Subcontractors are hired to complete a specific task or project tied to helping you deliver your products or services. One of the mistakes most small businesses make with subcontractors is poor oversight of their work to ensure it’s executed and completed as specified. They fail to connect how the work of their subcontractors is no different from what they pay their employees to perform.
As far as the customer is concerned, your subcontractors work for you, which makes them representatives of your company, so manage them accordingly.
Overview
Spending on subcontractors can significantly impact the profitability of most businesses—especially when the cost of paying the subcontractor is less than what you would pay your employees to do the same type of work.
Subcontractor Spend Productivity is a Throughput Ratio that measures the efficiency of your subcontractor spend. It’s calculated by dividing the operating profit as the ending output for a period by the total costs incurred for that input in that same period.
This throughput view is used to determine how productive your subcontractor spend has been in contributing to your company’s Gross Profit. Your outside service providers have been hired to help you generate revenues that produce profits. The more productive your subcontractor base is, the greater the profit return you’ll earn from your investment in outside help to get the work done.
The formula for calculating Subcontractor Spend Productivity is as follows:
Output (Gross Profit) / Input (Subcontractor Expense)
A ratio of 0.5 means that the company is generating 50 cents in operating profit for every dollar invested in subcontractors. A 0.0 ratio means that no Gross Profit contribution is generated for every $1.00 subcontractor spend.
Higher Creates Opportunity: a positive ratio increasing each year indicates a well-placed investment in outside services.
Lower Creates Challenges: a ratio significantly below 1 indicates that your investment is inefficient in producing operating profit.