Enquiry for BERR and DWP on the predicted administrative costs of additional payroll services to support personal account

Centre for Enterprise and Economic Development Research Middlesex University Business School, London September 2007 URN: 07/1581

CEEDR Report on PA pensions administration costs


Enquiry for BERR and DWP on the predicted administrative costs of additional payroll services to support personal account pensions
Centre for Enterprise and Economic Development Research Middlesex University Business School, London September 2007 1 Introduction

In December 2006 the Government announced proposals to promote private pension saving across UK workplaces. These proposals are explained in the Government’s White Paper, ‘Personal accounts: a new way to save’1. The proposed personal accounts system will operate from 2012 and will require all employers to enrol eligible employees into a qualifying workplace pension scheme. All employers will have to engage with pension reform, meaning that many micro-businesses will be expected to make employer contributions to a pension for the first time. However, employers with satisfactory arrangements already in place, or who would prefer to set up an alternative qualifying scheme will not be required to join the personal accounts scheme. CEEDR was asked to conduct a survey-based enquiry on behalf of BERR and DWP to estimate the administrative cost of calculating and collecting monthly contributions for personal accounts, for businesses which outsource their payroll. This research project was intended to form part of the evidence base used by the joint DWP/BERR working group tasked with estimating the administrative costs of the personal accounts reforms. We were asked to contact and interview 30 payroll service providers. These would be drawn from separate directory lists, and would ensure coverage across a range of IT-based services (payroll specialist agencies), accountant-based services (with a mini payroll bureau in their back office) and multiple business support services (large companies dealing with complex IT and logistics systems). CEEDR made efforts to secure a balanced sample and developed an enquiry instrument that was applied consistently across all of the interviews. Our researchers interviewed 30 respondents by telephone during 29-31 August 2007. As well as data from the telephone interviews, this report draws on some background desk research, including contacts in the Institute of Payroll Professionals, the Institute of Chartered Accountants and the national chairperson of the IRENE network.

2 Details of the sample of 30 payroll service providers
Quota sampling methods were used to obtain 30 interviews, including 12 accounting practices, 14 payroll agencies plus four big providers. To obtain this sample, we used the internet Yellow Pages directory yell.com to produce England-wide reference lists of (a) selfannounced payroll-specialist-led service agencies and (b) accountant-led services which advertise some payroll functions. These had a good spread across regions, with at least one representative firm in each English region This sampling frame covered firms that provided payroll services to firms with up to 250 employees (a description of the structure of the payroll services sector is included as an Appendix to this report). We made separate enquiries to identify four large firms that provided payroll services to large employers. Preliminary enquiries were made by telephone cold calling; where the response was encouraging we either did a screening interview to identify a person and a time for talking with or began the telephone interview. For the accountancy firms and some payroll practices, an

Further information on pension reform can be found at: http://www.dwp.gov.uk/pensionsreform

CEEDR Report on PA pensions administration costs


email questionnaire was used. Generally, the payroll service firms were more responsive to our explanation of the purposes of this enquiry than the accountant led firms. This was potentially the result of the survey being conducted during month-end; a busy period for accountancy firms. The breakdown of our completed interviews is shown in Table A.

Table A: contacts made and interviews completed by type of provider

Type of business process service firm Accountancy firms offering payroll work Payroll processing specialist firms Large business process outsourcing (BPO) service firms Total firms contacted and total interviewed 3

Number approached 59 44 4 107

Number interviewed (and response rate) 12 (20%) 14 (32%) 4 (100%) 28

Payroll services’ charges for their services to different sizes of employer

3.1 The overall pattern The pattern of provision, and how payroll services are bundled, costed and priced, is very complicated so that generalisation is difficult. However, in the case of monthly paid staff payrolls which make up the majority of most services’ workload we have learned that service providers tend to price the work per payslip processed, with many reporting facilities (such as PAYE and CIS for HMRC) offered as integral rather than charged additionally. Micro firms (1-4 employees) and very small firms (5-9 employees) face a reserve minimum charge per employee or per workforce for the agreed service across the whole year. Employers with 250 or more employees almost all went to the large BPO service firms; these clients typically had a bundle of services provided for an agreed contract price with allowance for extra services to be added later. For medium sized firms with 10-249 employees, there is a “batch production” market, where the majority of services are standard pricing per payslip. Depending on whether services include BACS transfers, special reporting, and volatile payroll membership or not, prices varied from £1 per payslip per monthly-paid person (£12 per annum for one employee) up to around £5 per person per month (£60 pa). This was dependent partly on the package and also on the provider. The market for payroll services is imperfectly competitive; considerable asymmetries and distortions of information allow wide discrepancies in what is available and at what price. In principle, small firms offering other services – typically accountancy – could provide payroll work at deeply discounted rates as a sweetener to the other work. However, some of our
CEEDR Report on PA pensions administration costs 3

evidence perhaps points to the opposite case where accountancy firms in a small local market with a good reputation may charge more than the normal market price for these additional services.

Table B: Annual actual fee per employee charges by types of payroll service provider and by client size

Client size by number of employees Micro (1-4 employees)

Small (5-49 employees)

Medium (50249 employees)

Large (250+ employees)

Actual or expected fees for monthly payroll admin Average actual annual fee charged now and the range of responses Average increase due to personal accounts and the range of responses Average actual annual fee charged now and the range of responses Average increase due to personal accounts and the range of responses Average actual annual fee charged now and the range of responses Average increase due to personal accounts and the range of responses Average actual annual fee charged now and the range of responses Average increase due to personal accounts and the range of responses

Payroll specialists £64.20 Range: £30 to £160 £5.62 Range: 0 to 20% £35.10 Range: £24 to £55 £1.58 Range: 0 to 10% £26.00 Range: £12 to £40 £1.10 Range: 0 to 12% NA

Accountancy practices £88.50 Range: £30 to £192 £5.23 Range: 0 to 15% £44.60 Range: £20 to £100 £2.99 Range: 0 to 20% £35.00 Range: £30 to £40 £3.75 Range: 0 to 15% NA

Large BPO service firms £61.00 Range: £40 to £82 £3.05 Range: 5% only £31.00 Range: £24 to £50 £1.08 Range: 2 to 5% £24.00 Range: £20 to £30 £0.84 Range: 2 to 5% £20.00 Range: £18 to £22 £0.70 Range: 2 to 5%



3.2 Micro businesses (1 to 4 employees)
CEEDR Report on PA pensions administration costs 4

Summary of costs for micro businesses: • • • • • •
PAYROLL service firms charged £64.20 per year per employee on average (assuming an average size of three employees); PAYROLL service firms predicted an average of £5.62 extra (+8.2%) in fees for accommodating PA deductions and both monthly and annual reporting; ACCOUNTANCY firms charged £88.50 per year per employee on average (assuming an average of three employees); ACCOUNTANCY firms predicted an average of £5.23 extra (+4.5%) in fees for accommodating PA deductions and both monthly and annual reporting; VERY LARGE MULTIPLE business services providers charged £61 per year per employee on average (assuming an average of three employees); VERY LARGE MULTIPLE business services providers predicted an average of £3.05 extra (+5.0%) in fees for accommodating PA deductions and monthly/ annual reporting.

For those payroll services serving a particular locality, very small businesses (sole traders, partnerships, starting enterprises etc) may make up the largest client group. Both payrollfocused providers and accountants told us that this market was an important slice of their business. We were told that providers tended to state a basic annual fee for the whole payroll operation, or a minimum annual charge, even if there was a ‘per payslip’ price. Accountants were more expensive than payroll providers for both micro and small business payrolls, based on our enquiries about servicing a monthly paid payroll. The majority of payroll service firms processed more monthly paid staff than weekly paid staff, although more than half processed weekly paid as well as monthly paid employees Some respondents gave a ‘block deal’ or ‘minimum charge’ figure for these very small clients and we assumed three workers on payroll as the typical case. Some respondents gave absolute cash amounts for their predicted increase in fees while others offered a percentage increase; we have entered cash and percentages in Table B. We think most respondents were hesitant about quantifying the predicted increase (some suggested “minimal” or “little” rather than a figure); there is clearly some guesswork involved in estimating the costs of a process which will not be introduced until 2012. 3.3 Small businesses (5-49 employees)

Summary of costs for small businesses: • • • • •
PAYROLL service firms charged £35.10 per year per employee on average; PAYROLL service firms predicted an average of £1.58 (4.5%) extra in their fees for accommodating PA deductions and both monthly and annual reporting; ACCOUNTANCY firms charged £44.60 per year per employee on average; ACCOUNTANCY firms predicted an average of £2.99 extra (+6.7%) in their fees for accommodating PA deductions and both monthly and annual reporting; VERY LARGE MULTIPLE business services providers charged £31 per year per employee on average;

CEEDR Report on PA pensions administration costs


VERY LARGE MULTIPLE business services providers predicted an average of £1.08 (3.5%) extra in their fees for accommodating PA deductions and monthly/ annual reporting. Note: Some of our respondents ran tariffs for this group starting at eight or ten employees with the smaller ones treated as micro firms with a reserve flat rate for the whole payroll.

3.3 Medium businesses (between 50-249 employees) Summary of costs for medium businesses: • • • • • •
PAYROLL service firms charged £26 per year per employee on average. PAYROLL service firms predicted an average of £1.10 (+4.2%) extra in their fees for accommodating PA deductions and both monthly and annual reporting; ACCOUNTANCY firms charged £35 per year per employee on average; ACCOUNTANCY firms predicted an average of £3.75 (+10.7%) extra in fees for accommodating PA deductions and both monthly and annual reporting; VERY LARGE MULTIPLE business services providers charged £24 per year per employee on average; VERY LARGE MULTIPLE business services providers predicted an average of £0.84 (3.5%) extra in fees for accommodating PA deductions and monthly and annual reporting.

In the case of charges for services currently provided and predictions about extra costs for servicing PA contributions for clients with 50 to 249 employees, there were fewer providers among accountants and small payroll agencies while the large business services firms had a large proportion of the total business in this category. We could not weight for volume as we did not have enough detail on these matters. 3.4 Large businesses Only the four large multiple providers served the large employers market sector. Two of our other providers had one client each just below the 250 employee threshold, and likely to grow beyond this quite soon. The large providers are business support services with up to 1000 employees active in several markets requiring extensive IT capacity. They are well placed to offer a bespoke service which might include (for example) the employer’s own occupational pension scheme or a group scheme, and capacity to handle special deductions and additions and special reports. For these reasons, among others, the large providers told us that they had no set scale of charges for payroll services; instead their senior sales people negotiated a package fee for one year or in some cases for three years. They did have costing guides to inform their pricing but were not willing to take us through these in a way which would allow reasonable comparisons. Two of the large BPO providers gave us illustrative prices and we have used these in the summary table below and in table B. One other talked us through pricing approaches without offering definite figures. The fourth was unwilling to talk about any commercial aspects of what they do. Consequently the data for the large providers needs to be treated with caution but we have included these figures which are the average of just two cases and they suggest that big BPO providers have scale efficiencies which allow them to charge somewhat less per employee than other providers.

CEEDR Report on PA pensions administration costs


Summary of costs for large (250+ employees) businesses using large payroll service providers: •
VERY LARGE MULTIPLE business services providers charged their large employer clients various fees per employee or per payslip processed. However, if the services offered were similar to those offered to medium sized employers there would be a further discount from the £24 per employee per year quoted for them to (say) £20. VERY LARGE MULTIPLE business services providers have well qualified senior staff able to make informed judgements about the additional costs of servicing PA pensions from 2012 under various assumptions about how the software will work and so on. One of those we interviewed is the chairperson of one professional group (‘IRENE’) dealing with HRMC payroll provider returns and had also contributors to the DWP early consultation at the design stage of the PA pensions legislation.

Officials at DWP and BERR provided a list of payroll processing operations that the outsourcing company would have to carry out on behalf of their client for the monthly collection process. In order to cover the varied nature of the market and ensure comparability, we used our data on prices charged for monthly paid workforces getting a full data processing and reporting service (including annual returns for PAYE etc) but not a BACS payment service We understand that 10p per BACS process plus some in-house administration time is the typical cost for this work. Many of the respondents who estimated price increases for personal accounts arrangements provided percentage rises rather than absolute cash amounts and we have converted these to align with the cash sums quoted for current prices. For the very large (250+ workers) clients we have restricted figures for the cost of services because smaller payroll providers reported having either none at all or just one of these clients and they were for the most part beyond their capacity or confidence. As discussed above many larger firms use a large bespoke provider for payroll and other HR services which are provided in a bundle of products and so the smaller providers tend to cater for the smaller employers. Further notes on the distribution of values Actual charges There was a wider range of charges amongst accountancy practices. In this group, several high-end outliers pushed up the mean charge, most noticeably in the ‘services to micro firms’ category where several charged over £100 per person per year, compared to only one payroll service charging this much. Anticipated price increases to meet cost of personal accounts arrangements The most notable outlying values for the price predictions were small clusters of zero scores from both accountancy and payroll service providers. In the micro and small firm markets, there were three zero scores for accountants and three zero scores for payroll services. These respondents told us that they believed the only impact of personal accounts reforms would be in setting up new systems. After this the software would generate what was needed, so that they could absorb the minimal costs of transmitting data files. In the interviews some said “none at all” and others said “really very minimal”. We scored these answers as zero

CEEDR Report on PA pensions administration costs


unless they went on to say that minimal would in fact mean a small price increase, in which case we prompted them to put a number on this.

5 Uncertainty about the reported estimates
Our brief was specifically concerned with the steady state costs of the process after software and manual routines had been run in. It was clear that a substantial proportion of respondents believed that much of the cost load would occur at the setting up stage. Small agencies tend to use Sage software although there are two or three alternatives. Most of them told us that Sage would look after all the design issues, so that reports on personal accounts contributions could be generated at the press of a button. As a few realised, this ignores questions about entries and exits to the scheme, and more generally the need to help employers get their basic personal accounts contributor data into good order. For those services which also handle payments there is also the cost of BACS transfers (though at 10p per process this is not a heavy additional burden). Finally there are the costs in professional time of senior staff and IT staff for fixing process problems when things go wrong, or for checking quality and security of data transmission and inputting. The large providers are acutely aware of all these issues, but they have research and development departments who – to an extent – are readily available for setting up new systems and might be regarded as an investment to support the acquisition of new business. We learned that the larger providers have their own purpose-designed systems or have adapted Unipay software and now own the long term licence to use this as they wish. They will pass on some of their development and preparation costs for accommodating personal accounts tasks, and informally are quite optimistic that these additions will imply only modest price rises. In their case their optimism is not naïve but probably assumes a steady expansion of their client base which will yield increasing returns to their invested capacity. In Section 9 below we give our own view on possible sources of error in respondents’ estimates of future prices. Here we have simply reported the assumptions which they told us they made while talking through the prediction task.

6 Ways in which the government could reduce the administrative cost of their reforms
Most of our respondents were fairly complimentary about how HMRC has handled the move to online handling of PAYE and more generally had a favourable view of HMRC as an agency which had made the right efforts to help businesses meet their obligations. For example, some were serving a range of small builders and were relaxed about the quite difficult tasks involved in processing CIS returns for short-term building workers. On this basis, several suggested that the body responsible for the introduction of personal accounts should model their approach closely on current HMRC good practices. The three large providers emphasised the importance of continued consultation with industry key players; their senior technical people had been to at least one DWP consultation meeting and hoped to have further such contacts in the future. These experienced executives generally saw the provision of very good information on procedures and rules as a high priority. Several of our respondents cited cases of concern in the running of other pay deduction initiatives in recent years: the Child Support Agency and SERPS were both mentioned by more than one respondent.

7 Views on current trends in the payroll services market

CEEDR Report on PA pensions administration costs


The great majority of providers said they were expanding year on year. Rates of growth varied between 2 or 3 % per year, up to 20 % per year. Micro and very small businesses accounted for much of this growth according to nearly all our respondents, and they thought this was because increased complexity in PAYE and NIC regulations, plus the shift to online reporting, had driven more and more of these very small employers away from running their own payroll even though they had previously shown a taste for keeping their hands on their own accounting. There were also substantial sectors of personal service work - child-minding and nursery care, elderly care, private tuition - for which government grant aid had the effect of bringing sole traders into the formal economy for the first time, and these new micro-businesses often needed help with their own pay. These, and larger businesses too, were likely to put their payroll work into the hands of a local accountancy practice if they had an accountant already and trusted him or her; or otherwise seek out a payroll agency through local search or the recommendation of others. Several of our respondents suggested that word of mouth reputation was as important as price in acquiring new business; however, ease of entry into the payroll support sector means that competitive pressure on prices in many areas is quite strong. A few service providers said that their business volumes had reached a plateau and that they ascribed this to saturation in their local market. However, other informants suggest that aggregate market demand is still rising nearly everywhere. Clearly, if demand rises faster than providers can expand their capacity (and there are some skill bottlenecks) prices for any new work may rise more than the fairly modest estimates we have collected in respect of the personal accounts costs. But the historical trend suggests that productivity improvements due to more powerful and comprehensive software will at least counter skills shortages such that the current level of competitive pressure is likely to continue. While most of our respondents thought that some increased demand for their services was almost bound to follow the introduction of personal accounts, there were a few who thought that the whole market would have reached a plateau by 2012.

8 Judgements on the impact of personal accounts on demand for payroll services
Over twenty respondents said in response to a question about this: • YES, this is bound to feed further demand for our services.

However, four respondents said:

NO, the market has recently peaked and employers not capable of running their payroll function will already have come into the supported payroll service area.

There is clearly a general understanding that the increased volume and complexity of tax and benefits regulation has driven demand for payroll services into a steady climb over the past fifteen or twenty years. Two factors which could counter personal accounts arrangements inflating demand further would be (a) growing confidence of micro and small businesses in using Sage software to run their own payroll and (b) such severe pressures on overhead costs from national or local competition that managers decide to do new tasks themselves rather than add to costs by buying in services. Most payroll providers discounted these factors but four respondents did not do so.

CEEDR Report on PA pensions administration costs



Concluding notes on our interpretation of the data in this enquiry

We have been asked to consider possible shortcomings in the evidence and interpretations presented here. In a very rapidly conducted survey using (mainly) telephone interviews there are a number of ways in which questions might be incorrectly interpreted and/or understood. Answers could be given without proper consideration, or using faulty reasoning, and the overall context might be misjudged by either the researcher or respondent. Timing requirements also meant that the sample for this survey was based on quota sampling methods and was relatively small. We made conscious decisions to ask respondents to focus on the case of the monthly paid staff payroll, give more attention to data processing than BACS transfers, and consider “steady state” running costs rather than setting up costs. These decisions could have tempted our respondents to under-estimate additional service charges, although in our opinion such under-estimation would be fairly minor. Many respondents thought that additional software modules provided by such suppliers as Sage would cover much of the resource requirement for handling personal accounts contributions, so that only the concomitant increase in their software package licence fee (spread over all clients over several years) would represent new chargeable costs. If they are wrong about software developments, this will have been a source of under-estimating bias. However, there are some factors working in the opposite direction. Several providers told us that the HMRC guidance provided through the CD supporting PAYE work had recently made the PAYE side of payroll administration easier for them, and more generally our respondents seem to believe that both software and human skills in this area improve over time so that productivity in the payroll support sub-sector is steadily rising. If this continues it could moderate the current predicted increases in service charges. Finally, increased competition in the business services market, which could be enforced by information gains such as the increased presence of “shopper’s guides” on the web could drive payroll service providers to absorb extra costs until they can find ways to cover them through new efficiency savings. In our professional opinion, therefore, there are as many reasons for suggesting that our data on cost increases due to PA have overstated the likely outcomes as there are reasons for suggesting that they have understated them. In a market which may not yet be fully mature it is a matter of scenario-building to make a judgement on prices four and five years ahead.

CEEDR Report on PA pensions administration costs


APPENDIX: Structure of the payroll services industry sector
The several thousand payroll service providers are distributed between a few large providers (we have identified four of these), a varied group of medium to small providers, and a large number of micro businesses. Many of these last group are young firms, having been started up by IT specialists, some of them former in-house payroll administrators, seeking to exploit the growing market among smaller firms which have recently decided to outsource their payroll.

A.1 The biggest payroll service providers: four big BPO companies
It should be kept in mind that the number of England-based employees whose pay is processed by the large Business Process Outsourcing (BPO) providers is more than proportionate because there are economies of scale. There are also economies of scale as these firms offer various services (IT, logistical, security) and their customers typically subscribe to more than one of these. Taken together, the largest BPO service providers may well cover more than four million of the 26 million employed workers in the UK. The largest provider (ADP Business Services) supports almost 750,000 UK employed workers, and its three closest competitors each serve 400,000 workers. Assuming that around half of all payroll support work in England is still done in-house, we think the share of these four big BPO companies in outsourced payroll work is around one sixth of the total payroll services market. We note that two of them report annual growth in BPO services turnover for 2006 at around 20 percent, as against 3 per cent growth in the whole economy. These firms are strong in IT systems development, so they may have their own payroll software, though this will probably have been developed from a former proprietary package. Their payroll service divisions offer HR and other services going well beyond the monetary payroll handling functions.

A.2 The medium to small payroll service providers
Historically, small firms have run their own payroll either by manual book-keeping or by adopting the payroll modules of the Sage accounting package. Over the past fifteen years this situation has been changing steadily. Regulations, including income tax and NICs rules, have driven more and more small and micro sized employers into becoming users of payroll services. The shift towards requiring all PAYE and NICs to be run online, the introduction of the CIS system for previously self-employed building workers, and the mushrooming market for small-scale care services have all pushed small firms towards subscribing to payroll and related services. They find two main types of provider, and have to make a choice between these.

A.2.1 Payroll services provided by local accountancy practices
Growing demand has encouraged many local accountants to add payroll expertise to their back office staff and thus pick up a slice of the “managed” and/or “bureau based” payroll support service market. These are typically practices with five to twenty staff with just one or two payroll professionals in their back office. Some local accountants are micro businesses with just three or four staff, including their payroll staff. In these cases the usual approach is to offer routine payroll data processing charged on a monthly or annual fee basis, calculated per employee or per payslip processed. In addition, the accountant in charge will offer extra services to sort out problems, usually applying his or her hourly rate (which will often be in excess of £100 per hour). So long as the payroll process is routine the costs to the employer are predictable; where overtime or sporadic employment enter the picture there may be difficulties.

CEEDR Report on PA pensions administration costs


A.2.2 Small and medium sized payroll agencies and bureaux
These service providers are typically run by an IT-led payroll expert who has either done the job previously as an in-house payroll officer or has acquired wider data processing and IT software skills and seen an opportunity to apply these in payroll work. The most basic service would be preparation of monthly salary payslips and the associated summary data file showing deductions for PAYE and NICs and adding reports as needed for HMRC and individuals. In this kind of “payroll bureau”, a powerful software package is used and clients are charged an annual or monthly fee related to the firm’s overall calculation of unit costs (i.e. cost per payslip issued). The more capable agencies also provide processing for more difficult employee workforces such as seasonal and sporadic workers, care workers or catering workers with very variable hours, and weekly and fortnightly paid workers. Purely payroll agencies rely heavily on the capability of their software packages (most use the Sage package) and try to counsel their clients into producing raw data suited to feeding into this package. As they grow in experience these payroll agencies gain confidence in their ability to advise on HR or pay policy issues, and become more confident in dealing with tax procedures. Some provide money transfer (“managed payroll”) services in which they transfer cash from the employer’s bank accounts directly to employees by BACS. However, we found that the majority prefer their clients to look after the money transfer side of payroll themselves as did many clients.

A.3 Micro businesses providing payroll services
The majority of single local payroll services are businesses employing four or fewer workers. On the accountancy side, these are practitioners who may well have decided to operate in a restricted geographical area with word-of-mouth recommended clients as an alternative to larger scale work. Such a firm would typically have three or four workers, at least one of these a fully qualified accountant and just one running the payroll service. We interviewed several such accountants’ practices where staff absence for field visits or leave stretched their capacity to operate; they told us that they had to manage their single payroll expert very carefully to maintain services. On the specialist payroll side, with a very small client load two or three skilled people can cover a substantial client load once setting up arrangements have been secured. We interviewed one firm, comprising three partners plus one assistant, in which the principals were all accountants who had decided to switch from providing accountancy to payroll services for business reasons.

CEEDR research team:

Stephen Butters, David North, Ian Vickers, Sue Engelbert, Pamela Macaulay

CEEDR Report on PA pensions administration costs


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