Change agent Featured

8:00pm EDT June 29, 2006
The date sticks in Paul J. Sarvadi’s memory: Sept. 14, 2001. And it’s not because of the terrorist attacks on New York and Washington, D.C., three days earlier.

His company, Administaff Inc., headquartered in Houston, suffered its own form of attack on Sept. 14 — a major supplier suddenly upped its charges, an act that would eventually cost Administaff an extra $12 million that year and $25 million the next year. And there was nothing Sarvadi and his management team could immediately do about it.

“It was really a disaster,” says Sarvadi, Administaff’s chairman and CEO, who co-founded the $1.2 billion company in 1986 and has headed it ever since. “It was going to dramatically affect profitability [and] it basically plateaued our growth.”

As the company’s financial performance deteriorated as a result of the additional costs and other related factors, its stock dropped, closing at $5.92 on Dec. 31, 2002, down from an average high around $26 the previous September. It lost hundreds of millions of dollars of market capitalization, its growth momentum came to an abrupt halt and its reputation was in ruins.

But the long-term result is that today, the company is better and stronger, and the stock is at record levels in the $40 range.

Administaff is the country’s largest professional employer organization. It acts as an off-site, full-service human resources department for small and medium-sized companies, for which it arranges employee benefits, management services and productivity resources such as training. Client companies number about 5,000 with more than 90,000 employees who are served by Administaff’s 1,500 employees.

Among the services Administaff provides is health insurance for the employees of its client companies, and it was on this very important cost component that Administaff got blindsided that September day in 2001.

The company that provided the medical insurance had troubles of its own. It was responsible for providing Administaff with accurate and timely claims information, which Administaff needed to price the health insurance component of its service.

The insurance carrier was merging 17 claims systems into three and had problems with the data and payment processes.

“They were paying claims twice and paying wrong ones and crediting some to the wrong account,” Sarvadi says.

Data accuracy was compromised not just for Administaff but for the insurance company’s other clients, as well. As a result of its inaccurate cost data, the insurance company sought to reprice the contract it had with Administaff not just immediately but retroactively, despite a contract provision that required it to give Administaff six months’ notice for any rate increase.

“We had to make a decision at that point, and this is what led to the loss in the next year,” says Sarvadi. “If we didn’t pay them, they were going to terminate the contract within 30 days. That would put all of our employees and their families on the street without health coverage. That’s not an option, so we paid them.”

Sarvadi says Administaff could have tried to get reimbursed from its clients for the higher expenses, but its contracts with customers called for prices to be changed only once a year, when contracts were renewed.

“I had to make the decision that basically said, just because someone didn’t honor their contract with us, was I going to go back to all of our 4,000 customers and break my contract with them?” says Sarvadi.

Instead, Administaff paid the insurance company, absorbed the higher costs — and then constructed a strategy to help it avoid a similar situation in the future.

“We certainly weren’t going to continue to do business with someone who did business that way, so we left them,” says Sarvadi. “And, of course, we left them without the accurate, timely claims data that we needed to price our service.”

The immediate effect of the higher insurance charges, says Sarvadi, was a dramatic impact on Administaff’s profitability and growth. Administaff lacked the information it needed to make sound pricing judgments and customers, when their contracts came up for renewal, were faced with increases of between 20 percent to 50 percent in their health care costs. Administaff’s salespeople, who had been focused on finding new client companies and spurring growth, now found themselves working on retention, as some clients were hesitant to renew in the face of such higher costs.

The consequences of focusing on retention rather than on growth were significant. Historically, Administaff had grown at a double-digit annual rate, as much as 20 percent, 30 percent or more, year-over-year. In 2002, with the company focused on damage control, unit growth fell to minus 3 percent. It was the one and only year in the company’s history when the number of employees covered fell, and profitability evaporated.

Sarvadi and his management team knew something had to change, and they created a strategy to turn the company around and make it better than ever.

“Generally, what doesn’t kill you usually makes you a whole lot better,” Sarvadi says.

The result was several systemic improvements in the company’s strategy. First, Sarvadi and his team decided that the company would never again rely on just one supplier for a service as important as health care insurance.

“We didn’t just move from one carrier to another,” says Sarvadi. “We now have a national network of eight different carriers.”

Next, they reorganized part of the business. The pricing group, which typically was in the sales area, and the cost-management group, which was in a separate area, were brought together.

“We put these two together so they would have direct and timely throughput between cost data coming in and pricing going out,” says Sarvadi. “We have to estimate what the health care costs are going to be per year, then we have to manage those expenses. And at the end of the year, you see how well you did between estimating costs that you built into the price and the actual costs as they turn out a year later.”

The net effect of bringing these two functions together is more timely information and more accurate pricing.

Doing this meant bringing in-house actuarial capabilities that previously were provided by the insurance provider. As another part of the company’s reorganization, expertise in benefit plan management has now been developed within the company.

“We actually triangulate on an ongoing basis between our internal staff, the carrier’s staff and an independent third-party actuary to make sure that we’re paying for what we bought and to make sure that our customers are getting the most value out of the dollars that are allocated for benefit costs,” says Sarvadi.

The benefit of developing this in-house expertise is to ensure that Administaff provides its customers with the best value. In addition, says Sarvadi, “For us internally, it helps us to manage in a way that we make sure we have a match in how we price to our customers and what our costs turn out to be, which means we have a more stable, reliable earnings model.”

The reorganization wasn’t the only thing Sarvadi was focused on. At the same time, the company sued its insurance carrier. A jury found in favor of Administaff and awarded it $8.25 million, but that was much less than the losses it incurred and was not much more than the $6 million the company spent on legal fees.

“But much more important to us was to be vindicated in terms of our reputation,” says Sarvadi.

By 2005, the sales force was again selling, and Administaff’s annual growth had returned to 20 percent. Client retention numbers are also returning to precrisis levels. And Sarvadi says that the company’s internal surveys find that 91 percent of customers say Administaff is good value for the money, 94 percent say they are likely to recommend the company to others and 91 percent say the company meets or exceeds their expectations.

“Probably the most important lesson is that you have to keep the faith, you have to persevere,” Sardavi says. “You sometimes have to ignore what’s being said when you know that the perception doesn’t line up with the reality. Perceptions are a strong force to contend with, but you just have to persevere.”

When things are going particularly badly, when it seems that the sky is falling, that’s when you really have to dig deep and carry the responsibility you have for your people and your company, Sarvadi says.

“Follow your instincts to do the right thing, and then persevere through it,” he says. “It will pay off.”

In addition, he says, the company has developed a corporate culture to deal with adversity. Sardavi says upper-level management has to recognize that change is inevitable and talk about how it will deal with it.

“We literally put in writing that, in our company, we want to anticipate and respond to change as an opportunity to innovate and learn,” says Sarvadi.

The most important element to doing this is to build a senior leadership team that you can trust, but one that is also diverse in how the individual members think, he says.

“CEOs have to be brutally honest about what’s working and what’s not working, and they have to have the people around them who can be part of the solution,” Sardavi says.

For Administaff, a serious shock to the system led to a re-examination of how it operates, how it views its core competencies and how it organizes itself. Millions of dollars in profits were lost, and the company lost even more in market capitalization. But the end result more than four years later is a stronger company that is more self-reliant and less at risk to outside forces. From adversity, opportunity can really come knocking.

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