Labor Costs: 7 Effective Tips While Rebuilding Your Business

Rebuilding after forced closures due to the coronavirus pandemic can be a scary experience for small business owners. No one is sure what consumer behavior will look like in the near future. And while it’s exciting to be able to bring your staff back to work, you’ll need to understand managing labor costs responsibly to avoid any future layoffs.

It’s no secret that annual payroll costs are the majority of a business owner’s expenses—and costs are only rising. Still, your long-term labor cost reduction strategy doesn’t have to include letting anyone go.

Here are a few tips on how to manage total labor costs and boost employee productivity at the same time.

What are Labor Costs?

When you break it down, labor cost encompasses the total amount paid out for employee salaries, perks, and payroll-related taxes. These can be categorized as either direct or indirect costs. The first deals with salaries for employees hands-on in creating a product, like those on an assembly line. The latter deals with salaries for roles like maintenance or security staff.

Key Points to Keep in Mind About Labor Costs

• Labor cost divides into direct and indirect categories.
• The salary of those involved in making a product falls under direct costs.
• Support roles, such as maintenance, fall under indirect costs.
• Not correctly allocating labor costs can skew the actual cost and affect profit margins.

Going Deeper into the Concept of Labor Costs

Calculating the right selling price for a product or service involves considering labor costs along with other expenses. Missing any cost component can cut into the profits. So, businesses aiming to stay ahead often look for ways to curtail labor costs, especially during downturns. In specific sectors, like hospitality, customers might indirectly bear some labor costs through mechanisms such as tipping.

Drawing a Line Between Direct and Indirect Costs

Let’s look at a firm named ABC Furniture that’s set to launch dining room chairs. Here, the salaries of those managing machinery for the chair components would be direct labor costs. In contrast, the salaries for roles such as security would be indirect since they’re not tied to distinct manufacturing processes.

Fixed and Variable Labor Costs

Labor costs might be static or dynamic. The dynamic ones shift as the production level changes, giving businesses flexibility. However, static costs don’t waver, irrespective of production quantities. These typically manifest in long-term commitments like maintenance contracts.

The Pitfalls of Misallocation of Labor Costs

Attributing indirect labor costs correctly to specific products or services isn’t straightforward. For instance, if ABC Auto Parts misassigns labor costs between products, such as parts and services, it can mislead the final price. Mistakes in allocation can mean selling prices don’t reflect true costs, leading to profit dips.

Labor Cost vs. Living Costs

It’s essential to differentiate between labor costs and living costs. Living cost refers to the money needed to maintain a certain lifestyle in a location, factoring in housing, food, commute, and more. Sometimes, in areas with high demand, such as New York City, living costs might surpass labor costs.

7 Tips to Manage Labor Costs

We have curated the 7 best tips from experts on finance and labor cost management. These experts include Homebase’s VP of Sales and Service and CFO. You’ll also hear the perspective of a small business owner just like you, to offer you first-hand insights when it comes to rebuilding a business.

Know Your True Labor Costs

In order to determine how to manage labor costs, paint an accurate picture of what you’re spending on each employee. The true labor cost includes more than just their hourly wages. This is called your labor burden rate.

Extra payments like payroll taxes and benefits can add 12-20% on top of the gross wages. Be sure to calculate the true amount, it’s important!

To calculate the burden rate of an employee, add up the annual salary or total wages paid in a year, any bonuses or overtime payments, payroll taxes, and benefits like healthcare, paid vacation time, and 401(k). Understanding your burden rate can help you make more informed labor cost decisions.

Homebase VP of Sales and Service Luke Wilson highlighted how important it is to know in real-time exactly what you’re spending on each employee so you can make changes to avoid spending extra money.

“I think a lot of people do not know when their employees are into overtime,” Wilson said. “A lot of people find out they had five employees in overtime that week when they’re doing payroll, not in real-time.”

Understand the Labor Cost of New Operations

It’s no secret the world has drastically changed due to the coronavirus pandemic—and businesses all over the world are reflecting that change by pivoting or trying new operation tactics and implementing more stringent health and safety strategies.

With new operations and strategies come updated labor costs and staffing level needs for your business. Pay close attention to how much you could potentially be paying for your new changes and determine if the project profit is worth the increase in cost.

Optimize Scheduling

Speaking of overtime, a great way to eliminate it is to get a clear employee scheduling process in place. Not only will you have a more regular look at the work weeks and number of hours ahead, but your employees will also know ahead of time what their shifts will be and can plan accordingly, and you’ll be able to avoid any surprise overtime shifts.

Even better, utilize software like Homebase to do the hard work for you. With Homebase, you can create work schedules in minutes with our easy templates, and you’ll be forecasting your labor costs easily.

The Homebase app takes overtime avoidance a step further by automatically calculating overtime hours for you and alerting you when an employee is about to hit them so you can save money on overtime costs. This way, you can forecast labor costs right there from the app.

Enforce Time Clock Compliance

It’s more important than ever to ensure the hours you schedule for an employee match up with the schedule you created in order to prevent early clock-ins or overtime payments. If overtime is needed, but it’s unplanned, make sure that the extra time worked requires manager approval or override.

The Homebase free time clock app can help automate this as well. The feature helps you save money by preventing employees from clocking in early and automatically clocking them out when they forget. This means that every week the hours you scheduled equal the hours worked by your employees, and you won’t encounter any expensive surprises.

Reduce Voluntary Benefits

No one wants to be the employer who takes away provided benefits and perks, but if reducing small amounts here and there can increase your team’s job security and leave the door open to hire new employees—like the extra staff needed for new operations—the sacrifice may be worth it.

Homebase CFO Jason Liu said it’s important to rethink what you’re spending on each employee when determining how to manage the cost of labor, at least for right now.

“Revisit your budget in the new world,” Liu said. “Be conservative, there’s a lot of uncertainty.”

Part of the labor burden for each employee includes your benefit package. Take a look at what you’re offering and determine if you can cut back anywhere.

Reducing your spend in the bucket of benefits doesn’t mean you have to stop offering them. Make adjustments where you can, such as increasing the employee’s deductible slightly or converting pension plans to profit-sharing plans.

Whatever you change, change it across your entire team—and make sure everyone is aware. Trying to hide the alterations from your employees will lower morale, but transparency will keep everyone informed and prevent employee turnover.

“After you make changes, be transparent to your employees about what you’re doing and why,” Liu said.

Know Your Customer Tolerance

Your consumer base most likely has an expectation on how long they’re willing to wait to be greeted or served. Know this expectation, and work around it.

This awareness could make you realize that you may not need to schedule as many people on one shift. You may also realize your employees can get other work completed instead of spending their energy on customers.

Wilson said knowing that customer expectation and tolerance means your team can increase productivity while satisfying consumer needs.

“What’s the tolerance the customer will give you?” Wilson said. “If you look at the automobile business, if someone walks into a showroom and doesn’t get greeted, they’ll turn around and walk out because they feel snubbed. It’s because everyone is with someone else.

“But instead of having 20 salespeople, you have 10 salespeople and maybe two greeters. Or an active receptionist who focuses solely on the incoming customers for the front showroom. Then he or she can say hi, get them some coffee, let them know it’s going to take about 15 to 20 minutes to speak to a salesperson. One thing I’ve learned is if they know what to expect, they’ll be patient.”

Consider a Commission-Based Pay Structure

One strategy on how to control labor costs is to tie employee wages into revenue they brought into the business. Your employees may prefer a commission rate and lower base pay if the end result is more money.

Marnie Gaston, owner of Gaston Wrecker Service & Storage, pays her tow truck drivers 25% of every service ticket they complete. She said her employees are more productive and appreciate the opportunity to make essentially as much money as they want.

“It’s easier for me to just pay my drivers 25% of the total ticket,” Gaston said. “Plus without a base salary, they work harder and take pride in the fact that they are truly earning every commission they make.”

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The bottom line, is to be transparent with your employees about any changes you decide to make to your business. Whether you’re switching to commission, reducing employee benefits, or getting creative with staffing levels, lay it out in detail.

Tell them how you came to the decision and why you think it’s important. Doing so will instill confidence in your team that you are looking out for the best interests of everyone and keep employee retention high.