Why does a company accept middle vendors or sub contractors in contracting?

Question

My friend told me that he works for a big company in the USA that hires contractors from a preferred vendor who is free to get contractors from other vendors, if they do not have a contractor on their database for a particular position. As you might know, each vendor will take his share of the hourly pay of my friend for the entire period of the contract, leaving the parent company with a big bill and the contractor with a smaller piece of the pie. I think this is what they call corp-to-corp employment in the industry. Example:

Company = $100/hr
vendor1 = $16/hr (preferred vendor)
vendor2 = $8/hr
vendor3 = $8/hr
contractor = 100 - (16+8+8) = $68/hr

It seems fair and okay if the preferred vendor takes a significant cut. As you can see in the example above, the middle men vendor 2 and 3 are adding $16 to the cost without adding any real value in the chain. Hypothetically, out of this $16, the company could save maybe $10 and offer $6 more to the vendor. The contractor could then get $4 of the $6. Everyone would be happier.

I don't know why companies would want to do this instead of working directly with one vendor. Everyone would make (or save) more money and the contract would attract more quality contractors. Besides, it would reduce the cost of software significantly if a company is dependent on a lot of contract labor.

To satisfy my curiosity, I requested my friend to ask his boss the actual rate for the position and also why they accept middle vendors, but he does not feel it is appropriate to ask such questions. Since he won't ask his boss, I am posting the question here to get some answers as to why big companies would be open to such arrangements.

Answer 1

I'm not privy to employer negotiations but I've worked as a subcontractor, and depending on the particular niche you're talking about, the main contractor simply may not have anyone available with the required skillset for the job. However, they may know a company who has supplied them with good people in the past and are willing in this case to take a smaller cut in exchange for getting the job done (in fact, often they might end up ahead of the game since they often don't have to take care of the subcontracted employee's benefits and the like).

From the standpoint of the company, they just want someone who can do the job. It's not that they require the contractor to provide one of their people, it's that the fact that the employee is contracted out to that company represents one less hoop they have to jump through to determine whether or not the person is qualified or not. I'm not going to say that bad contractors never slip through the cracks here, and that in some part is what the interview process is for, but at least you are dealing with people who have presumably been vetted by someone else before you even begin talking to them.

In the end, my experience with most companies is that even if they don't know that a person was hired via a subcontractor rather than being a direct employee, if the person hired can actually do their job that's all that matters. I should add a disclaimer that I work in IT, an industry where there can be a high variability in competence on the one hand but often a great need to move forward with a project quickly on the other. In many cases the cost of bringing on an incompetent employee long enough to "ramp them up" into competence or figure out that they can't cut it and then hiring someone else is not significantly greater than employing the tactic of interviewing person after person for several months until someone they can be assured is competent out of the gate (this assuming that we live in a world where you can discern competence from an interview or, really, anything but actually watching a person work for several weeks, which of course, we don't, but for the purposes of the argument...). Either way, what you primarily wasted was time. $100 an hour is a drop in the bucket compared to the costs of releasing a product 6 months late, and there is always the possibility that you'll find a good contractor using the first tactic.

Answer 2

I have some experience in this area being in both the contractor side and the client side.

From the client's standpoint - we usually ask for a resource of a particular qualification. This is the basic minimum we need. In some industries there are some other specific requirements, which are based mainly on the job position.

For example, in Oil & Gas, field engineer resources should be:

1. Certified
2. X years of experience
3. Be paid at minimum X (this is actually what the company will offer, not what the supplier will pay the resource, more on this later)
4. Be provided accommodation
5. Be provided transportation suitable for field work

For all this a price is agreed per resource between the client and the master contractor (the supplier).

From the contractor providing manpower, their job is to provide this resources - no matter where they acquire the actual resource. This is why it is often subcontracted out. Especially if the requirement is a large amount.

I once was in a deal where they were recruiting 5000+ personnel for a hospital. It is unimaginable for any single provider to have all these resources, so they obviously sub-contracted out.

In the end, the client receives the resource as per their requirements - this is what they are paying for. The other thing that they pay for is availability, it is the responsibility of the contractor to provide the resource. This means that sometimes even if the actual person is on leave, the supplier needs to fill in that position.

Other things to keep in mind:

1. For larger companies - there is a qualification process for vendors and suppliers, which is why they tend to have master agreements rather than deal with the headache of administering multiple agreements with multiple vendors. The US military is a good example of this.

2. Contractors for large companies have to meet certain financial obligations - sometimes in the form of financial guarantees, sometimes in the form of payments to bid on contracts. In this case, only the larger suppliers can afford this and thus they win the contract, and then provide resources from other parties.

Now, for the rates/charges. The company only has one agreement against which they will pay for a resource to their master contractor. There are generally two different revenue models:

1. For permanent hires, the contractor gets a percentage of the salary of the resource as a fee.

2. For contracted hires, the contractor get a fixed fee per resource; and are free to pay the resource whatever their own agreement is. This is typical in large manpower agreements where the company does not want the extra associated costs (insurance, liability, taxes, etc.) to on-board a large workforce. Especially if this is for a support or project contract.