Overview

One might view the PEO model as an outsourcing, compliance, and consulting model. While this vantage-point isn’t incorrect, at its truest sense, the PEO model is something more. The model, at its core, is an aggregation model, with horizontal integration and market focus, plus emerging vertical focus and integration elements.  Before diving into the rationale behind this statement, let us first review what the meaning behind these highlighted terms.

Aggregation Definition

• A cluster of things that have come or been brought together.

Horizontal Integration

• A horizontal integration consists of companies that acquire a similar company in the same industry.

Vertical Focus | Horizontal Focus

• Vertical markets are business niches where vendors serve a specific audience and their set of needs. By contrast, a horizontal market has a focus that reaches a wide array of individuals, regardless of their industry or niche.

Vertical Integration

• The combination in one company of two or more stages of production normally operated by separate companies.

The PEO Model: An Aggregation Model

If we view the PEO model as an outsourcing, compliance, and consulting model, with an emphasis on human capital management, it narrows the scope of what is possible with model evolution. By nature, if the model is focused on human capital management, the offering is bound by the same focus. In contrast, if the PEO model is viewed as an aggregation model with horizontal integration, a horizontal market focus, and an emergence of vertical market focus and verticalization within the model itself, the possibilities for model evolution are endless.

Let’s review why the PEO model, at its core, is an aggregation model. Remember that the definition for aggregation is a cluster of things that have come or been brought together. Now let’s review the PEO model with that thought in mind. A PEO clusters a suite of services which are delivered to an SMB via internal and 3^rd party efforts. For example, a PEO may offer the following suite of services:

• Payroll processing (internal payroll reps, 3^rd party software)
• Payroll tax filing (3^rd party software, internal filing and responsibility)
• HR consulting and resources (internal or external HR rep, potentially 3^rd party online resources)
• Safety consulting (internal or external safety reps, potentially 3^rd party safety resources)
• Regulatory compliance assistance (internal resources, 3^rd party employment attorney)
• Workers’ compensation insurance (3^rd party coverage, potential internal captive)
• Workers’ comp claims management (carrier claims adjusters, potential 3^rd party TPA, potential internal claims liaisons)
• Health Insurance (3^rd party carrier, internal/external wellness initiatives, internal/external underwriting)
• Ancillary benefits (3^rd party carriers, internal sales force, internal payroll deductions)
• Retirement plans (external financial partners, internal payroll deductions and sales force)

While we can continue to cite examples of the aggregated service suite and the marriage between internal and external deliverables, the above bullets should be enough to prove the point. An SMB chooses to partner with a PEO for the “PEO” service suite. However, the PEO’s service suite is comprised of many moving parts and partnership alliances. Therefore, at its truest sense, the PEO model is an aggregation model of meaningful services to an SMB.  I always found it somewhat ironic that a PEO offers an SMB the ability to outsource some functions of business, when the PEO itself, outsources a number of its own functions. One could argue that a PEO, by default of its own model, is a true believer in the value of outsourcing certain functions of business. Through the PEO’s ability to aggregate meaningful solutions for SMBs, it creates a single conduit to services an SMB requires.

When we view the PEO model as an aggregation model in lieu of a human capital outsourcing model, the question that begs to be answered is: what else can a PEO aggregate for SMBs that would be meaningful outside of human capital management? When we do not put the confines of human capital outsourcing on the model, and instead view it as an aggregate model, it opens our minds to the possibilities of other services which can be aggregated into the PEO model. This creates an avenue for further innovation within the model itself to provide a more comprehensive solution to SMBs outside of solely human capital services.

Horizontal Integration

The PEO industry is one of consolidation. Let’s review the definition for horizontal integration: A horizontal integration consists of companies that acquire a similar company in the same industry.  If you have been around the industry long enough, you have witnessed the consolidation of PEOs by strategic and private equity buyers. This trend is expected to continue for the foreseeable future. Therefore, the PEO industry is one of horizontal integration.

Vertical and Horizontal Focus

Again, let’s look at the definitions for vertical and horizontal market focus: Vertical markets are business niches where vendors serve a specific audience and their set of needs. By contrast, a horizontal market has a focus that reaches a wide array of individuals, regardless of their industry or niche. The majority of PEOs utilize a horizontal market focus. Meaning, the PEO focuses on client size by WSE count rather than industry verticals. PEOs may utilize a macro client segmentation, i.e. white, grey, or blue collar but very few have a vertical market focus. There are some exceptions to the market focus where a number of PEOs may adhere to a vertical market focus. Here are some examples of a vertical focus:

• Transportation and logistics (i.e. Peoplease and TLC)
• Hospitality such as restaurants and hotels (i.e. MBA)
• Trade contractors and construction (i.e. WBS)
• Some PEOs have verticalized their offering via client size and industry vertical (i.e. TriNet)

However, the vast majority of PEOs still adhere to a horizontal market focus. Although the utilization of a vertical market focus appears to be emerging in greater capacity in recent years.

Vertical Integration

A vertical integration is the combination in one company of two or more stages of production normally operated by separate companies. A good example of a company whom has achieved vertical integration is Walmart. Walmart controls its supply chain, retail outlets, has its own store brand of white labeled goods, and now executes delivery to customers. This is a solid example of vertical integration.

PEOs have begun to verticalize to a small extent, though future increase in verticalization is a potential. Some PEOs have created captive insurance programs which is quasi verticalizing insurance procurement. Some have created proprietary technology, again quasi verticalization. Some have bought or built insurance brokerages which is quasi verticalizing its channels and/or ability to place and procure insurance.

A full example of a PEO whom has truly verticalized would be one which owns the insurance company, acquired some of its distribution channels, has acquired its software providers, etc. Some partnerships have the feel of verticalization without the acquisitions. Take PrismHR and MasterTax for example. These two companies saw the benefits of partnering together for mutual benefit internally and to their clientele. By partnering, PrismHR and MasterTax have provided a two-step solution through one entry point. Moreover, when PrismHR acquired NetWise Technology, it was a step toward verticalization.

Conclusion

If the industry begins to view itself as an aggregation model, it may stimulate innovation into different facets of business offerings that may benefit the SMB outside of human capital management. As the model evolves, future verticalization is likely. The possibilities are exciting when the industry begins to think outside the box and explore what ancillary offerings would be meaningful to SMBs. We all know that the PEO model is “sticky” due to the multiple functions it fulfills for its clientele. If these functions expanded beyond the traditional PEO scope, how much more attractive would the PEO offering be, what type of pricing elasticity would that create, and what impact would it have on client retention? I imagine that as the model evolves, opportunities for vertical integration would increase, as would valuations within M&A.

Time will tell how the industry will evolve but one thing is for certain, there is room to evolve the model. The takeaway from this article should be that when we remove the confines of basing the PEO model on human capital elements, increased innovation is possible. The question is, which PEO will answer the call and blaze into uncharted territory? Instead of focusing on what has been done, it may be time to focus on what is possible.

Author

Rob Comeau is the featured Author for this online PEO publication and CEO of Business Resource Center, Inc., a business consulting and M&A advisory firm to the PEO industry. To contact Rob, you may email him at rob.comeau@biz-rc.com or visit BRC’s website at www.biz-rc.com.