Contractor vs Full-Time Employee Cost Analysis

Beyond the Rate Card Comparison

The most common mistake in contractor-versus-employee analysis is comparing a contractor’s hourly or daily rate directly to an employee’s base salary. On the surface, a contractor billing $120 per hour looks more expensive than an employee earning $180,000 per year. But that comparison ignores the fully loaded cost of the employee and the flexibility value of the contractor. A rigorous analysis must account for the total economic cost of each option and the strategic context in which the decision is being made.

Quantifying the Full Cost of Each Option

Full-Time Employee Costs

The fully loaded cost of an employee includes compensation (base, bonus, and equity), benefits (health insurance, retirement match, life and disability), employer payroll taxes (FICA, FUTA, SUTA, workers’ compensation), equipment and software licenses, facilities or remote work stipends, recruiting costs (amortized over expected tenure), onboarding and training costs, and management overhead.

For a US-based knowledge worker with a $180,000 base salary, the fully loaded annual cost typically lands between $240,000 and $280,000, depending on benefits richness and location.

To convert this to an hourly rate for comparison purposes, divide by productive hours per year. Assuming 2,080 total hours minus PTO (15 days), holidays (10 days), and non-productive time (meetings, training, administrative tasks), productive hours are roughly 1,700 to 1,800. At a fully loaded cost of $260,000 and 1,750 productive hours, the effective hourly rate is approximately $149.

Contractor Costs

Contractor costs are more straightforward but not as simple as the bill rate alone. The total cost includes the bill rate (hourly, daily, or project-based), agency markup if using a staffing firm (typically 20 to 40 percent on top of the contractor’s pay rate), onboarding time (usually shorter than FTEs but not zero), management and coordination overhead, tools and access provisioning, and contract administration and legal review.

A contractor billing $120 per hour with no agency markup works out to roughly $216,000 per year at 1,800 billable hours. If the contractor comes through an agency with a 30 percent markup on a $92 per hour pay rate, the bill rate is $120 but the contractor only receives $92.

The Apples-to-Apples Comparison

The correct comparison is fully loaded employee cost per productive hour versus contractor bill rate per hour. Using the example above:

In this example, the contractor is cheaper on an hourly basis. But cost per hour is only one dimension of the decision.

Non-Financial Factors That Affect the Analysis

Institutional Knowledge and Continuity

Full-time employees build institutional knowledge that contractors typically do not. For roles that require deep understanding of the company’s systems, processes, and culture, the cost of constant contractor turnover, including repeated onboarding, knowledge transfer, and relationship building, can outweigh the hourly rate savings.

Intellectual Property and Confidentiality

Employees are generally bound by broader IP assignment and non-compete agreements than contractors. For work involving core intellectual property, trade secrets, or sensitive strategic information, the legal and competitive risk of using contractors may outweigh the cost benefit.

Scalability and Flexibility

Contractors offer the ability to scale up quickly for a specific project and scale down when the work is done. This is particularly valuable for time-bound initiatives like system implementations, product launches, or seasonal demand spikes. The cost of carrying an underutilized full-time employee during a slow period can be substantial.

Regulatory and Classification Risk

Misclassifying an employee as a contractor carries significant legal and financial risk. The IRS, Department of Labor, and state agencies enforce classification rules based on behavioral control, financial control, and the nature of the relationship. Penalties for misclassification include back taxes, benefits, and fines. Any contractor engagement that involves full-time hours, company-directed work, and an indefinite duration should be reviewed carefully for classification compliance.

A Decision Framework

Rather than defaulting to one option, use a structured framework to evaluate each situation.

Use a Contractor When

The work is project-based with a defined scope and timeline. The skill set is specialized and not needed on an ongoing basis. You need to scale quickly and cannot wait for a full recruiting cycle. The budget is variable or uncertain and you need the flexibility to adjust. You are testing a new function or role before committing to a permanent hire.

Use a Full-Time Employee When

The role is core to the business and will exist indefinitely. Institutional knowledge and cultural integration are important. The work involves sensitive IP or strategic decision-making. The total cost comparison favors an FTE over a 2-plus year horizon. You need someone who will grow, develop, and take on increasing responsibility over time.

Consider a Contractor-to-Hire Path When

You are unsure about the long-term need but want to move quickly. The role is new and you want to validate the job requirements before committing. You want to evaluate a candidate’s work before extending a full-time offer.

Modeling the Break-Even Point

For roles where either option is viable, calculate the break-even tenure. This is the point at which the cumulative cost of a contractor equals the cumulative cost of an FTE, including the upfront recruiting and onboarding investment.

If the FTE has a $40,000 one-time recruiting and onboarding cost and a $260,000 annual fully loaded cost, while the contractor costs $216,000 per year with minimal onboarding, the FTE becomes cheaper after approximately 11 months ($40,000 / ($216,000 - $260,000 annualized differential)). Wait, in this case the contractor is cheaper annually too, so the FTE never breaks even on pure cost. This illustrates why non-financial factors must be part of the decision.

In scenarios where the FTE is cheaper on an annual basis (common for lower-cost roles where contractor markups are proportionally higher), the break-even calculation shows how long you need the role to justify the upfront investment. Typically, if the role will exist for more than 12 to 18 months, the FTE is the better financial choice.

Presenting the Analysis

When presenting a contractor-versus-FTE recommendation, structure it as a total cost comparison (annualized and over the expected duration), a qualitative assessment of non-financial factors, a risk assessment covering classification, IP, and continuity, and a clear recommendation with the reasoning documented.

Decision-makers appreciate transparency. If the contractor is cheaper but riskier, say so. If the FTE is more expensive but strategically important, quantify the premium and explain why it is worth paying. The goal is to give leadership the information they need to make a well-informed decision, not to advocate for one option over the other.