How to Know If Your Labor Cost Is Too High

Payroll feels expensive because it is visible.

Every week or two, a large amount of cash leaves the bank.

Owners look at that number and say, "Labor is too high."

Maybe.

But payroll dollars by themselves do not answer the question.

The better question is: What is the labor supposed to produce?

A $30-an-hour employee can be incredibly expensive.

A $50-an-hour employee can be incredibly profitable.

It depends on what the company gets back.

Your Employees Are Billing You

I like to explain labor this way.

Every employee sends the company a bill.

They may not hand you an invoice, but that is what payroll is.

They are billing you for their time.

If the company pays someone for 40 hours, what does it receive in return for those 40 hours?

In a service company, maybe we can measure billable hours.

In construction, maybe we compare estimated labor hours with actual labor hours.

In manufacturing, maybe we measure units produced, throughput, rework, or standard hours.

The exact measurement changes.

The principle does not.

Paid time should create a measurable result.

Available Hours Are Not Productive Hours

Suppose a technician is paid for 40 hours.

That does not mean the company gets 40 productive hours.

There are meetings.

Travel.

Setup.

Cleanup.

Waiting.

Training.

Callbacks.

Parts delays.

Unplanned interruptions.

Some of that is necessary.

Some is not.

If the company only gets 24 productive hours from 40 paid hours, the true cost of each productive hour is much higher than the wage on the paycheck.

Here is a simple example.

Suppose the fully loaded labor cost is $35 an hour.

At 40 paid hours, that employee costs $1,400 for the week.

If only 20 of those hours create productive work, the labor cost per productive hour is $70.

If the company only charges $85 an hour for that work, there is not much left to cover overhead and profit.

The employee may feel busy all week.

The owner may see everyone working hard.

The economics can still be bad.

This is why effort is not the standard.

Production is.

Set the Standard Before You Judge the Person

This is where a lot of employee conversations go wrong.

The owner says: "You need to work faster."

The employee hears: "Work harder."

Nobody knows what faster means.

That is not accountability.

If a job was estimated for 24 labor hours, the field team should know that before the job begins.

If a technician is expected to produce 30 billable hours in a 40-hour week, make the expectation clear.

If a production employee is expected to complete a certain amount of work at a quality standard, define it.

You cannot hold people accountable to standards you never established.

The standard has to come first.

Then we measure.

Then we coach.

Then we decide.

Training Problem or People Problem?

Once you have a real measurement, employee decisions get easier.

Suppose one person consistently produces 90 percent of the standard.

Another produces 55 percent.

Now we can ask better questions.

Does the second employee need training?

Are they in the wrong role?

Are they waiting on information or materials?

Is the estimating standard wrong?

Is equipment slowing them down?

Is the owner constantly interrupting them?

Or is the employee simply not capable of meeting the job requirement?

The number does not automatically tell you to fire someone.

It tells you where to look.

That is a much better management system than walking through the shop and deciding who looks busy.

Labor Should Connect to Revenue

There is another simple way to look at labor.

How much of every revenue dollar should go to direct labor?

Suppose the company decides that direct labor should consume 20 cents of every sales dollar.

At $1 million in sales, the labor budget is about $200,000.

If actual labor is $260,000, something is off.

Maybe productivity is poor.

Maybe prices are too low.

Maybe overtime is uncontrolled.

Maybe labor is coded incorrectly.

Maybe the company is overstaffed.

Now reverse it.

Suppose sales are growing and labor is only consuming 15 cents of every dollar when the budget allows 20.

That might tell you something else.

The team may be stretched.

The company may have room to hire.

Now the hiring decision is not based only on whether everyone feels overwhelmed.

The economics help tell us whether the company can support another person and how much compensation capacity exists.

That is what I want financial reporting to do.

Help make decisions.

The Question Is Not "Is Payroll High?"

Ask: What should labor cost as a percentage of revenue?

What should each role produce?

What is the actual result?

What is causing the gap?

Then manage the cause.

Labor is not automatically expensive.

Unproductive labor is expensive.

Productive labor at the right price can be one of the best investments in the company.