Do you measure labor in hours or dollars?

If you collect labor hours and multiply by average wages and benefits to calculate product cost, you will want to read the rest of this blog.

The Bureau of Labor Statistics recently released data on average wage and benefit costs for U.S. Manufacturing.

For production employees , average wage is $16.92 with benefit costs reaching $9.50. 33.5% of a production employee’s cost is in benefits. This includes paid leave, supplemental pay (overtime, bonuses, and shift differentials), retirement pay, insurance and legally required benefits.

While this in itself is not newsworthy, but it got me to thinking, how variable is each of these components?

In almost every company wages, paid time-off and supplemental pay is changes from employee to employee based on tenure, skills, past performance and all the other factors that go into compensation.

But as I did a little research, I realized yet an additional component is becoming even more variable  And at 11% of total compensation, this is a big one.

Companies are looking at the 2010 Patient Protection and Affordable Care Act and realizing that to avoid fines, benefit costs may have to become variable based on the total wages an employee earns. Here is a good article explaining how this works.

Insurance was already variable. Medical Compensation is based on the prior history of claims in the plant which is the financial side of the reasoning behind the importance of safety programs.

This healthcare legislation is just another step to increase the variability of compensation. Even for employees who earn a “static” hourly wage.

For manufacturers who are interested in accurate product costing and track labor in hours, this news makes it just that much harder to understand what their true product cost is. To get a sense of the problem they are facing, consider how compensation might vary between employees on a production line and even from one hour to the next with the same employee.

Average wage = $16.92 Variations of plus or minus $2 an hour doesn’t seem unlikely

Paid time off = $1.72 Variations from $1.50 to 2.00 seems possible

Supplemental Pay = $1.14 Variations from $0 to 2.25 seem very reasonable

Insurance  = $3.13 While this is a large percentage of compensation, it’s probably not going to vary much in the next couple of years so we’ll say it can range from $2.75 to 3.50.

With these ranges one can look to see what how this variability might impact a company’s cost from day-to-day.

So when the costs all stack in one direction or another there is a swing of 33% in hourly costs. My guess is that this rarely happens, but let’s use engineering math and say that half the swing does occur on a more regular basis. That means there can be an occasional 16% swing in costs from one employee to the next on the production line and probably a frequent swing of 8%.

The question becomes, if we’re talking about random swings in labor cost, what does it matter? No one can control “random” so everything will wash out. The problem with this argument is that much of this is not random. People earn pay through pay policies, supervisors schedule people with specific intentions in mind, so wages are not random. Their variability is a result of work and pay practices which are controllable.

O.K. so pay variability is not random, is this variability worth understanding and managing?

This is a question for each individual company to answer. If it were my company, the first thing I would look at is my profit margin. If my wage & benefit variability is  significant compared to my profits, it would be really important for me to understand and control it. In other words, if I earn $7 on every labor hour I invest and my wage and benefit variability ranges from plus or minus $3-4 (similar to the example above) that means my profits could swing 50% just based on who is working on the line even if their output is identical.

Companies that have realized this is a problem are now tracking not just labor hours but using their Timekeeping and HR systems to allocate exact wages and benefits to every hour worked to ensure exact labor costs are known for every hour spent. They re-use much of the information that generates their employees’ paychecks to generate their product costs.

Aker Philadelphia Shipyard recently spoke on an Industry Week webinar and claims that 95% of their wage and benefit costs (including salaried workers) are allocated to specific projects to ensure they know exactly how profitable an effort is. Understanding cost is important, but Aker really takes advantage of this information and identifies where the cost spikes are occurring so they can change their work and pay policies to manage them more effectively.

Measuring labor performance by hours is easy, but is it profitable?

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