Introduction

A Human Resources (HR) department is a critical component of employee well-being in any business, no matter how small. Human Resources responsibilities include payroll, benefits, hiring, firing, and keeping up to date with state and federal tax laws.

Any mix-up concerning these issues can cause major legal problems for your business, as well as major employee dissatisfaction. But small businesses often don't have the staff or the budget to properly handle the nitty-gritty details of Human Resources. Because of this, more and more small businesses are beginning to outsource their HR needs. In fact, the HR outsourcing industry is expected to grow from $13.9 billion in 1999 to $37.7 billion in 2003, according to the market research firm Dataquest.

Today, HR outsourcing goes beyond just handling payroll and benefits. Deciding which HR functions to offload and which firm to outsource to can be quite a challenge. This buyer's guide will help you to easily navigate through the process.

What is HR outsourcing?

HR outsourcing services generally fall into four categories: PEOs, BPOs, ASPs, or e-services. The terms are used loosely, so a big tip is to know exactly what the outsourcing firm you are investigating offers, especially when it comes to employee liability.

PEOs
A Professional Employer Organization (PEO) assumes full responsibility of your company's human resources administration. It becomes a co-employer of your company's workers by taking full legal responsibility of your employees, including having the final say in hiring, firing, and the amount of money employees make. The PEO and business owner become partners, essentially, with the PEO handling all the HR aspects and the business handling all other aspects of the company.

By proper definition, a service is only a PEO when it takes legal responsibility of employees. But take note--some HR outsourcing services like to use the recognized term "PEO" when they handle the primary aspects of HR like payroll and benefits, yet they do not take this legal partnership.

BPOs
Business Process Outsourcing is a broad term referring to outsourcing in all fields, not just HR. A BPO differentiates itself by either putting in new technology or applying existing technology in a new way to improve a process.

Specifically in HR, a BPO would make sure a company's HR system is supported by the latest technologies, such as self-access and HR data warehousing.

ASPs
Application service providers host software on the Web and rent it to users—some ASPs host HR software. Some are well-known packaged applications (People Soft) while others are customized HR software developed by the vendor. These software programs can manage payroll, benefits, and more.

E-services
E-services are those HR services that are Web-based. Both BPOs and ASPs are often referred to as e-services.

Who's who?
These services listed are fairly straightforward in their own right. But the confusion comes as these services increasingly cross over into other types of services, or shed some of the services for which they are known.

For example, some BPOs will take over legal responsibility in much the same way as PEOs, while others do not. And many ASPs/e-services will also consider themselves to be BPOs because they are implementing new technology by hosting software and allowing self-service for employers and employees.

So know these service terms, but don't get too sidetracked by the names when interviewing potential outsourcing firms. The key to hiring the right outsourcing firm is knowing what services your company needs and then find an outsourcing firm that can provide them.

What can you get?

When you outsource HR functions, some services go with the "all-or-nothing" approach, requiring that they handle all your HR functions or none at all. Others offer their services "a la carte," meaning you can pick and choose from the services they offer.

Typical services include:

Some services are full-service and will provide these as well as additional services like on-call consultants, who will come in to train or even settle a dispute.

Online services tend to be limited in their offerings, but you'll get added options like Web access, which will allow you to view information (like benefits packages) and even make changes to such information online. Most will give you and your employees access to view their benefits plans, enroll in benefits, read policies, and make changes to current data.

Even PEOs that have survived off-line since the early 1980s are starting to offer online access for certain aspects of their service (like viewing benefits packages).

Pricing

There are no clear-cut price ranges with HR outsourcing. The fees range greatly between services, as well as within the services. Aspects like number of employees, the options you choose to use, and even geography, will affect your overall cost.

A PEO typically charges 4 percent to 8 percent of each employee's pretax salary per month. The monthly range can be as little as $20 per employee to as much as $200.

A typical package with an online service, including insurance, 401(k) and workers' compensation, costs $75 to $130 per employee per month with an upfront setup fee of about $2,000.

If you think this sounds expensive, do a cost comparison of an outsourcing program you are investigating and the average salary and maintenance of an in-house HR director or staff. You might find significant savings either in money, hassle, or both.

Contracts with HR outsourcing firms will usually run a year. But you should work in a clause in which you can give 30 days' notice to break the contract if you are dissatisfied with the services or don't need the services anymore.

Advantages

What are the biggest advantages to outsourcing your HR needs?

Does your business allow you the time to personally deal with federal and state employment laws? A big reason businesses turn to HR services is that they don't have the time, or expertise, to deal with this. And if you choose to go with a PEO, you can pass the legal responsibility of your employees onto them.

You may also save money. You can usually count on a reduced benefits rate when outsourcing to HR services. Because they buy so often from vendors, they usually get a discounted rate that they pass on to you.

If you opt for an online service (ASP/e-service), you don't have to purchase software, install it, and worry about configuring it. An ASP business model is hosting software, so you don't have to bother with additional software or installation.

Downsides

So what are some key things you'll have to give up if you favor outsourcing to hiring a full-time, in-house HR department?

There are some definite drawbacks to not having an HR manager in-house. An in-house HR person handles perks that you can't necessarily count on an outsourcing service to carry out--like looking into group offerings, building employee incentive programs, even taking care of recognition for employees' birthdays. And employees may want someone in-house--an impartial co-worker they can trust and see daily--to turn to if they have a work-related problem or dispute with another co-worker.

Because an in-house HR person interacts daily with your employees, they will likely have more of an interest in your employees. For example, employees often appreciate having someone on staff who will help negotiate in their favor for certain benefits that are critical these days for employee retention (like 401(k) plans and vacation policies).

Also, in the case of using a PEO, giving up the right to hire and fire your employees may not be desirable for your particular business. Most PEOs insist that they have the final right to hire, fire, and discipline employees. While having the extra time and not having to deal with the stress of this may be appealing, you may not want this responsibility out of your hands.

And if you decide to use an e-service, the same issues you'd have with any ASP remain. When everything is stored and handled online, there are concerns about security as well as potential crashes, both of which can be detrimental to your business.

Common complaints about HR outsourcing range from payroll mix-ups to payroll not being deposited on time to denied medical claims.

Should you consider outsourcing?

If you have fewer than 100 employees, the answer is yes. At this size, you often don't have the resources for an in-house HR staff, so outsourcing is just right for you. You don't have to worry about managing all the details that are so critical to HR in your business, and most small-business owners just don't have the skills and experience to do so. Remember, HR functions must be handled correctly as close to 100 percent of the time as possible; slip-ups can cause your business major problems.

If you have at least 12 employees, consider a PEO. Most PEOs only take on businesses with at least a dozen employees. Get recommendations and references for PEOs, and consider one that is part of the NAPEO (National Association of Professional Employment Organizations). The NAPEO is committed to educating PEOs. If a PEO is a member, it's a good sign that they are committed to being the best in the field.

If you're even smaller, online services are the way to go. These services are tailored to work with all sizes of businesses, even the smallest. You don't have to give up legal responsibility just yet, and you'll be able to easily access your information online. And since the charge is usually by user, you won't be overpaying.

If you're uncertain about outsourcing everything but know you don't have the staff or experience to keep it in-house, try outsourcing only certain parts, such as payroll and benefits. You can also purchase HR software right off the shelf to support any in-house efforts.

Whatever you decide, make sure to keep your employees in the loop. They will appreciate knowing that you are seeking the most affordable solution for the business while doing your best to meet their needs.

Mie-Yun Lee, BuyerZone.com's founder and vice president of strategic services, oversees the marketing, content development and customer care initiatives for the company. She's widely recognized as the trusted expert on purchasing for small and midsized businesses and has served as an authoritative source for articles and TV shows including USA Today, The Wall Street Journal, Business Week, Smart Money, and CNBC.