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Subcontracting

Last updated 8 October 2026

Subcontracting is hiring another business to carry out part of the work you have contracted to deliver, while you remain responsible to the customer for the whole job. A builder who wins a contract to fit out an office may subcontract the electrics and the air conditioning to specialists.

The customer's contract is still with you, so any failure by the subcontractor is your problem to fix and your liability to carry.

From the Money Master HQ dictionary, founded by Shihan Sheriff (FCMA, CGMA, CPA (Australia), MBA (General), MBA (Data Science & AI), UAECA, CAAB, CAIS; VP of Finance at Nomod, CFO at Esanjo Ventures). How these definitions are written.

On this page

What it means

The commercial logic is straightforward. Subcontracting converts fixed costs into variable ones, gives access to specialist skills or licences you do not hold, and lets a business take on work it could not staff from its own payroll.

The structure matters legally. There are two contracts, not three: the main contract between the customer and the main contractor, and a separate subcontract between the main contractor and the specialist, which means the customer generally has no direct claim against the subcontractor.

The financial risk sits mainly with margin and cash. If the main contract is fixed price and the subcontractor overruns, the main contractor absorbs the difference, and if the customer pays in sixty days while the subcontractor expects thirty, the main contractor funds the gap.

Documentation is the practical defence. Back-to-back terms, where the subcontract mirrors the obligations, timescales and payment terms of the main contract, are the standard way of stopping the main contractor from being squeezed between two mismatched agreements.

There is also an employment status nuance worth knowing. A long-running subcontractor who works only for you, uses your equipment and follows your instructions may be reclassified by a tax authority as an employee, bringing payroll taxes and employment rights with it.

In practice

Real-world examples

Example 1

A software consultancy wins a $600,000 implementation and subcontracts the data migration to a specialist partner for $140,000. The client's contract, warranties and support obligations all remain with the consultancy, which prices the risk into its own fee.

Example 2

A commercial cleaning company covering forty sites subcontracts window cleaning at height to a licensed access firm. It keeps the customer relationship and the recurring revenue while avoiding the insurance and equipment costs of doing the work itself.

Example 3

A manufacturer facing a seasonal spike subcontracts assembly of one product line to a nearby workshop for four months. Output rises without a permanent hiring commitment, though the quality team has to add inspection at the point of return.

Think of it

Imagine you are building a custom house for a client. While you manage the overall design and architecture, you hire specialist electricians and plumbers to install the complex wiring and pipes, rather than trying to learn those trades yourself.

Formula

Calculation

Gross profit = contract value - (direct costs + subcontracted costs) Gross margin = gross profit / contract value A fit-out contractor wins a job with a contract value of $800,000. It expects to incur $344,000 of its own labour and materials, and to subcontract electrical work at $210,000 and mechanical work at $150,000. Subcontracted costs total $210,000 + $150,000 = $360,000, so total direct cost is $344,000 + $360,000 = $704,000. Gross profit is $800,000 - $704,000 = $96,000, and the gross margin is $96,000 / $800,000 = 12%. Now suppose the electrical subcontractor's quote turns out to have excluded containment work, and the true cost is $40,000 higher. Because the main contract is fixed price, the contractor cannot pass that on: total cost rises to $744,000, gross profit falls to $800,000 - $744,000 = $56,000, and the margin drops to $56,000 / $800,000 = 7%. A single scope gap in one subcontract has removed 42% of the job's profit.

Case study

Seen in the real world

The following is an illustrative and entirely fictional example. Renshaw Interiors, an invented office fit-out contractor, won an $800,000 refurbishment. Its estimate showed $344,000 of its own costs and $360,000 of subcontracted electrical and mechanical work, giving $96,000 of gross profit at a 12% margin.

The electrical subcontract had been agreed on a one-page quotation rather than back-to-back terms, and it quietly excluded cable containment. When the issue surfaced on site the extra work cost $40,000, and because the main contract was fixed price Renshaw carried all of it. Profit on the job fell to $56,000 and the margin to 7%.

The response was procedural rather than dramatic. Renshaw introduced a rule that no subcontract above $50,000 could be issued without a scope schedule mirroring the main contract, matched payment terms and a retention held until practical completion. In this illustrative case the next four projects delivered margins between 11% and 13%, and the estimating team stopped treating a subcontractor's price as though it were a guaranteed cost.

Watch out

Common mistakes

  • Assuming that subcontracting transfers the risk. The customer contract stays with the main contractor, so a subcontractor's delay or defect remains the main contractor's liability.
  • Signing a subcontract with different payment terms from the main contract, which forces the main contractor to fund the gap out of its own working capital.
  • Accepting a quotation without a detailed scope, because the gaps between what the customer expects and what the subcontractor priced always end up in the main contractor's cost column.

Questions

People also ask

What is the difference between subcontracting and outsourcing?

Subcontracting passes on part of a specific job you have contracted to deliver, while outsourcing hands a whole ongoing business function, such as payroll, to an external provider.

Do I need to tell my customer that I am subcontracting?

Many contracts require written consent or restrict subcontracting entirely, so the main contract should always be checked before work is passed on.

How much should be marked up on subcontracted work?

Enough to cover management time, warranty risk and the cost of funding the payment gap, which in practice commonly means 10% to 20% depending on how much supervision the work needs.

Sources and further reading

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