Read this before hiring a PEO for your small business

Are you thinking about hiring a PEO for your small business? Read about the pros and cons, and alternative options, in our article about why a PEO is not the best HR outsourcing strategy for small business owners

By David Bradshaw, SVP Client Services
5th October, 2022
David is a highly experienced consultant specializing in business strategy, lean operations/automation, and human resources. He holds a Master's degree from the University of Cambridge, UK, and an MBA from Quantic School of Business and Technology.

PEO is an acronym for Professional Employer Organization - an outsourcing model that provides HR services to its clients, including payroll, benefits, and insurance.

What differentiates a PEO from other outsourcing models is that the PEO company is actually a co-employer and has a significant amount of control over how the workforce is managed. Smaller companies use a PEO when they need to manage their HR needs without having to invest in building out the infrastructure and human capital required.

What are the Benefits of Utilizing a PEO?

A PEO can provide a wide range of benefits to its clients. These include:

- Lowering the cost of employee benefits, such as medical insurance

- Providing administrative services such as payroll and benefits administration

- Providing human resources services such as recruiting, onsite training and coaching

- Offering peace of mind by managing compliance with labor laws

There is no doubt about it, these are attractive benefits - especially to small business owners who often become distracted, or even overwhelmed, by the complexity of supporting a team of employees. It’s easy to see why many small businesses outsource HR to a PEO in the early days of expansion. So why is it that so many small business PEO relationships end quickly?

What are Some Drawbacks of Using a PEO?

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Managing a workforce is a complex and time consuming task that needs specific knowledge and experience, so it is no wonder that many smaller organizations turn to PEOs for help.

However, there are some significant drawbacks to using a professional employer organization, especially for small businesses. The first is that you have to pay the company for their services - and the fee structure is complex and opaque, to say the least. There’s no getting around it - using a PEO is incredibly expensive, and PEOs are notorious for burying fees in unfathomable invoices that make it very difficult to understand exactly what you are paying. Many PEOs bundle their fees in with employment taxes, so you can’t easily see the total cost.

Another significant drawback is lack of control. As a client of a PEO, you need to abide by the company’s rules and regulations, which may not be in your best interests. PEOs make more money by being efficient, which means that they are incentivized to do the minimum amount of work possible to retain their clients. They offer ‘one size fits all’ services, which are highly automated and repeatable, which means you don’t get the human touch, nor do you get flexibility. It’s their way or the highway.

Last and not least, PEOs can be difficult to deal with. Interacting with a PEO can be a time consuming and frustrating experience for your employees. In a world where providing a positive employee experience is a key retention strategy, this is unacceptable and is often the factor that causes small businesses to end their relationship with a PEO.

What are the alternative HR Outsourcing models?

There are many pros and cons when it comes to using a professional employer organization, but did you know that there are alternative models that could work better? The traditional alternatives to using a professional employer organization include HROs, independent contractors, or insourcing. Let’s deal with insourcing first.

Insourcing is the act of getting your existing employees to take on management of the HR function. In a small business, this often means the founder or owner. This is how most small businesses start out, and it can be an effective strategy, at least in the short term. By taking on the work his or herself, the small business owner avoids fees, and feels connected with the day-to-day operations of the business. As the business grows, tasks may get delegated to operations leaders or supervisors. Unfortunately, this model does not scale. Running the HR function is a distraction from the day-job, and most people outside of the HR field do not enjoy many of the tasks involved. It is often at this stage that the small business starts to look for another solution, usually around the 10-20 employee mark. As well as being unscalable and unenjoyable, this model carries a significant amount of risk - it is easy to get into trouble by straying outside of legal compliance, or not having the systems and processes in place to make sure that your employees are staying engaged, productive, and developing.

The next solution that small businesses often turn to is using an independent contractor. They recognize that they don’t have the expertise in-house to manage the HR function themselves, but they are not yet large enough to be able to justify a full-time hire. This option is a significant upgrade over insourcing, and avoids most of the issues with that model. However, independent contractors don’t usually offer a full solution - for example, they may be proficient in employment law and hiring practices, but lack the connections to benefits providers and expertise in insurance to construct an effective and affordable benefits package for your employees. Sourcing medical, vision and dental plans that are both high quality and affordable for smaller teams is a serious challenge. Additionally, it can be difficult to find the right independent contractor for your business, as an inexperienced small business owner might not know how to spot the difference between a good one and a bad one. Other drawbacks of the independent contractor include the fact that many don’t stick around for long, and lack the systems to securely process and store confidential information that is protected by law.

An HRO organization (Human Resources Outsourcing) is a company set up to provide outsourced HR services to its clients. They are similar to a PEO, but different in that they are not co-employers of your team. While they tend to offer a more flexible service than a PEO, an HRO comes with many of the other drawbacks.

Recognizing the difficult situation that smaller businesses are in, and the growing importance of the HR and PeopleOps functions, Northstar created a new model for HR outsourcing that solves all of the problems associated with insourcing, PEOs, independent contractors, and traditional HROs. Our popular Fractional HR service provides you with your own dedicated HR Manager, on a part time basis, backed by the infrastructure of the Northstar team and its third party partnerships. It offers a personalized service tailored to the needs of your business, at a fraction of the price of a PEO. There are no lengthy tie-ins, enterprise-grade IT systems, no call centers, and a steadfast commitment to customer service and satisfaction. Our Fractional HR service is hands-down the best choice for smaller organizations on the market. You can read more about the Advantages of Fractional HR here.

Conclusion: PEOs are NOT Working for Smaller Organizations

PEOs are one way for businesses to get HR help and benefits, but they come with major drawbacks, and they just don’t work for smaller organizations. The cookie-cutter service design, high fees and frustrating interactions are driving away customers in droves.

Why not book free, no-obligation discovery call and learn about our revolutionary Fractional HR Service today?