The mutual fund giant Fidelity Investments reported a 39% plunge in 2002 profit this week, and revenues dropped 9%, but the company's human resources outsourcing subsidiary has continued its rapid growth, helping buffer the parent against the lengthening market malaise.
Fidelity reported Monday that earnings had dwindled to $808 million last year, from $1.32 billion in 2001. And its revenues fell to $8.9 billion, from $9.8 billion the year earlier.
Fidelity Employer Services Co., meanwhile, increased its share of corporate revenues from about one-quarter in 2001 to one-third last year, according to Peter J. Smail, the unit's president. It has prospered by selling human resources services to companies looking to minimize employment costs; about half of its 176 customers already were Fidelity customers, often for its 401(k) program.
For example, when First American Corp. decided to outsource some of it human resources services, the Santa Ana, Calif., financial services firm turned to Fidelity, which was managing its 401(k) plan.
"We felt that there were more components to employee benefits than just a retirement plan. It just made sense, it makes sense, to have one-stop shopping for employees," said Liz Brandon, the vice president of administration at First American. "Retirement product, health and insurance, and pension benefits - we wanted a provider who could do it all."
The Boston fund company then sold pension, health, and insurance plans to the $4.7 billion-revenue financial services company, which specializes in real estate title services.
The business is so promising, in fact, that competitors like Mellon Financial Corp. and a small California firm, Exult Inc., have charged into it, assembling impressive client rosters but not yet, at least, accruing the sort of revenues of which Fidelity can boast.
Hewitt Associates Inc. in Lincolnshire, Ill., and CitiStreet, a joint venture between State Street Corp. and Citigroup Inc., are among the older competitors in benefit outsourcing.
Fidelity has spent eight years developing the unit to supply pension and retirement services, health and welfare plans, and human resources capabilities. Fidelity Employer Services Co., founded in 1998, has agreements with 176 companies nationwide, with four million employees, and Mr. Smail said that he has just begun to tap the 11,300 defined contribution plans that Fidelity sponsors.
Mr. Smail said he expects the unit to contribute half of Fidelity's revenue within 10 years.
"Tough economic conditions have more companies looking to cut costs. People want to get things done faster and cheaper," Mr. Smail said. "Everyone wants to cut costs and focus on their core products and services."
More than 90% of American companies outsource some functions in an effort to reduce overhead and exposure, according to a study released Feb. 12 by Cutting Edge Information, a Durham, N.C., research company.
Gartner Inc., a Stamford, Conn., research and advisory firm, reported this winter that employee benefit outsourcing is a $27 billion industry in the United States. It predicted that the industry would grow 15% annually through 2005.
Ann C. Marhdt, an analyst at Chicago's Spectrem Group, said benefits outsourcing is primed to grow because companies increasingly are looking to take advantage of it.
"I think it has started at the high end with the very largest of companies and you will see it shift down as economies of scale build up," she said. "They are offering more and have found a new outlet for cross-selling. Companies want one place that they can go to."
Mr. Smail said Fidelity's large corporate customers - like IBM Corp., Shell Oil Co., Ford Motor Co., and Verizon - outsourced their benefit services to save money. "It cost more for the company to build these services for themselves than to pay us to do it for them," he said.
His customers save 15% to 20% by outsourcing their human resources services to Fidelity, Mr. Smail estimated.
These relationships also position Fidelity to cross-sell its other products and services, he said. Fidelity Employer Services' client roster consists about half of companies that already were Fidelity customers and half of companies new to Fidelity. Of the latter, he said, about 50% buy other Fidelity products.
"Two-thirds of new 401(k) customers demand that we provide other benefit services to them," Mr. Smail said. "Companies don't want separate providers. They want one provider who can provide a seamless business. They want one source."
CitiStreet, the Citigroup-State Street Corp. venture, supplies benefit plan services and employee retirement services to eight million people. Amy McGeorge, its executive vice president of client services, said more plan sponsors are asking her Quincy, Mass., company to do more than provide retirement services.
"They want retirement benefits, they want payroll services, they want all sorts of human resources services for us to administer," she said.
Hewitt Associates is the largest human resources outsourcer; it has been in the business for 60 years. Its client roster includes more than half the Fortune 500 companies and more than one-third the Fortune Global 500 companies.
The Lincolnshire, Ill., company has more than 13 million plan participants and had $1.72 billion of revenues last year, 16% more than in the previous year. The company attributed the growth to its outsourcing business.
In June, Hewitt bought the actuarial and benefits consulting business of Bacon & Woodrow, a London retirement and financial management consulting firm. It said it plans to spend this year expanding its business worldwide.
The company said in a press release that it expects 15% to 18% revenue growth this year. In its fiscal first quarter, which ended Dec. 31, revenue rose 19% from the year earlier, to $480.3 million.
Early last year, Mellon Financial Corp. started Mellon HR Solutions to offer 401(k) asset management, custody and administration, and benefits outsourcing. Mellon bought Unifi Network, a Fort Lee, N.J., human resources outsourcing and consulting unit of PricewaterhouseCoopers in November 2001 to jump-start the business.
Mellon's human resources sector, comprising Mellon HR Solutions, the employee benefits and human resources consulting firm Buck Consultants, and the shareholder services unit Mellon Investor Services, contributed $1.1 billion of revenue to Mellon Financial Corp.'s $4.2 billion total last year.
Tony Martin, the managing director of strategy and products at Mellon HR Solutions, said his unit generated about $400 million of revenue last year.
Mellon HR Solutions handles benefits outsourcing for 200 companies with a total of four million employees. Half of these came with the Unifi deal. Mr. Martin said he expects the business to grow 12% to 15% annually during the next two years.
With roughly comparable numbers of client companies and employees to Fidelity, Mellon is realizing less than half the revenue. Mr. Martin said that, because last year was essentially its first in the business, the revenue opportunities, particularly with the former Unifi customers, have not been fully exploited yet.
Kevin Daniels, an analyst in Boston, said the discrepancy in revenue can be attributed to time in the market. The longer Mellon works with customers, he said, the more assets it can gather.
"The key to success in this business is to devote enough capital to enhancing technology," Mr. Daniels said. "Mellon has tackled this business with a steady course in mind. They began by acquiring. If they want to succeed they must invest in technology and offer a wider variety of services to employers."
Mr. Martin said providing these services can give a financial services company bonds with employers.
"With the right relationship, managed the right way, we become a partner with the employer and the employee," he said. "We are involved earlier. When they think about making a change to their retirement services or to another benefit, they usually think about how they can make things easier. They want to structure one plan."
Mr. Smail said the heavy cost of technology means most financial services companies cannot handle human resources outsourcing, regardless of its cross-selling potential. Fidelity spends $2 billion a year on technology to maintain its position, he said.
"Scale is king in this business," he said. "Companies have to maintain scale in order to provide the best services to the widest array of customers. … Downstream, a customer can fall in love with their outsourcer and want every product they offer, but the barriers for entry are steep and significant."
A small provider disagreed, however, that benefit outsourcing must exclusively be the province of giants like Fidelity. Exult Inc. in Irvine, Calif., has contracts with six large companies, including International Paper, British Petroleum, Prudential Financial, and a $1.1 billion benefit services deal with Bank of America Corp.
James C. Madden 5th, Exult's chief executive officer, said the company has invested $200 million in technology and process design over the past three years. It manages $3.8 billion of long-term contracts and generated $420 million of revenue last year.
"Firms don't have to be big to be good," he said. "This is our primary business. Benefit outsourcing is a sideline business to a firm like Fidelity. They start out selling 401(k) services. This business is our core competency. We have nothing to cross-sell; all we want to do is run a company's benefits as well as possible."
Mr. Madden said that for competitors to use benefit services as a platform for selling other products is "a disservice to their client and a total conflict."
Mr. Smail said cross-selling is never forced on customers. Employers want one package of benefit services from a single provider, he said.
"Half a dozen companies offer defined benefit, defined contribution, health and insurance plans, but no one offers everything the way we can," Mr. Smail said. "We have the broadest offering."
This means clients are always deepening their relationships with Fidelity, he said. Ms. Brandon, for example, said First American is outsourcing both payroll and human resources functions to Fidelity.
"Owning all of these businesses, doing all of this work, it isn't prudent and it doesn't help the bottom line," Ms. Brandon said. "We want to work with Fidelity and create that one-stop shop for our employees and one-stop shop for us as a corporation."
