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PEOs bouncing back following shakeout: Professional employer organizations enjoying growth as companies seek better ways to manage benefits

October 8, 2007

Even though Sentelligence Inc. in Noblesville has only five employees, the tiny tech firm offers an appealing benefits package rivaling that of a large corporation.

The designer of diagnostic sensing devices for diesel engines has not discovered the Holy Grail of human resources. Rather, it's using what's known as a professional employer organization.

Companies contract with PEOs to handle all the headaches of human resources, including payroll, payroll taxes, Worker's Compensation claims, health plans, and other employee benefits, not to mention government regulations.

By pooling the employees of several businesses, a PEO often can offer better rates on insurance while providing better benefits than a company could on its own.

"It allows us to act like a corporation with 4,000 employees," Sentelligence CEO Rob Qualls said. "It was extraordinarily attractive, from that standpoint."

A report released early this year by Massachusetts-based research firm IDC revealed that once-trendy PEOs again are flexing their outsourcing muscles following a few years of industry upheaval. A rebound following a few years of widespread consolidation and lingering economic concerns led PEOs to generate roughly $51 billion in revenue last year.

The figure represents collective growth of 20 percent, yet falls well short of the 35-percent gains the industry enjoyed during the boom times of the late 1990s. Still, smaller companies particularly are recognizing the advantages of contracting with a PEO, said Milan Yager, executive vice president of the Virginia-based National Association of Professional Employer Organizations.

"If you're a small business, you have to offer the best benefits if you want to attract the best workers," he said. "People want to work on Main Street, but they want the benefits of Wall Street."

A robust economy, low unemployment, and an explosion in small-business growth are among the reasons cited for the recovery.

PEO popularity

PEOs began sprouting in the early 1980s and quickly matured to become the fastest-growing business service in the United States during the 1990s, according to the Harvard Business Review. It is estimated that 2 million to 3 million workers receive benefits through about 700 PEOs.

Driving part of the demand is the increasing number of employment laws and regulations, which grew about 60 percent between 1980 and 2000, the U.S. Small Business Administration said.

Further, PEOs not only give business owners the chance to offer competitive benefits but allow them to shed administrative duties to instead focus on building their companies.

That's critical for Qualls, who anticipates having 50 employees within the next five years.

"With that comes the burden of hiring human resources people," he said. "The cost per employee is considerably more advantageous to us instead of bringing that all in-house. They do all the work for you."

PEO services typically require a onetime startup fee and then an ongoing percentage of payrolls, which can range from less than 5 percent to more than 15 percent, depending on the services and the average worker salary.

The NAPEO membership includes 15 companies that are registered to conduct business in Indiana. The largest locally owned PEOs include Professional Staff Management Inc. in Richmond, which has a Carmel office, Tilson HR in Greenwood, and WorkSmart Systems Inc. in Indianapolis.

Qualls opted for the startup Human Capital Concepts LLC, which he hired a few months ago. Steve Kellam, a human resources veteran who formerly worked at Professional Staff Management, launched the company in May.

The lack of a non-compete clause enabled him to start the company by bringing aboard former co-workers, making the transition of starting from scratch easier. Kellam thinks he's in a much more stable environment now compared with a few years ago.

"There were some bad players in the market," he said. "There were also some people who were managing PEOs who really didn't understand the kind of support and education they needed. So they got burned, and they went out of business."

Improved conditions

The situation has improved since then, however, with the passage of legislation in 25 states, including Indiana, that regulates the industry.

The law here went into effect in July 2006 and requires PEOs to register annually with the state, as well as provide financials and details of their benefits programs to ensure they're compliant.

WorkSmart President Matt Thomas welcomes the additional scrutiny.

"It's created an environment where you really have to have the financial resources and the management capabilities to run a PEO," he said. "Those things have weeded some out."

Thomas is another veteran of the PEO industry and started WorkSmart in 1998. Four years later, the firm had 100 clients and serviced 900 employees. Today, those numbers have swelled to 300 clients and 3,700 employees in 30 states, with average annual revenue growth of 35 percent. The aim is to double representation within the next five years, Thomas said.

Growth by acquisition

Tilson in Greenwood, formerly known as Adminiserve, is a pioneer in the Midwest, offering the type of outsourcing arrangements that were already widely available on the coasts when the company opened in 1995.

It now provides services in 25 states to more than 3,500 workers. For Tilson, the shakeout that occurred earlier in the decade helped fuel its growth.

From 2003 to 2005, the company acquired three Indiana-based competitors-PPL in Evansville, Strategic HR Group in Columbus, and The Personnel Department Inc. operated by the insolvent Church Extension of the Church of God Inc. in Anderson. In that case, Tilson visited its clients and gained their business while hiring almost the entire staff of The Personnel Department.

Ensuing growth has been about 20 percent annually.

"It has a lot to do with the fact that more companies are recognizing PEOs as a strategic solution," company President Brent Tilson said. "Those companies today are looking at PEOs and saying, 'You know what? This might be a better alternative.'"

Companies seeking human resources assistance from a PEO have an average of 17 employees, according to the NAPEO. But Tilson said several of his clients have more than 100 workers, indicating that even medium-size companies are beginning to recognize the benefits.
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