Editor’s Note: Dr. Hough is a frequent contributor to this blog.
Subcontracting is a common practice in the construction industry. The general contractor selects individuals or companies to handle who specialize in certain aspects of the construction. For example, the general contractor may hire plumbers, electricians, brick layers. Other types of businesses also subcontract work on a regular basis. The buyer of the finished goods or services may or may not be aware that the work was not handled in its entirety by the primary source. Here are examples of other types of organizations that subcontract work from time to time.
Work that may be subcontracted includes printing, recording, writing, and mailing services. When the buyer allows the agency to purchase such work it is common for the agency to have the invoices marked up by 15%.
A manufacturer may subcontract work because of lack of equipment, a certain skill, or for lack of capacity. It is likely that the manufacturer would also markup the purchase cost in any quotation or invoice to the buyer. For example, a producer of a casting might send the casting to a plating company before it is delivered to the customer.
Perhaps not considered subcontracting per se, but it amounts to the same thing. The trading company finds the source and negotiates with the producer. The buyer in the U.S. may not even know the name of the actual producer.
The buyer can prevent subcontracting by stipulating that all work must be performed by the seller. Alternatively, the buyer can allow subcontracting, but require the name of any subcontracted source used as well as a copy of all invoices from the source. Another option is simply to insist on approval of any supplier before being used by the primary contractor.
The advantage of buying all services directly is that the buyer is in control. He or she can shop and negotiate with many sources to obtain what the buyer believes is the best supplier. The buyer can make sure that each source is covered by insurance and operates legally. Also, paying for any markup applied to a subcontracted item by the primary source is avoided.
The advantage of allowing the primary source to obtain any needed services is that the source may have had more experience selecting organizations that perform the best or that match the technical requirements of the primary supplier. In addition, the buyer can hold the primary source completely responsible for a good completed product.
However, primary suppliers still try to blame their subcontractors for delays or poor quality. If the primary has done the sourcing, he should be held responsible.
Difficulty arises when the primary sends material to another supplier for some intermediate process and then has it returned for completion. Each organization tries to blame the other for improper specifications or poor quality. It is more difficult to resolve when the buyer selected both sources. The primary contractor is responsible when he subcontracted the work.
It is even more important to be aware of subcontracting arrangements if work is to be performed on the buyer’s property. A buyer must make certain that suppliers have workmen’s compensation insurance and sufficient liability coverage. A copy of the policy should be obtained. However, there could be a problem if the supplier hires a subcontractor to perform certain duties and that subcontractor does not have his own coverage. Know who each person working on your property is working for. Make sure you know what insurance coverage they have. Make sure they abide by your company’s safety rules and abide by all government regulations.
You can make it easier to protect yourself from potential undisclosed subcontracting by including a clause on your standard purchase order form that either prohibits it or requires the buyer’s source approval for any subcontracting work. It is still a good idea to discuss this issue with your supplier to avoid any misunderstanding and to emphasize its importance. It is probably better, if time permits, for the buyer to contract with each source directly when dealing with a weak primary contractor.