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

By Klaas, Brian S.; McClendon, John et al. | Entrepreneurship: Theory and Practice, Fall 2000 | Go to article overview

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). …

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