Managing Vendors – Articles by Jim Everett

Tips on managing vendors, skills and competencies required

Mindsets and Business – Part 2

Posted on | November 9, 2010 | CLICK HERE TO COMMENT OR ASK QUESTION

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Employees are free and vendors are expensive – true? Let’s do the math.

In many companies and non-commercial organizations, managers and executives baulk at what they see as the high costs of vendors, and are very conscious of the rates for contractors and external expertise. But they often ignore costs of internal employees, except for headcount constraints. The mindset is that, for all intent and purposes, employees are free, and vendors are overly expensive. Partly, this is due to the how their budgets are organized – often managers are only responsible for expenditure, and not all employee-related costs. This post explores the math and the mindset.

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We all know that employees are not really at no cost. And recently, some CEOs have come under fire in the media for sacking lots of employees, adding the savings for that year into the profit side of the company, and taking a huge bonus for making the company successful and raising share prices.

But within the workings of a company, there is a difference in how employees and vendor staff are viewed. Contractors and vendor staff are seen as having meters ticking, racking up bottom line costs. So, every hour must be spent productively, creating visible and measurable results. Employees are seen as readily available resources, that are deployed as required, moved around, and whose performance is reviewed a couple of times each year.

Many reviewing managers are not highly skilled in reviewing performance and, as a result, the employee bottom line (the impact they have on the overall results of the company) is never full explored. I have designed, implemented and managed performance review systems, so I have seen this first hand.

With external resources, or vendors/providers/suppliers, the deliverables are often done at a higher level than the person managing the vendors on a day-to-day basis. So the vendor manager often (but not always) has more defined criteria by which to measure that predetermined vendor performance.

In my own corporate roles, I have been in situations where the department is going through reorganization. And for weeks (one time months) a whole team of employees had had no real goals or performance measures on their work. Yet they still kept getting paid, being covered by medical insurance,accruing vacation days, and having the air conditioning or heating on in the offices. It was very frustrating, and all were delighted when the engines started once again.

Let’s look at another example of the “free employees” mindset. How many executives or managers will bring in a specialized attorney, or organizational consultant, whose time they are paying for, and then keep them waiting for three hours with the meter running? Not likely. Yet how often do we see that in companies where employees have to wait for hours, sometimes days, for a meeting or decision so they can get on with the next stage of a project.

When vendors are engaged, often it is because they have specialized expertise or operational model that equips them to do a particular job at a high level of proficiency. They go through rigorous selection processes with detailed RFPs (Requests for Proposal) so that the most expert vendor, or the vendor with the most well-suited methodology is selected. And their value against the outcomes is assessed in advance.

On the other side, we often see employees deployed to projects in which they have no experience or subject matter expertise. There is a long and steep learning curve, they burn up time along the way, the project takes longer, and may often be done less than ideally. It is painful for the employees, and costly for the company. But it falls under the mindset that “employees are free” and there to be used.

So, it makes a lot of sense for managers to have budgets that include expenditure as well as employee costs, and to be measured on total expenditure and the outcomes they create with that total amount. Additionally, employee costs are not just the salaries they earn. In working with clients and advising on appropriate costs for vendor staff, I have run up against the mindset model which takes the annual salary for an employee and divides it by 52, then by five, to get a daily rate. For easy math, let’s say $52K per year will boil down to $200 a day.

Whoa there! First, 52 weeks times 5 days is 260 days. Then deduct: 10 days for vacation; 10 days for holidays; 5 days for sick leave; 5 personal days; 6 days for training; 3 days for cleanups; 2 days for office moves; 5 days cumulative waiting for systems upgrades and troubleshooting; 4 days for offsites, travel, and corporate communications events; etc. We need to deduct these 50 paid days of not producing.

That leaves 210 actual days of productivity. Divide $52K by that and it comes close to $250 per day.

But we are not finished yet!

We need to take the employee salary and add: recruitment costs; benefits, bonuses and stock options; taxes; equipment; supplies; office space; facilities; technical support; proportioned corporate overheads (Legal, Accounting, HR, Procurement, IT, etc); training and development; and a few others. That can all add between 25-50% to the base salary. Let’s say 30%. A $52K employee is now around $68K to the bottom line. Divide that by 210 days, the effective daily rate is now closer to $325. Wow. That needs a shift in mindset.

Let’s now look at the vendor side costs (and this is just one scenario). We apply the same per-employee cost base, and add in additional costs of running their business, including taxes, equipment required to deliver the services, and other operating expenses not staff-related, and a profit margin. That could add an add to a loading of 50-100% on top of the daily rate for staff allocated to the client project. Let’s say 75%. That is now $568 per day. Almost three times the first figure from the original mindset.

An interesting side note. In one large client organization, one vendor manager was very upset that his vendor added in a profit margin. “They are making a profit out of us”, he complained. I quietly pointed out that his own company had something like a 35% profit margin. Even with this information, his mindset was still that the vendor should not be adding a profit margin to the project costs.

The figures used in example calculations are for notional scenario. Every situation is different. Some vendor figures are lower that this. Some could be more. I included these as a way of thinking realistically about costs. The key point is that often we have mindsets around costs that are out of line with the reality when all is calculated out.

And this can be a management problem when decisions are based on mindsets, without looking at the math.

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