsourced, there were efficiency
gains in supplementary activities and lesser investment in IT software and maintenance.
Originality/value – These insights are important for cost-based make-or-buy decisions. Influence
factors on governance decisions, however, went beyond considerations of transaction costs, quality
and risks to include historical, political and individual rationales. They are depicted in a framework of
outsourcing motivations.
Keywords Payroll data processing, Outsourcing,Transaction costs
Paper type Research paper
Introduction
Payroll must be the most standardised and regimented (activity) that my department
conducts (interviewee notes, head of HR).
This sentiment seems to be shared by a number of writers. Quantitative benchmarking
studies implicitly assume such a uniform set of activities that they generally only
provide data on the cost of the whole payroll process (Saratoga, 2001; BNA, 2002).
Moreover, Apte and Mason (1995) imply a high standardisation in their argument that
payroll has a high disaggregation potential as there would be low interpersonal actions
and high information actions involved in the whole payroll process. Thus, payroll is
often seen as a prime candidate for outsourcing (Maurer and Mobley, 1998 ). In an
administration-heavy, highly standardised function the contribution to organisation al
competitive advantage has often been seen in increasing efficiency. This is why many
authors have used a transaction cost economics (TCE) approach to the study of payroll
(cf Klaas et al., 1999).
This article aims to refine our understanding of payroll and the applicability of TCE
to the function, especially with respect to governance decisions. It argues that payroll is
treated as a “black box” and that we need an improved understanding of distinct
payroll processes and their cost implications to take more informed decisions on
whether – and for what specific activities – to use external service providers or to
conduct the transactions internally. In a review Silverman (2002, p. 474) does not only
The Emerald Research Register for this journal is available at The current issue and full text archive of this journal is available at
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Outsourcing
payroll
451
Received August 2003
Revised January 2004
Accepted April 2004
Personnel Review
Vol. 34 No. 4, 2005
pp. 451-467
qEmerald Group Publishing Limited
0048-3486
DOI 10.1108/00483480510599770
point out that TCE offers a framework to infer which mode of organisation will best
govern transactions but also that since the 1980s a substantial body of empiric al
evidence supporting the TCE predictions of organisational form has evolved. There are
more than 600 empirical studies whose results are consistent with transaction cost
principles (Boerner and Macher, 2000).
Taking account of the limitations of TCE (cf Pfeffer, 1997), an exploratory research
approach allowed us to outline a range of outsourcing motivations that went beyond
the discussion on “transaction cost economizing” (Williamson, 1981). The findings are
formalised in a tentative framework of outsourcing motivations. The next section
applies TCE to the payroll function and examines the reasons why this perspective is
especially suited for highly standardised activities.
Transaction cost considerations in payroll
There are three key elements of TCE that have to be analysed with respect to payroll:
governance structures, transaction attributes and transaction costs. Williamson (1975)
argued that there is a range of alternatives to obtain the same product/service. There
are market based governance structures that rely on a contractual relatio nship with an
external supplier. In contrast, hierarchy based governance structures encompass the
internal production of the goods or services, relying on a system of organisational
relationships. Hybrid forms, such as joint ventures and franchises exist. In payroll,
both market-based outsourcing and hierarchy-based internal delivery of services exist.
While Williamson (1975) maintains that internal organisation restrains the
opportunism of actors inherent in the market exchange, Dow (1987) suggests that
authority relations may elicit novel forms of opportunism. There is no ex ante inherent
superior form of governance without regarding the context and the substantive content
of the transaction.
Governance structures cannot be seen independently of the second key element of
TCE, transaction attributes, which build a characteristic space in which the transaction
is located. Key attributes are the asset specificity needed to execute the activity, the
frequency of transaction and the level of uncertainty involved. Dow (1987) argues that
TCE theory includes an unrealistic assumption that the attributes are constant while
actors can vary the governance structures in order to economize on transactio n cost. He
suggests that it is impossible to keep the attributes the same so that one would
inevitably not compare like with like. The study of payroll by using a TCE perspective
is especially appropriate as this problem is minimised: the frequency of transaction is
highly defined, there is a low level of uncertainty due to a wide range of regulations
and, apart from specialised payroll software, there is a low level of asset specificity as
computers could be used for other administrative purposes when a firm switches its
payroll governance from internal to external.
TCE theory holds that human cognition is subject to bounded rationality
(Williamson, 1979) and that cognition will lead to behaviour that is intentionally
rational, but only to a limited extent (Simon, 1957, p. xxiv). Thus, organisations are
seen to attempt to minimise transaction costs relative to the insights and capabilities of
the actors. Due to payroll’s high degree of administrative standardisation and the
mostly relative ease of information access for payroll specialists when legal or other
regulatory changes occur, the problems of bounded rationality and information
asymmetry of the various actors in alternative governance structures are likely to be
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