Contractor Payroll: The $1.4T Market to Build the Cash App for the Global Labor Market

Deel launched out of Y Combinator’s Winter ‘19 batch as a way for companies to hire anywhere in the world.

Deel abstracted away the messiness of remote hiring, putting payments and compliance behind a simple SaaS interface.

Few launches have been as well-timed: in less than a year, worldwide COVID lockdowns hit and Deel took off, growing revenue 20x from $200K to $4M in 2020, and 13.5x from $4M to $54M in 2021.

But while Deel’s success heightened the attention on remote work and global hiring, the nature of Deel’s product-market fit has more to do with enabling teams to hire contractors than hire employees.

Today, freelancer earnings represent $1.4T of $25T in annual B2B payments. Of about 59 million people who work outside traditional employment structures, 85% or 50 million work as freelancers or contracted-out workers, per data from Wingspan, while only 15% are virtual laborers hired through platforms like Upwork, Uber, or Handy.

And Deel isn't the only company going after what we call “contractor payroll”—the combination of payments and SaaS built to help companies hire, onboard, work with and pay contractors at scale within a payroll-like OS.

Contractor payroll, on the contrary, is a space that is being contested by some of the biggest companies in B2B SaaS:

Contractor payroll is quietly becoming a core part of the products of several billion-dollar market cap companies.

Each is looking to win contractor payroll because of the unique opportunity that it represents—to own the contractor wallet and build a closed loop payments network for the global labor market.

Contractor payroll platforms turn the purely transactional business of contractor payments into subscription SaaS by layering a set of workflow products on top.

The core payroll business model is characterized by:

Contractor payroll platforms charge customers a monthly fee to access their payments and compliance tools. They will also charge an additional per-seat fee based on the number of contractors that a company is paying.

Most revenue, however, comes from how they monetize their customers’ total payroll volume via:

The upshot is that a company paying out $10M a year to 600 independent contractors can generate about:

Financial services are likely to be the biggest driver of transactional revenue for mature contractor payroll companies: if half of the contractors at a company doing $10M in payment volume per year opt into instant payouts, and the platform charges a 1% markup, that’s $50K in revenue.

Float revenue is likely to decrease over time. For example: Bill.com ($12B) started monetizing off float after introducing bill payments in 2009. As late as Q3’19, float was 22% of revenue. As of Q3’22, with the rise of features like Instant Transfer, it’s down to 1%.

Contractor payroll platforms also make some money via the international currency exchange necessary every time a company wants to pay a contractor in a different country.

In the 90’s, the grandaddy of geo-arbitrage, GE CEO Jack Welch, moved all of GE’s IT services to India to save money.

Other big American companies would go on to do the same, like IBM, whose Indian workforce grew from 3,000 in 2002 to 53,000 in 2007.

Over the course of the 2000s, all American multinationals hired 2.4M foreign workers across countries like Mexico, India, China and Ireland while also reducing their total workforce by 2.9M—a total 5M+ total net increase in offshore employees.

The launch of platforms like Elance in 1998 and oDesk in 2003 promised to enable any company to offshore, as the marketplace era of labor geo-arbitrage kicked off.

Suddenly, anyone could go online and hire someone in a country with a lower cost of living for gigs like data entry, designing a website, or writing a blog post for significantly lower wages than a domestic employee would demand.

At IPO, Upwork (NYSE: UPWK)—the company formed when Elance and oDesk merged—reported having 2M+ unique projects on the platform, more than 375K freelancers earning an income, and 475K paying clients.

The era of the global EOR followed.

The rise of global EORs was fueled in part by the late 2000’s financial crisis. In its aftermath, companies began looking for ways to geo-arbitrage labor at a greater scale than just gig work and blog posts—they wanted, Welch-like, to build whole teams and departments out-of-country.

Companies like Globalization Partners (2012), Velocity Global (2013) and Papaya Global (2016) were founded to capitalize on this desire, providing companies with the material presence necessary for them to hire teams internationally.

Today, what we’re seeing emerge with companies like Deel (2019) is a new kind of relationship between companies and contractors.

Rather than bringing on international teams as a supplement to their existing domestic base, companies are building global teams using contractors from day 1.

They're hiring their core team as contractors, then only going through the significant costs of setting up a material presence in another country or using an EOR to scale.

Those contractors aren’t ancillary members of the team, or used only for tightly delimited projects—they behave more like employees, only employees that can be freely and cheaply hired from anywhere in the world to work anywhere in the world, with minimal bureaucracy, without needing to pay expensive healthcare and benefits upfront.

To enable this, the core thing that was needed was to eliminate the manual, repetitive, and time-consuming process of paying those contractors—to build a payroll-like experience so teams could pay their contractors as easily as they pay their regular employees.

Before companies like Deel payrollified labor geo-arbitrage, startups would routinely pay contractors using P2P payments apps like Wise ($8B) and PayPal ($97B), B2B payments apps like Bill.com ($12B) or writing money directly out of their bank account.

As your number of contractors grew, this manual, one-off payments process and all the background moving parts would become a bigger pain.

What companies like Deel and Wingspan did was create a solution to help companies manage teams of contractors at scale by bundling payment tools like Wise into SaaS solutions for paperwork, invoicing, and compliance that give both company and contractor a payroll-like experience.

When COVID hit, these kinds of services enjoyed huge growth as the idea of building a global, remote team became, for many companies, the default choice:

With these services, any company of any size can hire anyone in the world as a contractor. They can run payroll across all of them with a single click as easily as they would their regular employee payroll, and they can have the legal and compliance backing to feel confident that they’re doing it the right way.

In this way, Deel and co. opened the door to a new kind of geo-arbitrage of labor: instead of just leveraging the cost of living difference between different places to get cheap gig work or offshore a whole division, companies now had access to a form of low capex global hiring that could allow them them to have a global-first perspective on building their team.

The cost savings on bringing on full-time members of the team as contractors rather than employees are significant: between two 40 hour per week workers with an hourly rate of $60, the employee will have an effective cost of around $130 after insurance, taxes, benefits, and other overhead costs, while the contractor will have an effective cost of $70 per hour.

While COVID accelerated the trend towards this new kind of labor relationship, the tailwinds have been there for decades:

Far from a temporary COVID bump, what we’re seeing in the labor market today is part of permanent, secular trends that are going to continue.

But global payroll companies like Deel and Remote aren’t the only ones that are going after this opportunity: many of the biggest B2B SaaS companies, hoping to own the relationship between contractors and their companies, have been building and launching their own contractor payroll products.

As B2B products all compete to eat up B2B transactions, we’re seeing the widespread bundling of contractor payroll into their products.

These companies want to eat up contractor payroll and include it in the larger bundle of payments and back-office functions they already perform:

Some of these services target different segments of customers. For example, Wingspan primarily targets mid-market companies paying hundreds or thousands of contractors with a particular need for workflow automation around contractor payments—their average ACV on SaaS is around $20K-$70K. Gusto, which is focused on SMB payroll, brings in about $260M a year in revenue on more than 200,000 customers for about $1.3K per customer.

On the other hand, they’re threatened by an emerging set of companies like Check ($119M raised) and Zeal ($15.4M raised) that are abstracting the payroll function into a set of APIs open to any vertical SaaS to use.

Vertical SaaSes want to offer their own payroll functions because doing so adds another layer to their business model with:

These payroll APIs effectively threaten to turn the contractor payroll use case into a commodity by giving every vertical SaaS and every work marketplace the power to do its own payments as part of its overall product bundle.

But the big reason all of these different kinds of companies want to own contractor payroll is that while employees are networked via professional graphs like LinkedIn, freelancers are networked via payments graphs.

Companies like ADP, Gusto, Rippling and Ramp want to own the network of contractors not just for cheaper user acquisition but because it is a network with high built-in retention, trillions in fund flows every year, and a long list of monetizable products and services that can be sold into it.

While the average employee only changes jobs once every 4 years, the average contractor works for as many as 12 clients per year. That has created avenues for the networks of contractor payroll platforms to grow larger via each encounter between contractors and companies:

The problem is that this continued depth of competition creates fragmentation across the payments graph.

Say you’re a contractor and you receive a payment from a company via Bill.com, but you don’t use Bill.com to receive payments. You could make an account, but you’d rather receive payments via the payments app you already use—PayPal, or Wingspan, or Wise.

This kind of fragmentation is widespread in the world of contractor payments today, and it perpetuates its slowness and friction. Companies and clients all have their preferred tools, and because there’s no centralized place where companies and contractors are tracking work together and exchanging funds, contractors have to spend time hunting down and making sure all their invoices have been paid.

This costs contractors money, and makes it harder for them to turn freelancing into a sustainable, full-time source of income.

To win, contractor payroll companies need a value proposition that brings companies and contractors together on one platform—and incentivizes both of them to stick around.

In the first phase of payroll, when it was time to pay your employees, you sent the funds to your payroll processor’s account rep, and they sent back an envelope with physical paper pay stubs.

Gusto changed all of that in the second phase when it moved payroll onto a shared web portal. By bringing companies and employees onto the same platform, Gusto made payroll easier and let employees download their pay stubs, check their benefits, and track their time digitally.

What we’re seeing today is the third phase of payroll:

We’ve seen this kind of progression play out before with Square and Cash App.

Cash App (now at $2B a year in gross profit) won over Venmo and other apps by giving users access to their money faster, and they continued to strengthen that time-to-money value proposition over time:

Additional product launches would further strengthen Cash App’s low time-to-money value proposition, make it stickier, and also grow ARPU.

Now, by launching a way for Cash App users to pay Square sellers using Cash App, Block is lurching towards building a closed-loop payments network.

Building a closed-loop network between Cash App users and Square merchants would give them:

The big opportunity in contractor payroll is to build a similar closed loop network for the $1.4T and growing of freelancer payments made every year.

Cash App found product-market fit with Americans living paycheck-to-paycheck for whom speed was of the essence because of the potential ripple effects that could arise with any volatility in their personal lives. In the freelancer economy, volatility is the rule, with contractors going from company to company, making their income lumpy and unpredictable.

That has opened up the opportunity for a service that can get money into contractors’ pockets faster, and contractor payroll platforms are perfectly positioned to do that.

Contractor payroll platforms:

If contractor payroll platforms guaranteed timely freelancer payment based on the amount of work done, it would give contractors a vastly upgraded sense of financial security—and also give their platform the kind of stickiness that Cash App was able to reach in the consumer space by reducing time-to-money in the same way.

By owning the contractor wallet with that 10x better experience, contractor payroll platforms have an opening into selling a range of other products and services into their network. As Gusto built products like Embedded Payroll and Gusto Wallet on top of their network of SMBs, contractor payroll companies have the opportunity to sell things like:

Across virtually all of these services, contractor payroll platforms can derive a powerful advantage over other traditional providers by virtue of the data and visibility they have into the activities of both contractors and companies.

The contractor model offers workers a lot of potential positives: quicker time-to-work than within traditional employment structures, extra income outside an existing job or job search, and greater flexibility—especially important for the inclusion of those with disabilities.

Contractor payroll platforms are fundamentally a bet on the future of this kind of working relationship, and on the upside of the millions of people who are working freelance today and will join the freelance workforce tomorrow.

But to win, contractor payroll platforms will need to beat out stiff competition—not just the other well-capitalized contractor payroll platforms competing for the same turf, but the growing number of vertical SaaS products and gig work marketplaces that are building out their own payroll and workforce management solutions to try and get a slice of what will be trillions of dollars of international fund flows.