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, equipment and basic IT services) and employee support services such as those provided by 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 and hire an employee who leaves after three years due to a better job offer or layoff, that amounts to an extra $20,000/yr you are paying for that employee. If the $60,000 sounds ridiculous, consider that costs of hiring top engineering talent may include some or all of the following: flying multiple candidates in for interviews (including car rental and hotel expenses), paying a search agency commission, moving expenses, the time spent by management (among your most expensive personnel) and other employees interviewing and discussing the prospective candidates, as well as the paperwork performed by the human resources department for the actual hiring and compliance with government regulations. Finally, how much does it cost your company in salary and benefits while your new engineer comes up the learning curve for the project(s) he was hired to work on, as well as learning how your company operates?

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.

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 additional financial consequences. This makes the risk of hiring the wrong contractor quite low when compared to hiring the wrong employee. 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. Due to employment laws and government regulations, there are many other possible problems with laying off an employee. 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.