What does an employee really cost?

Do you know how much you are paying for your employees? The cost of an employee is not just their salary, it includes their benefits package, government mandated overhead, the cost of hiring and firing or layoffs, as well as facilities (office space and equipment) and employee support services such as those provided the human resources department.

Many people find it hard to believe, but a rule of thumb for the cost of an employee in the USA is roughly twice their salary. This leads to a good rough approximation that the hourly cost of a salaried employee is their annual salary divided by 1000. For someone earning $100,000 / yr, they are costing your company about $100/hour of actual work performed. A large percentage of this can come from the indirect costs listed above, particularly when you take into account how long the employee may actually stay with your company. If you spend $60,000 to find, hire, and layoff an employee over a three year period (this is not unusual), that amounts to an extra $20,000/yr you are paying for that employee.

As an example, using numbers from the USA for a senior engineer in a metropolitan area at a mid-size company. Though these numbers may vary widely depending on the country and city your company is located in as well as the size of your company (overhead is generally higher at small companies), these numbers are generally representative for a mid-range market and would be much higher if your company was located in some place like the silicon valley area. Of course the salary would be much higher in silicon valley as well, so the general rule would still hold.

Hours worked per year
Hours Description
2080 52 weeks per year, 40 hours per week
- 80 10 days paid holidays
- 80 10 days paid sick leave
-160 20 days paid vacation
1760 Total working hours

 

Benefit / expense payments
Amount Description
100000 Salary
7650 Social security and medicare (employer payment = 7.65%)
2000 Unemployment insurance (2.0% of payroll)
10000 Medical/dental insurance (employee and family)
10000 Training and education (conferences, books, online training, company training, etc.). The actual cost is even higher because they are not working on company projects during this training. Though this would likely save money in the long run due to increased skills, that only applies if they don't leave the company.
5000 Facilities (phones, desk, office equipment, office maintenance, ...)
2000 Legal, accounting, HR (hard to quantify)
4000 Office/work space (@$20/sq ft/yr)
20000 Hiring / Firing / Layoffs (severence package), 60% of salary spread over three years
10000 Miscellaneous business overhead per employee: insurance (bus. liability and facilities), energy (heating, cooling, electricity), team building, support staff (secretarial, janitorial and other services), ...
170650 Total

Computing the hourly rate:

$170650 / 1760 hours = $97 / hour

or, using our rule of thumb:

$100000 / 1000 = $100 / hour

An outside, independent contractor will generally have the same overhead per employee that any other company has, whether they are a one man shop or a large consulting firm. Some who are new to independent contracting may charge artificially low rates because they are not aware of their actual overhead costs or to attract new customers, however, they are selling themselves short. Many don't last as indepdendents because they find that they will make more money working as an employee for someone else due to setting their rates too low.

Some companies reject the hiring of consultants on the grounds that they want to retain the knowlege in house, but this goal is an illusion. In a normal market, employee turnover for the technically skilled is often in the three to five year range, in a good market, that may drop down to as little as one year. Your employee may have barely learned your products before leaving. A professional contractor on the other hand can provide you with services on demand, without repeated training, spanning many years. I worked on a variety of projects for one customer spanning a period of 15 years. It is a safe bet that I knew more about how their products worked than any employee of the company, as only some members of management had been with the company for that entire time period. Despite being an outside contractor, with me they had been able to maintain the continuity that they were not able to maintain using employees. Unfortunately, they were finally purchased by a company which had an absolute "no contractors" policy, so they lost access to my knowledge and skills.

Other advantages of using a contractor:

  • On demand development that can be hired or dropped without financial consequences. If you hire and then lay off an employee, this can significantly affect the rates you pay for unemployment insurance, which are a percentage of your entire payroll. There are no such consequences with an outside contractor.
  • Expensive skills that you only need occasionally. Do you really want to pay the long term salary for a developer with highly specialized skills that you only really needed for one short term project? It makes more sense to pay for the specialty skills you need, only when you need them.