Managing HR in the Small and Medium Enterprise: The Impact of Professional Employer Organizations

Klaas, Brian S., McClendon, John, Gainey, Thomas W., Entrepreneurship: Theory and Practice

Due to their limited size, many small and medium enterprises (SMEs) cannot justify full-time HR professionals in their organizations. Thus, the complex and time-consuming nature of many HR activities can result in a significant drain on existing managerial resources. Professional employer organizations (PEOs), however, offer SMEs an alternative for handling their workforce by providing compensation programs, regulatory compliance, and other HR-related services. This study examines the satisfaction levels of 763 customers of one large PEG. Results show that firm growth, past HR problems, workforce size, contractual detail, service representative-client relations, value congruence, and overall PEO usage are significantly related to managerial satisfaction with PEO services.

While managing HR presents significant challenges to a fly firm, small and medium enterprises (SMEs) face unique challenges that stem largely from their size (Greening, Barringer, & Macy, 1996). While economies of scale permit larger organizations to employ a team of specialists to address the complexities involved in managing HR programs, this is not a viable option for many SMEs. The costs associated with hiring highly trained HR professionals on a full-time basis are likely to be prohibitive for many smaller organizations (Arthur, 1995). As a result, HR activities often become the responsibility of general managers (Longenecker, Moore, & Petty, 1994). This is problematic for two reasons. First, the complexity of many HR activities is likely to result in them becoming a significant drain on managerial time and resources. As such, HR tasks may interfere with managerial responsibilities that are directly related to revenue production (Cook, 1999). This problem is even more critical given that scarcity of man agerial talent is often cited as a key factor limiting growth in SMEs (Arthur, 1995). This scarcity of managerial talent increases the opportunity costs associated with time spent on HR administration by SME general managers. Second, many HR tasks involve substantial complexity and, thus, the quality of HR decisions may well be affected by the fact that general managers often lack significant training and expertise in HR (Greer, Youngblood, & Gray, in press).

SMEs also face unique challenges with regard to the attraction and retention of employees. Attraction and retention is clearly linked to the ability to offer a competitive benefits package (Williams & Dreher, 1992). However, since benefits costs decline as firms become able to aggregate risk across a larger number of employees (Beam & McFadden, 1992), SMEs are at a disadvantage in their ability to offer competitive packages and, in turn, attract and retain employees.

The Professional Employer Organization (PEO) was developed in response to these unique HR challenges facing SMEs. PEOs first emerged in the 1980s and now cover approximately four percent of those employed by firms with fewer than 500 employees (Cook, 1999). When an SME signs a contractual agreement with a PEO, the PEO agrees to become a co-employer of those working at SME facilities. The SME agrees to pay to the PEO an amount sufficient to cover wage and benefits costs, administrative expenses, the costs associated with HR programs and services, plus a mark-up for profit. The PEO then serves as the employer-of-record for many HR functions and becomes jointly responsible for managing HR within the SME. Through this contractual arrangement, the PEO becomes the outsourced HR department for the SME that it serves. It handles payroll, provides and administers a benefits package, ensures compliance with regulatory issues, works to ensure a safe workplace, and provides a number of additional services to assist in the effective management of a workforce (Cook, 1999; NAPEO, 1992).

Clearly, PEOs offer an approach for addressing some of the major HR concerns faced by SMEs. Many of the major PEOs serve as a co-employer for over 40,000 employees (NAPEO, 1992). As a result, the ability to aggregate risk across a large number of employees allows them to obtain a competitive rate for benefit programs. Increased size also provides PEOs with greater leverage in negotiating favorable rates with benefit providers (Cook, 1999). Thus, PEOs are able to provide benefit programs to employees in a cost-effective manner, which, in turn, assists clients in their efforts to attract and retain employees. Further, while most SMEs do not have sufficient economies of scale to justify employing a team of HR professionals, larger PEOs have no such constraints. By relying on a PEO, SME managers are able to gain efficient access to HR expertise and are able to outsource time-consuming HR tasks to those with the ability to perform them more efficiently (Greer, Youngblood, & Gray, in press). This should result in higher quality HR decisions and allow general managers in SMEs to focus more on revenue-producing activities.

The challenges faced by SMEs in the HR area suggest that they may well benefit from reliance on a PEO. It is important to note, however, that evidence from the "make or buy" literature suggests that firms seem to differ in their ability to take advantage of the benefits potentially available through outsourcing (Monteverde & Teece, 1982; Walker & Weber, 1984). We might expect, therefore, that there is likely to be variation across SMEs in overall satisfaction with the PEO and satisfaction with the PEO' s role in helping contain HR costs. The purpose of this study is to examine how characteristics of the SME and of the SME-PEO relationship affect overall PEO satisfaction and satisfaction with the PEO's role in containing HR costs.

THEORY AND HYPOTHESES

While the outsourcing of HR has received relatively little attention in the literature (Klaas, McClendon, & Gainey, 1999), outsourcing more generally has received much attention by institutional economists and strategic management scholars (Walker & Weber, 1984). Transaction cost economics and social exchange theory have both been used to understand why firms rely on outsourcing and the conditions under which it is most likely to yield positive outcomes for the firm (Williamson, 1996; Gulati, 1995). We will draw on these theoretical perspectives in developing hypotheses about the conditions under which reliance on a PEO will be most likely to result in overall client satisfaction and in satisfaction with the PEO's role in containing HR costs.

Growth Pattern

Transaction cost economics (TCE) argues that decisions about whether to outsource are driven by efforts to minimize the total transaction costs associated with obtaining some needed input or service (Williamson, 1996). Transaction costs are thought to include, in addition to traditional cost factors, monitoring and contracting costs and the effects of opportunistic behavior. TCE also argues that outsourcing introduces some distinctive ways for reducing transaction costs (e.g., increased economies of scale, increased incentive intensity, and more efficient access to expertise) as well as some distinctive risks that might increase transaction costs (e.g., opportunistic behavior by suppliers) (Williamson, 1979). It is further argued that firms differ in their capacity for benefiting from the cost-reduction methods offered by outsourcing and in their vulnerability to the risks introduced by outsourcing (Williamson, 1975).

Accordingly, outsourcing is likely to yield more positive outcomes in firms that have a greater capacity to benefit from the methods offered by outsourcing and in firms that are less vulnerable to the risks introduced by outsourcing (Williamson, 1996). Consistent with this, we argue that a number of SME characteristics are likely to affect a firm's capacity for benefiting from reliance on a PEO and also their vulnerability to the risks introduced by outsourcing. One such firm characteristic is the growth rate experienced by the firm. We argue that firms growing at a more rapid rate will be more likely to experience positive outcomes from relying on a PEO. In a growth mode, SMEs must devote substantial energies to building an effective workforce. Greater attention must be given to hiring employees, ensuring that they receive adequate training, and administering relevant HR programs. In the absence of a PEO, these activities are likely to place intense or even overwhelming demands on an SMIE's managerial staff and may require the hiring of additional staff (Greening, Barringer, & Macy, 1996). As a result, HR tasks are more likely to interfere with revenue-production activities and more likely to increase costs. When rapidly growing SMEs rely on a PEO, the economies of scale offered by the PEO should allow the SME to acquire HR expertise in a way that is efficient both in terms of time and costs. Because of this, in a rapidly growing SME, the costs of forming and maintaining a relationship with a PEO will be more easily offset by the time and cost savings that result from such a relationship. As a result, rapidly growing SMEs are likely to be more satisfied with their PEO, both overall …

Questia, a part of Gale, Cengage Learning. www.questia.com
Publication information: Article title: Managing HR in the Small and Medium Enterprise: The Impact of Professional Employer Organizations. Contributors: Klaas, Brian S. - Author, McClendon, John - Author, Gainey, Thomas W. - Author. Journal title: Entrepreneurship: Theory and Practice. Volume: 25. Issue: 1 Publication date: Fall 2000. Page number: 107. © 2007 Baylor University. COPYRIGHT 2000 Gale Group.

This material is protected by copyright and, with the exception of fair use, may not be further copied, distributed or transmitted in any form or by any means.