The two components of direct labor costs

opportunity-24The third profit driver we will examine is direct labor cost. Direct labor is a sensitive area for obvious reasons, but despite this it’s frequently targeted when companies are trying to reduce their operating costs because it’s one of the more immediately “compressible” costs. What that means is you can often reduce labor costs fairly quickly in relation to how volumes are fluctuating. Some of the typical tactics include reducing shifts and overtime, or combining positions. Direct labor is driven by hours worked and wages per hour and opportunities exist in each of these components.

Hours worked are driven by how many people you need to run a process to achieve some volume output. So there are two distinct analytical questions; how do you staff the process, and how well does the process run? The more problems and issues that slow the “speed” of the process will result in needing to run it longer. The opportunity is to eliminate variation and “downtime” of a process so more can be done in a shorter period of time. The second component is how many people are needed to operate the process. The opportunity here is to see if there are any positions that aren’t needed or could be combined with others. In some environments, where volumes can fluctuate significantly (like hotels and restaurants for example), a basic issue is to assess what the true minimum staffing levels are when there is little or no volume.

The key to finding opportunity in the other part of the equation, wages per hour, is to reduce the average wage cost. So it’s more about figuring out how to most effectively use the various wage rates that are available, rather than lowering wages themselves. The two main areas of opportunity here are to try to reduce overtime requirements (reducing the premium portion of wage costs), and to make sure work is properly allocated to the appropriate pay level.