Much of the attention paid to contract workers has tended to focus on their use by large companies.  However, in recent years, small business owners have dramatically increased their use of contract workers.  

The figure below shows the share of net income spent on contract workers at sole proprietorships from 1998 through 2006.  Over the nine year period, the share of income spent on this category of workers more than doubled.

Amount Spent on Contract Workers as a Percent of Net Income at Sole Proprietorships, 1998-2006

Source: Created from data downloaded from IRS, Statistics of Income Division, May 2008

So why are small businesses turning more and more to contract workers?  Some of the explanation appears similar to that accounting for similar trends among large companies.  Contract workers provide businesses with greater flexibility.  When the economy turns bad, these workers can be let go more easily than permanent employees.  Conversely, when the economy turns good, they can be added more quickly.

In addition, companies, big and small, can “test out” potential employees by first hiring them as independent contractors.  If they don’t work out, the company doesn’t need to get rid of them.  They can just let the contract expire.  On the other hand, if the contractors are good, the company can take them on as employees.

But small businesses have also been adding contract workers for other reasons.  One is to gain access to specialized skills at a lower cost.  Many small businesses don’t have enough employees to hire many specialists, so hiring contract workers can provide a wider range of skills than the company could otherwise get.

Another is to keep down benefits costs, which have been rising very rapidly.  Because contract workers aren’t provided with benefits, like employee health insurance, companies can minimize the impact of rising benefits costs by shifting from employees to contract workers.

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About the Author: Scott Shane is A. Malachi Mixon III, Professor of Entrepreneurial Studies at Case Western Reserve University. He is the author of nine books, including Fool’s Gold: The Truth Behind Angel Investing in America ; Illusions of Entrepreneurship: The Costly Myths that Entrepreneurs, Investors, and Policy Makers Live By; Finding Fertile Ground: Identifying Extraordinary Opportunities for New Ventures; Technology Strategy for Managers and Entrepreneurs; and From Ice Cream to the Internet: Using Franchising to Drive the Growth and Profits of Your Company.