Crain's Chicago Business - July 12, 1999

An Alternative to Paperwork:
Proliferation of Small Firms Fuels Expansion Among PEOs

By Rebecca Johns Trissler

Patrick and Darlene Echlin, co-owners of Harvey-based Echlin Co., went into business in 1981 to repair tractor-trailers, not to do paperwork.
But even with a small business of about 13 employees, Mr. Echlin still had payroll, benefits and other employee-related functions to handle. So about seven years ago, the Echlin’s hired a professional employer organization (PEO) to take on their human resource issues.

"I was spending about half my time handling payroll and benefits," Mr. Echlin says. "When we found out about PEOs, we gave one a try and have been using it ever since."

The Echlin’s aren’t the only ones who have found PEOs to be a boon. More than 2 million American employees work in businesses that have a co-employer agreement with a PEO. Most are small, with an average of 16 employees. There are more than 1,500 PEOs around the United States, a number that is increasing 20% to 30% each year, according to the National Association of Professional Employer Organizations (NAPEO) in Alexandria, Va.

A PEO is an organization that contracts with businesses to provide human resource functions. As such, the PEO acts as a co-employer of the company’s workers, along with the client (known as the worksite employer).

The employer pays the PEO a fee, which can range from 4% to 10% of a company’s gross annual wages, depending on the services contracted and the turnover rate. Costs depend on the services provided, experts say, but often the PEO will offer a bundled package or break out a few services for the client.

Unlike a payroll service, PEOs can perform a variety of services including recruiting, hiring, reassigning and firing employees, providing drug testing services, medical coverage and other benefits, including 401(k) plans; preparing paperwork and legal expertise for disability and workers’ compensation; providing payroll services, including paying employees out of the PEO’s own accounts and covering employees’ state and federal income taxes, depending on the terms of the contract. And unlike temporary employment agencies, the PEO’s relationship with both the client and the employee is long term.

The PEO trade began in the 1980s and exploded in the late ’80s and ’90s, says Milan P. Yager, executive vice-president of NAPEO.

"The number of government rules and regulations accelerated astronomically," he says. "Between COBRA, OSHA, etc., regulation was turning into alphabet soup. It was overwhelming entrepreneurs."

Another impetus, Mr. Yager says, was the spiraling cost of providing health care and other benefits to small business employees. In the ‘80s, he says, when boomers started looking toward the future, companies had to provide good retirement benefits. But most Americans work in small businesses, which have less money to put together comprehensive benefits packages.

This says Mr. Echlin, is where the PEO relationship really shines.

"The PEO offers better rates than what we as a small office could offer on our own," he says. "And it’s brought in a big cost savings, maybe 20% to 30% less than what we were paying before."

The reason PEOs can offer benefits at a lower cost is simple, Mr. Yager says: A PEO, being a bigger employer, can negotiate better rates from insurance companies and financial organizations. And as an expert in human resources, it can offer greater legal expertise in business regulation. All of this can save a small business owner time and money.

But there are some things a PEO can’t do, says Daniel A. Cacchione, senior vice-president of marketing for CNA UniSource in Chicago, the PEO division of CNA Financial Corp. – such as dictate the goods and services of a business, or manage every aspect of employee relations.

"The PEO becomes the back room," he says. "But they need employers to maintain contact with their employees."

Although PEO managers say there is no particular type of business they cater to, they agree that some industries are more receptive to PEOs than others, such as accounting offices, doctors’ and lawyers’ offices and food-service and technology companies.

Staffing Plus, which Mr. Echlin uses, is a full-service PEO with 2,000 employees. A division of the Lombard-based staffing services firm Plus Group Inc., the agency works with everything from software companies to fast-food restaurants.

The best overall candidates, Mr. Yager says, are companies that place a high value on keeping their employees. "In a tight labor market like this, it’s hard enough to hire good people," he says. "You don’t want to lose your best people to the competition."

Michael Gorham, regional manager with Administaff, a PEO in Rosemont, says technology businesses often make good candidates because of their emphasis on retaining skilled workers.

"Technology is so fast-paced that if they don’t pay attention, they’ll be left behind," he says. "PEOs give technology startups instant infrastructure, and they allow owners to focus on their core business."

There are a few things small business owners can do when researching a potential PEO. First, look for a company that’s financially sound, says Mr. Cacchione.

Second, says Mr. Gorham, ask if the PEO offers fully insured employee benefits or self-funded benefits. If it’s not fully insured, "that may raise some flags," he says. Some PEOs are starting to offer service over the Web as well.

Next, says Donald L. Shewmake Jr., managing director of Staffing Plus, look for NAPEO membership and referrals from the PEO’s other clients. Finally, since all PEOs have ties to legal and accounting organizations, call around to check whether the PEO is involved in any legal or monetary disputes.

Reprinted with permission of Crain’s Chicago Business.