The rapid growth in integrated outsourced human resource (HR) services will spark a new round of merger and acquisition activity in the industry as vendors seek to achieve economies of scale, broaden service offerings, and add new customers in the middle market, according to a report released by the Mergers & Acquisitions group at the investment firm Robert W. Baird & Co.

With $46 billion in estimated revenues for 2003, the HR Outsourcing (HRO) industry is growing at a 10% annual rate, and is expected to reach $54.9 billion by 2005, the company pointed out.

Behind this growth is the recognition on the part of many large and mid-size corporations that outsourcing some or all of the traditional HR functions can reduce costs and increase efficiency, while maintaining or even improving the level of service offered to employees. Services commonly outsourced include payroll distribution, benefits administration, training, recruiting, and travel expense management.

"We expect human resources outsourcing to evolve in a manner similar to what occurred with information technology (IT) outsourcing, which is now a $115-plus billion industry," stated Judith Scott, managing director at Baird. "IT outsourcing started with a few limited applications, but quickly grew to encompass the entire IT function for many companies. We see clear parallels in HR outsourcing."

Indeed, HR Outsourcing more than doubled from 2001 to 2002, but with expenditures still below 5% of total HR expenses, Baird sees plenty of room for growth.

In the report, Baird states that there have been a growing number of M&A transactions over the last several years.

Between January 1997 and October 2003, a total of 509 HR Outsourcing transactions were recorded with 30% of those disclosing values that aggregate to a total of $14.4 billion. The median value of disclosed transactions during this period was recorded as $20 million, with the number of deals peaking in 1998 at 94.

While M&A activity in the sector subsequently slowed, the Baird report found that the number of transactions has increased at a steady rate since 1999.

Through most of 2003, the number of transactions was nearly level with that of the same period in 2002. However, M&A activity now appears set to accelerate, according to Breton Schoch, managing director.

"As with other service businesses, quickly achieving scale is important to the success of an enterprise," said Peter Kies, managing director. "The HRO industry includes a long list of financially rich potential buyers offset against a long list of potential sellers with real businesses and solid client lists in a space in which user awareness and demand are growing rapidly."