Creating and Driving a Successful PEO Model

Thought provoking elements for creating and driving a successful PEO model.

Opening

Let me state from the beginning that this will be a longer article. There is a lot of ground to cover on this topic. This piece will be chalked full of valuable information for those that want to create and/or grow a successful professional employer organization. You will note as you read further that all of the segments woven through this article are interrelated. One aspect affects the other and vice versa. The creation and execution of a successful PEO model requires harmony among multiple facets within the business model. Also, at the end of each section there will be key takeaways. These takeaways will be action items that your team may use, if it chooses to do so, to improve upon within your existing or perspective operations.

High-Level Industry Overview

It is estimated that the professional employer organization industry is comprised of over seven hundred PEOs. However, according to the most recent IBISWorld PEO Industry Report, over half the market revenue is driven by the industry’s top three players; TriNet, ADP TotalSource and Insperity. If we extend this revenue out to the top ten players which would include others like Oasis, Paychex, CoAdvantage and BBSI, it is likely that three quarters of the industry revenue is driven by less than two percent of the PEOs in existence today.

However, the market is not yet saturated. Most experts estimate a market penetration rate of less than ten percent. This means that while the industry is top heavy with larger players and in a state of consolidation, there is still a massive amount of the market that is still untapped. Conversely, while there is a vast amount which is untapped, most prospects that review the PEO option review more than just one. In other words, having a lot of untapped market potential doesn’t mean that there won’t be competition. This competition, if you are a smaller or regional PEO, generally comes in the form of a larger player with economies of scale that your organization may not currently possess. This article will provide your executive team with insight to create and drive a successful PEO model and compete in a manner that will allow your PEO to win business more consistently. Like with anything worth doing, it will take some work. However, if your organization is willing to put in the work, improved results will follow. For further industry insight and statistics, click here.

Coverage Points

The topics that will be covered within this article are as follows:

  • Customer Selection
  • Business Model
  • Value Proposition
  • Talent
  • Technology
  • Sales Engine
  • Cash Flow from Operations
  • Controls
  • Strategic Intent
  • Scale
  • Executive Leadership
  • Exit Strategy

Each of the aforementioned topics are interrelated. This means that one affects the other and vice versa. It is essential that all facets of a PEO work harmoniously to achieve optimal results. We’ll take each segment one by one and then tie it all together at the end of the article.

Customer Selection

Until a PEO knows its desired client segmentation, it cannot craft a model that will consistently beat top competition. A business model starts with ideal client selection and builds from there. Often a PEO may fall into a trap of servicing all undefined prospective clientele in an effort to bolster revenue growth. This is a mistake. PEO models differ based on the client segmentation serviced. A misaligned model to a particular client segment may yield unfavorable close ratios, poor client experience, higher insurance losses, damage to brand equity, etc.  For example, imagine a PEO that is heavily focused on white collar business. If it begins to write a lot of blue collar business without augmenting the scope of its offering, it runs the risk of poor performing clientele. The white collar focused PEO may not have the appropriate risk mitigation strategies, staff or insurance platform to best accommodate the blue collar client segment. Moreover, a competitor PEO with a well-defined customer selection process whom focuses on blue collar clientele and possesses knowledge in the client industry vertical will likely win out over a PEO without a well-defined customer selection process.

Key Takeaways

  • Discuss among your executive team, who should be your target client segments. Be sure to seek feedback from your sales and operations teams before finalizing your target clientele.
  • Conduct an OTSW analysis to determine the opportunities/threats in comparison to your strengths/weaknesses. For more information on how to do this, click here.
  • Once the client segmentation is decided upon, identify what would need to change within your value proposition, growth engine, marketing and brand efforts, technology, insurance, etc.

Business Model

Once the desired client segment(s) is identified, the PEO’s business model should be designed to support driving value to the client segmentation and profit to the PEO.  A concise business model can be made up of five key elements; customer selection, value proposition, scope, value capture and supporting infrastructure.  A PEO’s business model is a combination of internal capabilities and external alliances which collaborate to drive value to the end user. Internal capabilities are contingent upon superior talent which possesses the ability to consult and service the target client segmentation. External alliances are partnerships where the PEO can utilize the value of third party services and resources to consolidate into the PEO’s macro value proposition. Some of these external alliances would be in the form of insurance carriers (workers’ comp, health, EPLI, ancillary benefits), technology (payroll, HRIS, CRM, ACA calculations), retirement options (401(k)), claims management (TPA, nurse on call, investigatory services, wellness programs, etc.), and more. It is pivotal that a PEO integrate the internal and external offerings to put forth a unified value proposition in line with the target client segmentation requisites. For further information on creating a successful business model, click here.

Key Takeaways

  • Review if the internal capabilities of your PEO and the external partnerships are congruent. Are there areas that are disjointed which require your attention?
  • Is your business model designed to appropriately support your desired client segments?
  • As your PEO scales, what areas may change with regard to what your PEO handles internally versus what you outsource to a third party? How would these changes benefit your PEO?

Value Proposition

What is a value proposition? Is it a menu of services a PEO offers or is it the actual value driven to its clientele? The answer is the latter. While the menu of services should be designed to support the value the PEO drives to its clientele, the services themselves are not the value proposition. The value proposition would be better defined as the benefit the client experiences by partnering with the PEO. We’ll take a look at a couple of examples to better explain this thought process.

A PEO that provides risk management consulting may look at the services as the value proposition. However, from the client’s perspective, the value proposition of this service is a safe workforce, a reduction in lost productivity time, a regulatory compliant operation and protection against injury for its workforce.

A PEO that provides a sophisticated tech platform may look at the features of the technology as the value proposition. However, a client will value streamlined efficiency, greater transparency on workforce variables, increased management capabilities, connectivity among its workforce, greater speed at execution, etc. The capabilities of the tech offered by the PEO is the instrument that allows the company to drive the value to the client. It is not the capabilities themselves that are the value proposition but rather the impact it has on the clientele. For a further breakdown of the facets that make up a PEO’s value proposition, click here.

Key Takeaways

  • Does your PEO have a solid understanding of what its value proposition is?
  • Does your value proposition need to change to better service your target clientele?
  • What within your value proposition sets your PEO apart from competition? If the scope of the value proposition isn’t better than larger competition, the execution of the value proposition by your internal talent better be superior.

Talent

The PEO model falls within the business services field. This means that while some aspects of the model are more mechanical in nature (technology, insurance, etc.), a large part of the model is driven by consultative talent with applicable business acumen and experience. Even the mechanical aspects of the model are influenced by the talent supporting it, such as technology design, training/support, and insurance claims handling, mitigation and strategy. To a large degree, the value proposition of the current PEO model is business improvement and efficiency revolving around human capital management.

A business owner who is going to trust in a partnership with a PEO needs to feel confident with the capabilities and experience of its PEO servicing counterparts. Otherwise, the client is often choosing a PEO for insurance or tech. An insurance or tech buy will not yield the same high retention rates as a human capital management partnership. Client facing talent, behind the scenes talent and third party partnerships talent will drive the overall customer experience. This will impact the brand equity of a PEO and affect future client referrals, customer satisfaction rates and long-term revenue growth.

A PEO that is too restrained on paying for superior talent will likely have inferior results. If a PEO is cautious about paying higher rates for superior talent, it can design its compensation structure to include bonus capabilities which are a byproduct of the company’s increase. This will protect the PEO against frivolous spending and incentivize the talent to drive superior results.  A PEO should be sure to design the bonus structure in a way that doesn’t promote behavior that is unethical or misaligned with the company mission, vision and values. For further information on talent alignment and company culture, click here.

Key Takeaways

  • Are there any current talent gaps within the PEO?
  • What talent will be required as the organization scales?
  • What training and development does the PEO offer to its internal talent and external third party talent?
  • What expectations has the PEO set for talent to research on its own so that it may infuse this knowledge back into the PEO talent pool?

Technology

Technology is an essential function within the PEO model. With advancements and innovation consistently occurring in the tech space, a PEO must remain abreast to developments that could impact and/or benefit its target clientele. Technology allows a PEO to better manage its external clientele and run more efficiently internally.  It is generally technology that a PEO looks to first in order to improve upon its internal to worksite employee (WSE) ratios. Improving upon this ratio generally equates to increased profitability for the PEO. In addition to the technology available to a PEO today, the PEO should also be up to speed on alternatives that the client has the ability to choose. While a PEO offers more than just a payroll service for example, the tech of a PEO should not be brutally inferior to its payroll counterparts. Moreover, the advancements in technology can have a major effect on the PEO industry in the future. Advancements in machine learning and artificial intelligence (A.I.) can certainly disrupt the PEO model in the future. A PEO should be aware of the possibilities so that it gains a competitive advantage over competition when it sees the market indicators that allow it to be a first mover on new tech.  For more information on improving internal to WSE ratios, click here. For more insight into potential market disruptors, inclusive of A.I., click here.

Key Takeaways

  • Review your PEO’s current technology and capabilities to ensure it is best suited to service its client segments.
  • Are there changes within your current technology or by selecting alternative technology that would allow your PEO to improve upon its internal to WSE ratios?
  • Is your PEO using its technology to its fullest extent?
  • Is your data adequately secure to protect your PEO and its clientele from data breaches?
  • What contingency plans are in place if your PEO has a power outage or technology disruption?

Sales Engine

Regardless of whether your PEO utilizes a channel or direct go-to-market strategy, or a hybrid of each, educated sales talent is a requisite. A PEO sales professional is limited to sell on what the value proposition can deliver. When reviewing the sales engine, first review the company’s value proposition to ensure viability. Once that is achieved, a thorough sales engine review is possible.  Ten highly qualified sales professionals will outperform 20 mediocre reps every day of the week. Quantity isn’t a viable long-term solution. Quantity of quality is. If the choice has to be made between quality and quantity, take quality.

Let’s suppose your PEO has a 20% prospect to close ratio. In this scenario, 80% of the businesses which have interacted with your PEO, have likely done so only with your sales rep. In other words, your sales rep carries a lot of weight in how the market perceives your organization. They are heavily influential on your PEO’s brand equity. I have seen an M&A deal go south due to one sales rep’s poor judgement. Meaning, this one sales rep that was perceived to have made a poor judgement years prior affected a transaction worth tens of millions of dollars. A PEO should not discount the impact sales has on its organization both internally and externally.

Once a PEO decides whether it will utilize a channel, direct or hybrid approach, it should structure its hiring requirements and compensation design to best support its sales engine. The type of person a PEO hires for sales and the attributes it looks for within a successful sales candidate will vary to certain degrees depending on the go-to-market strategy the PEO chooses.  To learn more about a successful approach to sales and the difference in go-to-market strategies, click here.  To learn more about the impact a sales professional may have on brand equity, click here. For an intro on getting into PEO sales, click here.

Key Takeaways

  • Is your current go-to-market strategy yielding desired results for revenue growth? Why or why not?
  • Does your PEO select the appropriate sales professionals based on your go-to-market strategy?
  • Does your PEO have training, mentorship, and development processes in place to grow your sales force and increase your ROI per sales professional?
  • Is your PEO’s value proposition favorable to allow your sales force to differentiate from competition?
  • Is your compensation model in line with achieving desired results and promoting best practices?

Cash Flow from Operations

First off, what is cash flow from operations? According to www.investopedia.com “Cash flow from operating activities (CFO) is an accounting item indicating the money a company brings in from ongoing, regular business activities, such as manufacturing and selling goods or providing a service. Cash flow from operating activities does not include long-term capital or investment costs.”

The residual nature of the PEO model is designed to generate consistent cash flow from operations. This cash flow allows a PEO to scale, entice superior talent, invest into its infrastructure, make acquisitions, and create an enticing EBITDA number if/when it decides to exit.  Cash flow from operations is heavily influenced by four key areas: revenue growth, pricing, operational efficiency and claims mitigation.

Revenue growth expands upon the size of volume of cash flow from operations while pricing optimizes the revenue growth base. Operational efficiency helps maintain overhead levels so that more from gross profit funnels down to net profit. Risk and claims mitigation helps protect against the potentially most volatile aspect of the overhead expenses and creates a better opportunity for increased cash flow.

One of the most enticing aspects of the PEO model to potential investors is the PEO’s ability to generate positive cash flow from operations. Protecting and maximizing the PEO’s cash flow is not only beneficial in operating the PEO today but also positions the PEO in a favorable light if/when it decides to sell the organization.

Key Takeaways

  • What objectives can your executive team identify to increase the level of cash flow from operations?
  • What estimated level of cash flow would be required to scale your organization or make a future acquisition?
  • How could the Dupont Formula for Return on Equity bring light to decisions to drive greater return for internal shareholders? (formula illustrated below)
DuPont mathematically expanded upon the return on equity formula to bring greater transparency in the areas a business can impact its ROE.

Controls

Implementing appropriate financial and regulatory controls within the organization is essential to ensure appropriate action and compliance. Controls should be put in place for accounting, tax filing, etc. PEOs  have external controls available also. Many voluntarily choose to become ESAC accredited, apply to become a certified professional employer organization and conduct regular audits.  Having appropriate internal and external controls  is essential and protects against an occurrence that could financially impact the organization or its clientele.  Such a negative occurrence could hurt profitability, client retention, brand equity, talent retention, etc.

Key Takeaways

  • Review your organization to make sure it has the necessary controls in place.
  • Designate the appropriate internal stakeholders to take charge of these controls and have redundancy or separation. One person shouldn’t have the key to all controls.
  • Align with the appropriate external parties to ensure proper controls where appropriate.

Strategic Intent

This topic will be covered at a high level because to fully develop a strategic intent for your PEO would vary per PEO and take up the bulk of this article. Therefore, high-level, the first step in developing a PEO’s strategic intent, after it has created its business model is to conduct a SWOT analysis. However, we recommend that you reverse the order of SWOT into OTSW. This allows a PEO’s executive team to view its strengths and weaknesses in light of the market opportunities and threats and not vice versa.

Once an OTSW is complete, the PEO must identify what space it will play in and how it will play in that space. It must identify who the industry competition is and also who are the alternatives that a prospective customer segment may choose from.  At which point, the PEO may decide its generic strategy and build from there. An example of Michael Porter’s generic strategies is illustrated below.

Porter's Generic Strategies
Michael Porter’s Generic Strategies Example.

The strategic intent process is an intense process but will yield superior results to companies which take the requisite time to fully develop their strategy. Another area to analyze your PEO is by ranking your company and industry by using Porter’s Five Forces, illustrated below. This will allow your team to better understand where and how it should compete against competitors and alternatives. While the following link is in no way intended to supplant the process of creating a strategic intent for your PEO, for some insight into how a smaller PEO may compete with larger PEOs, click here.

Porters Five Forces. A company can rank in each category whether it has an advantage, disadvantage or is neutral.

Key Takeaways

  • Does your PEO have a clearly defined strategic intent currently?
  • Have you conducted a recent SWOT, OTSW or competitive analysis?
  • Is your business model clearly designed so that your PEO may develop a strategy?

Scale

As a PEO grows, it will scale its operations. How the PEO scales its operations will play a role in determining its operational efficiency and net profit as a percentage of net revenue.  The most common method of scaling within the PEO industry is the creation of regional operating centers to support client facing branch operations. A regional operating center allows a PEO to consolidate certain functions within the backend service team to achieve scale.  For example, a PEO may consolidate its payroll, benefits administration and claims management teams into a regional operating center. This allows that operating center to have acute focus on these operations driving greater efficiency.  A PEO may be inclined to consolidate its HR functionalities as well. However, before a PEO makes this decision for HR consolidation, it should review the affect that an HR consolidation would have on its value proposition. If the delivery method for HR consultation is designed to happen in person, consolidation would have an adverse effect on the whole of the business.

The other benefit to scale is purchasing leverage. A review of Porter’s Five Forces in the previous section Strategic Intent, will help your team identify where purchasing leverage may be available. Some obvious areas where scale benefits a PEO’s leverage to negotiate are insurance, technology, TPA, etc.  Ultimately it is the combination of scaling internal operations and purchasing leverage that will allow a PEO to drop more profit to the bottom-line. For information or ideas on scaling business units in conjunction with or in lieu of regional operating centers, please click here.

Key Takeaways

  • What are the key factors within your PEO that are indicators as to when you should scale?
  • Is a regional operating center right for your PEO? Why or why not?
  • What purchase leverage will your PEO have as you grow? At what size do you feel this leverage will occur?

Executive Leadership

While it is the sum of the parts that makes up the whole PEO, executive leadership sets the tone and precedence for the organization. Therefore, an aligned executive team with common vision, values and focus coupled with superior communication and departmental integration yields better results than those whom lack these components. This is true weather a PEO is large and publicly traded or small and emerging. The difference between the two is that a large PEO already has an established executive team whereas a small PEO may have an executive team but is normally lead by the owner more than the executive team collaboratively.

It is advisable as a PEO scales that leadership development is in place to create and grow a successful executive team. The earlier this is able to happen within a PEO, the better. When an executive team fosters an environment and culture conducive to knowledge transfer, it begins to create a learning organization. In a learning organization, the group IQ should exceed any one individual’s IQ.  A learning organization starts with the executive team and permeates through the organization. Creating a learning organization takes practice but pays heavy dividends with culture, morale, departmental harmony and profitability. There is a framework to begin creating a learning organization based on MIT Professor Peter Senge’s book The Fifth Discipline. An executive summary of this framework may be found at the following two links: dialogue and defensive routines and improving executive team communication.  When learning to communicate as a team in this fashion don’t expect it to come naturally. This process takes practice but is well worth it when the team is committed to creating this framework within executive meetings.

Key Takeaways

  • How optimally is your executive team functioning today? Where does it need work?
  • Is creating a learning organization the right recipe for your organization?
  • How may your company improve upon leadership development and succession planning?

Exit Strategy

You’ve likely heard the saying “start with the end in mind.”  Having a solid understanding of where you desire your PEO to go will help pave the way for the move necessary to arrive at this destination within the desired time-frame.  Having a desired endpoint also helps a C-Suite course correct when needed if the organization begins to drift away from the intended destination.  An exit strategy doesn’t mean a PEO must sell at some point. What it does mean is that the PEO is prepared for a sale or succession if or when appropriate. PEOs that do not begin with the end in mind may diminish some of the value it could have realized when the shareholder(s) do exit the organization.  An exit strategy helps an executive team maintain focus. It puts a timeline to objectives which helps maintain progress and promotes action when progress stifles or growth stagnates. Ultimately, it is to the determination of the shareholders what the exit may look like but all PEOs could benefit from having an exit strategy in mind, whether or not they plan on exiting the organization. For more information on having an exit strategy, click here.

Key Takeaways

  • Having a defined exit strategy helps keep the executive team focused and prepares the organization for an exit, if desired.
  • Having an exit strategy doesn’t mean you need to exit.
  • What would you change within your PEO if you were planning on exiting in five years to maximize your valuation?
  • Are there areas of an M&A transaction that you don’t know but would like to? What are those areas and how can you obtain that insight?

Synopsis

If you’ve made it this far in this article, I applaud you. It was a long article but the information contained throughout can help guide and grow your PEO. In summary, begin with defining your customer selection and build your business model to support driving value to this segment. Design your value proposition to support driving value to your customer and execute the delivery of the value prop with superior talent. Ensure that your technology supports the business model and talent of the organization and drives superior internal to WSE ratios. Determine your go-to-market strategy and then hire and develop the appropriate sales professionals while utilizing a compensation structure that promotes results and ethical practices. Review the organization’s cash flow from operations and determine areas to improve upon this number.  Ensure the company has the proper internal and external controls to protect against fraud, embezzlement and noncompliance. Spend the time to formulate a strategic intent so that the company is positioned to win and the direction is clear to internal stakeholders. Know how and when to scale and what indicators prompt the timing of scaling the organization. Uncover leverage points when scaling to improve upon cash flow from operations. Align executive leadership and determine if creating a learning organization is right for your PEO. The executive team should be aligned in mission, vision, value and focus with clear direction to execute upon initiatives and provide latitude to express differing opinions. Whether or not an exit from the organization is on the near horizon, develop an exit strategy. This will allow your team to remain focused and determine what facets of the business need to improve to increase valuation. Having an end in sight also provides a constant to determine when the organization is adrift and requires course correction or augmentation of the end destination.

Final Thoughts

Hopefully the information contained within this article will provide your executive team with some key takeaways and actions items that will ultimately guide your PEO towards greater prosperity. For additional information and insight in any of the covered areas, feel free to contact us.

 

Author: Rob Comeau is the CEO of Business Resource Center, Inc., a consulting and M&A advisory firm to the PEO industry. Business Resource Center’s website is www.biz-rc.com. You may reach them by phone at (949) 888-6627.

How to Build a Business Model Framework

How to build an effective and concise business model framework to guide your business plan, competitive analysis and strategic intent.

How to Build a Business Model Framework

Creating a business model can be a misunderstood process. Often, the business models I’ve reviewed are overly convoluted and lack continuity. This article will provide a high level step by step guide in creating a business model and conducting a business analysis.

Business Model Creation

There are five elements for creating the framework of a business model.

  1. Customer Selection
  2. Value Proposition
  3. Scope
  4. Value Capture
  5. Infrastructure

Customer Selection

Until a company knows who their customers are, creating a plan is useless. A new or pivoting organization should review who its core customer base will be. The company should also pay attention to the fringe and identify potential customers for the future. These potential customers may come from the segment your industry services or outside of the industry’s current client segmentation.

 

Value Proposition

Once the target and ancillary client segments have been identified, the next step is to create a value proposition that drives value to this customer base.  This value proposition should support and drive value in accordance with the company’s perspective clientele requisites.

 

Scope

Scope refers to how the company will execute upon its value proposition. In other words, how will the organization deliver the proposed value to its clientele? The scope includes the personnel, tools, resources and delivery method of executing the value proposition.

 

Value Capture

The value capture is how the organization makes money. How does the company monetize its offering? How many perspective profit pools does the company have? Where does the company price its various offerings? Does the pricing model have elasticity?  Is the company pricing off what market competition sets as the “standard” or has it done the requisite research to better price its deliverable?

 

Infrastructure

The infrastructure is the supporting framework and functions within the organization to allow it to run appropriately and scale in future growth cycles. The infrastructure should include all functionalities of a business such as finance, HR, IT, etc. The infrastructure (5) should be built to support the delivery of the value proposition (2) through the offering scope (3) in order to satisfy the identified client segmentation (1) and ultimately capture value or profit (4).

 

Sample Business Model Framework

 

Business Model

 

External/Internal Analysis

SWOT (Strengths, Weaknesses, Opportunities, Threats)

While the acronym SWOT is catchy, it can be dangerous. When an executive team conducts this analysis in the order of S-W-O-T, it runs the risk of skewed analysis. For example, when a team reviews the company’s strengths and weaknesses first, it may view the opportunities and threats in light of the current strengths and weaknesses. This process can be flawed and yield bias results.

 

OTSW (Opportunities, Threats, Strengths, Weaknesses)

The order of O-T-S-W is advised to gain an unbiased assessment of external and internal variables. When a team reviews the external opportunities and threats first, it may then align the internal strengths and weaknesses appropriately. It is able to view opportunities and threats unfiltered through the company’s current capabilities and allows the team to more accurately augment and align the company to match the opportunities and avoid the threats.

 

Misconception about Weaknesses

The world we live in today gives us the impression that we should always improve upon our weaknesses. That improvement takes time, resources and money. Prior to such improvement efforts, take a look at the pond the company is fishing in. Is there an area to fish that minimizes the relevance of the organization’s current weaknesses? If so, the company can instead spend that time, resources and money to improve upon its strengths since the company weaknesses are not a pivotal factor based on where the company is operating.  Time, resources and money are not in endless supply. An executive team should be wise in where it allocates these resources.

 

For more information on SWOT vs. OTSW, click here.

 

Final Thoughts

The framework discussed in this article will provide a starting blueprint for ancillary and supporting information inclusive of value chains, supply chains, pro forma and financial modeling, capital requirements, talent acquisition, etc. While a business plan or investment proposal will include more than what was covered in this article, without a solid understanding of the company’s framework for a business model, the organization runs the risk of a disjointed model.

 

Once a business model is designed, the executive team may then proceed to develop a strategic intent and plan. Without a business model in place, it is virtually impossible to create an effective strategy.

 

Author: Rob Comeau is the CEO of Business Resource Center, Inc., a management consulting and M&A advisory firm based in Orange County, California.  A special thanks for the teaching of Dr. Kurt Motamedi, Professor of Strategy for Pepperdine University Graziadio School of Business and Management’s Presidents and Key Executives MBA program. 

Reader Requested Topics: Profit Pools & Cost Effectiveness of PEOs

A PEO that manages their profit pools successfully has greater flexibility to manage business.

Requested Topics

We’ve received requests to write articles addressing two questions.

 

  1. Can a PEO be cost effective over a client using a traditional insurance carrier?
  2. What profit pools does a PEO have available? In other words, how do they make money?

 

Both of these questions can be answered in the same article as they are in some ways, interrelated. This article will review each question individually and then provide a synopsis at the end. We’ll review if a PEO can be more cost effective than a traditional standalone insurance policy and whether or not it should be. We’ll also look at the main profit pools available to a PEO and the affect that has on PEO pricing.

 

Question One – Can a PEO be cost effective over a client using a traditional insurance carrier?

Yes, but not always. A PEO offers a wider scope of services than a traditional insurance carrier so when comparing the two, all facets must be factored into consideration. I’ve heard it said by some in the PEO industry that comparing a traditional insurance carrier to a PEO is like comparing apples and oranges. That is not entirely correct. While a PEO offers additional services above and beyond the traditional carrier, the commonality is that both offer insurance.  Therefore, a better analogy would be that we are comparing apples to apples and oranges.

Therefore, when comparing a PEO to a standalone insurance policy, you must include the “oranges” or alternatives that a buyer would need to use coupled with the insurance policy for an accurate comparison to a PEO.

 

What are the methods that allow a PEO to be more cost effective when comparing it to the available alternatives?

  • Economies of Scale
  • Diversity of offering (multiple profit pools)
  • High deductible workers’ compensation
  • Master group health plan
  • Effective reduction of employee turnover
  • Risk mitigation services
  • Macro vision for HR and employment management

 

Economies of Scale

It is no secret to business owners that economies of scale allow a business to run more efficiently internally. This means that the cost of goods sold (COGS) and/or selling and general administrative expenses (SG&A) can be a lower percentage of total revenue than for competitors whom haven’t achieved scale. This lower overhead as a percentage of revenue equates to an increase in gross profit (GP). As a result, an organization with economies of scale may have a higher GP and EBITDA than those without. Conceivably, a company of scale can maintain comparable profit margins to that of their competition while still providing a lower price point.

 

Diversity of Offering

Anyone experienced in insurance understands what a multi-policy discount is. When a company diversifies its risk and has multiple profit pools, it can price more aggressively if it desires to do so. PEOs have a diversity of profit pools rolled into a singular offering. For example, a PEO can generate profit from administrative fees, insurance premiums and rebates, tax deltas and profit from ancillary services such as recruiting, staffing, tax preparation, etc. Some PEOs also have transactional fees associated with their program which we will cover later in the article. With multiple profit pools, it isn’t reliant on one pool to generate all the profit. Some PEO profit pools are predictable such as administrative fees. Others are not, such as insurances (claims) and taxes (unemployment). When a company has a diversity of profit pools, that are managed well, they can become more cost effective. When the profit pools which can be impacted by claims and unemployment are mismanaged, the PEO can have the opposite result.

 

High Deductible Workers’ Compensation

A PEO only remits a percentage of the premium it collects when it operates on a high deductible program. It then is required to reserve and collateralize against claims maturation to the backing carrier. A PEO that effectively manages its underwriting and risk mitigation programs can create a lower loss ratio.  A PEO that utilizes a successful claims strategy can effectively close claims out quicker than claims that are only sporadically touched by overworked claims adjusters. As a result, the PEO is able to keep more of the delta between the costs of the program versus what the client is charged. In this scenario, the PEO can become more cost effective if it chooses to price lower. However, a PEO must be cognizant to appropriately price business and manage their program effectively. A poorly or mismanaged program and underwriting process can act detrimentally to the PEO and erode profit.

 

Master Group Health Plan

The typical client size for a PEO in the United States hovers between twenty and twenty-five employees (Small Group). Therefore, a PEO generally has improved options for a prospective client through their master health plan. Like workers’ compensation, a solid pricing and mitigation strategy is key to maintaining a “cleaner” pool. The amount of lives a PEO brings to the table gives it leverage over a smaller competitor. However, if the pool begins to get “dirty”, regardless of size, the PEO can lose its leverage on its health benefits plan. A PEO utilizes wellness programs and ancillary tactics to try to reduce utilization rates where possible in order to maintain a healthy pool.

 

Effective Reduction of Employee Turnover

According to a white paper released by the National Association of Professional Employer Organizations (NAPEO), companies which are partnered with a PEO experience 10% to 14% less employee turnover than those not partnered with a PEO. In nineteen of the fifty States, a PEO will file on their own SUTA number. Since PEO clients have a range of SUTA rates depending on their individual turnover experience, a PEO will generally set up multiple shell corporations in a given State. This allows the PEO to have varying SUTA rates so that they can most closely align their client’s historical SUTA experience with the most appropriate SUTA rate. In States where a PEO files on their client’s SUTA rate through a power of attorney (POA), this is a moot point. In the States where the PEO files on its own SUTA rate, it generally experiences a small profit pool from the delta between the client’s actual SUTA rate and the PEO’s closest SUTA shell. If the PEO is successful in mitigating turnover and fighting erroneous unemployment claims, that gap may widen and the PEO may experience increased profitability. Ultimately, the PEO will likely realign the client to a different SUTA rate if the reduction in unemployment claims appears sustainable.

 

Risk Mitigation Services

When evaluating risk, there is the underwriting process and the proactive approach to claims mitigation. While the underwriting doesn’t vary significantly between a carrier and PEO, the proactive approach generally does. A good PEO uses a combination of strategy, field consulting and proven techniques to bring awareness to risk mitigation at a client level. Some PEOs use an annual safety incentive rebate to incentivize a customer to pay closer attention to safety, hiring practices and return to work programs. All of which have an impact on managing risk. With most business owners, production is at the forefront of their agenda. A PEO keeps visibility on safety to help manage against future issues.  The result of a well-run program is a reduction in claims frequency which supports increased profitability in the premium versus premium remittance delta.

 

Macro Vision – HR and Employment Management

A PEO has a better vantage point for HR and employment related issues than most companies. This improved visibility on such items is inherent to the PEO model. A PEO HR professional may service fifty accounts. Therefore, they have the ability to see commonality with HR and employment related issues across a wider base of companies than the client would have on its own. If the PEO fosters good internal communication, that vision can be scaled. For example, a PEO that employs twenty HR professionals, whom regularly converse and strategize, has the experience of overseeing one thousand businesses. That insight and experience acts as a valuable resource to an average client with twenty employees. That expertise will save the client time and money and help them avoid potentially costly mistakes.

 

Question 2 – What profit pools does a PEO have available?

Profit Pools

Now let’s take a quick look at the common profit pools a PEO can generate and then we’ll tie it all together at the end of the article.

 

  • Administrative Fees
  • Insurance Premium
  • SUTA
  • Additional Services
  • Fees

 

Administrative Fees

A PEO charges a client either an annual per head amount or a percentage of payroll for its administrative fees. These fees pay for the PEO overhead, outsourcing and consultative services. An administrative fee as a percent of payroll can range anywhere from 1.5% to 6% on average. The sweet spot that is charged seems to be in the 3% to 4% range. The administrative fees are the most predictable of the profit pools a PEO can generate. A common metric the PEO industry uses is the internal employee to work-site employee (WSE) ratio. PEOs strive to improve this number through training, technology and infrastructure changes. However, a PEO must be careful not to overextend this ratio or client attrition will occur due to a watered down value proposition and lack of availability from service personnel. When a PEO achieves an optimum balance in the ratio, SG&A as a percent of net revenue decreases which widens this profit pool.

 

Insurance Premium

A PEO is responsible for remitting premiums to its carriers in accordance with the agreement between the PEO and carrier.  It may also be responsible for some of the claims costs, reserves and collateral requirements. A PEO may receive additional profit from the carrier for good loss years depending on their agreements. Ultimately, a PEO that effectively manages risk can generate profit within the insurance vehicles. However, a PEO that is poorly run can experience major losses due to claims. These profit pools are the most volatile within the PEO model as claims frequency, severity and development can quickly erode profitability.

 

SUTA – State Unemployment Tax

As previously mentioned, in nineteen of the fifty States, a PEO will file the client unemployment under the PEO SUTA. This could be the case in some other States as well, but many PEOs opt to use the client’s SUTA and file through a power of attorney (POA). In the States where a PEO files on its own number, it sets up multiple entities so that it has a diversity of SUTA rates to most closely align with the client’s SUTA experience. A PEO would never put a client on a lower than historic SUTA rate to begin the relationship as it would lose money so it picks the closest SUTA rate available that is higher than the client’s historic SUTA rate. Therefore, there is generally a slight overage which equates to a profit pool for the PEO. If the PEO effectively manages the turnover and unemployment claims, that profit pool can increase in direct correlation to the PEOs mitigation efforts. Ultimately, if a PEO client shows a trend of having a lower SUTA rate after being with the PEO, the PEO should look at moving the client into a lower SUTA rate when appropriate. To better understand the PEO pricing models for employer payroll taxes, click here. 

 

Additional Services

PEOs today are diversifying their offering to include services commonly used by small and medium sized businesses (SMBs). For example, a PEO may offer staffing services, direct hire recruiting, tax services, technology, etc. When a PEO offers ancillary services that were not part of the PEO agreement, these services are generally fee based. These fees equate to additional profit pools.

 

Fees

A PEO should disclose any fees that it may charge in the course of the PEO relationship. Those that don’t, I personally would be weary of. These fees may include setup fees, delivery charges, W2 fees, etc. Some PEOs don’t charge for any of these fees, with the exception of delivery charges as those are pretty common. Additional fees, depending on the COGS associated with them can equate to additional profit pools.

 

Tying it Together

The ability for a PEO to be cost effective depends largely in part on how well it manages its profit pools. A PEO that has achieved economies of scale and effectively manages its profit pools has greater diversity in profit and thicker profit margins. This means a PEO has more profit to play with if it want to price more cost effectively.

 

However, should a PEO be more cost effective on paper than a traditional carrier? The answer to that question is, it depends. A PEO should not emphasize winning business on price. It invalidates the value proposition to a degree and sets a poor precedence with the sales force and future clientele. Moreover, when comparing cost factors of a PEO to alternative options, all variables must be weighed. These variables may include insurances, payroll costs, technology, etc.

 

A PEO should be sold on the return on investment to the client driven by the PEO value proposition. This selling process should be handled by an internal PEO employee directly to the clientele whether or not a channel partner was used to source the deal. A PEO with a poor or vanilla value prop shouldn’t expect to consistently win or achieve high profit margins when faced with superior competition. A PEO with a superior value proposition can still generate solid profit margins even if that PEO hasn’t yet achieved scale. To see how a smaller PEO can compete with those of scale, click here.

Ultimately, a PEO’s ability to be flexible on price is a byproduct of how effective the executive team has managed the business. A well-managed PEO can keep a higher price and increase profit margins as a result of protecting profit pools and streamlining internal efficiency. Or, they can reduce their price when appropriate but maintain industry standard profit margins due to their ability to effectively manage the business.

 

A PEO that does not have scale and poorly manages its profit pool will always be a cost plus program. If the offering is vanilla on top of the lack of scale and poorly managed profit pools, growth is likely to stifle.

 

Final Thoughts

Can a PEO be more cost effective? Yes. Can it drive greater ROI than alternatives? Yes. Can partnering with the wrong PEO be a headache for a client? Yes. Were there poorly run PEOs in the past? Yes. Are their well-run PEOs today? Yes. Are all PEOs today well-run? No. Should a prospective client meet/speak with a PEO directly prior to partnership? Yes. Can a well-informed PEO sales professional illustrate the value of the PEO? Yes. Are all sales reps adequately educated on their PEO and alternative options? No. (To learn about a good approach to PEO sales, click here.) Is it tougher to leave a PEO relationship than a traditional insurance carrier? Yes (there are more things to switch for the company; i.e. payroll, tech, insurance, etc.). Can a client impact its renewal pricing with a PEO? Yes. Does the client have complete control over the variables that impact renewal pricing? No. Should a PEO be compared to only a carrier insurance premium? No. Should the full PEO value prop be compared to alternatives (inclusive of all the variables) in the market? Yes.

 

A PEO is an excellent option for a company that is looking to receive a greater return on the money they spend for insurance, payroll, etc. Not every PEO is created equal. Proper evaluation is key to determining if the PEO model is right for a company and which PEO is the best choice.

 

Author: Rob Comeau is the CEO of Business Resource Center, Inc., a management consulting and M&A advisory firm to the PEO industry. Business Resource Center’s website is www.biz-rc.com

 

 

 

 

 

 

 

 

 

Is This Good for the Company? – The Culture Change Argument

“Have you seen my stapler?” – Milton Waddams

The Culture Change Argument

Most professionals agree they would prefer a positive and engaging company culture over an oppressive dictatorship style. The question is, how does a company change its culture? There are opposing views over what exactly impacts and ultimately changes the culture of an organization. Today, we’ll examine two popular theories to better understand how to approach change.

 

The Influence Method

Changing culture through influence requires messaging, communication, reinforcement and top down example setting coupled with bottom up feedback channels. Any change requires time to see results and while the focus is using influence as a change agent, processes will likely change as well. The difference between this approach and the process change method is that the impetus is on the messaging, values, vision and mission, not necessarily the processes and procedures.  The processes and procedures should adapt to be in line with the messaging where needed but are not generally considered the driver for culture change.

 

The Process Change Method

Others believe culture change is a byproduct of shifting dynamics within the workplace or external factors. These dynamics would include processes, procedures, compensation structures, technology advances, etc. The thought is less on the messaging from the organization and more on the accepted norms of conducting business.  These people believe that culture change is created when shifts in how business is conducted change the status quo. Therefore, to create a culture change, a change in how business is conducted and/or how employees are rewarded is required.

 

Which is Correct

So which approach is correct? Is culture change driven by new messaging and beliefs, or is a change in business practices the only way to achieve desired change?  It can be suggested that it is a combination of both. Messaging alone will not get it done, nor will solely changing business practices.  With either approach, a company may recognize minor shifts but to truly achieve a cultural change, both must be present.

 

If a company solely utilizes messaging and communication but business practices counterproductive to the new culture remain, the change will not fully take hold. Conversely, if a company solely utilizes a change in business practices but does not have congruent messaging, the organizational culture may become disjointed. While most companies have sub-cultures within the macro culture, each sub-culture must still support the overarching vision of the organization. Without consistent messaging and shared vision, this can create conflicting sub-cultures which can cause rifts within the organization.

 

Takeaways

It is recommended that an executive team make sure that the culture of the organization supports the vision of the company. While the executive team will drive the messaging of culture change, it should not ignore the bottom up feedback of the workforce. Pushing messaging for culture change with a blind eye to workforce feedback is ill advised. Moreover, the executive team should ensure that policies, procedures, business practices, technology, promotional opportunities and compensation structures should be in line with supporting the vision and desired culture of the organization. Conducting an anonymous culture sensing project will allow the executive team to understand where the company is currently in order to better understand the climate and the feedback will provide variables to consider when embarking on a culture change initiative.

Culture change should not be a hypocritical undertaking. All levels of the organization must live the change or it will not achieve the desired results. You cannot adhere to the “do what I say not what I do” philosophy and drive a successful culture change. Internal politics can and will erode progress. Give the workforce a voice. When the workforce feels heard, they are more apt to give change a try, even if the change isn’t exactly in line with their preferred direction. If a workforce feels unheard, the result is stifled, or at best, delayed change.  Ultimately, remember that culture should support the continuing vision, values and execution of the company. If the culture is in line with these items, no change is needed (assuming the vision and values are appropriate).

 

Author: Rob Comeau is the CEO of Business Resource Center, Inc., a management consulting and M&A advisory firm with a focus on the PEO industry. For more information on BRC, please visit their website at www.biz-rc.com

 

 

 

Lifelong Learning Isn’t an Option but a Necessity in Business

Lifelong Learning Isn’t an Option but a Necessity in Business

The world is in a state of constant change. Some changes happen swiftly and others are gradual in nature. Change can be revolutionary or minute. It is essential for a professional to adapt the philosophy of becoming a constant learner if they hope to be the best version of him/herself. The combination of talent that makes up a company, when individually adhering to a constant learning philosophy, creates a talent pool to drive innovation and profitability.

 

This article will cover some of the benefits for pursuing lifelong learning and the subsequent impact it has on business.

 

The Importance of Consistent Learning

A consistent learning philosophy is important on an individual and organizational level and it impacts an industry as a whole.  On a personal level, the more knowledge, skills and capabilities an individual possesses, the better equipped that professional is to perform optimally.  This can lead to superior work, pay increases and promotion opportunities. On an organizational level, a company where the sum of its parts is made up with superior talent has an advantage over competition. The byproduct of a superior talent pool is increased value to the customer which in turn can equate to higher profit margins, increased market share and better cash flow from operations. From an industry perspective, talent within an organization that is always learning possesses more variables in which to innovate.  It is these innovations that can change the scope of an industry for the better.

 

Take a look at Amazon for an example of innovation through consistent learning.  Amazon initially began as an online book retailer. Hence the logo with the swooping arrow from A to Z. It competed with the likes of Barnes and Noble, whom at the time was the market leader. Amazon later expanded into other products outside of the literary vertical. The talent at Amazon innovated, mastered supply chain management and diversified its scope of offering throughout the evolution of the company. This is not possible without continuous learning. As a result, in 2015, Amazon surpassed Walmart as the United States most valuable retailer measured by market cap. They are doing it again with the acquisition of Wholefoods and even more impressively, guaranteed one hour delivery times.

 

Amazon built this empire with internal talent and sourcing external executives at major competitors. Without consistent learning, a company like Amazon would likely never be where it is today.  Remember, when Amazon began in 1994, the internet was still an unknown quantity. Innovation and continuous learning were paramount to Amazon becoming the giant it is today.

 

Decisions Are Based On The Known

A leader is limited by three things.  1) The number of known variables in a decision equation, 2) their known decision frameworks and 3) the company’s capabilities to execute the decision.  Each one of these three key areas is drastically impacted by learning. In addition, the elements are fluid.  This means that they are consistently changing.  A decision framework that worked 10 years ago may be irrelevant or less successful today. The variables that impact a decision, both external and internal, are constantly evolving. The company’s ability to execute is dependent on its growing and evolving capabilities. An industry leader has positions itself to know as many variables as possible, possess a host of decision making frameworks, and places the organization in a position to execute on many levels.

 

Creating a Learning Organization

A learning organization is one where the group IQ exceeds that of any individual’s IQ.  When a company employee individually learns and then transfers this knowledge across the team, the organization benefits.  When this is done by each employee throughout the ranks of the organization, the company is infinitely more equipped to innovate, adapt to change, increase profitability and scale the company. To learn more about the framework of creating a learning organization, click here.  To learn more about how an executive team creates an environment conducive to creating a learning organization, click here.

 

Internal & External Learning

Both internal and external learning initiatives are required to be an industry leader. Internal learning is the training a company provides to develop its workforce. External learning is the information, capabilities, and knowledge gained from external resources and research.  If a company solely limits itself to internal learning, their workforce will predominantly regurgitate what the company has taught them.  As a result, the organization in many ways may become stagnant.  A company that fosters a culture which promotes external learning in addition to internal training, positions the organization to learn and evolve.  It is the combination of external influences with internal standardization that give the company operational stability with the ability to innovate.

 

Conclusion

The United States has evolved in its business industries.  Our country which used to be the world leader in manufacturing is now highly comprised of service based industries.  Over two-thirds of US based businesses are in the service sector.  Internal talent affects a company’s ability to drive value to its clientele and shareholders. Talent that pursues consistent learning and then shares that knowledge with internal peers positions the organization to gain competitive advantages over competition, drive increased value to clientele and increase profitability for shareholders.  The old adage that knowledge is power has never been truer than it is in today’s business environment.

 

Personal Thoughts

Learning doesn’t and shouldn’t be limited to higher education institutions but should occur on a daily basis through multiple channels. Business evolution often moves faster than curriculum development and what is being taught in schools today may be less relevant in five to ten years.  Am I advocating not going to school? Absolutely not.  I just graduated with my MBA in 2017 after being out of school for twenty years.  The point is to not limit your education and learning solely to higher education institutions. Learning as a lifelong pursuit takes many forms and isn’t limited solely to business, but to all aspects of life.

 

Author: Rob Comeau is the CEO of Business Resource Center, Inc., a business consulting and M&A advisory firm. To learn more about Business Resource Center, Inc., visit them on the web at www.biz-rc.com.