Agency Research: Digiday’s “The Hidden Cost of Agency Freelancers” (Study Summary)
Digiday published an article citing research we did. Agencies that rely on contractors (who doesn’t?) need to understand that the economics of outsourcing roles goes beyond just hourly rate.
What follows is the research summary from the case study used in the Digiday article: “The Hidden Cost of Agency Freelancers“.
Agencies tend to treat contractors as plug-and-play accessories to their existing teams. Don’t have enough people? Hire contractors. Not familiar with the technology or industry? Hire a contractor! Yet business research suggests that these “black-box” relationships are not so simple, and may have hidden costs.
To be fair, agencies estimate most projects poorly – underestimating the scope and work required by 25-35% on average, according to AgencyAgile, a consultancy that teaches effective scoping and estimation techniques to agencies like Digitaria, Firstborn and 360i. But companies that outsource IT find that hidden management costs can drive up the overall cost of using external resources. So do these costs make the effects of already-poor agency estimating even worse?
To understand this better AgencyAgile analyzed more than 100 projects that a fast-growing digital agency delivered over a two year period, comprising slightly over $7.5MM in billings, ranging from several-thousand dollars in size, to over $500,000.
Since the contractors were paid on an hourly basis, the calculations were done using the “realized average rate” – basically, total dollars received by the agency, divided by the total hours of work expended. In all cases, the contractors only provided a portion of the total project labor.
The base data showed that, despite the fact that the agency priced its projects at $150/hour, the actual “realized” rate, on average, was about 40% less than that, $92.00 per hour.
But projects that used contractors fared even worse than the average, a bit below $82/hour, and the rate gap between contractor- and non-contractor involved projects was almost $18/hour. That is, non-contractor projects delivered a 20% better return than contractor-involved projects.
In general, larger projects have more risk, and also suffer from lower overall margins. We saw the same trend amplified with use of contractors: the 8 largest projects (by revenue) all used contractors, and their average rate was a soul-crushing (for CFOs) $73.20 per hour.
So What Does a Contractor Cost?
The $82 per hour rate is sobering, for sure, more so once we calculated the average rate that contractors were paid: slightly more than $83.00 per hour. This number does not include the time spent sourcing the contractors – that data was unavailable – but when you factor in the decreased margins (versus a non-contractor project), the actual cost of the contractors was more than $133.00 per hour!
Contractors Can Be Sources of Agency Misery
The cost of contractors exacerbates a fundamental problem with agency economics: Agencies chronically underestimate on projects, so everyone ends up working more for less. Our calculations use hours so that we can show an implied cost for using contractors. The real cost – since budgets are fixed – is in the hours that agency staff need to spend to get a project done. So the $18 per hour difference cited above, really means about 20%+ hours needed to complete the project. That’s an extra 10 hours on a 50-hour work week. The data confirm a common refrain among agency staff and teams: Projects with contractors are often harder than those without.
 Aubert, B. A., Rivard, S. and Patry, M. (1996) A transaction cost approach to outsourcing behavior: Some empirical evidence, Information & Management, 30, 51-64.
 The list was pared down from 300 total projects, by removing projects that were less than 100 hours, discontinued, ongoing, involved media spending or direct pass-through, or billed at an abnormally high rate.