You have just been quoted an hourly bill rate from a recruiter at a tech staffing firm and you are wondering: Is this pricing fair? If you would pay $110K for a full time hire, why do they bill you $90-$115 per hour, or even higher?
You are a contractor or consultant, and you are wondering why you are getting paid less than the bill rate to the client. Is it fair?
How is pricing set at IT Staffing companies? What are staffing pricing models? How do they calculate bill rates? How is the pay rate calculated? What explains the difference in the bill rate and the pay rate? Are staffing agencies worth it?
I have sometimes heard people say, “Why is the staffing company taking my wages?” “Why does the staffing company take such a big cut?” “What percentage does the staffing company take?” or “I should be paid a bigger percentage of the bill rate.”
This article explains the reasons for the pricing that IT Staffing companies charge. This article applies to Technology Staffing (or IT Staffing) which includes positions such as Software Engineers, Software Developers, Software Architects, Data Engineers, Cloud Engineers, Network Engineers, Enterprise Architects, IT Security professionals, Business Intelligence Analysts, Business Intelligence Developers, AI (artificial intelligence) and ML (machine learning) Engineers, Product Managers, Scrum Masters, Product Owners, Product Managers, Business Analysts, and Business Systems Analysts, Technology Managers, and similar positions.
Everybody knows that tech staffing firms make an hourly margin. They charge client companies a bill rate that is higher than their hourly pay rates. This is the basic business model of IT Staffing.
A lot of misunderstanding comes from people comparing the bill rate with the pay rate. The first thing to understand is that the Tech Staffing firm’s hourly cost is higher than the actual pay rate. Therefore, the difference between the bill rate and the pay rate does not equal the margin for the staffing company. This is explained below.
The second thing to understand is that a tech staffing firm has a lot of costs behind the scenes. These are the general expenses of running an IT Staffing agency that need to be considered. It takes considerable investment to run a reputable and stable firm that provides excellent service.
The margins in IT Staffing have settled into place over years of trial and error by many different IT Staffing companies in a competitive market. Companies that tried to charge too much failed. Companies that charged too little went out of business also. Pricing has settled at this level for a reason. This is the pricing needed to run a viable company.
IT Staffing Firms usually net about 5% of revenue which makes it a low margin business. In comparison banks and software companies have net margins of about 24%, drug companies 14%. The “Business and Consumer Services” category has an average net of 5%.
First – A Common Misconception
A very important thing to understand is that staffing companies do not take a cut of the wages.
The contractor and consultant always earn a fair market wage for the work they do. Otherwise, they would not accept the job, or they would not stay in the job. They would take a different job instead.
The starting point of the pricing is a fair market wage for the contractor / consultant. Then comes added expenses which are explained below. And then yes, some margin is added as well.
Tech staffing is like any other service business. Employees are hired to provide the service and paid market wages. Client companies buy the services at a higher price which covers the employees’ wages, the other costs of running the business, and some margin as well.
The client company pays the margin by paying added fees on top of the market wages paid to the contractor/consultant. The contractor/consultant gets a full wage, and the client company pays the service fees.
Top 12 Factors in Pricing IT Staffing Services
Contractors Are Paid More on an Hourly Basis than Full Time Hires
Tech workers demand a premium for taking contract roles. They have less job security, time off, and their benefits are not as strong as full-time employees at companies.
In addition, they need to bank some money for the inevitable downtime that will come from between one project and the next.
It is one of the benefits of working as a contract consultant – you make more money on an hourly basis.
This is one factor that increases the costs for the IT Staffing firm. In the example scenario at the top of this article, the salary level for the position is $110K. This would be $55/hour if you do not consider a contract consultant premium. In this scenario, the IT Staffing company will typically pay $60-$70 per hour or more to secure top talent on a contract basis.
The IT Staffing Company has Direct Payroll Costs on Every Dollar of Payroll
Most IT Staffing companies hire their contractors on a W-2 basis. There are payroll taxes such as state and local taxes and social security taxes. This typically runs 12-15% of the amount paid in wages. These are costs directly associated with every dollar of payroll paid and does not include overhead expenses such as payroll processing costs, most benefits costs, or payroll vendor costs.
The IT Staffing Company has Benefits Costs
For example, at ProFocus Technology, we offer high end health care benefits through the premier health insurance company in our market, 401(k) with match, educational reimbursements of $1200 per year, Employee Assistance Programs, employer paid life and disability insurance, and paid sick time off. This adds costs of another 8-10% or more of the amount paid in wages. Different IT Staffing companies have different benefits, and this is worth looking into to make sure your service is not cutting corners here.
Contingent Nature of Each Placement
An IT Staffing firm will put a lot of effort and work into your request for an IT contractor. They will invest thousands of dollars working on the opening for you. There is no guarantee that you will not cancel the job order before the person starts. It happens all the time.
In fact, IT staffing firms fill between 5% and 30% of the job orders they work on. The different placement ratios depend on the types of business they are working on and who their clients are, but the point is that a lot of effort goes into positions that are never filled. This means that the pricing model of the business overall needs to cover the costs to work on multiple placements for each one that is filled.
Highly Skilled Internal Staff – Recruiters, Account Managers
Part of the success of IT Staffing firms is that the Recruiters and Account Managers are salespeople. Unlike HR departments that advertise for candidates and screen incoming resumes, IT staffing recruiters are constantly hunting for talent. They must be proactive and persistent. Tech staffing Recruiters and Account Managers are sales professionals, doing outbound sales activities.
Salespeople are highly paid professionals. It is also well known that the technology industry pays well. Combine these factors and you have sales professionals in the technology industry, a combination this is in high demand.
Both Client Managers and Tech Talent want to work with high caliber tech staffing professionals. They will choose this every time over the alternative.
This all adds up to highly paid internal staff…and this adds to the cost structure that results in the pricing for tech staffing services.
The Team Involved
You may be a candidate, or a client manager, and what you experience is that you had some discussions about the position, and then the contract engagement got started a week or two later. This can give the impression that not much happened that cost very much in providing this service.
In reality, there is a whole team involved behind the scenes. Your job order will be discussed at team meetings and meetings with management. There will be team troubleshooting meetings if the position is getting difficult to fill. There are operations people making taking care of details behind the scenes. There are accounting people. There are managers overseeing the quality of the work. Time is money and all these people involved are involved in your job order.
This is all in addition to the company operations that were in place to support all the work…
The Company Operations Involved
There are many expenses for the IT Staffing company. They have rent, utilities, computer systems, software licenses, insurance, training, accounting, financing, and more. It is not all back office costs either. Many costs are investments that directly result in the services such as recruiting related software licenses, applicant tracking systems, advertising for candidates, hosting or sponsoring networking events, etc., etc.
In summary there are many business costs behind the scenes, and they all need to be paid with that hourly margin that we are discussing in this article.
The truth is that an expensive system has been put to work on your behalf. Account Managers had to be hired and trained. Relationships were nurtured over time. Computer systems were paid for and built over years. Lawyers developed contracts. Brand names were built. All these foundations and many more were in place and made your placement seem easy, even though it was not.
Costs of Financing for IT Staffing
An interesting aspect of IT Staffing is the financing. Consultants are paid weekly, and client companies take quite a long time to pay. Many companies pay their bills in about 30 days, but it is also common for the IT Staffing firm to be paid 45, 60, and even 90 days later.
This situation results in a large amount of cash to fund every contract consultant who is working.
It works like this. Assume a consultant earns $65/hour and the Client company has requested Monthly invoices. Also assume they start at the beginning of the month.
The contractor/consultant turns in a timecard on Monday or Tuesday from their work the week before. The next Friday, they are paid by the Tech Staffing company. That means that one week of pay and payroll taxes is out the door, about $3000. This goes on for a month, until 4 weeks of payroll have been paid, or $12,000, when the monthly invoice is finally sent to the client. By the time the client pays the invoice 45 days later, an added $18,000 (6 weeks x $3000) has been paid to the consultant. That is a total of $30,000 in cash needed to finance that one contractor/consultant in the field.
This is an entirely unseen factor that is an important aspect of the pricing for IT Staffing services.
Risks of Financing
In the situation above, $30,000 is at risk of non-payment from the client. This is essentially the same as making a $30,000 loan. It will not always be paid.
It gets worse for the staffing company. Usually in non-payment scenarios, it will get far beyond $30,000. If a client stops paying, the IT staffing company will not realize it right away. It will take time to realize there is a payment problem developing, then finally at some point the IT Staffing company will realize there is a problem. This means that every consultant in the field there is a risk of losing $60,000 or more due to non-payment from a client.
There are other risks as well, such as a client refusing to pay for other reasons.
The rule is that the W-2 contractor/consultant will always get paid on time, while the IT Staffing company needs to finance these risks.
IT Staffing firms usually have guarantees for their services. This is another risk of non-payment for work that the IT Staffing firm carries. Again, the W-2 contractor/consultant will always be paid.
There are myriad legal risks that IT Staffing firms face, just like any other business. These are hard to quantify but they are not trivial and there is certainly a cost over time that needs to be accounted for.
Imagine being legally responsible for an IT Professional’s actions inside a large corporation. Now try to buy insurance to protect against that risk. Insurance for IT Staffing companies is expensive.
Pricing Models for IT Staffing
Pay rates and bill rates are calculated by account managers, managers, and recruiters inside IT Staffing agencies.
They typically have spreadsheets that calculate the many factors involved. These spreadsheets will consider factors such as the client’s payment terms, the difficulty in finding the needed talent, market pay rates for the role, the length of the assignment, etc.
These models will usually end up calculating the gross profit margin on an hourly basis. The staffing firm will ensure that the pay rate and the bill rate meet the staffing firms margin requirements. From this, pay rates and bill rates are set.
Some firms will shortcut this process by using a markup pricing model. This consists of multiplying the pay rate by a markup percentage. However even this is not a fixed markup amount, as multiple factors are considered as to what the markup should be. These factors would include the length of the assignment and whether it is full or part time. It will often also depend on the pay rate of the assignment with higher pay rates having lower markups.
Additional Things to Consider
Sometimes IT Staffing companies subcontract to other staffing companies, outside consulting companies, or individual consultants who have consulting businesses. In these cases, the payroll and benefits costs mentioned above do not apply. A reputable IT Staffing firm will take these savings into account when setting pricing, making a fair margin that considers the reduced costs in payroll taxes and benefits.
Here is a link to an article with more details about the differences between Corp-to-Corp, 1099, and W-2.
Stacking Service Providers
Some companies have realized they have a problem of “stacked” IT staffing vendors. Sometimes an IT Staffing firm will find a contractor / consultant from another IT Staffing firm. In this situation each IT Staffing company should theoretically make half the margin they normally would.
But sometimes this gets out of control and multiple service providers can be involved. One company subcontracts to another which subcontracts to another…ending up with 2, 3 or more subcontractors, each making margin from the project. This normally ends up increasing the pricing for the client, but it can also create downward pressure on the wages paid. This is something that is good to know about and try to prevent. Some clients take strict measures to ensure this is not happening. We at ProFocus Technology would not get involved in situations like this.
Consulting firms have a different pricing model than the IT Staffing industry which is discussed above. Their hourly margins are much higher than the scenarios described above. While IT Staffing usually has a bill rate that is tied closely to the pay rate, consulting companies bill rates and pay rates are not highly dependent on one another.
For companies concerned about costs, I can recommend being careful not to buy IT Staffing services (i.e., Staff Augmentation) from consulting companies. If you do, your hourly bill rates will be much higher. If you are in this situation, ProFocus Technology would be happy to give you some quotes so you can compare.
This article has been written to describe industry standard ethics and behaviors. Certainly, there will be cases with unscrupulous players who are unfair in their practices. If you work with a reputable firm that has a good reputation, you can feel confident in avoiding problems.
Note on Terminology
This article refers to Tech Staffing, Technology Staffing, and IT Staffing. The terminology can be confusing for people outside our industry. Sometimes people refer to this business with different terms including employment agency, staffing agency, temp services, temporary services, temporary staffing, staff augmentation, recruiting agency, recruitment agency, contracting, consulting, employee solutions, staffing solutions, headhunters, recruitment firm, recruiters, or search firm.
Integrity, Honesty, and Fairness
We hope this article has been helpful for you. If you are looking for a technology staffing company that has high integrity and a commitment to honesty, which includes fair pay and fair pricing, ProFocus Technology would be happy to be of service to you.