Some companies rely heavily on contractors to staff projects and even entire departments within IT. Others exclusively prefer full-time employees. Understanding the total cost of an employee is crucial in the decision-making process. However, the ultimate decision should be based on your company or department’s business strategy. Learn more about this at Part 1 of this series: To Hire Contract or Full Time: 8 Questions to Help You Decide.
Businesses often underestimate the total cost of a full-time employee. It’s true that hourly rates are usually higher for contractors and consultants than full-time employees, but we must consider all hard and soft costs. Some are not so apparent.
Hourly rate – This one is easy. For this example, let’s use $75,000 per year as a pay rate, which equates to slightly more than $36 per hour for 2,080 hours per year. One key difference with contractors is you only pay for productive hours. Full-time employees are paid during non-productive hours, such as vacation, holidays and sick time.
Statutory costs – Social Security and Medicare cost employers 7.65% of a base salary plus federal and state unemployment insurance. For a $75,000 employee, this equates to more than $3 per productive hour worked.
Employee benefits – Full-family benefits such as health care costs, which rise each year, and 401k matching can equate to $8 per productive hour worked.
Training costs – The actual amount per employee depends on the type of job and varies from company to company. It is estimated that the cost per hour worked ranges from $0.50 to $2.50. Using contractors or consultants allows you to avoid paying for training courses, conferences, subscriptions and certifications.
Training time – Contractors and consultants are paid for hours worked. Companies pay only for the value created and not when a contractor is focused on non-productive tasks. Five days of training per year equates to nearly $2,000 in lost productivity for an employee making $75,000. As such, use of a contractor abates approximately $1 per hour of training expense.
Vacation time – Like training, vacation cost is abated by using contractors. Depending on your time-off policy, you can avoid two to three weeks of cost. Two weeks of vacation equates to $4,000 per year for an employee making $75,000 or approximately $2 per productive hour. In addition, paid breaks can amount to an additional two to four hours per week.
Paid holidays – Most companies offer approximately ten days of paid holiday time, equating to $4,000 per year or $2 per hour.
Sick time – Depending on your policy, you may avoid the cost of between 5 and 10 sick and/or personal days. This equates to $2,000 to $4,000 per year or $1 to $2 dollars per productive hour worked.
Bad hire costs – Bad hires are expensive. Studies indicate that the cost of a bad hire is two and a half to three times the employee’s salary. This cost is avoided with contractors, who can be terminated with little headache if things don’t work out. If one in thirty hires is a bad one, then we should increase the hourly rate by 10% per productive hour work.
Hiring costs – Hiring is an expensive process. Significant management time is invested in gathering resumes, screening resumes, making calls to candidates, testing, scheduling interviews, conducting interviews, evaluating and choosing a candidate, negotiating the offer, and repeating the process if the candidate does not accept. These costs can be reduced by using contractors. This management and human resources time can be focused in areas of greater value to the business. For the purposes of this example, I’ve included no allocation for hiring costs.
Separation costs – The unfortunate situation where you choose to terminate an employee creates costs for the company. If the employee is laid off, severance costs are avoided. If the termination is performance-based, all of the time invested by HR and management on counseling, deliberations and termination are avoided. While incurring these costs are not certain, by using contractors you avoid this risk. For the purposes of this example, I’ve included no allocation for separation costs.
For a $75,000 resource, hard costs equate to approximately $22 per productive hour worked or nearly $40,000 per year!
Soft costs are more difficult to quantify. The opportunity cost of time spent managing employees from a human resources perspective is the most often overlooked and underestimated employee cost. Contractors and consultants do not require a career path, training plans, performance appraisals or counseling sessions. It is estimated that up to 15% of a manager’s time is spent in these areas.
By using contractors and consultants, management time can be focused in areas of greater potential value to the business. One industry benchmark shows that day-to-day management and other soft costs equate to an additional 25% of an employee’s total cost.
Of note, decision makers correctly consider management costs as fixed…they are not avoided when using contractors instead of full-time employees. Unfortunately that misses the point. I’m specifically calling out the opportunity cost of management time, which can be focused in higher ROI areas.
Totaling it up
The total cost of an employee making $75,000 per year is approximately double – nearly $150,000 per year.
While using a contractor is definitely not appropriate for every situation, it’s not as expensive as it sometimes seems. As such, our recommendation is to base your decision to use full-time or contract resources on business strategy, not hourly pay rates.