Business Turnaround Basics – Understanding the Real Cost of Labor

In today’s business environment, labor is much lower as a total percent of sales than it was several decades ago. I can remember in the 80s that it was not uncommon to have labor be well over twenty percent of the COS. In today’s world, with all of automation, outsourcing of subassemblies and offshore production, the labor costs on most products produced in the US are now well under 10%. Even though it is a shrinking proportion of total costs, there are still many areas that need review to insure these costs are accurate for each product.

When we consider labor costs, we need to factor in other items that can have an impact on the accuracy of these costs as they pertain to a specific product. It is common practice to amortize all overhead costs over the entire labor hour base, distributing overhead costs and variances over all products, regardless of their contribution to the problem, which hides the need to make changes. Listed below are some areas that need analysis with respect to these costs. The recommendations used would be based on an Activity-Based Costing approach which ties all costs to the driving behaviors.

 

Labor Efficiency and Productivity Cost

In every business, there are products that are easy to manufacture and the labor performance outcomes are predictable. There are a variety of situations that can impact labor productivity and they include the following:

  1. Where labor is experiencing a learning curve during the production of new products.
  2. The processes are unpredictable and difficult to control consistency.
  3. The product is infrequently manufactured.
  4. 4The logistics for the production of the product are tough to manage in general.

In these cases, the additional inefficiency and productivity costs should be assigned to these specific products so the product costs are reflective of these problems. Otherwise, management will not see the cause and effect relationship and will avoid fixing the issues.

Quality and Rework Costs

When a product has a much higher reject and rework component, this cost should also be allocated to these specific products. Only then will the margin impact of these problems become visible and drive change.

Conclusion

Given the areas of unpredictability that occur in manufacturing, where variances can be tied to the driving behaviors it will both tie costs to the correct area as well provide visibility for management to focus resources to fix the real problems.

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Posted in Blog Post, Restructuring Businesses and Struggling Businesses

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