Consider the following scenario: John has managed to secure the funding he needs to start his company and is now in the process of hiring his development team. He wants to hire the best software engineer talent possible and was referred to Andrew, a freelance consultant who came highly recommended. There’s only one problem. Andrew’s rate is $70 an hour, and after doing some basic calculation John decided that that the asking rate is way too high considering the average work hours per year is 2080, which would make Andrew’s annual salary over $145K. John figures that he can hire an equally good employee for $100K or less and so decides to look for a permanent addition to his company rather than a consultant.
An inaccurate analysis
Regrettably, like too many hiring managers out there John’s analysis was overly simplistic and highly flawed. Fact of the matter is that when hiring a permanent employee vs bringing on a consultant, the costs are vastly different when you consider all the different factors involved in hiring either a consultant or bringing in an employee. John doesn’t realize it but he would actually have saved money had he considered working with Andrew.
It’s truly mind-boggling how few business owners consider properly accounting for the actual cost of their labor. Errors like these can eat away at your bottom line if you’re a product company, and if you have a services company then these errors can result in you spending more money providing a service than charging for it.
The debate between employee vs freelancer is not a new one so there are many methods that are available to help you make an informed decision when facing this dilemma. In this blog let’s talk about the information that you need to know when making smart hiring choices.
The real picture
John is thrilled. He’s found Pete, an employee for $95K/year.John made a few calculations and figured that this means Pete is costing him $45/hour where Andrew The Consultant was costing him $70/hour. John pats himself on the make for making such a smart hiring decision and saving such a substantial amount of money.
But is he really?
Unfortunately for John things are not so simple and many of the readers must have also gauged that there are plenty of factors that were not taken into account when John was making his calculations. John didn’t factor in the benefits that employees receive as a norm. Aside from health insurance, dental insurance, 401K contributions, John didn’t even factor in the vacation time that his employee has to be given as a company policy. But benefits are only the tip of the iceberg. Let’s look at how much it really costs when hiring an employee.
Tipping the scales
When you’re running a business there are many things that are required as a given. Running a business is Expensive. From the cost of office space to phone systems to computer equipment to administrative staff to payroll services, it all adds up to quite a hefty amount. And these are things that are part of the infrastructure that your employees get to use for free.
While you’re not charging your employees for these costs they are most certainly benefiting from them. That means that a portion of the corresponding cost can be attributable to him or her. Search for a company’s indirect costs and you’ll get a list that includes the following:
- Accounting fees
- Bank service charges and fees
- Check orders
- Computer hardware
- Computer software licenses
- Computer software subscriptions and maintenance
- Conferences and trade shows
- Corporate graphics and web design
- Corporate taxes (property, etc.)
- Credit card processing fees
- Delivery and postage
- Digital certificates
- Dues and subscriptions
- Filing fees
- Hosting services
- Insurance (liability, workers comp, etc.)
- Interview expenses
- Legal fees
- Meals and entertainment
- Meeting expenses
- Office supplies
- Overhead staff (executive, administrative)
- Printing services
- Recruiting (advertising and fees)
- Repair services
- Voice and data communications
That’s certainly a long list and you know what? It’s not even a complete representation of the indirect costs a company has to bear.
The consultant’s side
Not being an official employee of the company there are many costs that do not apply to an outside consultant or freelancer. Yes, there are certain costs that the company has to pay their consultants that are similar to an employee, but they are significantly less. The price of a consultant are affected by General and Adminstrative (G&A) costs only. Company benefits and overheads are irrelevant for the consultant and there is no requirement for the company to pay these out.
There are certain financial risks to consider as well. It is not uncommon for companies to keep under-performing employees on the payroll through various stages of probation to avoid the risk of a wrongful termination lawsuit. Consultants are let go with little to no notice if they aren’t performing as they should and this has no risk to the company from a legal perspective.
One obvious savings with consultants is the avoidance of often hefty recruiting fees. What may be less obvious, though, is that each recruiting fee paid drives up the real cost of all employees. Since recruiting costs are including in overhead expenses, every recruiting expense that your company incurs increases your overhead costs, which in turn raises your overhead rate multiplier, which in turns drives up the effective cost of each and every one of your employees (i.e., since the overhead multiplier is used in calculating every employee’s real cost, the higher that multiplier is, the higher each employee’s real cost ends up being).
When making the in-house vs consultant decision it’s very important to consider all of of the hidden costs that are incurred during hiring. Not everything is what it seems and over-simplifying your hiring process can be damaging to the potential success of your company. Hopefully this article shines a little light on the matter and provides you a better picture when it’s time to send out that email vs printing out a contract.