Nielsen Advisors

Whether you call it Labor Cost, Payroll, or something else, the money you spend to compensate your employees is precious. Every dollar you invest in your people is a dollar you can't invest in areas like products, marketing, or capital.

Rule one of business is that you must get a greater return than your investment. It goes without saying that without a positive ROI, your business will fail. Labor cost is the number one cost for most non-retail companies. But how many businesses truly understand their labor cost and the corresponding return on investment?

Labor cost is simply defined as money paid to workers during a defined period, including wages, benefits, and related taxes. It should not be confused with payroll as that does not include the full scope of Labor Cost.

The value of understanding Labor Cost goes beyond the awareness of expense. It is critical to strategic decisions such as pricing and product mix as well as staffing and development. It also provides a measuring-stick view of productivity and efficiency.

Let me give you one example of using labor cost to make strategic decisions based on an experience I had.

I was working with a technical organization with a low profit margin. The executive team decided to hold labor costs constant for the coming year. However, there were a number of vacancies in the organization that the executive team wanted to fill. Each manager of a vacant position believed the only acceptable candidate would be an experienced professional. Hiring a number of seasoned professionals would have ballooned our labor cost (and exceeded the budget).

By putting in place a staffing/cost model that identified revenue projections and goals with specific positions, we were able to demonstrate how managers could obtain qualified candidates who would meet the required goals but within the cost structure allowed. Managers were then able to move forward in filling their positions by hiring less-experienced individuals at a lower compensation rate. The organization remained within the cost targets and met revenue projections.

Without the view of labor cost, managers would have continued to push to exceed the budget, and in some cases would have ended up paying significantly more for someone who delivered only minimally greater results.