- Under the PEO business model, a company partners with a Professional Employer Organization (PEO) that handles payroll, benefits administration, employee tax reporting, and other human resources tasks.
- PEOs charge monthly fees based on gross payroll, number of employees, or services rendered.
- PEOs represent thousands of employees working in different companies. They are able to negotiate lower rates for benefits packages, which saves money for their clients and drives their own revenue.
- Companies can grow quickly with the PEO business model as they devote less resources to developing internal HR capabilities.
- Packages and rates differ among PEOs. Companies must research which PEO will provide them the best service and highest savings. Possible risks to the PEO business model include loss of control over HR functions.
PEO stands for “Professional Employer Organization”: These are professional services companies that partner with client businesses under contract to outsource tasks otherwise handled by internal HR departments. Under the PEO business model, the PEO handles payroll processing, benefits administration, employee tax reporting, and other functions such as unemployment tax reporting and payment.
PEOs serve as the ‘Employer of Record’ for many employees working at many different companies: This means that the PEO serves as the legal employer for a range of specific legal purposes (such as tax withholding, workers’ compensation, or pension contributions). It is this fact that allows the PEO business model to benefit clients and generate profit for the PEO. Through bulk purchasing, PEOs are able to negotiate lower-priced benefits packages than their clients would be able to alone. The PEO profits on the margin, and can also earn commissions from the insurers and benefits providers that it works with.
To dig deeper into the PEO model, see our comprehensive guide below.
What are the benefits of the PEO business model for businesses?
The PEO business model can mean substantial cost savings for businesses:
- Companies contracted with a PEO usually pay lower rates for insurance and employee benefits packages
- Unemployment tax may also be lower with the PEO business model; normally the unemployment tax rate will increase as unemployment claims increase, a PEO can mitigate this expense as employees work for the PEO for tax purposes, not for the client business.
- Workers’ compensation rates may be lower (this depends on the country/state in which the client company is based).
- Competitive advantage means it is usually cheaper for a PEO to perform payroll, admin and HR tasks than for a company to do it themselves.
In 2019, the National Asocciation of Professional Employer Organizations (NAPEO) commissioned research which estimated a return on investment (ROI) from engaging a PEO of 27.2 percent.
How does the PEO business model benefit employees?
Employees under the PEO business model may receive better healthcare, vision, dental, and retirement packages than they would under a company of similar size that does not use a PEO. The PEO business model should also be more efficient in processing payroll, tax, and benefits payments. Since PEOs specialize in providing one business process to thousands of employees, they will likely be less prone to human error than a strained or overworked internal HR department.
What are the risks of the PEO business model?
Under the PEO business model, all co-employee benefits, payroll and tax records are held by the PEO. This results in some loss of control for the company. A PEO could switch providers at any time, which could cause difficulties for employees and management.
If the PEO takes over tasks that were previously handled by the internal HR department, HR staff could experience difficulties in adapting to the new system. This may result in complaints from co-employees and HR staff, and mistakes made when migrating to the new system.
If a business requires a very specific benefits or insurance package that is only available from a few providers, there is a risk that the PEO does not work with those providers and will not be able to provide the best package for that business.
What are the costs associated with the PEO business model?
A PEO earns revenue by either charging a percent of total payroll, or a fixed amount per pay period. Fixed charges may be a minimum for the entire account, or be based on the number of co-employees. There may be additional charges depending on services provided. Generally PEO costs run between 2-15% of total monthly payroll expenses.
The PEO business model allows small and medium-sized businesses to access benefits packages generally only available to large employers. It provides business owners with professional and efficient HR administration services without having to invest in building those capabilities themselves. It also provides a co-employment partner who can should tax liabilities and ensure compliance with local regulations.
At the same time, benefits providers are chosen by the PEO, not the client business, and the client must go through the PEO partner when accessing employee data or onboarding new employees. For some companies, this loss of control may not be justified by the potential savings and increased capabilities the PEO provides.
Company owners interested in the PEO business model should research the potential co-employer partners on the market and choose the PEO that best meets their unique needs. To learn more about the PEO industry, take a look at the info sheet provided by NCCI.
Companies generally choose the PEO business model because they want to grow quickly and expand their workforce without the administrative strain. They also work with PEOs to reduce their monthly expenses, reduce potential liabilities, and provide more competitive benefits packages to their employees.
The obvious alternative to the PEO business model is for the company to handle all of its own payroll and benefits packages internally. Another alternative is for a group of companies with similar needs to pool resources and create their own PEO; they will all benefit by reducing the strain on their HR departments and from lower-priced benefits packages. While it will take extra work to develop a PEO as a separate business entity, it can become a revenue stream in the future by taking on additional clients.