Prepare for evaluating options surrounding payroll outsourcing in the SAP environment. Payroll outsourcing involves evaluation as well as implementation. Evaluate several payroll factors to determine which approach is most suitable for your organization.
Key Concept
Payroll outsourcing in an SAP environment can follow a methodology that goes far beyond a typical in-house payroll implementation. The methodology is divided broadly into two stages: evaluation and implementation. Every organization is unique and requires different business considerations to properly outsource its payroll. The evaluation stage is especially important for US payroll, due to its complexity. A strong evaluation is advisable to prevent implementation pitfalls and to ensure that you appropriately take all payroll aspects into account.
Payroll outsourcing in SAP Human Capital Management (HCM) implementations can take different forms and shapes. Users can outsource different aspects of the payroll process, from check printing and tax filing to full net payroll. You can divide payroll outsourcing into two major aspects. The first aspect is the business case and evaluation, which is covered in part one of this series, and the second is implementation and operational challenges, which I’ll cover in part two (Figure 1).
Figure 1
Lifecycle of payroll outsourcing
- Gaining cost savings over time
- Handing over compliance and statutory exposures to the outsourcing vendor
- Moving away from the administrative hassles of running payroll, giving your company time to focus on the core business
- Avoiding the stress of keeping up with the tax rates and regulation updates
- Avoiding maintaining an information technology staff to support your payroll environment
- The need to adapt the processes and operations with similar implementations
- A lack of flexibility
- Integration and interface challenges with Finance, Accounts Payable, Garnishments, and other types of external systems
- Dependency on the outsourcing vendor
- The risk of losing the capabilities for running payroll (functional as well as technical)
- Not easily reversible process steps
Figure 2 presents a simple upstream and downstream view of payroll processing. This view can help you take stock of the incoming and outgoing data of your payroll system.
Figure 2
Payroll processing systems
Note
The references to SAP HCM/Payroll are generic and applicable across versions. Also, my discussion is restricted to the outsourcing of payroll processing and not the outsourcing of managed services for SAP HCM/Payroll. Typically with managed services, the entire payroll department is outsourced. This discussion, however, focuses on outsourcing the payroll processing only.
Options
Figure 3 illustrates the spectrum of payroll outsourcing from check printing to full payroll processing outsourcing. Keep in mind that you can also combine some of them. For example, you could outsource check printing and garnishments or check printing and tax filing.
Figure 3
Spectrum of payroll outsourcing
Although Figure 3 shows the progression from left to right, it does not necessarily mean that you can progress logically from check-printing-related outsourcing to full payroll outsourcing (i.e., you can adopt any of the options or all of the options). There is a progression, however, from check printing, the smallest and simplest option, to full net payroll outsourcing, the bigger and more complex option.
You should look at each of these outsourcing options in more detail to determine which is best for you. In some countries, the options from Figure 3 may not be applicable. For example, garnishments processing or tax filing may not be relevant in all countries. In the US and Canada, dividing the payroll outsourcing process among these options is very important. The gross to net and full payroll processing options, however, will likely be applicable to all countries.
Check Printing. Process your full payroll in SAP, including Business Software, Inc. (BSI) tax calculations. BSI is the tax engine mainly used by SAP in US Payroll. Then send over the checks, pay stubs, and advice files to an outsourced vendor who does the printing and distribution.
Tax Filing. Process full payroll in SAP, including BSI tax calculations, and then send over the tax files to an outsourced vendor who files the taxes. In most cases, it is logical to combine this with check-printing outsourcing.
Garnishments. If you are running payroll in house, then you need to maintain the garnishment order details in your system. If you decide to outsource the payroll to a vendor, you need to send the garnishment order data to the vendor’s payroll system. If the volume of garnishments is low for your implementation, then it may not make financial sense to outsource this functionality. Also, if you are running an in-house payroll, then you continue to share the workload anyway.
Gross to Net. Maintain the employee master data in SAP HCM and run gross payroll in the SAP Payroll module. The tax calculations and the net payroll, however, will be processed in the outsourced environment.
Full Payroll Processing. Use SAP as a system of records to maintain the employee master data and run gross, as well as net, payroll in an outsourced environment. This option includes the outsourcing of all downstream processing, such as tax filing, check printing, and garnishment services.
Evaluation
You should consider the evaluation criteria for each of the several outsourcing options carefully to determine which one is right for you. The outsourcing options are:
- Check printing
- Tax filing
- Garnishment processing
- Gross to net payroll
- Full payroll
Check Printing
By outsourcing check printing, your in-house resources are free from the high stress activity of chasing lost checks, enabling these resources to be used for other projects and increasing productivity. There could be potential cost savings depending upon the availability of Employee Self-Service (ESS) from the vendor. The major evaluation criteria for outsourcing the checks printing option fall into the categories listed below. Against each category, I have listed the preferred considerations:
- Infrastructure. This consists of the physical facilities and locations for printing the checks and pay stubs. It’s ideal if the vendor already has a secured check-printing environment.
- Distribution. If your company operates in many locations, verify that the Service Level Agreement (SLA) allows for this. I recommend using a vendor who has an established tie-up with large distribution partners, which is especially useful if you have remote or overseas locations for distribution.
- Technology issues. These involve handling the signatures and security measures. Ideally, the vendor supplies an established SAP interface and can adopt your pay stub, logos, and signatures easily.
- Interfaces. The availability of standard and ready-made interfaces from the vendor is important. Also, the technology and tools for interfaces should play a role, such as the encryption of files. For this reason, I also suggest using a vendor who can supply an established SAP interface.
- Number of languages. If you operate in a multilingual environment, a vendor might be able to support different languages. In the best-case scenario, the vendor is able to print pay stubs in different languages.
- Fiduciary. This includes handling the money in the bank for every type of payroll (whether that be regular, bonus, or off-cycle), as well as the associated terms and timing
- Availability of ESS and access to pay stubs. If the vendor also can provide the self-printing capability for employees, you increase savings on postage and printing
- SAP tools. You can use standard SAP Data Medium Exchange (DME) programs when generating the files that you send to the outsourced vendor. However, there isn’t a clear functionality or tool in SAP that does this (i.e., there is no equivalent Interface Toolbox for sending check-printing files to an outsourced vendor).
Tax Filing
Outsourcing tax filing means you no longer need to handle the compliance for different tax authorities or manage risk and exposure, which can be especially difficult if you are operating in many tax jurisdictions. It eliminates your employees’ stress from processing annual W-2s.
The main evaluation criteria for tax filing should cover:
- Tax jurisdictions. If your company operates in Puerto Rico, you expect the outsourced vendor to provide you services for that territory. Your business case looks better if you have a large number of tax authorities to which you need to remit and file.
- W-2 processing. Typically, the month in which W-2 printing and distribution take place is a stressful period for payroll departments. Tax filing normally covers W-2 as well as W-2C (corrections) printing and therefore outsourcing this task can free up your in-house resources for other jobs. Similar to pay stubs, if the vendor can provide the ESS-based self-printing capability for W-2 forms, you have increased savings.
- Payroll calendars and discipline. If the payroll frequency — calendars as well as overall discipline of run controls — is high, then outsourcing tax filing is more beneficial. For example, some SAP implementations have many off-cycle payrolls and payroll areas, while some customers are successful in consolidating payroll areas to a few.
- Technology and interfaces. Similar to check printing, evaluate whether the vendor already has an established interface with SAP Payroll. It is also a good idea to find out if the vendor can build the quarterly and annual tax processing based on per pay period files that you send.
- SAP tools. In the case of tax filing services, SAP has functionality that you can use. If you follow the menu path Payroll>USA>Outsourcing>Tax Services, you can get to the functionality that is used for sending data to service providers. SAP has delivered IDocs. In addition, you also have a reconciliation report available to ensure the reconciliation between data transferred and the payroll clusters.
Garnishments
The generic benefits for outsourcing garnishments are similar to my earlier discussion on checks and tax filing. If you decide to outsource the complete garnishment management to the vendor, however, there are more benefits around risks and compliance.
The garnishment evaluation criteria include:
- Volumes of garnishments. Generally, if the volume of garnishments is low (in tens rather than in hundreds), then the outsourcing option is not viable.
- Handling the calls. Even if the volume is low and you spend your resources answering the calls related to garnishment processing, it might be a good idea to outsource the garnishments. This option still has potential savings based on the number of calls handled. You also are better able to manage the compliance issues and risks with a proper SLA. For example, the turnaround time to respond to a call for an inquiry on a child support check can be decreased now that more resources are available to respond to the matter.
Gross to Net
BSI TaxFactory is not required in SAP but provides a direct savings on licensing, maintenance, and operations. BSI TaxFactory or tax engine is an integrated product with SAP Payroll in the US and needs its own licensing, maintenance, and operations. If you do not do tax calculations in your payroll environment, then you will be able to have cost savings against a BSI environment. An outsourced vendor carries out tax calculations. In countries such as Canada, you do not need BSI and therefore, this point is not applicable. You can easily combine check printing and tax filing with this option. This outsourcing option is the popular choice among many SAP customers.
Some of you may recall the PU12 interface toolbox and the gross-to-net interface in SAP Payroll. PU12 is discussed more extensively later in this article. The PU12 transaction and the interface toolbox have been around from earlier versions of SAP, such as R/3 4.6 and 4.7. It was not formally called outsourcing during these early years and was commonly referred as PU12. The evaluation criteria list covers:
- Interfaces. In the case of check printing and tax filing options, the interfaces, typically restricted to one or two, are much easier to use between your company and a vendor (for example, sending an outbound interface from SAP Payroll to an outsourced checks printing vendor and receiving an inbound interface from the vendor to SAP Financials). In the case of the gross-to-net option, however, the number of interfaces could vary. Possible interfaces include:
- Outbound master data interface from SAP to the payroll vendor
- Outbound payroll results interface from SAP to the payroll vendor
- Inbound Finance posting interface from payroll vendor to your SAP or non-SAP financial systems
- Inbound interface to bring net payroll results back in SAP and to decide whether financial posting needs to be done directly from the vendor’s system or your SAP system
- Decision about running gross payroll in SAP. People often set the gross-to-net decision against full payroll outsourcing. They question the advantages of running gross payroll in your in-house SAP environment and then sending out results for net processing. Some of the typical evaluation criteria to address this challenge are:
- If you are running time management and time evaluation in your SAP environment, I recommend running gross payroll in SAP. It also makes sense to run gross payroll in SAP if you have benefits administration in your SAP environment.
- If you want to continue using an established payroll department or service center, while keeping the tax processing and BSI out of the picture, you should select this outsourcing option
- In some situations, users want to keep an option open for bringing back the net payroll processing and gross payroll run to your SAP system, and this outsourcing option makes this easy
- If you choose to bring back the payroll results into SAP, your reporting strategy follows the normal path and no special SAP NetWeaver BI or reporting strategy is required
- Some organizations have a policy that they do not run off-cycle payrolls. While most companies run off-cycle payrolls, some organizations have a policy that they don’t. The evaluation needs to figure out the interface strategy, logistics, and the vendor pricing around the off-cycle payrolls. I will discuss this and similar topics in part two of this series.
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SAP tools. SAP has provided plenty of tools for this scenario as well as the next scenario. You might have heard about the PU12 transaction in SAP. It is also referred to as Interface Toolbox. In recent versions of the SAP product, it is under menu path Payroll>USA>Outsourcing>Export. SAP has provided layouts for master data, time data, and gross payroll results. The layouts are also available for many countries besides the US.
Full Payroll Processing
With full payroll processing, financial and Accounts Payable postings need to be carried out based on a file from the payroll vendor. Reporting can become complicated and you may need SAP NetWeaver BI or an equivalent data warehouse system. Depending on volumes and the length of the outsourced contract, this option could bring the savings for which your management is looking. Over a period of time (usually between three and five years), management and leadership look for savings around operations cost. One of the areas that many users overlook or miss when outsourcing is the need to dedicate some of their internal resources to managing the outsourced vendor relationship. Someone needs to monitor the process, resolve issues with SLAs, and check performance. Companies tend to underestimate the efforts involved with this governance.
Most of the time, the full payroll outsourcing decision is relatively easy compared to a gross-to-net scenario. The criteria are along the themes that I previously discussed:
Part two of this series focuses on the implementation and operational challenges for each of the options that I discussed. I will further explore the challenges that you normally face in an outsourced payroll environment, how they arise, and how to address them.
Sidebar: Business Case
Two factors normally drive the business case for outsourcing — cost and non- cost factors. The cost factors are divided into two distinct areas — fixed and variable. Fixed or one-time costs cover:
- Standard implementation
- Customized implementation
- Building interfaces
- Training
- Process standardization and changes
- Wage types standardization along with payroll calculation rules changes
You need to amortize these costs over the duration that you are using to justify the business case. For example, if you are going with a payroll-outsourcing window of five years, then you need to distribute the upfront fixed costs over five years. Variable costs are the costs to run and operate the payroll on an ongoing basis. Volume plays a role here. These cost headings are:
- Per pay check processing
- Per W-2 processing for taxes
- Report processing costs (if any)
- Off-cycle payroll costs (if separate)
- Maintenance of interfaces
- Active versus terminated employee populations
Non-cost factors
These non-cost factors are the ones that are often ignored or not appreciated during business case and evaluation discussions:
- Systems environment. Do you have many distributed systems with a lack of integrated processes and environment? If your applications related to Time Management, Benefits, and Financial Accounting are within a single SAP environment, then the complexity is lower compared to a distributed environment.
- Payroll areas and frequency. Do you have reasonably consolidated payroll areas and frequencies for processing?
- Data conversion. Will the source data come from a single environment?
- Interfaces. What if you need to change vendors and reinvent the interfaces?
- Reduce headcount. Is there an agreement within the company to reduce the headcount (independent from the cost effects)?
Satish Badgi
Satish Badgi has been helping clients implement SAP ERP HCM and payroll for more than 15 years. He has been involved with large full-scale SAP ERP HCM and payroll implementations using the breadth and depth of SAP modules. Satish works for a large management and systems integration consulting firm and handles global payroll for clients. He has published two books on SAP payroll, Configuring US Benefits with SAP and Practical SAP US Payroll.
You may contact the author at sbadgi@comcast.net.
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