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Making Payroll Payroll has been a hassle for centuries. Archeologists have evidence that in 2600 B.C., the Babylonians used clay tablets to record laborers' wages received and hours worked. Outside of direct deposit, things haven't changed much since then. Business owners are still pounding out the payroll. As for bankers back then, they probably had their sites on small business customers but weren't focused on payroll services. That hasn't changed much either. Small businesses have increasingly become the bread and butter for many banks. In the quest to lure and keep small business customers, banks offer them a litany of services-payroll services conspicuously absent from the list. This looks like it is about to change-and why not? Payroll seems like a logical extension of banking services, so why haven't banks been offering payroll services to their small business customers since the days of the Babylonians? The short answer, it turns out, is that payroll is too difficult. "Payroll is a tricky business. No one gets credit for getting it right. But you hear about it as soon as it's wrong. It's an intense business. Ninety-nine percent accuracy is not good enough," said Michael Alter of SurePayroll, a service provider. Payroll turns out to be a much more complex service than it appears on the surface. Tax laws can vary not only between states but also between localities within states, like cities and counties. Tax laws tend to change often, if not annually. Fines are levied by the IRS when taxes are filed incorrectly and such a gaffe would be disastrous to the relationship between a bank and its customer. Nevertheless, payroll is not a service banks can easily ignore. Conceivably, every small business in America could benefit from outsourced payroll management and payroll is a logical extension of banking services. "From the banks' perspective, offering payroll can greatly enhance client retention and attract new business. Our research suggests that banks that offer payroll services to their small business clients find that these clients are the type to use more bank products and remain clients longer than their average bank customers," Alter said. "From the small business owner's perspective, outsourcing payroll provides tremendous advantages - and online payroll, in particular, overcomes many of the challenges inherent in traditional outsourcing services," said Alter. "If small business owners can go directly to their bank for online payroll service, that's winwin for everyone." In May, SurePayroll began selling a service that allows banks to offer payroll service directly to their customers under the bank's brand name. The company is hoping the product will score big with community banks. Offering payroll services makes sense in theory, but most banks have never been able to do it effectively. According to Alter, community banks have avoided payroll for two reasons. First, there is the complexity and hassle of paying and reporting taxes to federal, state and local government agencies. Second, staying current on payroll issues and building the back-end computer support is prohibitively expensive. The logistical problems don't stop at community banks. Most of the largest banks, which still offer payroll services, eventually dropped their in-house payroll departments and turned to third-party expertise to operate their payroll services. "Every time a bank has come into payroll, they have run into the complexity of staying up to date with all of these local, state and federal tax requirements," said Walter Turek, of Paychex, another payroll service provider. "Most banks that have moved into the payroll business have moved out of it." Turek said that nationwide, roughly 400 new tax requirements pass into law every year. As a bank grows and its customer base begins expanding across geographical boundaries, the likelihood of making an error increases. "Payroll is such a personal issue, unless you're perfect it affects your business relationship with that client. It's difficult to consistently deliver perfect payroll," said Turek. "Wells Fargo went third party. I remember a time when the branch managers at Bank of America were referring customers to outside service bureaus because they were afraid to steer their clients into a bad experience with their internal payroll service. They didn't want to spoil the rest of the business relationship." ADP, the nation's largest payroll service company, eventually purchased Bank of America's payroll business. Paychex has not answered SurePayroll with a service of its own geared toward small banks. Turek said Paychex is not planning to move from its traditional referral system just yet. Banks that refer business customers to Paychex become part of a structured program that gives them a percentage share of revenue. But payroll is like other services - credit cards, for example - in that technology has suddenly made it possible for smaller banks to offer the service with their brand stitched right on the product. For the first time, community banks can become more than a payroll referral service and it is likely many will. A service for an appealing market the enormity of a payroll service provider's potential market is not debatable. There are more than 10 million small businesses in the United States and less than 25 percent of them currently outsource payroll. According to the American Payroll Association, 80 percent of small businesses have nine or fewer employees, 20 percent have 10 or more, and 75 percent of small businesses handle payroll operations in-house. Through the payroll system, America's 135 million workers annually pay $1.2 trillion in payroll tax to the U.S. Treasury. According to the IRS, four out of 10 small businesses are fined an average of $845 yearly for various violations of payroll rules. As a result, the APA says the outsourced payroll industry is growing at 20 percent per year. More than 75 percent of companies that outsource payroll have less than $250 million in annual revenue, according to a study completed by The Outsourcing Institute in New York. Payroll outsourcing is undoubtedly a financial services opportunity for banks. "The biggest reason any business outsources payroll is getting rid of the tax headache, "Alter said. "Forty percent of businesses have been fined by the IRS. The second reason is to facilitate direct deposit. The larger banks are waking up to small business again. The idea is that to have the small business customer, you have to own their checking account. So the question becomes, `How do I make it harder for the small business to switch checking accounts'." Payroll as a bank service is just starting to catch on. Using SurePayroll behind the scenes, several regional banks have begun offering bank-branded payroll services in the past two years. Recently, LaSalle Bank, Chicago, began selling the service through all of its 125 branches. Old National Bank, Evansville, Ind., an $8 billion regional bank, also began selling SurePayroll services as its own. Wells Fargo began its relationship with SurePayroll two years ago, although it has been in the payroll business for 40 years. The nationwidebank has outsourced the service since the 1980s. "It's a little known secret that we've offered the service for that long," said Bob Brown, senior vice president of Wells Fargo's payroll services division. "We've always viewed it as one of the key parts of a banking relationship." The service has been well received by Wells Fargo business customers, although not as well as the company had expected. "The growth has not been as great as we would like," said Brown. "But if you read the press reports from the major payroll companies, the economy is a big influence. There are higher business failure rates and businesses are doing as much in-house as they can right now." Wells Fargo's own research, however, shows the customers that do engage their payroll service are glad they did. "They tell us it's a great service that they would be hard pressed to do without," Brown said. Marketing the service has been a challenge for Wells Fargo, Brown said, and the greatest successes have come via direct contact between banker and business customer-something community banks know a great deal about. "We don't have trouble generating excitement about the product. Translating that into an actual purchase decision has not happened as quickly as we would like," Brown said. "But when the customers hear about it, it intuitively makes sense to them to do payroll with their bank. But we don't have the name recognition of an ADP or Paychex. The question they ask is `why are you better than these other guys?' That conversation becomes more in-depth. But I've yet to hear of someone not understanding why it would be good to have everything in one place." (C) 2002 Northwestern Financial Review
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