Calculating The Cost of Contingent Workers

November 1, 1994
Managers in the United States are great at jumping on bandwagons without stopping to evaluate whether the direction the wagon is traveling is the right one for their particular company. Ask your HR colleagues about highly publicized management initiatives-diversity training, total quality management and reengineering, for example-and chances are they're involved in such efforts or are thinking about becoming involved in them.

The reason business people tend to follow each other's lead is because, when done right, strategic initiatives do save money and create more efficient organizations. The press reports on successful programs, people take note, and in an effort to improve their own organizations, they follow suit.

And so it goes with contingent staffing. You read surveys indicating that 44% of CEOs say that they rely more on contingent workers now than they did five years ago, and you don't want to be left out. You hear how companies such as McDonnell Douglas and Georgia-Pacific use contingent workers as an integral part of their staffing strategies and assume that what's cost effective for them might also be profitable for your company.

But is the use of contingent workers as cost effective as everyone claims it to be? How much money do temporary workers really save a company? And how do companies that rely on contingent staffers substantiate their savings?

In seeking to answer these questions, Personnel Journal searched for national studies comparing the costs and returns of contingent workers with the costs and returns of permanent employees. We found none. There's no way to calculate an average cost benefit for contingent workers, we discovered, because of great differences in the type of work they do, the length of their assignments, the nature of the employing companies and so on. The cost effectiveness of contingents, therefore, not only varies from company to company, it's likely to vary from department to department.

Unfortunately, we also couldn't find a single company that was able to document the savings provided by their contingent work force. Instead, most managers who rely on complementary workers told us something like, "It's apparent intuitively that temporary employees who are brought in to handle unpredictable bulges in work are cheaper than maintaining permanent employees on standby," as did David A. Riggs, first vice president and director of purchasing for Mellon Bank located in Pittsburgh.

He's probably right, but HR professionals today must account for their actions and demonstrate the bottom-line benefits of HR strategies. How do you prove contingent staffers are saving your company money?

Calculating the cost effectiveness of contingents.
"You must evaluate the 'true productivity' of contingent workers," says Myrna Hellerman, senior consultant with Chicago-based Sibson & Co. This is the output of goods and services produced per hour by contingents, divided by the input, which is the cost of employment per hours worked. Cost effectiveness depends not only on wages and benefits, you see, but also on productivity. High-wage labor might be cost effective if it's also high output, whereas low-wage labor may not be if the output also is low.

Although the equation seems pretty straightforward, in the real world there are additional factors, such as training costs and the length of time on a job, that must be considered to calculate the true productivity of contingents. Stanley Nollen, professor of management at Georgetown University and author of the study Exploding the Myth: Is Contingent Labor Cost Effective? published in 1993 by New Ways to Work, suggests HR professionals looking to calculate the return of contingent workers do the following:

  1. Compare the agency's charge or the wages paid to contingent workers with the wages and benefits paid to regular employees doing the same kind of work.
  2. Compare productivity between the two groups. If you don't have any way to measure productivity, Nollen suggests calculating three scenarios in which you assume the productivity of contingents is:
    • 10% better than the productivity of permanent employees;
    • equal to the productivity of permanent employees; and
    • 10% less than the productivity of permanent employees.

  3. Calculate the unit labor cost per employee, which is the cost of employment adjusted for productivity. If the wage and benefit cost of contingent workers is 12% less than regular employees, for example, and productivity is 7% less, then the unit labor cost of contingents is still 5% less than permanent workers.
  4. Factor the cost of training contingent workers, such as classroom rent, wages and lost output.
  5. "Now comes the really hard part," Nollen says. "You have to look at the payback of training after the training is over." That's done by determining the value of output produced by the contingent worker and comparing that to the money you're paying for that person's wages and benefits. After training, the output that workers produce for the company should exceed the cost of their wages and benefits, and that gap is how you earn back your training costs.
  6. The last thing you need to consider is how long the contingent worker stays on the job. "The problem is that if you lay out training costs up front, you have to wait to get the repayment over time," Nollen explains.

After all these factors have been considered, Nollen says that you face three possible outcomes. You've paid back all the training costs through increased productivity; you don't get all the training costs paid back, but you're still ahead because the lower wages and benefits you pay contingent workers provides savings large enough to cover the unrecovered training costs; or you don't get the training costs paid back, and furthermore, so much of the costs remain that they consume the savings you've generated by paying contingents lower wages and benefits.

Putting the formula to the test.
Nollen used this formula when he evaluated the cost effectiveness of contingent workers in three companies, including a large financial institution that used temporary workers to cope with fluctuations in work load. These workers were hired primarily to do 10-key data-entry work in the operations division, work that was also done by regular full-time employees.

In this company, temporaries received a wage rate approximately 12% lower than regular employees. The temps got no benefits except those provided by their agency. Because the fee paid to the agency was the same as the benefit cost for regular employees overall, the company paid less for temporaries.

Productivity records showed that the temporaries produced 7% less output per hour than regular employees after accounting for differences between the two groups in shifts and number of hours worked. Because the productivity shortfall was not as big as the wage savings, the unit cost of contingent labor was lower by 5%.

Training costs also were low at the company-only approximately $260 per new contingent worker-because the agency supplied people with some prior data-entry experience. This meant it only took four to six months for training costs to be recovered. Because the average temporary stayed on the job seven months, training was a good investment.

In conclusion, because unit labor costs were lower and training wasn't expensive, contingent labor was cost effective for data-entry jobs at this company. In the two other companies, however, contingent workers weren't cost effective because training costs were high and the workers' stays on the average were too brief to make up the training costs.

How to boost the returns.
If, after completing your own evaluation, you determine contingent workers aren't cost effective, instead of scrapping them altogether, Hellerman suggests taking a hard look at how you use them. "Obviously, for contingent workers to be cost effective, we need ways to maximize output and minimize input," she says.

A mail-order processing firm with which Hellerman worked, for example, would frequently temp-up to handle seasonal peaks in the business. On the surface, the $6-per-hour temps appeared less expensive than the $9-per-hour employees. But the temps could only process 500 pieces of mail per hour, whereas regular employees could process 1,500 pieces. The actual unit labor cost, therefore, was twice as high for temporary workers. "The whole argument for using temps went out the window," explains Hellerman.

Still, it didn't make sense for the company to get rid of temps altogether because seasonal fluctuations were a business reality, and maintaining a full-time staff of permanent employees during low periods would be cost-prohibitive.

What the company did was analyze the work flow to determine the actual amount of steady work. Managers discovered there was more regular work than previously estimated, and that instead of relying on temporary workers 68% of the time as they had been, they could reduce their usage of temporaries to 30%, saving money and boosting productivity in the process.

Another way to increase the cost effectiveness of contingents is to carefully analyze the arrangements you have with suppliers. "The savings aren't to be found in reducing the number of heads that come in the door, it's in the way the relationship is structured between the company and the staffing agency," explains Mitchell Fromstein, president and CEO of Milwaukee-based Manpower Inc.

Nashville, Tennessee-based Northern Tele-com, for example, recently signed an agreement giving Manpower total responsibility for meeting its temporary staffing needs in the United States and Canada. By going to a single supplier, the company not only has been able to negotiate volume discounts, but has significantly reduced administration and paperwork. "We used to work with 60 to 70 suppliers," explains Elaine Windsor, professional programs manager for the company's National Resourcing Center in Ottawa. "Now, one company will handle and bill us for all our needs. In terms of invoice processing alone, this represents a significant savings."

Jeffrey Schmidt, managing principal with Towers Perrin in Chicago, agrees that preferred-supplier arrangements are a smart business move for employers looking to get a handle on their costs for temporary workers. He adds that companies also should have a clear view of the skills and competencies needed by contingent employees. "If you don't, you're almost guaranteed a high-error and low-productivity rate."

So, in companies that do this kind of analysis and then negotiate with their suppliers, are contingent workers cost effective? "I'd say they are," Schmidt explains, "but not enough companies are evaluating their use of contingents from a cost benefit standpoint." If you're using large numbers of contingent workers without knowing the return they provide, you risk weakening the organization's ability to withstand unpredictable business cycles, rather than strengthening it

Personnel Journal, November 1994, Vol. 73, No. 11, pp. 48a-48c.