Welcome to the latest edition of The Contract Employee's Newsletter -- the free e-mail newsletter designed to bring tips and news about the world of Contract Employment right to your e-mailbox.

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*** NEW MATERIAL IN THE HANDBOOK ***

The content of this month's newsletter is excerpted from new material recently added to The Contract Employee's Handbook, http://www.cehandbook.com/. It's a big chunk of information, but worth the read if it helps you understand how the various types of agencies work. You won't find a similar overview anywhere else!

Also, visit the "FULL DISCLOSURE AGENCIES" page of the Handbook for a new listing, Softstream Corporation, an I.T. consulting firm based in Southern California that hires both permanent and contract employees. At Softstream all employees are told what the company bills the client for their services. As explained below, consulting firm permanent employees are not true contract employees, but they do share a very similar lifestyle. Click here, then select the "Agencies" button.
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*** A LACK OF INFORMATION ***

The lack of information exists, I believe, because the knowledge base is closely held by the agencies themselves. You see, traditional agencies using commissioned recruiters have a vested interest in withholding key knowledge from both the client and the contract employee. That is how they can continue to bill high and pay low. What is incredible is that contract employment is one of the fastest growing segments of the American economy, resulting in and from a virtual complete overhaul of the "New Workforce in America". Yet, the contract employment industry operates almost entirely as a sub-rosa business profiting enormously from an industry-wide "code of silence".

I have worked as a permanent placement headhunter, and I appreciate the hard work, enormous risks, and high overhead involved in servicing a client's staffing needs. But, I also appreciate the incredible opportunity for abuse that happens when information is suppressed. So here is my attempt to describe as concisely as possible how agencies work, and why some agencies take a higher cut of the bill rate, and why some take less.
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*** THE CONTINUUM OF CONTRACTING ***

The traditional temp agency model defines the first extreme in which the contractor depends entirely upon the contract employment agency for his or her livelihood. In this model the agency locates the assignment, the agency recruits the contractor, the agency negotiates with the client, the agency bills the client, and the agency pays the contractor on payday after withholding the agency's cut of the bill as well as all applicable taxes.

As one moves away from the traditional model, and progresses toward the opposite extreme, the influence of the agency is diminished. Control transfers from the agency to the contractor, and eventually the agency has no control at all.

In the traditional model the contractor works for the agency. At the opposite extreme the agency works for the contractor. Just where you settle on the continuum is, after all, a personal decision that has to do with your comfort level and immediate circumstances. But most of all it has to do with your understanding of how the contracting industry operates, and how you can use that information to your best advantage.

Your income and your professional security are strongly influenced by where you fall along the continuum. Ideally, all things considered, you want to progress as far from the traditional model as possible.

The Contract Employee's Handbook gives contract workers information they can use to make intelligent and informed decisions about where on the continuum of contracting they want to operate.

Now, let's examine the different types of contract employment agencies one is likely to encounter along the continuum of contracting as one moves from a fully agency-dependent contract employee to a fully agency-independent direct consultant.

On the surface, the comparison looks as simple as the difference between being a contract employee and being an independent contractor, but there are many shades of gray between the two extremes. For example, contract employees will almost always benefit when they think and act more like independent contractors, and erstwhile independent contractors occasionally find it necessary or advantageous to assume the role of W-2 contract employee.
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*** THE TRADITIONAL TEMP AGENCY MODEL ***

What distinguishes the contract employee from other temps is this: Contract employees provide specific, advanced, technical and professional skills. Contract employees are paid more than regular temps and they tend to have longer assignments. However, in every other respect contract employees are just like regular temps, and traditional contract employment agencies operate just like regular temporary employment agencies.

GETTING THE JOB ORDER. Recruiters call potential client companies to present the qualifications of individual candidates. Experienced recruiters try to reach individual hiring authorities such as project leaders, managers, and directors. They avoid calling the HR department because HR personnel have an inherent dislike for outside recruiters. The recruiter uses the candidate as bait to entice the hiring authority into giving the recruiter a job order or specific search assignment. Thus, even if the company does not need the particular candidate, the recruiter may still receive a valuable job order. When the recruiter receives a job order, he or she confirms the required skills, the duration of the assignment, and the bill rate, and quickly negotiates key elements of a contract between the agency and the client.

If the agency has previously worked with the client, there is probably an approved agency contract already on file with the client.

GETTING THE TALENT. Contractors solicit help in locating assignments by submitting resumes directly to contract employment agencies. Unsolicited resumes are often broadcast in mass mailings, or sent individually in response to a classified ad or Internet job posting. Job seekers also submit their resume to on-line resume banks, news groups and mailing lists. Recruiters may also call potential candidates who were referred to them by other contractors. From these sources the agency assembles a database of candidates.

MAKING THE MATCH. Armed with a specific search assignment, the recruiter searches the resume database for candidates who match the job order's search criteria. The recruiter then calls the best matches to see if they are available for an interview. The joint process of obtaining job orders and recruiting qualified candidates is time consuming and expensive, and contributes significantly to the agency's administrative overhead. Recruiting costs typically amount to 20% or more of the hourly bill rate charged to client companies.

THE HIGH COST OF RECRUITING. Traditional agencies control their overhead by placing recruiters on a commission-based compensation plan. In this way recruiters are rewarded in direct relation to their productivity and in relation to the gross profits they generate for the agency. Like most businesses in America, contract employment agencies operate in a free market economy where one succeeds by keeping revenues high and costs low. Consequently, in any given situation, a traditional agency is likely to bill clients as much as the market will bear, and pay contract employees as little as they will accept.

Every agency has a different formula for calculating the recruiter's commission. More aggressive commission schedules are based on the spread between the amount billed to the client and the amount paid to the contract employee. When this is the case, there is a strong incentive for the recruiter to increase the spread by billing the client more than, and paying the contractor less than, the contractor's skills and experience warrant.

Whereas most high-volume regular temp agencies operate with a fixed fee schedule, traditional contract employment agencies leverage their fee schedule to produce the maximum possible profit for a given placement. Consequently, bill rates and pay rates may bear little relation to the contractor's skill and experience, relating instead to the client's gullibility or indifference and the contractor's ignorance or lack of initiative.

BONA FIDE EMPLOYEES. In the traditional model the contractor is a bona fide employee of the agency. The agency is required to pay the employee on payday, usually several weeks before the client gets around to paying the agency. And, like every other employer, the agency is required to withhold State and Federal Income Taxes, Unemployment Taxes, Social Security Taxes and Medicare. Additionally, the agency pays out-of-pocket an amount equal to 10% or more of the pay rate to cover Workers Compensation, State Disability (in some states), Social Security, Medicare and Unemployment taxes. The agency must also assume the financial risks associated with slow pay or no pay by deadbeat clients. Bad debt is a significant risk factor contributing to the cost of operating a contract employment agency.

At the end of the year, the agency issues a W-2 form to the contract employee. The W-2 form reports the total compensation for the year, and itemizes withholdings for each tax category. Thus, contract workers who operate through a traditional contract employment agency are properly referred to as W-2 contract employees.

The agency is ultimately responsible for specifying the working conditions of the contract employee, but in reality this usually means that the contract employee must do whatever the client asks within the broad limits of a loosely written job description. The contract employee is paid by the hour at a rate set by the agency.

The client may decide at any time, without warning or due process, and for any reason at all (including reasons that would otherwise violate legal protections against discrimination) that they no longer want the services of a given contractor. The client simply notifies the agency, and the agency terminates the contractor "at will". Generally, a terminated contract employee has no recourse but to look for another assignment.

THE BOTTOM LINE. Traditional contract employment agencies find it difficult to operate profitably on less than a 35% cut of the bill rate. An out-of-pocket payroll burn of 10% plus a recruiting overhead of at least 20% leaves little left over to cover administrative overhead, risk of bad debt, owner's profit and franchise fees. For this reason, agency cuts of 45% are common, and some traditional agencies with especially aggressive commissioned recruiters will take 65% of the bill rate or more!

Too be sure, small one-man recruiting firms can afford to charge less than a 35% margin, but the incentive is ALWAYS present to charge more.
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*** THE NICHE SPECIALIST MODEL ***

KNOWLEDGEABLE PROFESSIONALS. Niche specialists are often veteran contractors themselves with special insight into their clients' needs. They know how to evaluate a contractor's skills, and how to market those skills appropriately. Their professionalism leads to repeat business and enhanced loyalty by appreciative clients and contractors alike. Word of mouth is the niche specialist's best marketing tool.

You are likely to see the niche specialist at local chapter meetings of their professional association where they enjoy a special rapport with the members. They are also more likely to visit their clients and contractors on site. It's this personal approach that sets the niche specialist apart from the "anything that fogs a mirror" approach so often practiced by the keyword counters in more traditional agencies.

Because niche specialists tend to operate out of trust and respect, they are also more likely to freely and openly discuss their fee structure with clients and candidates.

MAKING THE MATCH. Niche specialists carefully pre-qualify the candidates they are willing to work with. The more progressive agencies give qualified candidates access to a password-protected list of open assignments, and notify them by e-mail of new openings as they occur. Candidates then notify the agency of their interest, and the agency submits the best matches to the client for consideration.

THE BOTTOM LINE. By automating the job matching process, by specializing within a narrow set of skills, and by carefully selecting both clients and candidates, niche specialists are able to charge the lowest rates in the industry among full service agencies. Expect a good niche specialist to take around 30% of the bill rate to represent a W-2 contract employee.

Ethical niche specialists give W-2 contract employees more control over their contract assignments as well as a higher rate of pay, and they allow the contract worker to move even further from the traditional model toward independence and self-reliance.

Niche specialists are necessarily locked into a small agency format. For example, if they try to expand or franchise their business, they run the risk of losing their special relationship with clients and contractors. Also, by bringing on commissioned recruiters and additional marketing staff they lose their competitive advantage based on paying good contractors what they are worth and billing clients fairly.
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*** THE PASS THROUGH MODEL ***

THE CONTRACTOR TAKES CONTROL. Contractors who locate assignments on their own earn the privilege of shopping around for a pass through agency that will give them the best deal. Here the agency truly works for the contractor and not the other way around. The pass through agency negotiates a standard contract with the client. It still performs all the functions of billing and payroll, still withholds all applicable payroll taxes, and still issues a W-2 form at the end of the year, but that's about all it does. The contractor has assumed virtually complete control over the hiring process, and has moved as far from the traditional model as possible while still operating as a bona fide W-2 contract employee.

Some pass through agencies will work with the contract employee on a 1099 basis. Essentially, the contractor becomes an independent SUBCONTRACTOR of the pass through agency. The agency withholds no taxes from the subcontractor's pay check, and issues a 1099 form at the end of the year instead of the customary W-2. In such cases, the subcontractor assumes full responsibility for paying quarterly estimated income taxes, plus both the employee's and the employer's share of Social Security taxes (because the subcontractor is self-employed).

Short of actually negotiating a DIRECT contract between the contractor and the client, 1099 subcontracting is about as far toward independence that a contractor can move along the continuum of contracting.

As an independent subcontractor of the pass through agency the contract worker is paid when and if the client pays the pass through agency. By passing the risk of bad debt through to the subcontractor, pass through agencies reduce their administrative overhead to the lowest possible levels.

THE BOTTOM LINE. When pass through agencies represent W-2 contract employees, they typically charge about 20% of the bill rate. When they represent 1099 subcontractors, they usually charge their subcontractors a flat $4 to $6/hour to process billing and payroll, and to provide a contractual third-party presence to the client company.
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*** THE CONSULTING FIRM MODEL ***

SALARIED, FULL-TIME EMPLOYEES. Employees of consulting firms are usually salaried, full-time, permanent employees who receive the same kinds of benefits received by permanent employees of other firms of similar size. When a project is completed, employees assigned to that project are reassigned to another project. The new project may be in the home office, or in another client's premises in another city. The salaried employee is assured of continued employment, but may have little say as to where that will be.

It bears repeating: Consulting firms and job shops are NOT contract employment agencies. They are, in fact, an extension of the independent contractor whose solo consulting business expands to include additional staff. Consulting firm employees are integral members of the vendor's staff.

In the early stages, the principle consultant hires 1099 subcontractors "as needed". Later, as the workload expands, the consultant hires permanent, salaried, benefited, W-2 employees. Because the modus operandi of the consulting firm resembles that of independent contractors and W-2 contract employees, the consulting firm's employees are frequently referred to as "contractors". But, make no mistake about it; they are permanent, salaried, fully benefited employees, NOT temporary, hourly, contract employees leased under separate contract to the client.
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*** THE ASSOCIATION MODEL ***

A COMPUTER MATCHING SERVICE. The association model is a computer matching service for clients and contractors, operating literally on a global scale. In its simplest form, the association model operates as a newsgroup or e-mail service that lists resumes and job openings. For example, an industry association may sponsor the service as a benefit to its members. Association members pay nothing to post their resumes and access job listings. Clients and recruiters, on the other hand, almost always pay a fee to post jobs and access resume files.

The model has many variations. Some are highly successful commercial enterprises servicing the outside recruiting industry exclusively. Others operate as a completely free public service. All would be impossible without the Internet.

In its most sophisticated form, the association model is a fully automated keyword matching service that compares each client's requirements against a database of available contractors. The system automatically notifies individual contractors when a match is detected. The contractor then contacts the client directly and, if all goes well, the two conduct an interview.

The service may have no further involvement once a match is made. But some services extract a finder's fee from the client in the case of direct contracts, or a modest surcharge to the pay rate in the case of third-party contracts.

CAVEAT EMPTOR. Newsgroups, e-mail lists and automated matching systems help contractors, clients and outside recruiters make contact. They facilitate interaction on a global scale. They are the grease that lubricates the machinery. They are also cold, mechanical and impersonal. Properly used, the association model leverages your ability to take control of your contracting career, and move farther and farther toward independence. Used indiscriminately, the model may deliver you into the enfeebling arms of a greedy commissioned headhunter.
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If you have never before visited The Contract Employee's Handbook please do so now. The Handbook is a rich source of FREE information on W-2 contract employment. Whether you are already a contractor, or possibly a permanent employee facing the prospect of being downsized, you are sure to benefit from a visit to The Contract Employee's Handbook.

If you find the information in The Contract Employee's Handbook useful, by all means tell your friends and colleagues. I invite you to follow the instructions at the end of this newsletter, and add their e-mail addresses to the mailing list.

Several people have reported that they learned of the Handbook from a flyer that someone posted in their workplace. You might consider doing the same. There is a suitable flyer in the "Tell a Friend" section of the Handbook. Or, click these links and print the results:

-- Serious Flyer
-- Humorous Flyer
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LEGAL STUFF:

The Contract Employee's Handbook, The Contract Employee's Workshop, and The Contract Employee's Newsletter are trademarks of James R. Ziegler, Ph.D.

This newsletter is designed to provide information on contract employment, and is sent with the understanding that the editor and publisher are not engaged in rendering legal or financial advice. If expert assistance is required, the services of a licensed professional should be sought.
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Wishing You Happiness, Success and Prosperity,

James R. Ziegler, Ph.D.
Author and Webmaster
The Contract Employee's Handbook
jziegler@cehandbook.com
jziegler@cehandbook.com