There are various strategies that a Professional Employer Organization (PEO) will deploy to gain a competitive advantage. Often, multiple strategies are utilized simultaneously. This article will provide a high-level overview of some of the most common strategies used by PEOs. These strategies include Scale, Service, Innovation, Niche/Verticalization, Price, Technology, and Arbitrage.
Scale, or size, is a distinct strategic advantage for a PEO. While the industry remains fragmented via the amount of PEOs in existence today, revenue remains consolidated. This means that there are a small number of PEOs that have the distinct strategic advantage of scale. A PEO may deploy a scale strategy to gain advantages in 3rd party procurement such as insurance, technology, etc. Size carries weight when negotiating with 3rd party providers. Moreover, a PEO with a substantial WSE count typically has greater pricing elasticity to remain competitive. A larger book can provide a PEO with cushion to weather sizable claims, whether it be with the workers’ compensation or medical policies.
A scale strategy can be achieved via organic growth, acquisitions, or both. Most PEOs have gained substantial scale via acquisitions. Often, a private equity deploys a consolidation strategy to achieve scale via acquisition. There are pros and cons of a scale strategy, as noted below.
Pros: Greater buying power, ability to absorb a claims spike, increased brand equity, greater brand awareness, higher cashflow, increased pricing elasticity.
Cons: more difficult to maintain company standards, less nimble, more difficult to implement technology changes, lower client retention.
Service is a strategy used often, particularly by smaller PEOs. While some may view service as a part of doing business, phenomenal service and response times are most certainly a strategy. In today’s business climate, where service has given way to profit margins, superior service is a distinct competitive advantage. Service promotes client retention, higher customer satisfaction, greater pricing elasticity, and higher client referrals.
Service as a strategy can act as a viable differentiator for a PEO. A service strategy must be paired with a 2nd strategic initiative. For example, if a PEO has phenomenal service but a weak value prop and poor pricing, they will often lose in the marketplace. However, if the PEO has phenomenal service and either a strong value differentiator and/or favorable pricing, the service strategy thrives. There are pros and cons of a service strategy, as noted below.
Pros: higher client retention, greater pricing elasticity, higher client satisfaction, higher client referrals.
Cons: difficulty to maintain as organization scales, longer training curve with new hires, must be paired with an additional strategic initiative.
Innovation can provide a strong strategic advantage. While most people will think of innovation in the context of technology, there are many facets of a business that can be innovated. For example, some PEOs had migrated to a remote workforce prior to the COVID pandemic. This allowed the PEO to source talent throughout the United States in lieu of solely procuring local talent. Additionally, some PEOs have deployed a lean six sigma process to their operations, thus creating a more favorable WSE to EE ratio. Both examples are innovative and have yielded competitive advantages. Some PEOs have innovated with their insurance models while others have been innovative with technology.
Innovation can provide a strong differentiation to allow the PEO to win in the market. However, innovation often courts first mover advantages and disadvantages. There are pros and cons of an innovation strategy, as noted below.
Pros: first mover advantages, differentiation, efficiency, higher client retention, greater pricing elasticity, greater market share.
Cons: competitive adoption of differentiation, first mover disadvantages, innovation didn’t work or resonate, research expense.
Some PEOs deploy either a niche focus or verticalized approach. The difference between the two is that a niche strategy is focused on one industry vertical whereas a verticalized strategy segments their business to focus on several industry verticals simultaneously. There is a difference between a PEO servicing a multitude of verticals and a PEO that utilizes a verticalization strategy. The key difference is that the PEO which deploys the verticalization strategy, has positioned each segment’s offering and marketing to resonate with individual verticals. A niche or vertical strategy can create a competitive advantage in the marketplace. However, it can also pigeonhole a PEO into that vertical. There are pros and cons of a niche/vertical strategy, as noted below.
Pros: differentiation, brand equity, higher client satisfaction, high client retention, greater pricing elasticity, sniper marketing.
Cons: potential for higher cyclicality, lack of client diversity, competition adoption, sales force aggravation.
Pricing is a strategy that some PEOs have adopted. Pricing, as a strategy, can take multiple forms. It can be a low admin fee due to a streamlined model or minimal consultative offering. It can be lower insurance premiums. It can come in the form of safety rebates or other financial incentivization for client performance. While price can successfully secure new business, it can also come with potential pitfalls. Price almost always needs to be paired with another strategy in the PEO model. Low price without a differentiation results in customer attrition. Low price, coupled with an innovative strategy, i.e. technology driven PEO, can be affective. There are pros and cons of a price strategy, as noted below.
Pros: increased market share, quicker to scale.
Cons: only as good as last price, higher client attrition, lack of differentiation, lower pricing elasticity.
In today’s economy, technology can be a strong strategy. Often, within the PEO world, it is a part of a strategy. However, technology alone can be the primary strategy. This may take the form of online marketing and new client procurement, scaling the organization via technology, creating predictive outcomes with insurance models, streamlined customer interface, etc. There are substantial gains to be made when technology can offset some SG&A costs through automation. However, technology by itself, within the PEO construct, can be limited. There are pros and cons of a technology strategy, as noted below.
Pros: increased scale, lower SG&A, longer market reach, innovation, differentiation, ease of interface.
Cons: limited client engagement, competitor adoption, new replacement technology, issues with technology, one-dimensional.
Arbitrage is a strategy commonly used within the PEO industry. PEOs may use an arbitrage strategy with SUTA, workers’ comp, insurances, etc. Simply put, the arbitrage is the delta between what is charged and what is remitted. If a PEO successfully manages liability, it earns the arbitrage. However, there are liabilities that can erode arbitrage, both internally and on a macro level. For example, in the SUTA arbitrage model, when a PEO manages the unemployment more efficiently, it can increase margin from the widening delta. However, if the PEO doesn’t manage the SUTA well, or if there is an economic downturn, the delta can shrink and subsequently effect the profit mix.
Further, from an external macro perspective, if a State changes its SUTA rates due to a deficit, this can have a negative or positive effect on the SUTA arbitrage of a PEO. For example, if a State mandates client companies be charged the max SUTA percentage until the State deficit is paid back, this erases the SUTA arbitrage for the PEO. However, if the State simply increases the wage base on SUTA to repay the deficit, this can increase the arbitrage margin for the PEO. These scenarios are rare, but they are an outlier liability to the strategy, as it pertains to SUTA. There are pros and cons of an arbitrage strategy, as noted below.
Pros: diversified profit pools, increased margins.
Cons: potential erosion, client dissatisfaction.
This article covered some of the basic strategies within the PEO industry. While there are certainly more strategies we didn’t cover, along with overarching strategic intents, the information in this piece should provide some insight into different moves a PEO can make. It is advised that a PEO determine its strategic intent, and then deploy multiple strategies simultaneously to gain a competitive advantage and increase profit margins. The PEO industry still has a lot of white space to penetrate in the United States. However, as market share grows within the industry, defined strategies will become more important than ever.
Rob Comeau is the Founder and Featured Author of NPG. Comeau also serves as the CEO of Business Resource Center, Inc., a business consulting and M&A advisory firm to the PEO industry. Comeau holds equity positions in PEO, technology, insurance, and ancillary business services companies where he serves in various roles on the Board of Advisors and as Operating Partner. To contact Rob, you may email him at email@example.com. To view the offering from Business Resource Center, Inc., visit www.biz-rc.com.