They're Not Employees, They're People.

by Peter F. Drucker

"If by off-loading employee relations, organizations also lose their capacity to develop people, they will have made a devil’s bargain indeed."

Strangled in Red Tape

The reason usually offered for the popularity of temporary workers is that they give employers flexibility. But far too many temps work for the same employer for long periods of time – sometimes year after year – for that to be the whole explanation. And flexibility surely does not account for the emergence of PEOs. A more plausible explanation for the popularity of these trends is that both types of organizations legally make “nonemployees” out of people who work for a business. The driving force behind the steady growth of temps and the emergence of the PEOs, I would argue, is the growing burden of rules and regulations for employers.

The cost alone of these rules and regulations threatens to strangle small businesses. According to the U.S. Small Business Administration, the annual cost of government-required paperwork, and tax compliance for U.S. businesses employing fewer than 500 employees was somewhere around $5,000 per employee in 1995 (the last year for which reliable figures are available). That amounts to about a 25% surcharge on top of the cost of employee wages, health care, insurance, and pensions – which in 1995 was around $22,500 for the average small-business employee. Since then, the cost of employment-related paperwork is estimated to have risen by more than 10%.

Many of these costs can be avoided altogether by using temporary workers in place of traditional employees. That’s why so many companies are contracting with temp agencies for workers – even though the hourly cost of a temp is often substantially higher than the wage-and-benefit cost of a full-time, formal employee. Another way to reduce the bureaucratic costs is to outsource employee relations – in other words, to let a specialist do the paperwork. Aggregating enough small businesses to manage at least 500 employees as one workforce – which is, of course, what a PEO does – can cut employment-related costs by 40%, according to SBA figures.

It is not only small businesses that can cut their labor costs substantially by outsourcing employee relations. A 1997 McKinsey study concluded that a global Fortune 500 firm – in other words, a very big company indeed – could cut its labor costs 25% to 33% by having its employee relations managed by an outside company. This study led to the foundation of Exult a year later.

The outsourcing of employees and employee relations is an international trend. Although employment laws and regulations vary widely from country to country, the costs they impose on businesses are high everywhere in the developed world. For instance, Adecco’s biggest market is France, its second-largest market is the United States, and the company is growing at a rate of 40% per year in Japan. Exult opened an employee management center in Scotland in 2000 and has offices in London and Geneva.

Even more onerous than the costs of complying with employment laws are the enormous demands that the regulations place on management’s time and attention. Between 1980 and 2000, the number of U.S. laws and regulations regarding employment policies and practices grew by about 60%, from 38 to 60. The regulations all require managers to file multiple reports, and they all threaten fines and punishment for noncompliance, even if the breach was unintentional. According to the SBA, the owner of a small or midsize business spends up to a quarter of his or her time on employment-related paperwork.

Then there is the constant, and constantly growing, threat of lawsuits: Between 1991 and 2000, the number of sexual harassment cases filed with the Equal Employment Opportunity Commission more than doubled, from about 6,900 a year to almost 16,000 a year. And for every case filed, ten or more were being settled in-house, each requiring many hours of investigation and hearings, as well as substantial legal fees.

No wonder that employers (especially smaller companies, which constitute the overwhelming majority) complain bitterly that they have no time to work on products and services, on customers and markets, on quality and distribution – that is, they have no time to work on results. Instead, they work on problems – this is, on employee regulations. Employers no longer chant the old mantra “People are our greatest asset.” Instead, they claim “People are our greatest liability.” What underlies the success of the employment agencies and the emergence of the PEOs is that they both enable management to focus on the business.

This argument, by the way, may also explain the success of maquiladoras – the manufacturing plants on the Mexican side of the U.S. border, and, increasingly, in Mexico proper, that assemble parts made in the United States, the Far East, or Mexico into finished products for the U.S. market. In fact, avoiding hours of paperwork is probably a stronger incentive for manufacturing companies to outsource this kind of assembly work than the often questionable savings in labor costs. The Mexican company that is the maquiladora’s landlord acts as the coemployer, handling all employee regulations and activities – which are as complicated in Mexico as they are in the United States – thus freeing up the U.S. or Japanese plant owner to focus on the business.

There is not the slightest reason to believe that the costs or demands of employment rules and regulations will decrease in any developed country. Quite the contrary: No matter how badly the United States needs a patient’s bill of rights, that will undoubtedly create another layer of agencies with which an employer will have to deal – another set of reports and paperwork, another avalanche of complaints, disputes, and lawsuits.

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