Thinking PEO? Think Twice

By Jack Terrana and David Dourgarian with Casey Kraus

The decision to open a staffing company is not an easy one. The countless hours of thinking, planning, figuring and stressing often result in either no action or, sometimes worse, misguided action. If you spend weeks, months, or even years figuring out how to go about starting your own business, yet fail to ever open the doors, you probably haven't lost much more than time and energy.

Far worse off are those who expend the energy, plus spend a chunk of money to get the doors open, and then realize their plan won't work. Instead of having a plan B, the rookies try to adjust a plan that was weak to begin with. It's the beginning of the end, and on the slow spiral downward, the panicked owner begins to cut corners. It may be sending unqualified candidates or hiring unproductive but inexpensive employees. Either way, it almost always features a cost savings for the customers at a time when the original margins were low to begin with.

With little gross margin and no standout talent, what do you have? You have a poor product that you're able to deliver at a low price, but now you can't meet your expenses. You have a business that is a financially losing proposition. Without a change or a bailout, the ship will sink. It is an all too familiar story: a talented executive opens a staffing firm, but doesn't book the amount of business he anticipated. He spends more than what's in the budget, runs out of money, and has to close the staffing firm. Voila, Mr. Executive is back working for someone else.

There is positive news. Six out of ten startups do make it past the above cycle. Of those six, three create a profitable staffing business that more than replaces the income they received when working for someone else. Moreover, as the boss, they now call all the shots.

With better planning, those odds improve even more. Just by avoiding the PEO route and implementing a sound risk management plan from day one will separate you from the pack. Let's review why taking these measures will give you a better shot and help you to avoid major disruptions at a time when your company could, and should, be on a meteoric rise.

If you don't own the employees, then you don't own the business. Do not be lulled into walking down the path of least resistance when it comes to insurance. You have one product - people. They are your employees, your only real tangible asset. PEOs and similar "employer of record" services appeal like an entrepreneurial lollipop. No waiting for comp, no down payment and no aggravating audits or claims. "Wow, that sounds good, where do I sign?" you say.

You don't. You exhaust every possible option to secure your own workers' comp coverage and when you are ready to give up, you repeat the mantra "if I don't own the employees, then I don't own the business."

In 2001, workers' comp markets went through a George Costanza (of Seinfeld) period of severe shrinkage. Insurers figured out that the large premiums for risk-ignorant staffing companies could never offset the huge claims that had become rampant. Accordingly, they unilaterally cancelled the worst offenders and made life miserable for the rest. Fees increased and regulations tightened. The toll was devastating. The little guys who were cancelled or priced out ran for cover to a PEO, not realizing what a bad fit it would be.

What makes a PEO such a bad fit? Let me count the ways...
PEOs work on volume. That means that if there's no volume, there's no profit. If there's no profit, then there's no service. The PEO views the small staffing company no differently than a staffing company would view a small, low-margin, high-maintenance client.

PEOs maintain a separate database that doesn't integrated with your own. A simple payroll register may take days instead of minutes to process as it would with an integrated system. How about paperwork and rectifying mistakes, particularly payroll checks? Or generating a critical report for a client?

PEOs routinely deny many positions and codes because they never see a worksite or get to know your client company. You will no doubt lose opportunities with companies that may have exemplary safety records - good business lost with a PEO. Much of the ability to service a client is lost when you are not in control.

Your business may be able to survive like that for a while, when you're small and on target with every other part of your business, but soon the poor service will take its toll.

So, what do you do? You skip that phase entirely. Ignore the urge to pursue the quick fix and be sure to insure your employees from day one. But, is the workers' comp crisis over? Probably not, but the insurance companies fully understand that without a mix of large and small business premium dollars, they are sunk. To combat claims that offset premium income, they need to know that business owners will take their employees' well being seriously. They want management to demonstrate their willingness to become risk experts. Before, a staffing entrepreneur's most important assignment was to be a sales and service machine. Not anymore - that's not enough. Today, you need to be a risk expert, as well.

To be fair, if you are more of the permanent placement sort and temps or contractors are not the major focus of your company, then by all means, it makes sense to go the PEO route. But, if you consider yourself a temporary staffing company, there is no question about how you need to address this critical area.