Hewitt Associates -- An In-Depth Look, Part I: What They Do

| About: Hewitt Associates (HEW)
This article is now exclusive for PRO subscribers.

We promised a while back we would give Hewitt Associates (HEW) a second look. Our only follow-up since then was a post rehashing some old news. Well, now we are delivering a second look -- in a five-part series!

According to their 10K, Hewitt is one of the leading global providers of human resources outsourcing and consulting services. These range from 401k enrollment to defined benefit plan administration, to health care administration, talent recruiting - basically everything that a human resources [HR] department would do. Unlike many of its competitors Hewitt does not manage assets, which allows it to offer objective advice. It also offers a complete range of consulting and outsourcing services. In its own words:

Our global human resources outsourcing and consulting experience and expertise complement and strengthen each other. For example, our outsourcing clients benefit from our expertise in creating strategies and program designs that meet business objectives while being administered cost-effectively and efficiently. Our consulting clients benefit from our outsourcing capabilities in two ways. First, our ability to extract detailed design, demographic and plan data from our extensive outsourcing databases, and to aggregate and analyze the data to provide unique insights that we use to create strategies and program designs that best meet business needs. Second, our deep understanding of operational realities ensures that our consulting solutions are practical and operationally effective. We believe that this integration creates a competitive advantage by enabling us to provide our clients with more effective total human resources solutions across the full range of their workforce-related business challenges.

In their fiscal year 2005 the company’s revenue generation was 29% consulting and 71% outsourcing. The company had more than 2,400 clients, none of whom accounted for more than 10% of company sales. The company believes its position offers competitive advantage:

As a leader in human resources outsourcing, we have achieved the size and scale that enhances our continued innovation and flexibility to help our clients meet their changing business challenges. We employ new technologies as well as standardized proprietary technologies when existing technologies do not meet our clients’ needs or our requirements. This integrated combination of technologies provides the necessary economies of scale and balance of customization versus standardization to be flexible enough to adapt to a broad range of program complexity and to accommodate the needs of clients ranging in size from less than 1,000 to well over 500,000 employees.

It sounds to us like a difficult balance to strike, and we wonder if it can truly be managed.

Their HR Business Process Outsourcing [BPO] unit got much bigger with the October 2004 acquisition of Exult. This acquisition has led to many of the company’s current problems.

Some post-merger financial effects that we expect to see in future results include changes in business mix relating to the expansion of the HR BPO business. When we bring on new HR BPO clients, we typically assume their existing cost structure, including personnel and third party subcontractors, and work to transform the processes, systems and service delivery to reduce costs over time. As the HR BPO business grows within our Outsourcing segment, we expect near-term negative impacts on our firmwide and Outsourcing segment margins as we make investments in our HR BPO business infrastructure and upfront investments to implement new contracts and transform the underlying client processes. Margins are expected to improve as the initial HR BPO contracts mature and the average age of our HR BPO client contract portfolio increases.

You may recall that Hewitt’s recent blowup started with the company reviewing guidance in connection with a review of its human resources business-process outsourcing contract portfolio. The company records revenue on a percentage of completion basis, which means that if they were incorrect in estimating the costs and revenues of contracts there could be a substantial revision to make up for over-estimating revenue in past periods. Plus, with the costs re-estimated it is probable that future revenue on the contracts will result in no profit, hurting margins. That now looks likely to happen.