Ethical to markup off-shored services?

May 20, 2005 4:42 AM

My small company has been working on a relatively significant time and materials-based software development project for the past three months. We still have three months more of this to go. At any rate, because we don't have the expertise in house nor do we really have the need to build up a QA area (this is a one off project), we are looking into off-shoring the testing of the application. Is it ethical to markup the offshored hourly tester rates?

My partners think it is, but I really can't think of why it would be. More background on this is that we're being paid in the $100/hour range for the architecture, business process engineering, spec and development work. But the offshore tester (in Russia) will be charging us $22-$25 an hour for their services. Because we are getting paid our regular rate to manage the vendor (oversee their development of test cases, help them configure the test bed, do bug triage), I think we should pass through the base cost of the vendor to the client without any markup. Am I a sucker, or are there reasons to justify even a slight (10-15%) markup? The only possible reason I can think of is just having to take on the receivables risk in financing the float, if our client pays late, but seems to me that we could handle that by providing for penalties for late payment. Any advice would be appreciated.

posted by Flem Snopes to computers & internet (5 comments total)

You'll pay taxes on the total compensation you receive, so you need to mark up all subcontracted work just to cover your tax burden. In the same situation, I'd probably settle on a rate about half-way between your hourly rate and your subcontractor's hourly rate and roll up QA into a flat fee for customer billing purposes.

Unless you adhere to strict religious teachings, there is nothing inherently unethical about making money on somebody else's work. This situation is not much different than if you hired a junior associate to work on parts of this project behind the scenes. Would you charge the customer less for their time? There is an agreement for a specified application to be delivered, with its development paid for at hourly rates. Provided you meet your end of the bargain, how you economize the delivery is up to you.
posted by McGuillicuddy at 5:02 AM on May 20, 2005

If it helps, I've read a lot of IT contracts and invoices and they're split about 50-50 between marking it up and passing it through untouched. It depends what's written in the contract, and to some extent on how clear it is to the client that you're offshoring some of the work. Generally, though, it's not marked straight up to the full hourly wage of the in house staff, on the understanding that while the off shore resources charge less per hour, they charge more hours than you would have had to to do it locally.
posted by jacquilynne at 5:09 AM on May 20, 2005

It is absolutely, absolutely OK to mark up the work a reasonable amount.

For one thing, there's a certain level of expenses, like taxes, and the fact that you will still need to expend _some_ resources to manage the workflow, etc. So right off the bat, you're taking a loss if you just pass the subcontractor expense straight along to the client. You've got to mark it up by _something_, just to keep it from costing you money.

Secondly, and more fundamentally, the client is paying you to make sure the work gets done well, and on time. _That's_ what your value is based on, to them...not your internal costs. The whole _point_ of your business--and especially its profitability--is to do the work the client wants, but to charge them more than it costs you to get it done.

Following your logic, why is it ethical to mark up your employees' salaries, and your office rent before you "pass them along the the client"? Outsourcing some of the work is a business expense, just like your insurance costs, or if you hired a freelance designer/IA to pick up some slack for a couple of weeks.

The fact that you're writing an hourly check to these Russian guys just makes the reality of your business model very clear, because you happen to be able to match up the costs and expenses hour by hour, but that's really just a quirk of circumstance. That approach--of spending "X" to do the work, but charging the client "X+Y"--is already the basic foundation of your whole business.
posted by LairBob at 5:43 AM on May 20, 2005

And more to your point--if the Russian team is doing work at the level of quality you expect to deliver across the entire project, there is nothing wrong with charging your standard hourly rate to the client. The actual margin is irrelevant, as long as there's a seamless caliber of delivery across the board. You actually _deserve_ the excellent margin, for finding ways to deliver work that's worth $100/hr, but very cost-effectively. (I'm not saying that everyone should outsource everything--I'm just saying that when you find ways to deliver great work cost-effectively, _you_ should enjoy the benefit of your accomplishment, not the client.)

There are really only two circumstances when I'd say you should seriously charging less for the outsourced work:

1) You're in a competitive environment, and you need to compete on price. This definitely doesn't seem to be the case for you right now, but it still might make sense to position yourselves for future work with them--I just don't know.

2) The quality of the work you're passing through is sub-par, compared to the rest of what you're doing. If there were anything second-tier about the Russian team's work--like they couldn't test across all your target platforms, or their bug-tracking methodology is kinda loose, or the documenation's going to be sub-par--and you're passing that effect along to the client, then I'd consider charging less. (Of course, if it's anything that you need to expend effort to insulate the client, then the argument for charging your full-rate comes back in, since then their work is basically not so "cheap", all told.)
posted by LairBob at 5:53 AM on May 20, 2005

That approach--of spending "X" to do the work, but charging the client "X+Y"--is already the basic foundation of your whole business.

I think this is exactly, precisely, perfectly right. Thanks to everyone for responding, these were excellent answers and, as always, helped me see the business problems from more than a few angles.
posted by Flem Snopes at 5:54 AM on May 20, 2005