Why do businesses add middlemen?

Cutting out the middleman is a classic business move.

If you are a company that makes a product that sells through retailers, the retailers will take a percentage of the final cost to the customer. For example, a shampoo company will sell their shampoo to Target for $2/bottle who will then sell it for $5/bottle.

If the shampoo company was able to sell it to the customer directly, they could capture $5/bottle.

Cutting out the middleman (Target) would increase revenue by $3/bottle.

So...why doesn't the shampoo company do this?

There could be a numer of reasons:

  • The shampoo company is less efficient at getting customers than Target. Target knows how to get customers in the door profitably. The shampoo company doesn't, or might have to pay more than $3/bottle to get the customer (making it unprofitable)
  • The shampoo company wants to focus on what they do best, making great shampoo
  • The shampoo company does sell directly to customers, but they can't reach ALL their customers so they sell to Target to reach a different customer base
  • The shampoo company doesn't actually make much money selling shampoo and prefer to focus on higher margin products
  • The shampoo company had an exclusive deal with Target and can't get out of it for a few years

In the government contracting space, you might wonder why a prime contractor would ever add a 1099 or sub-contractors. Couldn't they just bring everything in house? Wouldn't it be more profitable?

Well, there are similar reasons why they'd bring on a 1099.

  • The prime can't hire W2 employees at a cost effective salary so they hire 1099s at lower overall costs with less risk
  • The prime won work that they don't specialize in so they'd prefer to sub-contract it out
  • The prime does do most of their work in-house but they can win more business by adding a few partners/1099s to their team
  • The prime is focused on staffing higher margin management consulting work and prefers to sub-contract out work with lower billable rates
  • The prime is required to sub-contract out a certain percentage of their work per the terms of their contract with the government

By becoming a 1099 sub-contractor you're adding another layer between the government and the service they're paying for. This isn't "efficient" in one sense, but there are good reasons why primes sub-contract out work they in theory could be doing themselves.

So don't think you have to charge extra low rates or be some super genius to become a 1099.

Sometimes a little effort and a little understanding of the real reason why a company would bring you on as a 1099 is enough.

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