For CEOs and CFOs of small and medium-sized businesses (SMBs), navigating the complex human resources (HR) landscape is challenging.
Ensuring compliance with employment laws, managing employee benefits, and handling payroll efficiently are just some tasks that can consume significant time and resources. This is where Professional Employment Organizations (PEOs) come in.
PEOs offer a comprehensive solution to manage these HR functions. However, understanding when to use a PEO versus an HR Information System (HRIS), how PEOs make money, and how they are priced is crucial for making informed decisions.
To make the most of their investment, SMB leaders need to learn why a PEO may be a good solution for them and, if it is, extract maximum value from their PEO provider.
When to Use a PEO vs. an HRIS
Using a PEO
PEOs are particularly beneficial for SMBs that may not have a dedicated HR department or those that need comprehensive HR management. SMBs may want to consider outsourcing most, if not all, of their HR functions to focus on core activities. A PEO can be a solid choice. They offer extensive services, including payroll processing, benefits administration, compliance with employment laws, risk management, and employee training.
According to the National Association of Professional Employer Organizations, the PEO industry’s 208,000 clients represent 17% of all employers with between 10 and 99 employees, demonstrating how common PEOs are within the SMB market.
Using an HRIS
An HRIS is suitable for companies with an internal HR team that needs tools to manage HR processes efficiently. An HRIS offers many benefits such as scalability, customization, and control over HR functions, making it ideal for businesses that control their HR processes internally. It centralizes employee data, tracks attendance, manages payroll, benefits, performance reviews, and more.
Which is best for your company?
If your business has fewer than 100 employees, you need to be thoughtful about investing in an internal HR resource. A well-constructed partnership with your PEO should eliminate the need for an internal HR Generalist, freeing up important payroll dollars for other value-creating roles like sales, business development, product development, and client services.
That said, there are some services that PEOs either don’t provide or don’t do well. Specifically, recruiting and talent acquisition. Adding a recruiting specialist to your team is affordable and recommended, as the costs of outsourcing recruiting are typically cost-prohibitive in the SMB world. An in-house recruiter is better equipped to attract and screen the talent you need because they understand the business, roles, and culture. No outside resource can bring this to the table.
How PEOs Make Money
Professional Employer Organizations generate revenue through various streams. Here's a breakdown of the key ways PEOs make money:
Service Fees
- Flat Fees: Charged per employee per month, covering services like payroll processing, benefits administration, and HR management.
- Percentage of Payroll: Fees based on a percentage of the total payroll, aligning revenue with the client’s workforce scale.
Benefits Markup
- Health Insurance: Negotiated bulk rates for health insurance and other benefits, with a markup added before passing costs to clients.
- Other Employee Benefits: Markups on dental, vision, retirement plans, life insurance, and disability insurance.
Administrative Fees
- Onboarding Fees: Charges for setting up new clients, including assessments, HR system implementation, and integration of payroll and benefits.
- Compliance and Legal Fees: Additional fees for handling compliance issues, legal advice, and regulatory changes.
Additional Services
- Training and Development: Fees for employee training programs and leadership development.
- Recruitment and Hiring: Charges for recruitment services, including job postings, candidate screenings, and hiring processes.
- Background Checks: Fees for pre-employment screenings.
- HR Consulting: Providing consulting services on organizational development, employee engagement, and performance management.
Technology Fees
- HRIS Access: Charges for access to their HRIS for managing employee data, payroll, benefits, and compliance.
- Software Integrations: Fees for integrating PEO systems with the client’s existing software.
Compliance and Risk Management Fees
- Workers’ Compensation: Managing workers’ compensation insurance, potentially earning money through reduced claim costs.
- Unemployment Insurance: Handling unemployment insurance claims and associated costs.
Profit Sharing and Incentives
- Vendor Rebates: Rebates or commissions from vendors for large volumes of business.
- Performance-Based Fees: Sharing in savings achieved through effective HR management.
Retirement Plan Fees
- 401(k) Plan Administration: Fees for administering retirement plans.
Volume Discounts
- Economies of Scale: Securing discounts on benefits and services, then charging slightly higher rates to clients.
Special Projects
Customized Solutions: Fees for tailored HR solutions, such as bespoke training programs and compliance audits.
Pricing of PEOs: Models, Levers, and Benchmarks
PEO pricing can vary significantly based on several factors. Understanding these factors helps make cost-effective decisions.
Pricing Structure
PEOs typically charge either a flat fee per employee or a percentage of the total payroll. A flat fee usually ranges from $100 to $150 per employee per month (PEPM). On the other hand, the percentage of payroll model aligns the PEO’s revenue with the scale of the client’s workforce, usually between 2% and 10%.
Notably, the smaller the company, the higher the monthly cost per employee of the PEO service due to the lack of economies of scale.
Factors Influencing Pricing
Several factors influence PEO pricing. Larger companies can negotiate lower per-employee fees due to economies of scale. Employee demographics, such as age, location, and health, also impact pricing, especially for benefits.
Industries with higher risk (like construction) and historically high turnover (like restaurants) may face higher costs due to increased compliance and risk management needs.
The range and complexity of required services, the type and level of benefits offered, and the company’s compliance needs all play crucial roles. Additionally, geographic location affects costs due to regional differences in wage levels and regulatory environments.
Benchmark Pricing for Different Company Sizes
5 Employees:
- Flat Fee: $500 - $750 per month
- Percentage of Payroll: 5% - 10%
- Total Monthly Cost: $2,500 - $3,750
25 Employees:
- Flat Fee: $2,500 - $3,750 per month
- Percentage of Payroll: 4% - 8%
- Total Monthly Cost: $6,250 - $9,375
50 Employees:
- Flat Fee: $5,000 - $7,500 per month
- Percentage of Payroll: 3% - 6%
- Total Monthly Cost: $12,500 - $18,750
100 Employees:
- Flat Fee: $10,000 - $15,000 per month
- Percentage of Payroll: 2% - 5%
- Total Monthly Cost: $25,000 - $37,500
Avoiding Surprises: Key Considerations for CEOs and CFOs
When selecting a PEO, there are several potential surprises that CEOs and CFOs should be aware of to avoid unexpected costs and issues:
- Miscellaneous Fees: These can include fees for replacement paychecks, off-cycle payrolls, and corrections to tax withholding or 401(k) contributions.
- Deductible Costs: Employee legal complaints covered by Employment Practices and Liability Insurance (EPLI) can come with varying deductibles.
- PEO Partnership Expectations: Taking adverse employment action without the PEO’s involvement can result in the PEO not covering the claim under EPLI.
- Benefits Renewal Timelines: Ensure you understand the renewal process and timeline to avoid being in a time crunch. 67% of employees and 68% of employers believe this to be the most important benefit, and you do not want to find yourself backed into a corner on this one. SMB leaders need to know that the PEO does not manage the annual renewal at the PEO level; rather, your specific company’s renewal will be based on the utilization and costs to run the play for your company. While being a member of a PEO does enable significant health care cost savings, your benefits renewals are based on the risk in your company alone.
- Annual Fee Increases: Try to lock in your monthly fee per employee for as long as possible, and expect adjustments to Workers’ Compensation and Disability Insurance.
- Coverage for Employment Claims: Have a plan for covering claims from employees who worked for you under a previous PEO or before you brought HR in-house.
New Horizons and Offerings in the PEO World
The world of PEOs is evolving rapidly, bringing cutting-edge solutions that were unimaginable a few years ago. These innovations are not just enhancements but game-changers that can propel your business into a new era of efficiency and growth.
Global Employment Organizations (GEOs)
Imagine seamlessly expanding your business into new countries without the usual headaches of navigating foreign employment laws and regulations. GEOs, akin to PEOs, are now enabling SMBs to achieve global reach effortlessly.
These partners can integrate with your current U.S. PEO, providing a unified solution that simplifies international expansion. It's a revolutionary step for SMBs looking to tap into global markets without the usual complexity and risk.
Next-Gen PEO Technology
The tech landscape within PEOs is experiencing a renaissance. Gone are the days of clunky, outdated systems. Today's PEOs are rolling out state-of-the-art Applicant Tracking Systems (ATS) and Performance Review Systems that rival the best standalone HR Tech solutions.
These tools are not just better; they are smarter, more intuitive, and designed to provide deeper insights and greater value. It's about turning HR data into strategic assets, giving you the competitive edge in talent management.
Enhanced Training, Development, and Retention Support
The focus on human capital is sharper than ever. Leading PEOs are now offering comprehensive talent support services that go beyond traditional training. Think bespoke development programs, cutting-edge retention strategies, and future-proof succession planning, all tailored to your unique business needs.
These services, often included in your existing fees or available at a fraction of the cost of developing them internally, are designed to ensure that your workforce is not just competent but exceptional.
These innovations are not just incremental improvements; they represent a bold reimagining of what PEOs can offer. By embracing these new horizons, you can leverage the latest advancements to drive your business forward, keeping you ahead of the curve in an ever-evolving marketplace.
Scaling the Business: When to Move On from a PEO
As your company grows, the dynamics of utilizing a PEO may change. A general rule of thumb is that when your headcount reaches around 100 employees, it might be time to consider bringing HR functions in-house.
This shift often makes sense because healthcare benefits can then be quoted based on your employee demographic, rather than community ratings, which can work to your advantage if you have a healthy, cost-effective workforce.
However, be prepared for a transition period.
PEOs typically do not release your medical utilization data, making it necessary to establish your own company baseline for costs. Brokers and carriers can estimate rates, but expect wide variability in the first two years of going internal.
Remember, while exiting the PEO will create additional investments in staff and technology, these costs will be partially offset by the savings from PEO fees. That said, don’t assume you’ll automatically exit the PEO at 100 employees. Larger employers are attractive to PEOs, and they often strive to retain them.
Due diligence is crucial to make the right choice. Consider the total cost, including any hidden fees, and the strategic benefits of maintaining or exiting the PEO relationship.
Maximizing Value: CEO and CFO Involvement
CEOs, CFOs, and other SMB leaders must be intimately familiar with their PEO offerings to maximize the investment, ensure performance, and manage costs and risks.
Learning how these things work early in your business will prepare you to scale as your company headcount expands and your revenue grows
