Gig Economy Creates Business Process Outsourcing Opportunities (and Some Risks)

Traditionally, business process outsourcing, or BPO, is the use of an outside contractor to handle certain functions that aren’t core to the business. Companies ranging from giant multinationals to small start-ups hire outside firms to provide a bolt-on function.

The outsourced work, generally performed by employees of a third-party firm, can be either back-office functions such as accounting, payroll, HR management and IT, or front office operations such as running a call center, help desk, or sales and telemarketing.

Big manufacturers like Coca-Cola and General Motors pioneered the BPO strategy more than a century ago. The Atlanta beverage giant began farming out its bottling and delivery operations to affiliated firms in 1899. The first U.S. auto dealership was opened in 1898 by a future founder of Cadillac; GM and other automakers later franchised hundreds of dealerships.

Today, BPO is a massive and growing market peopled by firms such as consulting and IT services firms Accenture and Cognizant. The BPO market is expected to grow to $220 billion in global revenue by 2020, according to a report by Global Industry Analysts.

A key advantage of outsourcing is flexibility: A company can ramp operations up or down depending on demand. Another is efficiency: A firm can cut labor costs and focus its scarce capital and employees on its core business and products, boosting its agility and profit margin.

Big Opportunities for Small Companies

But the gig economy, with its growing sea of independent workers and online marketplaces for freelance gigs, offers even small to mid-size companies a whole new arena in which to outsource work, including core functions. Using digital labor platforms, a start-up or growing mid-sized company can scale its contract labor force to meet current needs, or shop globally for the worker with the right skills for the job, rather than being limited to the local labor pool.

Upwork, which operates a digital job platform linking companies with freelance workers, said the fastest-growing demand on its site is for blockchain cryptographic developers, people familiar with machine learning applications such as TensorFlow, voice-over artists, subtitling specialists, and art directors.

The booming gig economy now employs 57 million Americans, or more than a third of the workforce, according to an annual survey by Upwork.com and Freelancers Union, which represents independent workers.

That swelling resource has not only made it easier to find outside expertise, but made such folks a strategic asset for some companies, Forbes noted in a recent article.

By some estimates, companies that hire gig workers can save about 30 percent on labor costs through lower employee benefits and related costs. Since much of the work by contract workers is done remotely, companies also can save money on office space and other fixed costs of an in-house operation.

A freelancer may be able to bring focus to a project that would be third or fourth on the to-do list of an employee busy with day-to-day tasks. As the company grows to the point that it needs to add in-house talent, freelance assignments can also be a way to try out a potential employee before hiring him or her, helping to avoid costly hiring mistakes.

In some cases, firms can get Uncle Sam’s help with hiring outside help for developing and improving new products and processes. The federal Research and Development (R&D) Tax Credit, created in 1981 to encourage innovation, provides a dollar-for-dollar offset to income taxes for qualifying research expenditures.

The company’s spending must be related to developing and improving new products or processes, and should involve hard science or engineering, such as computer science or biology. But such tax benefits can help fund labor expenses, whether for traditional employees or outsourced hires.

Trading Places: Swapping Employee Costs for Hidden Costs

The gig labor strategy also comes with challenges that firms must be prepared for, including tax and legal implications, the potential for data breaches, and less control over customer service or other functions.

Some companies are having second thoughts and shifting more work back to traditional employees “because of the lack of quality control. You may not be able to get as much out of contractors as employees. You have fewer carrots and sticks, ” said Charlotte Alexander. The Georgia State University assistant professor is studying federal courts’ decisions on whether contract workers should legally be considered employees, which could expose their employers to tax and legal liabilities that can cost millions of dollars.

Still, a big driver behind many businesses’ growing reliance on independent contractors is the chance to shed the higher costs and obligations associated with traditional employees.

“Employee status is expensive,” said Alexander. Employers must cover a portion of workers’ Social Security, Medicare, unemployment compensation and other payroll taxes, and typically pay vacation, health insurance and other benefits that can amount to about a third of an employee’s total labor costs. Employers also must meet IRS tax reporting and other paperwork obligations, and abide by legal protections for workers such as anti-discrimination, overtime and minimum wage laws, she said.

Contract workers, on the other hand, are paid a set fee per project. Businesses generally have to report contractor payments to the IRS on Form 1099s, but tax withholding obligations, benefit costs and legal and wage law protections typically do not apply.

“Record-keeping, paperwork and payroll taxes are one of the things that employers point to a lot,” Alexander said, as the reason to turn to contract or gig workers.

If He Walks and Talks Like an Employee…

But employers must tread carefully, Alexander added, to avoid creating a de-facto employee relationship by exerting too much control over how, when and where independent contractors do their work. Companies especially take on a risk if they lay off or retire existing employees and rehire them as contract workers, or hire new gig workers, with little or no change in job duties or how they are managed, said Alexander.

Using labor contracts and labels like “contractor” don’t provide protection against employee misclassification complaints if the company exerts too much control over contractors’ work, said Alexander, a former employment lawyer.

“If it looks like a duck, quacks like a duck, it’s still an employee,” said Alexander, who is co-investigator in a federally-funded study using analytics to examine some 10,000 decisions by federal district judges over the past decade regarding employee misclassification cases.

The cost of misclassifying employees can be steep. States’ attorneys general and labor departments have won settlements of up to tens of millions of dollars in some cases against companies accused of employee misclassification. Gig workers also have filed dozens of lawsuits against Uber and other digital platforms alleging abuse of the independent contractor classification.

Penalties Await Gig Workers and Companies Who Fail to Report

The IRS also can investigate. If it determines that a company misclassified employees as contractors, the employer is liable for past payroll and unemployment taxes, plus penalties and interest.

Still, the gig economy is creating powerful incentives for companies and contract workers to avoid reporting taxable labor income to the IRS, UC Hastings Law School Professor Manoj Viswanathan noted in a recent Georgia State Law Review article.

Online market platforms such as Lyft, Airbnb and TaskRabbit have claimed that they are third-party settlement organizations who, under IRS rules, only have to report payments to the agency if they exceed 200 transactions totaling more than $20,000 to an individual freelancer.

“Most payments made to the sharing economy participants are not reported because of the higher thresholds,” said Viswanathan, resulting in an incentive for workers to not pay taxes on that income. The situation also allows companies to pay less to workers than if the payments were taxed as gross income.

“As a result, payors do not report several billion dollars to the IRS, and most of that is likely unreported by taxpayers,” he said.

By 2020, about 40 percent of the workforce is expected to earn at least some income through the gig economy, resulting in even bigger tax compliance issues. Congress could react by imposing tighter reporting requirements on the digital market platforms at the heart of the gig economy, said Viswanathan.

Five Tips for Tapping Into the Gig Economy

Free up cash and turbo-boost growth and profits: You can cut direct labor costs roughly 30 percent, save on office space and free up other resources by hiring independent workers. The gig economy’s online platforms can also provide skilled workers as needed for projects or seasonal swings in demand. McKinsey & Co. estimates the strategy can boost profit margins by 2.75 percentage points through lower labor and fixed costs.

Optimizing employee recruitment: Use digital labor platforms to rapidly screen and recruit workers and support a shifting mix of project teams, says McKinsey. Such platforms can help with creating a more personalized “onboarding” experience that brings workers up to speed more quickly.

Beware fuzzy definitions: Legal definitions of who is an employee, a direct contractor for a company, or someone doing short-term gigs through a digital platform have not caught up with the gig economy’s rapid rise. The IRS and courts are thrashing those issues out case by case. But that creates uncertainty, which is bad for business and scary for investors, said Alexander.

Keep track of gig work: Your HR department should be aware of who’s doing work for the company and why. If managers are using gig workers because the budget prevents them from hiring full-time employees, the risk of misclassification is higher, according to Forbes.

Hiring former workers as contractors: The same risk arises with hiring laid off or retired workers as contractors. The government may assume the employer is circumventing classification laws, especially if the contractors are doing the same duties as when they were employees.