What Is the ROI of Using a PEO?

Running a small business requires a great deal of initiative, adaptability, and savvy decision-making. In the face of rising healthcare costs and related factors, many owners consider partnering with a professional employer organization, or PEO, to outsource certain HR and payroll processes, increasing efficiency while reducing costs. 

These arrangements pose advantages as well as disadvantages, though, so the decision whether to partner with a PEO or seek out an alternative, like HR outsourcing, should be carefully made.

If you’re a small business owner trying to figure out whether PEO services for small business are worth the investment, you’re asking the right question. This article will answer a few of the key questions that impact the ROI of partnering with a PEO, so you can make an informed decision for your business. 

What Does the Research Say About PEO ROI?

According to recent research from the National Association of Professional Employer Organizations (NAPEO), over 230,000 businesses in America currently partner with a PEO. That’s roughly 15% of all employers with between 10 and 4,999 employees.

NAPEO also notes that “smaller businesses are engaging PEOs at a higher rate, and PEOs are scaling with companies they help to grow,” which seems to indicate an increasing number of businesses perceive the value of working with a PEO.

Additionally, commonly cited NAPEO data indicates that the average return on investment (ROI) of using a PEO is 27.2%, and that PEO clients also experience notably lower employee turnover and improved business revenue growth rates (vs. non-PEO businesses).

How Do You Calculate PEO ROI for Your Business?

It’s important to understand how to calculate the ROI for PEO partnerships. Here’s how NAPEO arrived at the 27.2% ROI figure cited in the previous section:

For a PEO client, the net cost savings benefit of hiring a PEO is equal to the savings that the client experiences as a result of using a PEO minus the cost of being a PEO client. Dividing that by cost yields ROI. 

NAPEO tracks PEO ROI across five expenditure categories: HR personnel costs, benefits administration, workers’ compensation, payroll/HR administration, and compliance-related costs. NAPEO’s 27.2% ROI figure tells us that PEO clients were found to receive roughly $1,272 back for every $1,000 spent on PEO-related costs.

While this example of a positive ROI figure is helpful, it doesn’t necessarily tell the full story (or guarantee any specific ROI); in reality, this number will vary considerably from one PEO partnership to the next. Company size, state, and provider all affect the outcome.

Where Does PEO Value Actually Come From?

Determining the true value of working with a PEO means considering the impact it could have on three areas: time and opportunity cost, health benefits access, and reduced turnover.

• Time and Opportunity Cost: While individual HR administration tasks like payroll, compliance filings, onboarding, and benefits enrollment are manageable enough on their own, together they can consume hours of business owners’ time from one week, month, quarter, or year to the next. 

Partnering with a PEO enables small businesses to consolidate a wide range of HR services into a single relationship. Ultimately, it’s the opportunity cost of not consolidating these services (hours spent on administration rather than operations) that illustrates the ROI of using a PEO.

• Health Benefits Access: Another often-cited value driver of PEO partnership is the ability to offer a comprehensive benefits package at a reduced price point. That’s because a PEO has greater negotiating power than an individual small business owner has. 

Since a PEO pools employees from multiple partner companies, small businesses gain access to benefits packages they couldn’t access independently.

• Reduced Turnover: Another piece of NAPEO data shows a strong correlation between PEO partnerships and improved employee retention, with PEO-partner companies having a turnover rate that’s 10-14 percentage points lower than other companies.

Again, these results are not a guarantee of any sort, but do provide some context for understanding the type of ROI you might be able to expect when you work with a PEO.

Is Compliance Protection a Real ROI Factor?

It certainly can be, but it’s tied more closely to risk management ROI than PEO ROI. With the average cost of a single Department of Labor (DOL) violation ranging anywhere from a few hundred dollars to well over $100,000 per violation, avoiding just one of these fines can easily make a PEO investment worthwhile.

What Are the Hidden Costs That Can Reduce PEO ROI?

Even considering the potential advantages of a PEO partnership, small business owners must still answer the “is a PEO worth it?” question through the lens of their own organization and objectives. You also have to consider potential hidden costs that can impact the estimated ROI of working with a PEO. 

These can include:

• Annual Fees: While the average PEO cost per employee sits around $1,395 per year, fees can range anywhere from 3% to 12% of total payroll, depending on your provider and workforce size. 

Since PEO fee structures are so highly variable, budget allocation and calculating the cost savings can be difficult.

• Exit Risk: One of the least-discussed aspects of working with a PEO is what happens when you decide to leave the partnership. 

When you work with a PEO, they become the employer of record for your business. As such, the PEO provides payroll processing and tax reporting, for example, under their own employer identification number or EIN (not your company’s). That can make leaving difficult and potentially costly, with PEO exit risks including insurance gaps, administrative overload, data loss, and other complications.

Arguably the most important and overlooked exit risk, however, is that when you leave a PEO, your unemployment insurance experience rating reverts to a new employer rate, which is often higher than the rate you would have built on your own over the same time period.

• Limited Flexibility: Partnering with a PEO means entering into a co-employment arrangement, which can be convenient in some cases but severely limiting in others. 

One issue many small business owners encounter over the course of their PEO partnership is that the same structure that once simplified HR management eventually serves more as a constraint than an advantage. It can be difficult to adapt and scale PEO services alongside the business.

Is a PEO the Only Way for Small Businesses to Get These Benefits?

Before committing to a PEO, it’s worth knowing that co-employment isn’t the only path to effective HR outsourcing for small and mid-sized companies. Of course, while plenty of companies enjoy PEO cost savings (vs. their non-PEO counterparts), there are no guarantees.

PEOs are not your only option for effectively reducing HR administration burdens through outsourcing. For example, the fractional HR services model offers HR management expertise, compliance support, and other services without the long-term lock-in or flexibility constraints that come with a PEO partnership.

Key differences between fractional HR services and PEO partnerships include:

• Pricing Transparency: Fractional HR services are usually priced more transparently and straightforwardly than the more complex fee structures that come with a PEO.

• No Exit Risk: Since fractional HR service providers don’t use the co-employment model a PEO does, you can always walk away without the potential for early termination fees, administrative costs for setting up new systems, and potential double payments for FUTA/SUTA taxes (if you leave mid-year). 

• Flexibility and Scalability: Instead of the fixed co-employment model of PEO partnership, fractional HR services are highly customizable and ready to adapt, evolve, and scale alongside your business.

In terms of fractional HR’s potential ROI, Forbes research suggests that fractional HR costs 30–40% less than a full-time hire. Those are cost savings that really add up over time, and it’s much easier to adapt and scale services as needed, which provides a contrast against the more complicated logistics of leaving a PEO partnership.

Final Thoughts: Finding the Right Option for Your Business

As a small business owner, every decision you make has an impact on your organization’s efficiency, revenue, and operational stability. While PEO partnerships and outsourced, fractional HR services can both provide advantages for small business owners, the right solution for your business depends on your objectives and preferences.

To determine what’s right for you, start by considering three things:

1. Current pain points: If they relate more to the daily administrative burden of payroll, tax filing, and benefits administration, working with a PEO would be appropriate. If you’re in need of HR leadership for compliance, employee relations, or talent strategy, fractional HR likely makes more sense.

2. Maintaining control over HR operations: A PEO will take over responsibilities related to legal compliance and HR administration; that’s the nature of a co-employment arrangement. If you want to maintain more control over HR functions, fractional HR is more appropriate.

3. Budget and scale-up plan(s): It’s relatively easy to budget for a PEO partnership, since they usually charge a flat rate, either per employee or as a percentage of total payroll. 

For many companies, fractional HR services prove to be the more cost-effective option, providing increased flexibility and a rate structure that depends on specific services rendered, potentially on an hourly or project-specific basis.

Reach out to learn how Milestone’s fractional HR services can help to reduce your administrative burden and unlock cost savings. Our expert team is ready to answer any questions you still have about outsourcing HR or how fractional HR services could benefit your organization.