Academic journal article Entrepreneurship: Theory and Practice

Professional Employer Organizations and Their Role in Small and Medium Enterprises: The Impact of HR Outsourcing

Academic journal article Entrepreneurship: Theory and Practice

Professional Employer Organizations and Their Role in Small and Medium Enterprises: The Impact of HR Outsourcing

Article excerpt

While effective HR services and programs can help firms gain competitive advantage, small and medium enterprises (SMEs) often lack the internal resources required to develop and deliver these services and programs. As a result, SMEs increasingly are outsourcing HR activities to professional employer organizations (PEOs). Questions remain, however, about the conditions under which SMEs will benefit from outsourcing HR to a PEO, as well as about the type of benefits that are potentially available. The very nature of many HR activities raises questions about the risks associated with market governance and a PEO's ability to ensure service quality for SMEs. In order for these questions to be addressed, it is necessary to understand the process by which PEO utilization affects SME outcomes. In this article, we use transaction cost economics, social exchange theory, and the strategic HR literature to develop a framework for understanding the factors and conditions likely to affect whether and how an SME will benefit from using a PEO.

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How an organization manages its human resources is increasingly seen as a source of sustainable competitive advantage (SEA) (Huselid, Jackson, & Schuler, 1997; Becker & Gerhart, 1996; Welbourne & Cyr, 1999). The routines, processes, and cultural norms that are part of an HR system can become a valuable resource by virtue of their effect on employee behavior and attitudes. Clearly, however, developing an effective HR system is a difficult task, one that requires the firm to effectively implement a complex set of complementary HR practices that fit the needs of the organization's business and culture (Ulrich, 1996).

Small and medium enterprises (SMEs) face particularly difficult challenges in their efforts to develop HR systems that lead to SCA (Sexton et al., 1997; Baron, Burton, & Harmon, 1996). While the HR function often plays a critical role in developing the HR system in larger firms (Ulrich, 1996), economies of scale make it difficult for SMEs to maintain a professional HR staff and to internally develop required HR programs and services. As a result, an increasing number of SMEs now use market forms of governance to obtain HR services from professional employer organizations (PEOs) (Cook, 1999). While a relatively recent development, it is estimated that PEOs currently provide HR services to three million employees, with this number growing by 30 percent per year (Hirschman, 2000). Once a contractual arrangement is established with a PEO it becomes the employer of record for covered employees through a co-employment relationship. As such, the PEO becomes responsible for a broad array of HR activities, as well as assuming the liabilities associated with being an employer (Baron & Kreps, 1999). Reliance on a PEO offers SMEs several potential advantages. Greater economies of scale and an ability to negotiate more favorable rates for benefit programs offer the potential for substantial cost savings. Further, the efficient access to HR expertise offers mechanisms by which to improve the quality of HR programs and, in turn, HR outcomes (Klaas, McClendon, & Gainey, 1999).

While PEO utilization may offer advantages, questions have been raised about using market forms of governance to obtain HR services (Greer, Youngblood, & Gray, 1999). Many HR activities require asset-specific investments in order for services to be provided (LePak & Snell, 1999b). And asset-specific investments by a buyer increase the likelihood of opportunistic behavior by the vendor (Walker & Weber, 1984). Further, relying on an outside vendor for HR services means that other firms can acquire those same HR services. This raises concerns about whether advantages generated through PEO utilization can be imitated by competing firms (LePak & Snell, 1999a). Finally, service quality might be limited if the outsourcing relationship doesn't permit HR services to be tailored to the needs of the SME (Klaas, McClendon, & Gainey, 1999). …

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