Improve WSE to Internal Ratios
Overview
The work site employees (WSEs) to internal employee ratio is a common yardstick in the PEO industry. The ratio is commonly used to gauge internal efficiency in order to maximize the PEO’s profit. While there are a host of factors that impact the profit of a PEO, this article will focus on the WSE to internal employee ratio and provide some methods in which a PEO can improve upon said ratio.
Rationale
Logically it makes sense that if a PEO can service its client base with fewer internal employees, there should be a greater throughput of gross profit (GP) to net profit (NP). A variable that could affect this ratio is internal employee salary variances but for the sake of the article, we’ll suggest that if a PEO can widen the WSE to internal employee ratio, it is in a better position to increase net profit.
Other Factors
Other factors that affect a PEO’s profitability, which will not be covered in this article but bare mentioning are:
- Claims mitigation with internal high deductible insurance programs
- SG&A expenses (we’ll cover this slightly in job functionality)
- Pricing
Improvement Methods
Technology
The first method this article will mention in an effort to improve the WSE to internal employee ratio is likely the most obvious; technology. Technology plays a huge part in improving the ratio, especially in payroll. Through Business Resource Center’s consulting efforts, we have seen PEOs where an internal payroll professional can handle 600 WSEs and we’ve seen PEOs where a single payroll professional can handle 2,200 WSEs. This differential equates to an improvement of payroll to WSE ratio of 3.67X.
For example, a PEO with 10,000 WSEs on the lower end of the spectrum (1 to 600) would require 17 payroll professionals. Conversely, a PEO with 10,000 WSEs on the higher end of the spectrum (1 to 2,200) would require 5 payroll professionals. Arbitrarily assuming that an internal payroll professional makes $50,000 annually, the internal payroll differential between the low end and high end of the spectrum would equate to a profit increase of $600,000. To make this even more drastic, if the PEO sold at a 7X of EBITDA, this would result in an extra $4.2MM in purchase price.
Infrastructure
A smaller PEO may start out by utilizing a branch structure. This means that all service functions are performed by the local branch. As a PEO scales, it may want to consider regional service centers with local consulting teams. When a PEO uses a regional center for some of its functions such as payroll, benefits and claims management, it may realize additional efficiency within its operating model. In addition, utilizing a regional service center may ease the burden of acquisition assimilation if the PEO is active in M&A. By utilizing a regional service center, the PEO is able to realize additional efficiency by streamlining processes within these regional functions. If the PEO still maintains a local presence for consulting (i.e. HR and Risk), it maintains its local feel while the regional center handles the functions that are not client facing.
When a regional cost center’s sole emphasis is efficiency within payroll, benefits, and claims, its focus is more acute to ensure the best WSE to internal employee ratios. This is handled through improved infrastructure, technology, processes and procedures, etc. From Business Resource Center’s consulting experience, PEOs with regional service centers have experience the best WSE to internal employee ratios. This is not to say that efficiency cannot be achieved without regional centers, but from our experience, regional centers have a tendency to run better WSE to internal employee ratios. If a branch structure is maintained, it is essential that the leadership at each branch is aligned with the corporate vision to pay close attention to efficiency efforts in order to improve the WSE to internal employee ratio.
Job Functionality
Wage scales matter. What a PEO pays an internal employee versus where that internal employee spends there time has a big effect on SG&A expenses. While this article stated at the beginning that this wouldn’t be an area of focus, we’ll cover it briefly to explain the rationale. If a PEO pays an HR Consultant $80,000 annually but the HR Consultant spends 33% of the time handling client implementation, this may not be the most effective use of their time. We’ll make the assumption that an HR Consultant handles fifty accounts for a PEO. If a PEO has 10,000 WSEs at an average client size of 25 WSE per client, this equates to 400 clients. Assuming that the HRC can handle 50 accounts, the PEO would need to employ eight HR professionals at a total HRC cost of $640,000 (8 HRCs X $80,000).
If the PEO hired Implementation Specialists with a sole focus on client on-boarding, this may not improve the WSE to internal employee ratio but it should equate to the PEO achieving increased net profit. Consider that a PEO may pay an Implementation Specialist $40,000 annually. One Implementation Specialist could handle the client on-boarding of three HRCs. If a PEO had 10,000 WSEs with an annual growth rate of 20%, this would equate to 2,000 new WSEs requiring implementation that year. Conservatively, if an Implementation Specialist was able to handle two new client implementations monthly (they can handle more from our experience), this means that the new business growth would require roughly three Implementation Specialists.
At $40,000 per specialist, this is an investment for the PEO of $120,000 in new internal salary. However, if the PEO freed up a third of each HRC’s time, the PEO that previously employed eight HRCs to service 10,000 WSEs would now only need to employ roughly five HRCs. The five HRCs at $80,000 annually would equate to $400,000 in HRC salary. Add the three Implementation Specialists at $40,000 annually ($120,000) and the total internal employee spend would equate to $520,000. Compare this with simply employing eight HRCs to handle both functions at $640,000. The PEO, by employing Implementation Specialists would save $120,000 in annual salary and the retention of HRCs would likely improve (most HRCs like to spend their time on HR not on-boarding). Using the same EBITDA exit multiple of 7X, this would equate to an additional $840,000 in purchase price. If the Implementation Specialist could handle three implementations monthly, $840,000 would grow to over one million.
Conclusion
There are many ways to improve WSE to internal employee ratios and this article just covered a few elements at a high level. A couple of essential metrics to pay attention to while pursuing improved WSE to internal employee ratios are client retention and client referrals. If client retention and the number of client referrals dips, the PEO may be running too thin. WSE to internal employee efficiency is important, but stretching the ratio at the expense of a PEO’s brand equity and future propensity for sales is not advised.
Author: Rob Comeau is the CEO of Business Resource Center, Inc., a management consulting and M&A advisory firm to the PEO industry. To learn more about Business Resource Center, Inc., please visit them on the web at www.biz-rc.com.