ADP Built Scale in Services and Then Tech. Next Is AI. (1 of 2) (Tech Strategy)

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This is a strategy and business model breakdown of Automatic Data Processing, Inc. (ADP), an American company providing human resources management software and services. It’s a company that:

  • Has a long history as a service provider in human resources and payroll processing.
  • Evolved into a software plus service provider for a broad range of human capital management activities.
  • Is now well-positioned to move into data-intensive AI services – and (maybe) into non-human workforces.

First some of the basics for ADP.

ADP’s Long March to Global Scale in Services

ADP began in 1949 as Automatic Payrolls, which was a payroll processing business. It was founded by brothers Henry and Joe Taub. Frank Lautenberg, from sales and marketing, later became a partner in 1957. And he was later president until 1982, when he was elected to the US Senate.

The company changed its name to Automatic Data Processing (ADP) in 1961. This was the same year it went public. At the time, it had (according to Wikipedia) 300 clients, 125 employees, and revenues of approximately US$400,000.

The evolution of ADP in services is important. It began in payroll processing, back when professional management was just emerging in post-war America. Over time, it expanded into other human resources services. And, as a labor-provided service, it had a long march to superior scale versus rivals. They slow added clients, staff, and services over decades.

This is a common pattern for enterprise services businesses. Accounting firm Arthur Anderson was founded in 1913 and grew to global scale over 80 years. Management consulting firm BCG was founded in 1963 and has spent 50 years adding clients, staff, and countries.

How fast such service businesses grow depends on the intensity of the services they provide. Payroll services are required every month, which is great. Accounting is needed every quarter, which is not as good. And strategy work happens only occasionally (not great).

Growth also depends on the types of skills required. Payroll services are much simpler than legal work requiring lawyers. That makes growth faster.

Fueled by payroll and an increasing suite of other HR services, ADP became a market leader in the US. And then they went international. ADL expanded to the United Kingdom in 1965. And then to country after country.

And, along the way, it grew from payroll services to human resources, payroll, talent management, time management, tax and benefits administration and other services.

Today, ADP has about +63,000 employees and its 2023 revenue was $18 billion. It has +1M clients and oversees the payroll for 41M people in 140 countries / territories.

ADP Has Lots and Lots of “Services Plus Software” Solutions

Today, ADP offers a long list of enterprise solutions. Here’s a pretty good summary from their webpage.

Note the activities on the right.

And note how these solutions are a combination of “expert guidance”, “technology” and “employee support”. That’s a pretty good summary of the business. Their many solutions are a combination of services (i.e., people) plus software.

The main services are:

  • Payroll services. They pay +25M workers in the USA. Payroll includes electronic cards, wages, summaries, pay statements, check preparation, tax filing with IRS, etc. It also integrates with ERP systems.
  • Benefits Administration. Administration of benefits in health and welfare. This includes insurance company enrollment.
  • Talent management. This includes acquiring, activating, and managing the workforce. It also includes ongoing learning and performance.
  • Workforce management. This includes time and attendance solutions. Scheduling, shift swapping, etc.
  • Compliance solutions. This includes payments and taxes. The company files 79M year-end tax statements.
  • HR Management. This is the information system and data insights.
  • Insurance services. They are a licensed insurance agency. This covers workers comp and health.

They categorize services in two businesses:

  • Human capital management (HCM)
  • Human resources outsourcing (HRO)

And they sell to everything from large multinationals to small businesses. Here is how they describe their offerings in their 10K.

That shows their main services. But there are a lot of them. And they each have multiple tiers. You can buy a full suite or a la carte. There is lots of bundling, upselling, and cross-selling.

It’s worth looking at their complete solution for large companies (TotalSource) in detail. You can see everything. From their webpage, here is the description of TotalSource.

Note how they also pair software with labor-dependent services.

Here is the complete list of services within TotalSource:

It’s pretty impressive as a suite of services.

Their HR outsourcing business (HRO) is pretty similar. Here is how they describe it in the 10k.

One different aspect of HRO is their PEO Solutions. This is an interesting service for small and medium businesses where ADP becomes the “co-employer” and manages the staff. The client doesn’t need an HR department.

Ok. That’s the basics. Let’s get to the “so what”.

Point 1: ADP Has Really Pretty Financials

Selling services with software that requires implementation and ongoing maintenance is a nice business. Especially when you have +1M clients. It does require a big sales direct force. But you get ongoing relationship and significant switching costs.

Implementation of ADP solutions can be fast for small companies (under 24 hours) but are more like 6-9 months for large clients. And it can take years for multinationals. So, these services are big commitments that can create long-term relationships (with recurring revenue). The average ADP client lasts for 13 years (6 years for PEO).

And you can see this in the deferred revenue on the ADP balance sheet. Note the balance sheet below. I really like deferred revenue, which reflect contracted commitments and predictable revenue. Plus, it usually means negative working capital. I put ADP’s working capital at around negative $700M USD. Awesome.

The income statement looks pretty much like what you would expect for a global service plus software business.

  • Revenue is $18B, with 9% growth.
  • Operating expenses are 48%. Higher than software but not bad.
  • SG&A is 19%
  • Operating profit is 26%

Point 2: Enterprise Labor-Based Services Are Mostly a Long Play for Economies of Scale

The above description is only about 50% of ADP. I’ve skipped over most of the software stuff. I’ve mostly described it as a labor-intensive service business. That’s a good starting point for the business model. You can see the same model in law firms, accounting firms, consulting firms and so on. As mentioned, the differences are about:

  • Skilled vs. unskilled labor.
  • Recurring vs. non-recurring revenue.

Payroll services was a really solid foundation for ADP to build upon. Payroll services create monthly recurring revenue. And it’s relatively unskilled so scaling was much easier and faster.

And the big weakness of services-based business model is always scalability. Labor just doesn’t scale as well as software, tech, and products. You’ve got to hire lots of people. And you usually have to do it locally in market after market. ADP had a good foundation in monthly payroll services. From this, they were able to add more complicated and episodic services.

If the weakness of this business model is scalability, the strength is bundling and cross-selling. You can easily pair other services. You can bundle and sell for one price. Services don’t bundle as well as digital products but it’s much easier than in manufactured products. Virtually all enterprise services firms are big into bundling, upselling, and cross-selling. Recall, I listed this as a soft advantage of digital business.

But this business model is mostly a long and slow game of building economies of scale.

You build a scale advantage at the domestic level (usually North America) and then, if possible, globally. And that gets you three types of economies of scale over smaller rivals.

  • Economies of scale in the fixed operating and capital costs in IT spending. ADP spends about 5% of revenue on “systems development”. Plus, there is ongoing capex and M&A in IT. All of this spending is about leveraging their scale in services into becoming a software company. This has been their primary strategy for forty years.
  • Purchasing economies of scale. In certain services, ADP is actually providing insurance services and other benefits for their clients. That means they are negotiating and buying these benefits for them. Their big scale gives them big purchasing power to do this. Certainly, they can get better deals than smaller rivals (and their clients).
  • Economies of scale in fixed costs in R&D. Often in publishing and thought leadership. Companies like McKinsey & Co do tons of publishing and original research. And far more than their smaller rivals. They are using their superior scale in fixed costs to do research and publishing. This really helps in marketing. It also helps in reputation building and thought leadership. This isn’t as big a deal for ADP (yet).

ADP’s business model was about slowly building relative scale in labor-based services. This got them some advantages (purchasing economies, bundling). But the big advantage was to use their services scale to outspend rivals in IT spending. That’s how they went from one service to many. And then from services to services plus software.

There is one last scale advantage I should mention. This one is a bit softer but it’s something you always hear from enterprise services. It’s the idea of best practices as a scale advantage.

Most consulting and client-based firms are able to tell clients how they are doing versus the industry. By virtue of having lots of clients, they see lots of data and information about the industry. They can then give advice on “best practices”. And business with more clients (i.e., scale) tend to have better industry and operational best practices. This is a soft advantage where scale can be an advantage.

But really what we are talking about is not best practices. We’re talking about scale in data as an advantage. And this is becoming a key factor for ADP going forward. ADP has become a data technology company? And large amounts of proprietary data is exactly what you want to move into AI-based services. Which ADP is doing.

I’ll get to that in Part 2, which is about ADP becoming a software company. And now an AI company.

That’s it for Part 1.

Cheers, jeff

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Related articles:

From the Concept Library, concepts for this article are:

  • Economies of Scale: Purchasing Economies
  • Economies of Scale: Best Practices?
  • Economies of Scale: Data advantages?
  • Human Resources / Human Capital Management

From the Company Library, companies for this article are:

  • Automatic Data Processing (ADP)

Photo by Hannah Busing on Unsplash

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I write, speak and consult about how to win (and not lose) in digital strategy and transformation.

I am the founder of TechMoat Consulting, a boutique consulting firm that helps retailers, brands, and technology companies exploit digital change to grow faster, innovate better and build digital moats. Get in touch here.

My book series Moats and Marathons is one-of-a-kind framework for building and measuring competitive advantages in digital businesses.

This content (articles, podcasts, website info) is not investment, legal or tax advice. The information and opinions from me and any guests may be incorrect. The numbers and information may be wrong. The views expressed may no longer be relevant or accurate. This is not investment advice. Investing is risky. Do your own research.

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