Subcontracting 669
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Subcontracting refers to the process of entering a contractual agreement with an outside person or company to perform a certain amount of work. The out-side person or company in this arrangement is known as a subcontractor, but may also be called a free-lance employee, independent contractor, or vendor. Many small businesses hire subcontractors to assist with a wide variety of functions. For example, a small business might use an outside firm to prepare its payroll, an accountant to help with its record keeping and tax compliance, or a free-lance worker to handle a special project. Subcontracting is probably most prevalent in the construction industry, where builders often subcontract plumbing, electrical work, drywall, painting, and other tasks.

Hiring subcontractors offers a number of advantages for small businesses. For example, subcontracting mundane but necessary tasks can free up time and resources to enable the small business owner to concentrate on making money and growing the business. In addition, hiring a subcontractor is usually less expensive than hiring a full-time employee, because the small business is not required to pay Social Security taxes, workers' compensation benefits, or health insurance for independent contractors. Subcontracting does pose some potential pitfalls, however, such as a loss of control over the quality and timeliness of work. But small business owners can take several steps to help ensure that their relationships with subcontractors are productive and beneficial for all concerned.


Although hiring an independent contractor to handle a special project or help out during a busy season may be cheaper than hiring a full-time employee, a small business cannot simply call someone an independent contractor in order to avoid paying Social Security taxes and benefits. The U.S. Internal Revenue Service (IRS) scrutinizes employer-subcon-tractor relationships carefully, and any misrepresentation may be subject to severe financial penalties. To avoid confusion, small business owners should be aware of the distinctions between independent contractors and employees and consult IRS guidelines when making subcontracting decisions. Most importantly, all subcontractors hired by a small business should present themselves as being in business for the purpose of making a profit. In addition, all work and pay arrangements should be spelled out in a contract that specifically mentions that the work is being performed by an independent contractor.

The IRS applies a 20-part test in order to determine whether a certain worker should be classified as an employee or an independent contractor. The main issue underpinning the test is who sets the work rules: employees must follow rules set by their bosses, while independent contractors set their own rules. For example, an individual who sets his own hours, receives payment by the job, and divides his time between work for several different employers would probably be classified as an independent contractor. Other criteria involve who provides the tools and materials needed to complete the work. For example, an individual who works at an employer's facility and uses the employer's equipment would be considered an employee, while one who works at a separate location and provides her own equipment would be classified as an independent contractor. Finally, an independent contractor usually pays his own business expenses and takes the risk of not receiving payment when work is not completed in accordance with a contract, while an employee is usually reimbursed for business-related expenses by the employer and receives a paycheck whether his work is completed or not.

To be safe, a small business may wish to include some of these factors in the contract provided to subcontractors. For example, the contract should specify a certain amount of work to be performed by a given deadline, but should not specify how that work should be performed in terms of working hours or tools and materials used. In addition, payment should be made by the job rather than by the hour, and the subcontractor should not be prohibited from working simultaneously with other clients.


Small business owners can take a series of steps to help ensure that the subcontracting process provides the desired benefits. First, it is important to assess the needs of the small business to make sure that outside help is needed, decide which specific tasks or projects to subcontract, and determine what sort of subcontractor could best perform the work. The small business owner should also give some thought to the type of relationship he or she wants to have with the subcontractor. Some businesses choose to share control of the project or process with a trusted subcontractor, even including the vendor in strategic decision-making. Indeed, subcontractors in many industries are often sources of valuable information and insight on ways in which small business owners can save time and money or improve quality. Other companies choose to maintain a high degree of control internally and subcontract only minor projects on a limited, as-needed basis.

The next step in the subcontracting process involves preparing in-house staff and obtaining the support of key personnel for the decision. Many companies encounter resistance from employees who feel that their jobs are threatened by subcontracting. Other companies may even find that turnover increases when the most interesting or fulfilling jobs are outsourced, leaving employees to perform less attractive tasks. To avoid these problems, in-house employees should be informed of the plans to subcontract work and told the rationale behind the decision. The small business owner may also wish to get employee input about what work is appropriate for subcontracting, and take steps to make sure that employees continue to receive rewarding, interesting, career-building responsibilities.

The next step is to begin contacting potential subcontractors, either formally or informally, and asking specific questions about the services provided and the terms of the contract. The questions should also seek to assess the subcontractor's intentions, or what they hope to gain from the relationship. Some subcontractors may be seeking a long-term business relationship, while others may simply wish to gather information in order to complete their work in a timely, professional fashion. Overall, the questions should establish whether the subcontractor will provide a good fit with the small business client. Ideally, the subcontractor will have experience in handling similar business and will be able to give the small business's needs the priority they deserve. "Consider the service company's knowledge of the entirety of your business, its willingness to customize service, and its compatibility with your firm's business culture, as well as the long-run cost of its services and its financial strength," recommended service provider Carl Schwenker in Money.

Once a subcontractor has been selected, the small business owner should then negotiate a contract in order to help ensure a mutually beneficial relationship. This document should include tangible measures of job performance, as well as financial incentives to encourage the subcontractor to meet deadlines and control costs. The contract should also clearly define responsibilities and performance criteria, so that no questions arise later about whether the subcontractor or the client was supposed to handle a certain task or pay any extra charges incurred. The contract should also outline the procedures for changing the subcon-tractor relationship, including the means for renewal, cancellation, or termination. Finally, the contract should set strict confidentiality rules if needed and specify who owns the rights to any new ideas, inventions, or materials that are created from the business arrangement.

The next step is to prepare the subcontractor to interact efficiently with the client company during performance of the contract. The small business owner may wish to introduce the subcontractor to key employees, for example, and establish reporting relationships. It is also important to arrange to receive periodic progress reports from the subcontractor, as well as feedback about both the project at hand and the overall relationship. At the conclusion of the project, the small business owner should conduct a post-mortem and provide the subcontractor with an evaluation of their work.

When it is all said and done, the use of subcontractors can be a tremendous boon or a terrible bane to a small company. Skilled, professional subcontractors with a strong work ethic can help boost your company's financial success and burnish its reputation with clients and community alike. Conversely, subcontractors who turn in sloppy or tardy work or behave in an unprofessional manner can quickly stain your company's name, and leave business owners (and any staff) with a heavier, messier workload. Given these factors, the wise business owner will choose her subcontractors judiciously and take special steps if necessary (such as sweetened financial compensation) to hold on to those with proven records of reliability and performance.


Evans, David, Judy Feldman, and Anne Root. "Smart New Ways to Manage Subcontractors." Money. March 15, 1994.

Foxman, Noah. "Succeeding in Outsourcing." Information Systems Management. Winter 1994.

Hammond, Keith H. "The New World of Work." Business Week. October 17, 1994.

Kelly, Joseph M. "A Bad Sub Can Harm a Good Reputation." Home Improvement Market. February 1997.

King, William R. "Strategic Outsourcing Decisions." Information Systems Management. Fall 1994.

Lacity, Mary, Rudy Hirschheim, and Leslie Willcocks. "Realizing Outsourcing Expectations: Incredible Expectations, Credible Outcomes." Information Systems Management. Fall 1994.

Schwolsky, Rick. "20 Ways to Keep Your Subs." Builder. January 1996.

Springsteel, Ian. "Outsourcing Is Everywhere." CFO: The Magazine for Senior Financial Executives. December 1994.

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