TERMINOLOGY

To understand what employee leasing programs are it is useful to make some distinctions at the outset. Four arrangements dealing with employees are common. 1) A business handles all relationships with employees and all employment-related activity inside the business. These relationships may or may not involve labor unions. If they do, the contents of labor contracts are part and parcel of the administrative implementation. 2) Many small businesses farm out the payroll function to a commercial service. The vendor organization keeps records in parallel with the employer but handles the payment of all salaries and wages, makes all the deductions, and submits appropriate payments to federal and state taxing agencies. The vendor performs an administrative service, pure and simple, and has no actual contact with the employees. 3) Some businesses employ a vendor who takes on the entire human resources administration function, including the management of benefit programs as well as handling complaints and legal problems. Finally, 4) but usually only in relation to a tiny subgroup of employees, the business may engage temporary employees from a vendor like Kelly Services; the people engaged are employees of the temporary service, but for the duration of the assignment they take their direction from the business's management. None of the four arrangements in dealing with employees is an "employee leasing program." That phrase refers to a fifth alternative.

The Professional Employer Organization (PEO)

The fifth alternative, and the one in which the phrase "employee leasing" occurs (or at least used to occur), involves a contractual relationship between the business and a professional employer organization. When a business enters into a contract with a PEO, the PEO becomes the co-employer of the business's employees. It takes over all personnel-related administrative activities, including payroll, the administration of benefits programs, the payment of payroll taxes, workers' compensation, etc. Under the co-employment arrangement, the employees of the company come under the PEO's control for personnel-related matters but remain under the business's control for operational matters. The business pays all of the employment costs involved and also pays the PEO a fee based either on payroll (2 to 8 percent) or a fixed fee per employee. The business, in effect, "leases" its employees; thus it participates in an "employee leasing program." In theory, at least, nothing changes at the business except that, in relation to personnel matters, the employee reports to the PEO. But employees still come to work, still take their day-to-day directions from the management, but now, in effect, they work for both the business and the PEO—but their checks come from the PEO.

Employee leasing became a visible economic model in the 1980s, when the phrase "employee leasing" also first occurred. But the phrase is being used less and less in the mid-2000s. In its stead, people refer to "outsourcing human resources" or simply "working with a PEO." Terminology continues to be murky because a milder form of this type of outsourcing (alternative 3 shown above) also exists. It is called "administrative services outsourcing"; companies that offer this service are known as ASOs. An ASO takes over the administrative functions only of the human resources activity but doesnot become a co-employer. Businesses also avoid the word "leasing" of late because, apparently, it has negative connotations—you lease a car, not a person'¦.

DRIVING FORCES AND BENEFITS

When ABC Business outsources its employees to XYZ PEO, the employees almost always immediately benefit because ABC did not have such fringes as health insurance but XYZ offers fringes. Since the employees are now "co-employed" by XYZ—and it is in XYZ's interest to keep unemployment costs down, employees laid off by ABC might more easily find work at one of XYZ's other clients.

ABC, as a small business, can now attract employees more easily because its benefits package is as good as that of much larger companies. Furthermore, ABC's management no longer needs to manage its personnel; XYZ takes care of it all. Thus ABC gets intangible benefits, a more attractive employment package, avoids administrative tasks, and, furthermore, its actual payroll costs may also go down because overall unemployment levies and workers' compensation payments may be lower. For all this ABC pays XYZ a fee. If in ABC's calculus the positives outweigh the fee, the deal is attractive.

XYZ is in the business of collecting fees for a service. It achieves low enough costs to offer fringe benefits and a lower payroll cost as a carrot through economies of scale. It buys medical insurance for 80,000 employees as a group—of which ABC's 25 employees are but a drop in a lake. The PEO's unemployment costs will be much lower because its 50,000 employees (pieced together from some 1,700 small businesses) will have a lower layoff experience. These lower unemployment cost savings are passed on to ABC and others, some of whom, alone, would have much higher unemployment and workers' compensation costs. Similarly, XYZ's administrative structure is supported by large numbers and therefore overheads are spread over many employees, not a few. XYZ targets as its market small businesses which have no fringe benefits but would like to offer them.

This hypothetical—but typical—case illustrates the benefits enjoyed by all the parties. These benefits act as the driving force behind this commercial development.

If instead of working with XYZ the owner of ABC had chosen to outsource the administrative labors of dealing with employees to an ASO, it would still have to pay a fee but would not be able to offer a richer benefits package or benefit from lower unemployment insurance or workers' compensation costs of the 50,000 employee group.

DISADVANTAGES

A very real but intangible negative of joining with a PEO is ambiguity created by the "co-employment" clause of PEO contracts. Under such arrangements, both the business and the PEO have equal rights to hire, fire, and direct employees. The employee suddenly has two masters. Looked at from the employee's perspective without too much reflection, one party has brought health benefits and pays the salary; the PEO, furthermore, is a large organization with potential other employment to offer; the other party, the small business, just manages the work—and handles the frictions that arise there. Potentially serious conflicts of loyalty are likely to develop. The small business has, in effect, delegated to others a vital, perhaps a central, aspect of its business. Employees may feel grateful because benefits have increased and yet they may wonder: this form of relationship is rather new. In short, ambiguity is a fundamental problem of the relationship between the business and its people after the PEO has "moved in."

From the business owner's point of view, loss of control, generally, is the chief downside of farming out the people. The PEO industry has seen some notable failures which have left employees stranded without pay and benefits—and the owner holding a huge empty bag. In a number of states litigation by the state is underway to eliminate the benefits PEOs have achieved by pooling the employees of many organizations into one. Unemployment taxes are levied on businesses based on their layoff experience. A company that hasn't laid off anyone in five years pays a much lower rate than one that routinely lets go one or two people every year. The PEOs, in effect, pool not only employees but layoff experience and thus, in the aggregate, lower the payments to state unemployment systems. For this reason, litigation is under way to force PEOs to pay unemployment taxes based on the experience of member businesses, not on the collective.

TRENDS

The PEO industry has been expanding and is in the process of consolidation; companies, of course, benefit substantially from size in spreading risks and absorbing overhead costs; in turn, large size provides greater security to clients. As Mike Vogel reported in Florida Trend (Florida being one of the early acceptors of this industry), PEOs anticipated double-digit growth in 2006—based in large part on the hiring activity of their clients. The top 10 companies in the U.S., Vogel reported, citing data from Staffing Industry Report had revenues of $19.6 billion in 2003.

The PEOs are, in a sense, a consequence of U.S. industry's fascination with outsourcing. The industry has and continues to concentrate on its primary market, companies in the 50 or fewer employee category. But, as Jessica Marquez reported in Workforce Management, ASOs, which target the midsize employer, are feeling increasing competition from PEOs now in their efforts to take over the human resources functions of these larger companies.

Interestingly, as the power of unions continued to wane in the mid-2000s and union membership continued to decrease year after year, another form of labor aggregation into ever larger pools was evolving—but this time under the leadership of the corporate sectors, small and large.

BIBLIOGRAPHY

Clark, Edie. "Working Definition." Security Management. August 2005.

Erlam, Alexander N. "Employment Liability." Security Management. September 2005.

Genn, Adina. "Outsourcing HR Functions Gains Traction." Long Island Business News. 13 August 2004.

Lane, Amy. "Groups Feud Over PEOs in SUTA Dumping." Crain's Detroit Business. 7 March 2005.

Marquez, Jessica. "PEOs May Heat Competition in Middle Market." Workforce Management. 30 January 2006.

"Outsourcing HR: Advisory firms are growing and staffs are burgeoning. Now there's a way to buy out of your personnel headaches." Financial Planning. 1 February 2006.

Vogel, Mike. "Growing Their Base." Florida Trend. January 2005.

Yager, Milan P. and Joan Szabo. "The Truth About PEOs." Entrepreneur. January 2006.

Zimmer, Matt. "Outsourcing: From soup to nuts or a la carte?" Club Management. December 2004.

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