Contractor Management

Cost of an Employee vs. Cost of a Contractor

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Cost of an Employee vs. Cost of a Contractor
Written by
Mayank Bhutoria,
June 24, 2024

Key Takeaways

The conventional 9-5 job is losing appeal, and the gig economy is booming, with 36% of the global workforce choosing to freelance. This has made HRBPs and finance leaders shift their focus from permanent employees to working with independent contractors.

Cost is one of the most common aspects employers focus on when weighing the pros and cons of employees vs. contractors. With contractors, you eliminate the financial burden of health insurance, 401(k) matches, vacation time, and additional benefits. However, it is vital to acknowledge the risks and limitations of working with independent contractors. 

In this blog, we’ll discuss in detail the cost of an employee vs. the cost of a contractor (with examples) to help you decide the best for your business. 

Let’s begin with the distinction between the cost of contractors and full-time employees. 

Employee vs. Contractor - The Distinction 

Here are some differences of Employee vs. Contractor for you to make an informed decision and meet your business objectives.

Key Distinctions Employee vs. Contractor Contractors
Employment Relationship Full-time employees have a formal employment relationship with your organization, while contractors are engaged through contractual agreements. Usually covered by contractors themselves
Control and Independence Full-time employees work under organizational supervision and direction, while contractors are more autonomous in managing their work. Not applicable
Benefits and Obligations Full-time employees are entitled to health insurance, retirement plans, and paid time off, whereas contractors are responsible for their benefits and tax obligations. Not applicable
Legal and Regulatory Considerations Different legal and regulatory requirements apply to full-time employees and contractors. Misclassifying workers can have legal and financial implications, highlighting the importance of proper classification. Not applicable

Factors Contributing to the Real Cost of Employees & Contractors

Factors Employees Contractors
Insurance Required Usually covered by contractors themselves
Social Security Contributions Employer and employee contributions Not applicable
PFs (Provident Funds) Employer and employee contributions Not applicable
Professional Taxes Applicable Not applicable
Annual Bonus Typically included Not included
Payroll Taxes Employer's responsibility Not applicable
Fringe Benefits Provided by employer Not applicable
Recruiting Fees Incurred during hiring Not applicable


The True Cost of Hiring an Employee & Its Calculation

To calculate the hiring cost of a permanent employee, ensure costs are allocated accurately. Hence, it is essential to categorize the indirect costs into three main types:

Fringe Benefits: These include costs such as health care, retirement contributions, paid time off, and workman's compensation.

Overhead: This encompasses business expenses not attributable to a specific project, such as rent, office supplies, communication charges, and hosting services.

We can determine the additional annual overhead costs incurred by including building costs, property taxes, utilities, payroll taxes, benefits, insurance, supplies, and equipment. 

Here’s an example.

Let’s assume that an employer spends an additional $80,000 on overhead costs for 10 employees, the per-employee additional expenditure amounts to $8,000 annually. Adding this to annual labor cost, the average hourly cost rises to approximately $68.

General & Administrative (G&A): These expenses pertain to running the business. It includes salaries for corporate executives, administrative personnel, legal fees, and accounting fees.

*Applying multipliers to these categories according to a report by Grant Thornton, such as fringe benefits (35%), overhead (25%), and G&A (18%), yields an estimated cost multiplier of 1.99. Each employee typically costs your company roughly twice their base salary.*

Let us illustrate the cost of employing a permanent employee with an example. 

Consider a permanent employee named Martin, who is paid $60 per hour. If Martin works 40 hours per week for 52 weeks, their labor cost will be $124,800 per year (pre-tax). However, when accounting for 15 days of paid leave, their actual working hours were reduced to 1,960 per year, making their effective hourly rate closer to $64.

Take  Martin's example; considering their $60 hourly rate, the true cost to the company amounts to approximately $248,000 per year when applying the 1.99 cost multiplier. This brings the hourly rate to approximately $120. The hourly cost rises to around $130 when paid time off is factored in. It is evident that the hidden costs of employing an individual can significantly surpass initial estimates, necessitating careful consideration of the comprehensive expenses involved. 


The True Cost of Hiring Independent Contractors & Its Calculation

To make a fair financial comparison between hiring an employee and engaging a consultant, it's important to consider the true costs involved:

Initial belief: The common perception is that hiring an employee is cheaper while engaging a consultant is more expensive.

Here are some additional points to remember:

Potential financial risks: Hiring an employee involves risks, such as the cost of retaining underperforming employees and potential legal complications. In contrast, ending a consultant's engagement is typically easier and less costly.

Impact of recruiting fees: Hiring employees often incurs recruiting fees, which can significantly impact the overall cost. It is essential to recognize that these fees not only affect the hired employee but also increase the real cost of all employees due to higher overhead expenses.

Key Takeaway:

Examining all the hidden costs is crucial when considering the cost implications of hiring an employee versus engaging a consultant. Each situation is unique, and there is no one-size-fits-all answer. However, knowing the factors discussed in this article will help you make informed decisions that align with your business needs and financial considerations.

Cost Of An Employee Vs. Contractor - Which One Should You Choose?

When deciding to expand your workforce, it's essential to consider the cost implications of hiring employees versus engaging contractors. Both options have advantages and can be justified depending on specific circumstances. In this section, we will explore situations where the cost of a contractor can be justified and times when the cost of an employee is more advantageous.

Cost of a Contractor - When can it be justified?

        1. Short-term Projects or Specialized Expertise:
  • Contractors are often suitable for short-term projects requiring specialized skills or expertise.
  • Hiring a contractor for a specific task or project can save costs associated with long-term employment commitments.
        2. Flexibility and Scalability:
  • Contractors offer flexibility in project duration, allowing you to adjust your workforce based on fluctuating demands.
  • Engaging contractors can be beneficial during peak periods or when additional resources are required temporarily.
         3. Access to Specialized Talent:
  • Contractors often bring unique skills or specialized knowledge that may not be readily available within your existing team.
  • By leveraging contractor expertise, you can access a wider talent pool and tap into industry-specific insights.

Cost of an Employee - When can it be justified?

         1. Long-term Commitment and Stability
  • Hiring employees is suitable when you need consistent and ongoing support for your business operations.
  • Employees provide stability, continuity, and long-term commitment, which can be essential for core functions and team collaboration.
         2. Company Culture and Loyalty:
  • Employees become part of your organizational culture and foster loyalty towards the company.
  • Hiring employees who align with your values and vision can contribute to a cohesive team and a strong company culture.
         3. Collaboration and Growth:
  • Your company grows with its employees. Having employees who are constantly upskilling means your organization’s abilities grow as well. Contractors don’t offer such growth. .
  • Building a team of employees fosters collaboration, knowledge sharing, and the ability to work towards common goals.

Team Up with  Gloroots To Hire Contractors & Employees

Choosing between employees and contractors requires careful consideration of costs, needs, and strategic objectives. Whether you opt for contractors' flexibility or employees' stability, making an informed decision is crucial for your business's success.

At Gloroots, we understand the complexities of managing a global workforce and offer a comprehensive solution to streamline your employment processes. With our cutting-edge technology, in-house expertise, and exceptional customer service, we simplify global employment, making it simple and scalable.

Our highly transparent EOR solution can help you onboard a global team without establishing local entities. We can manage your payroll, guarantee timely payments, offer the best employee benefits across 140+ markets, and help easily scale your contractor teams.  In short, our "all-in-one" EOR solution can empower you to hire anyone, anywhere, maximizing your workforce potential.

Contact us today and unlock a world of possibilities for your global employment needs.

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