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Contractor payroll: Are you overpaying for your Directly Sourced workers?

Feb 11, 2021

Alex MacKenzie
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Alex MacKenzie
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One of the advantages to engaging contingent workers is the ability to shift payroll expenses from fixed costs to more variable costs in order to gain greater control over contingent workforce spend. However, a de-centralized program will result in inconsistent hiring and management tactics that prevent seamless administration over functions like contractor payroll. 

If your organization is experiencing leakage in its contractor payroll program or you're interested in learning more about how to better manage your contractor payroll program, the following information will provide insight.  

Contractor payroll: How to pay contractors 

Contingent workers can go by many different names: contractors, temporary workers, gig workers, contingent labor, Independent Contractors, freelancers, contract employee, temporary talent or pre-identified contractors; yet they all refer to the same type of non-traditional worker.   

Depending on the method in which a contingent worker is engaged to perform the work - whether directly sourced through an organization itself or by way of a third party, there exists separate obligations to payroll and how to pay contractors.   

Payroll obligations to a directly sourced contractor

Directly Sourced Contractor Payroll refers to the tasks an organization must execute to ensure  contingent workers who have been sourced through the organization itself, rather than through a third party like a staffing agency, are paid correctly and on time in accordance with their contract or Statement of Work (SOW).   

These contractors are self-employed and are not employees; therefore, organizations are not responsible for the withholding, collecting or paying of income tax nor any other payments afforded full-time employees or Temporary W2 workers who are sourced through a third party.   

Now that we've established how to pay these contractors, here's why you may be overpaying them.  

Why you could be overspending on contractors

Organizations must classify contractors depending on their employment status (or face misclassification penalties and/or fines), and more often than not, this results in drawing a distinct line between workers, splitting management responsibilities between Human Resources and Procurement. 

Yet, when HR is concerned with talent opportunities and Procurement cares about cost and compliance, organizations end up operating their contingent workforce like separate entities, causing inconsistent pay rates across the entire program.  

Where and why overspending on contractors may occur within your payroll program.  

While a candidate may be the best resource for a job, they are often not the most cost effective one for the business. There may be a variety of reasons why an employer could be paying too much on contractors; the examples below offer insights into those reasons: 

Budget discretion  

When negotiating the job offer, an employer will often agree to a pay rate with the resource if there is room for it in their budget. 

Lack of payroll data  

An employer is often not always aware of the market rate for specific skill sets, and therefore, may extend an offer with automatic acceptance of the resource’s requested pay rate without challenging it. 

It's important to use talent acquisition data to establish payroll benchmarks on what the organization pays for specific contractor work. If your organization already has a rate card, even better. Use it and compare it against acquisition results, paying particular attention to the use of “niche” or “other” contractor worker types. 

Worker status 

An employer may not take the worker's status into account when negotiating pay rates, impacting the overall payroll cost when extending an offer.  

Lack of negotiation   

An employer may not be comfortable negotiating with the contractor for fear of disrupting the relationship and potentially losing that resource before an offer can be extended. 

HR and Procurement operating in silos 

HR and Procurement departments may both be engaging Independent Contractors in silos without a streamlined process in place, causing inconsistencies in pay rates and overall payroll for similar labor. 

Is your rate card up to date? Rate cards will affect Independent Contractor payroll!  

Most contingent worker programs use rate cards as a tool to control spending and evaluate program efficiency. This is great in theory, but in practice, it’s only as effective as the quality of an organization’s process for ensuring that contingent workers are assigned to the correct job categories. Incorrect categorization of contractors – whether intentional or accidental – will negatively impact a rate card’s integrity and reported numbers like savings.  

Rate card leakage  

Procom’s data estimates that over 80 per cent of payroll programs suffer from rate card leakage to some degree, resulting from category expansion (an intermediate worker being moved to a ‘senior’ rate card bracket), category shifting (a business analyst being placed as a business systems analyst) or the frequent practice of categorizing contractors to exception categories that are excluded from rate card analysis.   

Controlling rate card leakage starts with proper categorization of contractors based on their resume credentials, interview assessment and prior work experience. Improper categorization typically drives 6-13 per cent in additional rate expenses. This makes having a solid plan for position categorization a critical element in the overall framework of contingent workforce payroll spending controls. 

HR and Procurement: Breaking down the silos for contractor payroll cost savings 

To achieve a successful and cost-effective workforce, HR and Procurement must foster collaboration and communication to promote the types of cross-functional strategies that create greater visibility, access to data and enhanced control. 

While HR will track metrics like engagement and retention of contractors and Procurement KPIs will focus on cost and risk with contractors, it’s critical for each function to identify and embrace a shared goal. This means breaking down the silos between departments to understand what drives the other and what objectives each must meet.  

Understanding the needs of both departments and connecting priorities encourages each one to work towards its common goal: filling skill gaps with high-quality contractors in the most cost effective manner. 

Track your results 

If you can’t measure it, you can’t manage it!  

Make sure you track your hiring metrics. What are you finding? Are there certain hiring managers that are less compliant in the organization? Are there specific roles that you have less success negotiating with contractors? This is powerful information for your organization to be aware of.  

When paying contractors, it's critical to implement payroll solutions that will help engage proven talent and reduce administrative burden - allowing organizations to increase the time spent moving business forward. 

Are you interested into gaining deeper insights into saving on contingent worker payroll costs? 

View our free Case Study and get deeper insights into how Procom's payroll and rate negotiation services helped one client partner achieve cost savings and more: Download Case Study

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