“Mark-Up” Contingent Worker Program Pitfalls

This article focuses on the major pitfalls of using a mark-up strategy: the unintended consequences of choosing the easiest strategy to manage.

Introduction:

Contingent workers make up more and more of the world workforce every year. The flexibility, speed, and effectiveness of using contingent workers is driving the growth of the contingent workforce. Sources researched, including the Bureau of Labor Statistics, indicate that contingent workers make up about 40% of the total US workforce. A staggering number.

Because of the widespread use of contingent labor, many companies have focused on better managing what has become one of their largest GS&A expense categories. Some have implemented a Vendor Management System (VMS) that provides a single portal through which contingent labor is managed. VMSs are often integrated with other systems like financial and accounting systems, procurement systems, and human resources systems.

Other companies have selected a Managed Service Provider (MSP) to be the intermediary between the company and its contingent worker suppliers. All MSPs use VMS systems as part of their service delivery. Some have proprietary systems, others use “off the cloud” Software as a Service (SaaS) systems which are purpose-built for managing contingent workers.

MSPs often consult with their customers to develop the contingent worker cost management strategy of the program. Some companies choose to use a standard “rate card” for contingent worker position categories being managed. Others use a “competitive bid” strategy. While still others choose a “mark-up” (of W2 pay rate) strategy.

There are pros and cons to whatever contingent worker cost management strategy you select.

Mark-Up Program Cost Factors:

Almost all mark-up contingent work programs use a straight mark-up of only the worker’s W2 pay rate. This is where the pitfalls emanate. To understand the problem, one must look at how a bill rate from a contingent labor supplier is developed.

The major cost categories for companies like mine (that supplies over $100M in contingent worker services to large customers nationally) are these:

  • W2 Pay (direct compensation)
  • Statutory Expense (taxes)
  • Benefits (indirect compensation)
  • MSP Charges (usually a percentage of bill rate)
  • Profit

Workers always consider W2 Pay and Benefits when calculating their effective Total Compensation.

Some contingent worker suppliers, like my company, have a core cultural commitment to their W2 employees. As the Chief Executive Officer, I feel responsible for treating all our associates (which includes W2 workers as well as subcontractors) with respect, honesty, and compassion. We have above average health, dental, vision, short-term disability, long-term disability, and life insurance coverage. We have a 401(k) Plan with a 3% match that vests immediately (yes, that’s correct, IMMEDIATELY). We have FSA and HSA accounts.

We also pay a high percentage of the premiums for these benefits, which means there is less contribution and out-of-pocket expense for our employees.

At the other end of the spectrum there are contingent worker suppliers that treat their employees like any other expense in their business. They do everything they can to pay their employees the lowest wage possible. If they provide any benefits at all, they often pay only a token percentage of the total cost for benefits, or nothing at all. The cost burden for benefits from these suppliers falls almost 100% on the employee.

Let’s look at what this means to both the end user of contingent labor and the worker in a typical straight mark-up program.

Assumptions:

  • The customer has a Mark-up Limit of 40% of W2 Pay Rate
  • The customer has a Bill Rate target (expense budget) of $75.00 per hour for a contingent position they need filled
  • The MSP Charge is 2% of the bill rate
  • Statutory Expense is 14% of W2 pay rate
  • “Employee-Friendly Supplier” Hourly Benefits Cost = $6.00 per hour
  • “Employee-Unfriendly Supplier” Hourly Benefits Cost = ZERO
  • Effective Total Compensation (to Employee) = Hourly W2 Pay — Their Hourly Cost for Benefits

Comparison:

The unintended pitfalls of a straight mark-up contingent labor program:

  • It incentivizes Employee-Unfriendly Suppliers by allowing them to generate more profit in your program than Employee-Friendly Suppliers. You are penalizing Employee-Friendly Suppliers.
  • You get less qualified talent from Employee-Unfriendly Suppliers because their employees’ effective Total Compensation is less. Better talent costs more. Less talented workers will accept lower compensation.

Bottom line, you get less qualified talent from a straight mark-up program. Plus, our statistics show that there are many more engagements ended unsuccessfully by talent from Employee-Unfriendly Suppliers. Either based on unacceptable performance, or the worker leaves an assignment before its intended conclusion to accept an offer from an Employee-Friendly Supplier.

There is tremendous cost associated with premature departures of contingent workers and the additional ramp-up and training time (and expense) of their replacement. Not to mention impacts to project timelines for initiatives that need to be completed to reduce the company’s expenses or increase the company’s revenues.

Simple Solutions

The pitfalls of a straight mark-up program can be fixed easily:

  • Allow Employee-Friendly Suppliers to add their benefit cost to W2 Compensation and calculate the allowable mark-up on this number.
  • Take benefit cost out of the equation and allow Employee-Friendly Suppliers to bill you for their verifiable benefits cost for the worker with no mark-up.

These solutions can be easily implemented and audited using any VMS system and any MSP.

Conclusion

Leveling the playing field between Employee-Friendly Suppliers and Employee-Unfriendly Suppliers will get you better talent who stay for the intended length of your engagements.

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