Cloud adoption is on the rise across sectors as enterprises increasingly look to implement digital strategies. The payroll and Human Capital Management (HCM) sector in particular has seen positive momentum with Software as a Service (SaaS), as secular trends point in favor of cloud vendors.

We sat down with Mizuho’s Software Analyst Siti Panigrahi to take a closer look at some of the major trends and themes impacting the cloud HCM market.

You recently launched coverage of the cloud payroll and HCM software segment with a positive outlook. Can you briefly explain why software is attractive to investors?

It boils down to a common phrase we use in the technology industry: “Software is eating the world.” We’re seeing software penetrate every aspect of our lives, at work and at home, and IT spending continues to move toward software and software-defined elements for hardware, storage, and networking.

Industry data demonstrates that software has been the fastest share-gaining sector within the enterprise. In the past decade, software has appreciated by a remarkable 412% compared to 196% for the S&P. And in just the past three years, SaaS companies specifically have realized a total appreciation of 175% in their stock price. Besides growing secular demand for software, the recurring nature of revenues in SaaS companies, which generates sustainable cash flow, makes them more attractive to investors.

How is cloud adoption impacting the HCM industry?

Historically, payroll and human resources (HR) functions were outsourced to service bureaus such as ADP and Paychex, as organizations were not equipped with the technology infrastructure and human resources to manage those processes internally. However, the emergence of new technologies with self-service features shifted this responsibility, and organizations are now able to meet a much more diverse set of business functions. Specifically, given the current tight employment environment, the investment in modern HCM technology has become more strategic to hire, retain, and develop talent.

Through cloud adoption, HCM systems have evolved to manage and automate basic HR operations such as core HR applications, benefits, and payroll. Today, cloud/SaaS is the de facto standard to deliver such applications, and it’s enabling more efficient, user-friendly and mobile-friendly capabilities.

Cloud-based solutions have also made HCM software more affordable and accessible to small and midsize businesses (SMBs), materially expanding the market opportunity for cloud HCM vendors. Still, transitioning from service bureaus remains a major source of revenue, specifically from ADP.

What are the other trends influencing this market segment?

A number of trends are driving demand for the modern HCM technologies. Regulation and tax complexity is one such area: Because there is a shortage of expertise around managing the growing number of employment regulations and ever-more-complex tax laws, organizations are now looking to HCM and payroll applications to help them stay compliant.

Demographics also play a role, especially as millennials take over the workforce. Their familiarity with technology will drive demand for modern HCM applications that foster growth and mobility. Similarly, the rise of the gig economy with self-employed workers requires a change in how payroll and taxes are processed. Employers need access to HCM technologies to offer services and benefits tailored to this new type of worker.

At the same time, innovations in artificial intelligence (AI), machine learning (ML) and robotic process automation (RPA) will advance HCM technologies, making them incredibly valuable to enterprises as they continuously improve their capabilities, expand HR efficiencies, and reduce labor costs.

Do you foresee any headwinds for the cloud HCM market?

Since HCM and payroll application fees are based on a per-employee-per-month basis, total employment and wage growth are key growth drivers for this market. Therefore, these vendors are subject to the impact of an economic slowdown or rise in unemployment. However, some vendors indicate that recent employment growth has contributed low, single digit percentage growth to revenues and any negative impact to revenues would be offset by cross-selling opportunities for talent management and other non-core HCM products.

Additionally, the rise of interest rates over the last three years has been favorable for HCM vendors. But the Fed’s recent 25 basis points rates cut, and more cuts expected over the next several months, have the potential to turn a tailwind into a headwind.

 

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