Three Key Factors in Using Contract Labor Effectively

Choosing the right type of contract labor is crucial for ensuring a cost-effective, well-oiled staff machine


By Adam Cummins

As revenues and profits fall, corporations look for ways to cut costs, and large-scale employee layoffs move to the front page of media reports worldwide. The decision to terminate employees is never an easy one, and due to the costs associated (both human and financial) it is only after much deliberation that corporations take this step. For these reasons, once a business sector or economy begins to rebuild from a downswing — such as the past 18 months — hiring new employees on a large scale is typically the last step employers take.

As a result, employers in today's economy face a familiar but difficult challenge. Employees are let go and there is little to no support for hiring new staff, but workload generally has remained static, if not increased. To face this challenge, employers typically increase their use of contract labor to augment their existing employee base. With this approach, employers can "flex" their workforce as needed, without again facing the painful costs associated with employee layoffs. However, choosing the right type of contract labor can mean the difference between a cost-effective, well-oiled staff machine and a group of subpar or over-servicing, expensive resources.

Know the Differences

Contract labor, in its broadest sense, is any labor provided by non-employees. The types of resources and services generally included within this broad definition fall into three categories: Temporary, Staff Augmentation and Professional Services. Temporary generally encompasses resources that are utilized to fill low-skilled, highly repetitive work requirements (e.g., light clerical or administrative) lasting for short durations and paid for on a time and materials basis. Staff Augmentation typically includes resources that backfill for individuals no longer employed with a corporation. This category generally requires higher skills and performance of less repetitive activities than the Temporary category, for a period of anywhere from a few months to more than a year, and is also paid on a time and materials basis. Professional Services generally covers needs for highly skilled subject matter experts to deliver on specific, and usually unique, requirements. Professional Services firms often provide set deliverables or work to reach specific milestones and receive fixed or not-to-exceed payments upon successful completion of each.

Understand Cost Drivers

Two components drive costs in the Temporary and Staff Augmentation categories: the direct labor rate (which the individual performing the service receives) and the agency markup (which is applied to the direct labor rate, and is what the agency or firm representing the individual receives). In addition to profit, the agency markup includes costs the firm takes on to represent the individual (e.g., FICA, state tax, benefits, training). Agency markups for Staff Augmentation vary, depending on whether the resource is a "W2" (e.g., fully benefitted employee of the firm) or a "subcontractor" (often 1099) of the firm. Markups for subcontractors are significantly lower, as benefits costs and tax withholding for subcontractors is lower than for W2 employees. Both cost components can be competitively bid across Temporary and Staff Augmentation supplier pools, ensuring the most competitive total rates are achieved.

Professional Services firms also have the same cost components but are typically less willing to agree to buyer-dictated labor rates and agency markups. There are, however, opportunities to understand level-of-effort cost drivers related to milestones or deliverables. Carefully defining what is expected to reach a milestone, or what is expected of a deliverable, and minimizing assumptions by the delivering firm will enable the level of effort to be narrowed to exactly what is needed and no more. This will result in fees that are optimized for the work expected.

Use the Right Tool for the Job

If contract labor is determined to be the right approach to provide resources or expertise to meet a particular requirement, selecting the right kind of contract labor is instrumental in ensuring that the needed work is successfully completed, while balancing the total cost to deliver. Just as it would make little sense to select a Temporary resource to deliver subject matter expertise for a new technology initiative, it would also make little sense to attempt to utilize high-cost, highly specialized subject matter expertise to backfill a staff-level employee. In most cases, it is at this step where corporations make their biggest mistake: retaining and utilizing the wrong type of contract labor to meet their needs. Typically, this involves selecting extremely high quality, highly specialized subject matter experts to complete work or deliver services that could easily be provided by a different (lower) tier of resource. While the work gets done in this scenario (and usually very well), the cost of the work is typically far higher than it would be if a staff augmentation resource, eminently qualified to perform the same work, was retained at reasonable bill rates.

Understanding the different types of Contract Labor (and the major cost drivers within each) and ensuring the right type of contract labor is selected are the initial steps to successfully utilizing contract labor. With spend on outside resources on the increase, utilizing these building blocks with regard to contract labor ensures that the required workload is completed and that costs are balanced and reasonable. ¦

About the Author: Adam Cummins is an associate at Pace Harmon, an advisory and management consulting firm focused on providing business support through the sourcing lifecycle for large-scale technology, outsourcing, network and other complex transactions.

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