People at the center of payroll? Why payroll must change!

How old is your payroll engine? No, that’s not the month you went live on the system. It’s the year your vendor first introduced it and ran the first calculations. Was that between 5 and 10 years? Or even longer ago?

Globally, the payroll space has long been dominated by a handful of very large players. And while large companies have the resources to maintain a custom payroll solution to address their changing needs, a small business owner doesn’t have that luxury and must accept the vendor’s standard, no matter how old. 

Payroll is an interesting beast – more than anything it’s about trust, accuracy, security and reliability. Your workers trust that you correctly deposit their money and on time. You have a payroll calendar to ensure you’re on top of it.

But the payroll engine itself is a black box. You feed it with data and rules, and it calculates the gross and net amounts. And whenever someone proposes to change payroll or switch vendors, the desire to maintain the status quo often wins. Or you can’t get the business case to work.

And that was okay, because there wasn’t much happening in the payroll space. Not in the way we paid people or in the technology. Improvements were mostly tied to annual legislative or tax changes. Innovation was focused on Talent and core HR functionality.

But those times are over.

Why is that?

In the first nine months of 2021, it’s been daunting to keep up with announcements and new solutions to pay people. VCs are investing heavily: no category received more funding during the first 6 months of this year than HCM & Pay solutions.

The introduction of the platform economy in the 2010s kickstarted fundamental changes in how we pay people: platform workers get paid as soon as the job is completed. Most platform workers do this as a side-gig, but getting paid immediately raises expectations: why can’t my employer pay me now?

Around the same time the platform economy gained ground, young companies in the fintech space started to disrupt financial institutions and processes. Now that the financial system is digital, they are eying adjacent services to expand their footprint. What other process can they bring into their ecosystem? It’s quite straightforward to combine outgoing (payments) and incoming (salary) pay streams. And that means neobanks are pivoting to payroll and look to access a user’s deposit.

What the platform economy and the fintech industry have in common is that they are built on the latest technologies, thrive on data and take full advantage of open standards. From a design perspective, they use API’s to move data back and forth with minimal friction. I wrote about APIs in HCM and Payroll a few months ago.

There’s a big overlap between financial and salary data. So far, neobanks focused on outgoing data – the payments you make. But they want to evolve into a person’s trusted financial hub, that automatically collects and redistributes funds for the client. While that might sound great in theory, think about the additional insights that incoming payroll data can offer. It’s an area with great opportunities, but also with potential risks that have to be carefully examined in light of privacy and transparency.

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Payroll remains payroll, but…

And finally, the pandemic might seem like the catalyst, but even before 2020 young companies were seriously rethinking the way we pay people. Which has been the same since, well, the early 1900s! Sure, we don’t get our money in an envelope at the end of the week anymore, but that’s just the delivery method. Nothing else has fundamentally changed.

What did become clear during the pandemic was how many people are struggling to make ends meet. And how often financial problems lead to mental health issues, which spill over in the workplace and negatively impact people’s ability to focus on work.

In the past, turning to payroll lenders to overcome financial shortages was an accepted option. But it’s expensive, and it usually worsens people’s financial situation instead of improving it. It’s also controversial with critics claiming that the high interest rates are predatory. VCs are walking away from this category, and some companies, like LendUp stopped offering payday loans.

The problem is usually not that people spend more than they earn. The big issue is the timing of when people get paid in relation to when bills are due. This is the root cause to be addressed. Which means that employers want workers to be able to at least receive part of their salary when they need it most. That also allows employers to more easily pay a spot bonus in the moment, instead of weeks after the event, when the impact is much less.

Startups in the Earned Wage Access space have raised $1.13 billion in debt and equity so far this year, surpassing total funding collected by the companies in the sector from 2015 to 2020, according to PitchBook.

Payroll Early wage access investments

In addition, the call for more diversity and inclusion also puts the spotlight on the lack of pay equality in many companies. As a result, high-profile companies swiftly put measures in place to ensure that people receive equal pay for equal work. Governments introduce legislation and demand pay transparency. And that means businesses are introducing programs to understand what they need to do before they end up on the front page.

And last but not least, many companies discovered that when you’re less tied to a location, you can hire people anywhere in the world. But you also have to employ them legally and pay them properly and so global workforce management became a thing. It’s a category that has seen an influx of investment. But it’s also a group of companies that seamlessly combines the old (existing, local payroll vendors) with the new – a global layer that ties the service together and offers people insights.

The perfect storm

Which brings about the perfect storm for payroll:

  • People want a seamless, holistic user experience for their financials (in and outbound)
  • Workers request on-demand pay and other services like cryptocurrency and global pay cards
  • Talent must be paid anywhere in the world
  • Employees need financial wellness services, including education
  • Boards and People leaders want data insights and predictive analysis
  • Fintech companies are ready to disrupt adjacencies
  • 3rd parties create services to automatically integrate with people’s pay
  • It’s the end-of-life for legacy payroll systems
  • Technologies like RPA, AI and ML are mature enough

The inner workings

What we didn’t yet discuss is the inner workings of the payroll department: even if you outsource most of your payroll to a 3rd party provider, there is work to be done internally.

Running payroll correctly and on time is a critical business function. Someone must be responsible for payroll and that person must have payroll expertise. But payroll administrators are increasingly hard to find – people prefer a career in finance, which is a better paying job.

The reality is that a payroll administrator spends most of their time helping employees and managers correct mistakes. The rest of the payroll process is typically automated and/or outsourced.

But every time there is a change in the work environment, someone must evaluate that change and decide if and how it affects payroll. You can’t leave that to the vendor. The employer is always responsible for the result. Which means you need someone with enough experience and expertise to be on top of it. But they are becoming scarce.

Payroll vendors are therefor looking to lessen the burden on the payroll administrator. Using robotic process automation (RPA) they can remove manual efforts and increase payroll consistency and reliability. They introduced artificial intelligence (AI) and machine learning (ML) capabilities to support the process with prescriptive guidance.

With the latest technologies, vendors build new engines that calculate changes when they are submitted, instead of waiting for the monthly reconciliation. This new practice ensures that you always have “final” payslips available and it lowers the burden and time on the week of the payroll run, which enables a smoother process. The period each month that payroll is locked and unable to process changes is getting much shorter. And in some solutions, that period has completely disappeared.

Besides introducing supporting technologies, there is also a trend to give employees more insight in the process – from an early view of their payslip to the opportunity to approve and correct the input before the payroll is run. It’s actually a smart move: not only can it prevent administrative issues, no one knows their payslip better than the employee themselves. Having them take a look at the payslip before the final payroll run can improve accuracy and increase satisfaction.

Legislation and taxation

Earlier this month, the District Court of Amsterdam decided that Uber drivers are employees and supported the ruling with a number of arguments. And while Uber immediately appealed and claimed that drivers are independents, it’s unlikely that a higher court will completely overturn this decision.

There is a fine line between who is an employee, independent, employee of record or other contractor, and it becomes increasingly blurred. In this case, the court sided with the drivers, which means that Uber is responsible for withholding social security and taxes and for benefits. Instead of paying invoices, they have to pay a salary.

But this change doesn’t happen often: as more people take on side gigs and work as independents, the traditional work relationship is becoming less popular. Which means that ultimately, governments have to rethink (the timing of) taxation.

When people earn money from one employer and receive a salary, it’s easy. The employer withholds what is due, and submits the amounts to the local, state and/or federal government. Taxes are a major reason why payroll is so complex. It’s a major administrative burden with many costly mistakes and I’ve always wondered why companies are not lobbying harder to move that responsibility to the individual.

Employees receive a net payment, because employers withhold taxes during payroll. Independents receive a gross amount without any taxation and pay taxes in arrears. Upfront taxation by employers generates a predictable, steady income stream for the government. How will governments respond when that stream becomes smaller because the group of independents grows?

When people have additional income streams, the individual must submit that data to pay the taxes they owe. Sometimes they receive a monthly allowance from the government, or have deductions that lower the amount due. Put it all together and it results in complex reconciliations and money moving back and forth between the employer, the authorities and the individual. Serious mistakes do happen.

Eventually, we might end up in the situation where everyone submits their sources of income and pays their own taxes, just because it’s less complex and more efficient. That is not the case today, but certainly something to keep in mind when thinking about the future of pay and especially payroll.

Every country takes a different approach to paying taxes and it’s hard to predict changes. And an overhaul of the tax system only happens once in a dozen years, so it might never happen because governments would need to completely change their spending pattern. It all depends on how quickly the shift to the gig economy goes. And even though the Amsterdam court decided in favor of an employee contract, I think the trend to independent work is irreversible. People enjoy it too much.

With the current pace in administration, legislative and tax changes are probably a long way off. Governments move slow. But in the future of work, I see the individual at the center of pay and taxes and not the employer.

So with every change you consider, put the worker or the employee in the center of pay. You’ll end up with a more robust design.

What does that mean for your future payroll?

If you still look at payroll as an internal company process, you’ll have to change your thinking. Paying people is about people, and you’ll have to put them in the center of your approach. That probably means you’ll have to completely reimagine your current process. It’s key to remain an attractive employer.

You can’t run your business like you did a year ago – the external environment has fundamentally changed. And there are enough young companies challenging the payroll status quo. They are early adopters of new ideas and methods, and they offer you an opportunity to see the future of work in action: you can learn something from them about new ways of working and new corporate behaviors. I recommend that you include a couple of young companies with fresh solutions in your next RFP.

Fortunately, you have options. In the accompanying article, I will introduce you to emerging companies that are taking a hard look at traditional pay and deliver new ideas and approaches. Their solutions cover all aspects of pay including compensation and benefits. Many did a recent funding round. I hope their ideas spark your imagination to design your future approach to paying people. New solutions are introduced every month, and I’ll continue to follow the topic closely.

The next time your payroll contract is up for renewal, take a hard look at your incumbent vendor, and especially at the technology that runs your payroll process. How old is it? Is it future proof? Will it allow you to seamlessly introduce new services that the modern workforce demands? If not, think about what it will cost your company if you can’t attract the talent you need. Suddenly, that business case might seem a lot less important…

So who are the companies that are rethinking the way people get paid? Let me introduce you to a selection in: The new kids on the payroll block.

Additional inspiration

And finally, if you need more inspiration including a look at the latest solutions, take a look at these recent articles:

API’s for HCM and payroll: 7 startups to explore

Who dares to disrupt payroll?

These cool startups just raised millions to disrupt the future of payroll

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