The #1 Company

For most employers, FICA, FUTA, and COBRA are a noxious form of alphabet soup. But they're bread and butter to Kevin Grauman, CEO and founder of the Outsource Group, a professional employer organization (PEO) in Walnut Creek, Calif., that's soared to the top of the Inc 500 with 54,330% growth in five years.

A native of South Africa, Grauman landed here in 1984 with a one-year tourist visa, $400, and an airline ticket that was good only as long as he kept moving west. He wound up in San Francisco at accounting firm Hood & Strong, a logical home for the then-23-year-old former Ernst & Young employee. But after two years Grauman had had enough. "I absolutely detested being told what to do if it didn't make sense," he recalls. "That happened a lot in the corporate world."

In his first bid at independence, Grauman started an employment agency that grew to $5 million in annual billings before he sold it, in 1991. His second venture, Payroll Benefits & Experts, managed basic payroll accounting and human resources for businesses that were short on time and expertise. It offered services à la carte. By the mid 1990s, the business model was running out of steam, so he launched the Outsource Group, offering a bundled service that promised to deliver more value by streamlining the HR back office. Customers initially balked at the price, which was four to five times what they had been paying for individual services. But eventually, one-fifth of Payroll Benefits & Experts' customers signed up with the Outsource Group.

Today the Outsource Group -- which has been profitable since 1999 -- serves 400 businesses, with a total of 6,000 employees. It processes payrolls, manages benefits, and helps clients comply with the thicket of state and federal employment laws. In addition, by aggregating employers and negotiating on their behalf, it gives small and midsize businesses access to benefits on a big-company scale. To do all that, the company assumes responsibility for the administrative functions of employment -- paying workers and withholding taxes, for example, as if they worked for the Outsource Group. The workplace employer is responsible for direction and control. It is that legal structure that distinguishes a PEO from a plain-vanilla outsourcer.

"I absolutely detested being told what to do if it didn't make sense."

--Kevin Grauman

However, PEOs vary in how broadly they define their role under coemployment. The National Association of Professional Employer Organizations believes that PEOs should share the right to hire, reassign, and fire employees. But in those key areas, Grauman prefers to leave his clients in control. The Outsource Group doesn't pretend to be an employer, he explains. For that reason, he prefers to call it an "employee process outsourcing company" rather than a PEO.

Whatever the company's label, its payoff for customers can be substantial. The Outsource Group's negotiating leverage has kept annual increases in health-insurance costs at about 15% at a time when many small businesses face hikes of 20% or more. Customers also report savings in time and labor. "They free us up to earn a living," says Bob Beyer, executive director of Filice Brown Eassa & McLeod, a 100-person Oakland, Calif., law firm.

ADMINISTRIVIAL PURSUITS: Kevin Grauman has built a fast-growth company on the back-office morass that slows others down.

Since the Outsource Group relies heavily on referrals, satisfied customers like Beyer have helped drive revenues from $541,000 to nearly $300 million in five years. (The Outsource Group invoices clients for their wages, insurance, and related costs, as well as its own fees.) But Grauman's primary goal isn't growing fast: it's growing smart. That's why he rejects 60% of the companies that apply to become clients. "We don't want to pollute the risk pool," he says. The company has also cultivated a diversified customer base instead of depending on the venture-capital-funded start-ups that once sprouted like mushrooms after rain. Even during the Internet boom, "we were leery of concentrating too heavily in that area, because it didn't seem sustainable," chief operating officer Matt Miceli explains.

That philosophy may become more important as competition heats up. "The market is in the midst of rapid consolidation and turmoil," says Joe Vales of Vales Consulting Group, in Rye, N.Y., who cites the dramatic decline in the availability of workers' comp insurance and growing interest in the market from large business-process outsourcers. Many PEOs will sink, he believes. Those that float may align themselves with one of the giants invading the market. Alternatively, says Vales, "the firms that dedicate themselves to understanding the needs of the small-business owner and act as his partner will succeed."

Mary Kwak is a freelance writer in Cambridge, Mass. Sarah Stroback provided additional research for this article.

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