The Real Cost of Doing Business – Part II
In the second part of this series, we will discuss the ins and outs of paying for the labor you need to make your company run smoothly and thrive. (If you haven’t read Part I yet, you can find it here.)
You might think that you know what it costs to compensate your employees and manage your workforce, but the reality is that there are probably quite a few expenses involved which you aren’t aware of. These hidden expenses could be doing serious damage to your bottom line, and even your company’s future.
What Is the True Cost of An Hour of Labor?
It is easy to assume that the cost of an hour of labor is very simple and straightforward: a one hour unit of compensation at the rate you’ve agreed to pay an employee. But this isn’t the whole story; not by a long shot.
Remember the concept of burdened costs which we introduced in Part I of this series? In that article, you learned about cost burdens in the context of inventory and pricing your materials, but the concept of cost burden applies equally well to your labor force.
In the case of an employee working for your company, it’s important to understand that you’re never just paying an hourly wage; you’re also likely paying some (if not all!) of the following:
- Payroll taxes
- Worker’s Compensation Insurance
- Health insurance
- Paid time off
- Holiday pay
- Overtime pay
- Retirement contributions
- Supplies and uniforms
- Bonuses for holidays or a job well done
All of these costs add up quickly, and make up the burdened cost of keeping an employee on staff.
Are Your Technicians Cost Centers or Profit Centers?
Because each employee can represent quite a large expense to your company, you must keep a close eye on productivity and overhead. The more efficient and productive your workforce, the less expensive it becomes to maintain your employees.
Of course, it’s impossible to run a shop or business at 100% efficiency, all the time. It would be nice in theory, but this shouldn’t be your goal. Instead, you should focus on increasing efficiency and productivity as much as possible, while orienting your workforce toward a shared focus on billable services. If you’d like to learn more about how to cultivate a culture of efficiency in your company, read our article on Lean Thinking principles.
In order to get a grasp on just how productive (or not) an individual technician is, you can do some basic calculations. To calculate efficiency, simply divide the amount of time your technician spends engaged in direct billable services, by the number of payroll hours that he or she is present and available to perform those services.
For example, if a technician performs 30 actual hours of billable work in a week, but you pay them to be on the clock for 40 hours, your business has to absorb that extra 10 hours of idle time as a payroll cost. This is an example of a burdened payroll cost. Of course, you can’t just eat those 10 hours and take a loss on them; that is not a sustainable practice for any business. Instead, you will need to increase the cost of services, in order to cover the extra payroll burden without taking a loss. Once you look at employee efficiency from this angle, it’s easy to see why it’s so important to maintain an efficient and productive workforce!
To figure out just how much of your shop’s labor needs to absorbed by an increase in service costs, you would simply divide the unbilled labor hours (in our example, 10 hours) by the available payroll hours (40, in the case of a full-time employee). 10 divided by 40 = 0.25. So we learn that 25% of our burdened labor needs to be absorbed into the cost of services. This is called a “Variable Expense”.
Efficiency Is King
As a repair shop, your primary lever for improving profitability is to increase your workforce’s efficiency and productivity.
A few simple steps can help you cultivate a more efficient and productive workforce:
- Plan your schedule and work flow carefully.
- Make sure that all necessary parts and materials are on hand ahead of time, and ready for the job.
- Put a stop to idle time, and make sure every employee is working on a billable project while they are on the clock.
These simple principles will go a long way toward limiting your exposure to excessive absorption costs in your shop, thus improving your profit margin.
Watch Your Overhead
We’ve discussed the direct and indirect costs of maintaining an employee for your business, but another important set of costs to be aware of when pricing services is your overhead. Your overhead is your monthly lease, utilities, license fees, insurance, etc. You are probably already in the habit of keeping track of these expenses, and minimizing them as much as possible. Like the “Variable Expenses”, your business has to absorb due to loss of productive employee time, your overhead is a “Fixed Expense” which needs to be accounted for and absorbed if your business is to remain profitable.
It is also important to understand that your non-technician employees represent an overhead expense. While your technicians are operating as an efficient workforce, able to offset many of the expenses of running a business with their productivity and billable services, your non-technician employees are a financial liability. Because administrative staff, managers, receptionists, and other back-office employees are not working directly on billable services, but still collect a paycheck and various other benefits, they represent a cost-center for your company. This means that your shop’s technicians have to be efficient and productive enough to not only justify their own employment, but also to buoy the overhead costs of running the business and maintaining all of the other non-technician employees in the company. This, again, highlights the importance of maintaining a highly productive and efficient team of technicians. They are your primary profit center, and they will determine whether your business succeeds or fails.
Now that you have a better understanding of the direct and indirect expenses your business can expect to pay to maintain a workforce and work space, you should have a fairly clear view of how these various elements are impacting your company’s bottom line.
You are now well equipped to do some simple calculations to determine an appropriate price for your services, by considering direct burdened labor costs and those expenses that must be absorbed into the cost of providing those services. Performing these calculations, and using the data you uncover from them, will ensure that your company enjoys steady profitability.
Do The Math
To arrive at your fully burdened labor cost:
Payroll + Payroll Taxes + Paid Time-Off + Insurance + Retirement + Supplies = Your Burdened Labor Cost
To calculate your Fixed Expenses:
Monthly lease + Utilities + Insurance + Any other recurring monthly expense = Your Fixed Expenses
To calculate your Variable Expense:
(1 – (Customer Billed Hours / Available Payroll Hours)) X Fully Burdened Labor Costs = Your Variable Expense
To calculate the true cost of an hour of service:
Fully Burdened labor Costs + Fixed Expenses + Variable Expenses = Your real cost for an hour of service
Putting The Knowledge To Use – Your Action Plan
Now that you have a deeper understanding of the true cost of an hour of labor, it’s time to sit down and crunch the numbers. The two largest expenses (and, the most important to monitor) in an hour of billed labor are the fully burdened labor cost, and the variable expenses of unbilled labor which must be absorbed by the company because employees weren’t put to work efficiently.
If you don’t yet have a system in place to track these figures, implement one. When you first start out, your tracking system can be as simple as a spreadsheet where you input the number of hours you bill, and the number of hours your employees are on the clock. When you’re ready for a more thorough, 3-D view of the data for your business, consider implementing our Shop Management Software, specifically designed to help you eliminate unbilled labor hours and zero in on productivity issues.
Ultimately, the more you are able to accurately track the expenses we’ve covered in this article, the more empowered you will be to improve the performance of your company. As the performance of your company improves, so will your bottom line. Keep good records, be consistent, cultivate productivity with Lean Thinking principles, and your shop will perform better than it ever has.