Employee incentive programs are increasingly regarded as strategic business tools.
Once treated as little more than freebies with no measurable impact on a companys bottom line, employee incentives are now increasingly regarded as must-have programs, strategic business tools with the power to improve productivity and profits, and especially effective in dealing with a soft economy. The big difference is that now the roi power of incentives can be measured, and it is superb.
The PEO rollercoaster.
Surviving PEOs are bouncing back, but does it mean the industry will do the same?
When I began my career as an analyst in the mid-90s, my first major project was to understand an emerging area that promised to transform small business HR-the PEO. My goal was to figure out whether this would be an investible area. My conclusion? I am still working on it.
For those not familiar with the PEO concept, it is most easily understood from the client perspective. A company outsources their entire HR function and their employees become employees of the PEO for administrative purposes-a co-employment relationship. This offers small companies “big company” benefits. The value proposition is straightforward. The challenge is in managing the risks and the costs- PEOs act as underwriters and distributors of workers’ comp, healthcare, and state unemployment insurance. If the price charged to clients does not cover the losses, the PEO will have problems.
For the first few years, PEOs were a hit in the market. Employee Solutions, Vincam, Administaff, OutSource International, and Staff Leasing took turns in the IPO spotlight. Investor favorites ADP and Paychex paid large sums to buy their way into the business, legitimizing the model. However, investors discovered (the hard way) the difficulty PEOs have in managing risks. Employee Solutions and Outsource International became insolvent-largely due to inadequate workers’ comp reserves and acquisition-related issues. Vincam hit a wall following several acquisitions, before selling to ADP. Staff Leasing imploded more than once after discovering inadequate health and workers’ comp insurance reserves. And Administaff’s stock fell more than 90 percent during the nine months following the announcement of a dispute with its health insurance carrier. By mid-2002, investors had seen enough of the PEO.
But 2003 has been a different story. The two pure PEOs in the public markets, Administaff and Gevity HR (formerly Staff Leasing), have increased 81 percent and almost 300 percent, respectively (see charts below). Administaff is now trading at more than 5 times its low and Gevity at more than 18 times. TotalSource (ADP’s PEO) has arguably become one of ADP’s best performing business units, growing 37 percent in the recent fiscal year. Why the sudden turn? First, each of the Big-3 companies has undergone significant change resulting in stronger business-Gevity has refocused sales and retention on the less risky white collar clients; Administaff has changed health carriers and overhauled its billing system. Second, the extraordinarily tight insurance market has forced many smaller competitors out of business. Finally, rising insurance costs have become a big problem for small businesses, increasing the value proposition of the PEOs.
Is the PEO coming back? I don’t think so, and I would be cautious when considering investing. While the Big-3 should continue to show improving results, the industry faces three key obstacles: (1) Legislation is working against PEOs (more on that next month); (2) Insurance markets change-a less penalizing market for small businesses could take away from the PEO value proposition; and (3) The ASO concept is gaining traction, particularly among the payroll processors. Next month, I will elaborate on these challenges.