EORs and MCPs are on a collision course. The line between employer of record (EOR) companies and multi-country payroll providers (MCP) is blurring.
This phenomenon, though not widely discussed until very recently (Josh Bersin gives a good overview here and Anita Letink wrote a very insightful piece here),represents a pivotal moment for both sectors.
Traditionally, MCPs have developed deep expertise in delivering payroll services with accuracy and reliability for large volumes of employees. Their customer base consists mainly of established global or regional MNCs looking for a cost advantage on this narrowly-defined business process that is payroll. Operating margins have always been small, especially outside North America and Central Europe where scale and operational efficiencies are harder to reach.
In contrast, EORs, usually backed by heavy injections of capital, are still grappling with client acquisition and footprint expansion challenges. In contrast with MCPs, they offer a comprehensive suite of HR services that go well beyond payroll and often comprise the entire scope of traditional HR functions.
“The post zero-interest-rate era has been brutal for EORs, especially the smaller ones. Although one would expect to see a lot of consolidation where larger players acquire smaller ones, this is hindered by the complexity of the technology platforms being used — making consolidations complex and unattractive.”
Their entry point into the market was historically the “long tail” of hitherto under-served and high-touch workers hired far away from HQ. As VC money poured into the EOR industry, new entrants appeared everywhere, competition became fiercer, top-line growth slowed and prices dropped. The post zero-interest-rate era has been brutal for EORs, especially the smaller ones. Although one would expect to see a lot of consolidation where larger players acquire smaller ones, this is hindered by the complexity of the technology platforms being used — making consolidations complex and unattractive.
Customers, who are facing their own mix of globalization and cost challenges, are increasingly less inclined to care which “business model” their service providers belong to. They just want their employees hired, looked after and paid in a globally-standardized but locally-compliant way.
The Innovator’s Dilemma Strikes Again
Clayton Christensen’s “The Innovator’s Dilemma” provides a reliable lens through which to view this industry shift. EORs, analogous to the disruptive innovators in Christensen’s framework, are expanding their offerings to include “traditional” payroll services (one where they are not the legal employer), hoping to leverage their technical prowess and financial resources. Meanwhile, MCPs, akin to the incumbents, must decide whether to innovate within their domain of expertise or to expand their service portfolios in response to this encroachment.
A Tale of Two Payslips
EORs bring a holistic service mindset and a diverse HR product portfolio.
Backed by hungry VCs, they aim for exponential growth while facing the challenge of achieving, then maintaining, profitability — hampered by the complexity of automating data processes.
Their innovative teams, often with roots in the high-tech fintech sector, possess the agility to develop new products fast, with payroll technology as a notable exception. In fact, the sheer complexity of global payroll has been habitually dismissed or underestimated by EORs and so, decision makers, growing increasingly frustrated with the lack of speedy progress, are now resorting to extreme measures like acquiring old but reliable payroll tech companies. This is triggering a plethora of integration challenges as they discover a world of technical debt and arcane regulations — much more complex than the “vanilla” payrolls which they historically confined themselves to.
“The hint of smugness that previously existed in the MCP world, as it observed the emergence of ‘naive’ EOR players, is being replaced with a real sense of fear that these new players may be ushering in a new world in which MCPs are ill-equipped to compete.”
Conversely, MCPs embody a paradigm of meticulous methodology and deep-rooted payroll expertise. Even the largest players are artisans at heart. Their platforms, shaped by years of refinement under competitive pricing pressures, are optimized for stability and efficiency.
But in the payroll world, reliability and technical debt are often synonymous and, as a result (and somewhat ironically), it is the best providers who have struggled the most to evolve their platforms beyond their current payroll use cases.
The hint of smugness that previously existed in the MCP world, as it observed the emergence of “naive” EOR players is being replaced with a real sense of fear that these new players may be ushering in a new world in which MCPs are ill-equipped to compete.
EORs, with their marketing muscle, have steadily been shifting market expectations. In his article, Josh Bersin even raises the prospect that traditional HR and Payroll software players might be impacted. We agree: There is a real possibility that customers may decide to move away from licensing their own software —even though the “cloud” supposedly made it easier to own and operate — and instead look for “all-in-one,” completely outsourced platforms where traditional payroll services are blended in with newer EOR services. In effect, every business who has licensed HR technology has de-facto become their own system integrator, being responsible for the data architecture of the ecosystem they operate.
Strategic Implications: Offense and Defense
The evolving dynamics between EORs and MCPs underscore a strategic imperative: EORs must deepen their payroll expertise to solidify their offensive strategy, while MCPs are compelled to unleash their development teams’ potential in a defensive maneuver to sustain their own innovation and competitiveness.
EORs: A Quest for Payroll Expertise
For EORs, the expansion into the payroll domain is not merely a logical expansion of their services, it is vital to their growth: One of the biggest challenges EORs face is churn. By their very nature, the end-customers that the EOR industry services are fast-growing companies who quickly outgrow their EOR’s capabilities to service them. They often see EORs as a temporary solution needed to support fast growth. A solution to be replaced by more permanent ones, once they reach the required scale.
It follows that the only way for EORs to keep their best clients is to compete with MCPs and provide similar low-cost payroll services tailored for larger employee populations. On the upside, it is far more cost-effective for an EOR to keep an existing client than it is for an MCP to steal it from them. Expanding into the MCP space is therefore a no-brainer. Every EOR with ambitious growth targets is either doing it or preparing to do it.
“Expanding into the MCP space is therefore a no-brainer. Every EOR with ambitious growth targets is either doing it or preparing to do it.”
To successfully navigate this transition, EORs must acquire and cultivate deep domain expertise in payroll — a field characterized by its localization, idiosyncrasies, regulations, and parochial expectations by customers. All problems that technology isn’t particularly well-suited to solve.
In fact it is as much an economic problem as a technology one: The cost of producing localized payroll technology is rarely defined or constrained by technology but by the diminishing returns that small payroll markets (the infamous “long tail”) provide.
The road to global payroll hell is littered with the corpses of well-designed tech and well-meaning vendors who assumed that because they had early success, they could simply build a “global payroll engine”. Many of the most respected industry analysts, including Thomas Otter have written extensively about the challenges of global HR and payroll.
For EORs, this venture into MCP territory requires a blend of humility and pragmatism which, in tech-terms, means knowing what not to build.
Zero Interest Rate Phenomenon (ZIRP) and the New Old Problem
It isn’t much of a secret that many EORs aren’t profitable. While that was perfectly ok (indeed, it was expected) during the initial wave of enthusiasm from VCs who focused on land-grabbing, it is no longer so. 5+ year old businesses are expected to either start turning profits or at least have a clear path towards healthy margins.
We expect to see massive consolidation over the next two years as top-line growth remains stalled and funding dries up. Larger EORs are preparing to scoop up smaller players who are gearing themselves up to be as attractive as they can be to extract maximum value from these deals.
And here we see a challenge similar to the one familiar to HR and Payroll software vendors: Unlike MCP consolidations that are usually low key and relatively straight forward technically (large vendors like ADP typically just add the new clients and associated software side-by-side with existing ones, assuming platform and cost rationalization later), EOR consolidation looks much more like traditional software migration projects that follow M&As.
Because EORs are their own system of records (SOR) and the legal employers of the workers they pay, all their services are tightly integrated into this SOR. The acquisition of other EORs requires a technical migration to consolidate all clients and partner networks on a standard product set and SLA. This is, of course, complex, time-consuming and risky: The kind of risk that historically leads to a 20–30% attrition rate.
“We expect to see massive consolidation over the next two years as top-line growth remains stalled and funding dries up.”
This is made more complex by the legal nature of the service that EORs provide: Employees would essentially have to be “resigned” from one provider and “hired” into another with new employment contracts.This is logistically complex due to the communication requirements to ensure workers and end-clients are kept informed and whole.
This is about as challenging as migration projects can get.
MCPs: Innovation as a Defensive Strategy
Meanwhile, MCPs confront a defensive challenge. The thrust into their domain by cash-rich EORs demands more than just a guard of their established turfs.
If you accept Christiensen’s thesis, it calls for a strategic unleashing of their development teams’ potential to innovate. MCPs possess a foundational strength in payroll processing, built on years of refined expertise. This is a great base to build upon.
However, many of them do not see EORs as an existential threat. Yet.
But moves like this one by industry juggernaut Deel are in the process of changing that perception. Their growth is too mind-blowing to be ignored (nicely summarized here by Franck Neron Bancel, their VP of Corporate Business Development).
Here again, “The Innovator’s Dilemma” provides an accurate description of the challenge faced by incumbents: They have every reason to continue to focus on their biggest customers, allocate resources accordingly, misjudge the market and generally act according to their org structure and profit targets rather than strategically.
Getting out of this groove is going to be tough. But winning this battle surely involves repurposing their considerable tech resources from non-scalable activities like client implementation, maintenance, integration and one-off customer automation to strategic platform re-building and portfolio expansion.
The Stack Fallacy
About a decade ago, Anshu Sharma wrote a blog post where he made the following astute observation: “Stack fallacy is the mistaken belief that it is trivial to build the layer above yours.” For those not familiar with the reasons why, I invite you to read the rationale here.
“It is much easier for EORs to build the layer below them (payroll) than it is for MCPs to build the layer above them (everything else).”
What this practically means here is that it is much easier for EORs to build the layer below them (payroll) than it is for MCPs to build the layer above them (everything else). This is because when you build “down the stack” you are your own customer and therefore have a well-defined understanding of your needs — the essential ingredient in successful product management. Conversely, building “up the stack” is fraught with assumptions about what this new value proposition should be and inevitably leads to dead ends and missed opportunities.
One more challenge for MCPs to contend with.
SaaS, but for Real
Another approach that might be both less glamorous but more viable for MCPs is to go all in on their strengths and truly SaaS-ify their offering — to the point where they can become a true “black box” in the value chain and absolve EORs from dealing with payroll compliance issues altogether. This would incite EORs to purchase the payroll services “by the drink” and stay away away from MCPs’ core markets.
Many MCPs are already doing this to some extent, but margins are low and current technical stacks were not designed to provide this service efficiently. As the commoditization of the payroll industry continues, it will become increasingly harder for these players to remain profitable.
Nevertheless, this may still be the most viable option for many and this is likely to trigger renewed investments in technology by these players to package their existing services in a more efficient manner and preserve their margins.
The raison d’être of datascalehr
The journey forward for EORs and MCPs is intricately tied to their ability to leverage expertise and harness innovation. Easy to say, but combining the past (expertise) with the future (innovation) in a tangible and useful product today is about as hard a challenge as it gets.
“Our founding thesis at datascalehr wasn’t specifically to support EORsS or MCPs but to free the payroll outsourcing industry as a whole from the shackles of code maintenance, data integration and reconciliations.”
Our founding thesis at datascalehr wasn’t specifically to support EORs or MCPs but to free the payroll outsourcing industry as a whole from the shackles of code maintenance, data integration and reconciliations. For having ourselves grappled with the challenges described above, we knew that extracting better efficiency out of the industry would become vital. It was obvious to us that this was the problem that remained to be solved.
By design, this puts us in the unique position to help both types of providers achieve their goals, albeit for different reasons.
Empowering EORs with Critical Expertise
For EORs venturing into the payroll domain, datascalehr offers a bridge to the essential expertise required for this strategic expansion. Our platform serves as a buffer, an insulator from the messiness of local payroll and its data. By providing universal payroll connectivity, security, and reconciliations, and therefore allowing EORs to tap into the expertise of local providers (including the ones they acquire), they can escape the fate of previous generations of companies who had to build this infrastructure brick by brick and ended up spending most of their resources on piping and building maintenance.
“By providing universal payroll connectivity, security and reconciliations, and therefore allowing EORs to tap into the expertise of local providers, they can escape the fate of previous generations of companies who had to build this infrastructure brick by brick.”
While MCPs have been dismissive of the threat posed by EORs, similarly EORs have been dismissive of the complexity that MCPs have managed to solve. Even within the EOR sector, more recent entrants are dismissive of the earlier generation’s efforts to industrialize processes. In the end, the world doesn’t discriminate: Payroll is and will remain complex for all players. In its ability to suck up resources year after year, payroll is insatiable.
With datascalehr, EORs can leverage the best of global payroll knowledge and provide “enterprise-grade” payroll services without falling into the trap of becoming MCPs themselves, thereby preserving their ability to move fast.
Enabling MCPs to Innovate and Defend
For MCPs, datascalehr represents a strategic ally in their quest to defend their territory through innovation.
Up the Stack
We see two ways for MCPs to win this battle: First, they can innovate “up the stack” and compete head-on with EORs.
By automating the cumbersome and resource-intensive aspects of payroll data management and R&D, datascalehr frees MCPs’ development teams to pursue higher-value activities that support innovation. Free from the drudgery of backend data management, MCPs can allocate their resources toward developing their own Systems of Records, add HR products, build consumer-grade UX, and explore integrations that extend beyond payroll.
But innovation requires a combination of a lot of capital and low revenue expectations over sustained periods of time. Something EORs and their VCs innately understand. MCPs will need to open their war chests.
We help with that too. Since we solve the age-old problem of implementation (aka “sales-to-cash”), we drastically reduce the implementation backlog, locking in new sales fast and generating precious additional revenue.
Down the Stack
Although this may not be their original strategy, MCPs who have an indisputable advantage when it comes to efficiency and local know-how, could power the EORs. Their carefully curated networks of payroll solutions and providers, if scaled profitably, can be the solution that many EORs are seeking to power their own services. Not every EOR can buy a bunch of local / regional payroll companies and integrate them, and there aren’t that many regional payroll companies worth buying for that purpose to begin with.
“Although this may not be their original strategy, MCPs who have an indisputable advantage when it comes to efficiency and local know-how could power the EORs.”
Many MCPs are already selling their services to EORs who then in turn package it up for their customers. To do this efficiently, MCPs need to reduce their costs and drastically improve their integration technology to enable this low-touch, price-taking business model.
Once again, datascalehr can help: The levels of processing efficiency we provide are on the order of magnitude required for MCPs to grow profitably by providing “back-end services” to client-facing EORs.
Flattening the World One Consolidation at a Time
Regardless of the strategies that will be deployed, one thing is clear: Providers will need to get more efficient and more consolidated to reach economies of scale. This means that both platform migrations and/or consolidations will become the order of the day once again (for those of us old enough to remember the 2000s).
Takeaway
At a macro level, the evolution discussed in this article is actually not very surprising: Every industry will eventually decant into layers once it grows sufficiently and generates enough revenue to sustain and benefit from different types of specialized actors.
We have observed this in every other industry from car manufacturing to computers: Specialization is literally the story of the industrial revolution.
And now it is the story of Payroll.
