Managing human resources can be a significant challenge for small and mid-sized businesses that diverts focus from core operations. Professional employer organizations (PEOs) offer a solution by providing HR services and expertise.
But is the investment financially worthwhile?
Research shows significant monetary returns. According to a 2019 National Association for Professional Employer Organizations (NAPEO) study, the average PEO client sees $1,775 in cost savings per employee annually in areas like health benefits and HR overhead. However, PEO services also come at a cost, typically 2-15% of payroll expenses. The average return on investment is 27.3%.
Below, we will analyze the financial pros and cons of PEOs to inform business owners' decisions.
Benefits of PEO Partnerships
When weighing the financial implications of a PEO partnership, it is crucial to consider the many monetary benefits these services offer. PEOs provide strategic value that saves clients time and money in a number of ways:
One significant financial benefit of PEOs is reducing employee turnover costs. According to a 2014 NAPEO study, PEO clients have 10-14% lower annual employee turnover than the national average of 42% in 2012. Given that SHRM estimates the cost of replacing an employee at 50-60% of their salary, this reduction in turnover can lead to substantial savings.
By providing robust HR services and expertise, PEOs help clients improve talent retention. This preserves valuable institutional knowledge and avoids the recruiting, onboarding, training, and ramp-up costs associated with turnover.
Increased Access to Affordable Benefits
Access to affordable employee benefits is another significant financial advantage of partnering with a PEO. By leveraging their scale and consolidated buying power, PEOs can secure competitively priced health insurance, retirement savings plans, life insurance policies, and other benefits for client companies.
According to the 2019 NAPEO report, 63% of businesses new to PEO partnerships saw reductions in health benefit costs after joining, with average savings of $654 per employee.
With medical costs consistently rising, obtaining budget-friendly benefits packages is a huge perk. PEOs’ expertise and resources can provide benefits options simply inaccessible to many small and mid-sized companies seeking to attract and retain talent while controlling expenses.
Lower HR Administration Expenses
PEO partnerships can also substantially lower HR administration costs for client businesses. Rather than maintaining extensive internal HR staff and systems, PEOs provide specialized personnel and infrastructure.
PEO clients utilize 40% fewer HR employees on average, according to the 2019 NAPEO report. They also spend less on external vendors for payroll processing and compliance management.
By leveraging economies of scale, PEOs deliver comprehensive HR solutions more efficiently. This enables businesses to reduce HR overhead costs and redirect those savings toward growth-driving initiatives. For companies overwhelmed by HR burdens, outsourcing these functions through a PEO provides strategic value that far exceeds the partnership fees.
Improved Operational efficiency
A final financial benefit of PEOs is improved operational efficiency for client businesses. The business failure rate for PEO clients is 50% lower compared to similar non-PEO companies - just 4% versus 8% nationally, according to the 2019 NAPEO report. This huge survival advantage stems from PEOs handling complex HR tasks, enabling leadership to focus on core business functions.
The 2014 NAPEO study also found that PEO clients experience faster revenue growth than non-PEO businesses. With experts managing critical HR work like payroll, compliance, and benefits, companies can concentrate resources on strategic initiatives that boost productivity, spur innovation, and elevate profit margins.
Essentially, PEOs allow businesses to focus on what they do best - rather than getting bogged down in administrative minutiae. The hours saved and refocusing of efforts enabled by PEO partnerships directly translate to more robust financial performance over the long term.
Costs of a PEO Partnership
While PEOs provide strategic value, partnerships come at a cost that must be weighed in decision-making. There are a variety of expenses associated with outsourcing HR functions to a PEO:
Ongoing Service Fees
There are two major pricing models PEOs use: paying a percentage of gross payroll (PoP) and per-employee per-month (PEPM). The PoP model, where fees range from 2-15% of payroll, has some downsides. As payroll costs rise, PEO prices escalate proportionately. This unpredictable variability can be challenging for businesses with fluctuating staffing needs or tight margins.
PEPM provides more fixed, predictable costs by charging a flat rate per month for each employee. This model offers greater budget stability and control. PEPM also incentivizes PEOs to help manage expenses like payroll and benefits that impact their bottom line.
Additionally, locally-based PEOs have lower service fees than large, nationwide providers. Their market focus allows them to maximize operational efficiency. Working with a local PEO can provide the highest value PEPM rates.
Implementation and Onboarding Costs
Another expense to account for is PEO implementation and transition costs. Initiating a new PEO partnership involves onboarding fees, data migration to the PEO's platforms, integrating the PEO's systems with existing HR infrastructure, and training staff on new processes.
While these one-time costs may seem high initially, they quickly diminish as the benefits of outsourcing HR accrue over months and years. With proper planning and change management, businesses can minimize disruptions during the transition. And the long-term gains in efficiency and focus enabled by the PEO far outweigh these temporary growing pains.
When evaluating PEO costs, business owners should also carefully consider contractual terms and potential fees for early termination. PEO agreements often stipulate minimum service durations to access preferred pricing. There may also be substantial termination fees for ending the partnership prematurely.
Transitioning off of a PEO platform can be resource-intensive as well. Companies must recreate HR infrastructure and migrate data, which carry hidden costs. To avoid surprises, these considerations should be accounted for upfront. Checking the fine print in PEO contracts and understanding off-boarding processes is essential.
The Bottom Line
When weighing the pros and cons, the financial benefits of PEOs clearly outweigh the costs for most small and mid-sized businesses. Estimates peg the return on investment above 25% for many companies partnering with PEOs. The cost savings from reduced HR overhead, better benefits rates, lower turnover, and more add up substantially.
Qualitative advantages like risk mitigation and access to expertise deliver further value that cannot be quantified. Partnering with a PEO is an intelligent business decision for organizations overwhelmed by HR burdens. Carefully vetting providers to find one that suits your needs and provides maximum ROI is essential.
But for most SMBs struggling with HR functions, PEOs can offer a significant financial boost.