Government employees are making good labor decisions, they just don’t see the whole picture

I was pleasantly surprised during my time at the Governing Leadership conference in Maryland held last week.

First was the energy and diligence expended by the elected and appointed officials in attendance to continue to work through the challenges they face. It was a refreshing change from the articles frequently found in the media about less than stellar government performance.

Secondly, I was impressed by the prevalence of Lean methodology in place within different areas of government. As I told the attendees during my panel discussion on performance budgeting; the good news is that organizations in the private sector have been through this transformation and survived. Examples of how to use Lean are readily available, it continues to get easier to implement Lean as the number of successes grow and are publicized.

What struck me during the day was the complexity of planning and operations. While there are several examples, the one that hit home for me was the impact many small decisions  have on a government’s finances. For example, a simple choice between who works an overtime shift and who doesn’t can have a decades long financial implication that far outweighs any wage difference or even premium pay difference. But this cost implication is hidden from the decision makers and is often never connected.

It becomes easy to see how governments can get a poor reputation for managing its finances over the years because of what in hindsight look like obviously poor financial decisions.

When labor makes up to 90% of a municipal government’s labor budget (their stat not mine). It would seem like there would be more visibility and control over the decision-making process. The challenge for governments is that an hour worked today is impacted by benefit rules that take into account many years previously worked and then generates many years of commitment ahead. The supervisor making the daily decision has no visibility to this and therefore cannot take it into account.

If we could provide the information that shows the real cost of an hour of labor, supervisors would be enabled to make better decisions and I would bet that government would see immediate benefits from improved use of tax dollars without having to resort to tax increases or layoffs.

Consider these easily measurable areas of influence on the cost of an incremental hour :

  1. First is the cost of the wage paid. This is the easiest to measure and is often what is used in labor reporting and decision-making.
  2. Will this have an impact on benefit costs? (If the employee is classified as part-time, will they now be eligible for benefits under the Affordable Care Act? Do they generate any additional vacation, comp time or paid sick/personal time?)
  3. Are they now eligible for overtime? It could be 1.5 or higher based on negotiated contracts
  4. Will this hour impact their pension? Depending on pension rules, this incremental hour of work could increase their pension. Depending on the contract, it’s not just the last couple of years of a person’s wages that are used, but, for example, the highest average pay during a continuous 60 month span, whenever that occurs in a person’s career. This incremental hour of time could have an impact on government cost that lasts for 20 or more years!
  5. Is this work occurring due to a State or Federal grant? Has the amount from the grant already been used up? If so the department is now responsible for paying the overage must now find those funds from another area of the budget.

 

Every day the result of these calculations change for each individual, they can even change from one hour to the next!

It’s no wonder that supervisors can unwittingly rack up expensive labor bills at the end of the week when they are doing their best to apply resources to the work at hand. Even worse the may never realize what they have done because some of these costs never show up in their daily or monthly cost reports.

What’s the answer? This same problem is faced by supply chain managers all over the world. The cost of a good is impacted by many different factors during its life from raw material to delivered good. Rather than looking at the cost to manufacture the good (Raw Material + Production Labor + overhead) which often produces an incorrect cost, manufacturers look at the large drivers of cost across the entire supply chain and calculate a “Cost to Serve”. The cost to serve is a very useful calculation when making decisions (e.g. We could get cheaper labor in Vietnam but the lead time, shipping and warehousing costs go up too much.)

This same principle can be applied to an hour of labor. With benefit costs and regulatory compliance becoming a significant part of total wages, it’s time to provide the total labor cost to supervisors so that they can make better decisions about how they use labor or who is assigned the next shift.

The best part of this opportunity is that unlike manufacturing Cost to Serve where data collection costs are high but calculation requirements are low, the total cost of the next hour of government labor is already available, it’s a matter of aggregating that cost into a one simple dollar figure on a daily basis so that a supervisor understands the impact their decisions are having on their organization.

If your organization is having trouble containing its labor costs then it’s time to understand what the next hour of labor is really costing your organization. You have the data, you have the rules, it simply a matter of sharing them with the people who are deciding how much to spend in the next hour.

Is it worth the effort? Considering the 2103 PEW Trusts report found that 39 of 40 of the cities it analyzed do not have fully funded pensions and the amounts are measured in 10’s of millions and even billions, I would say this is an area worth looking into.

pensiongap

R&D Tax Credits, are you getting your fair share?

In today’s WSJ CFO’s Journal it noted that this quarter’s corporate earnings were lifted in some cases by 10% due to the extension of the R&D Tax credit. This was based on the accumulation of last year’s entire credit, which still averages to 2.5% a quarter of earnings growth. For Boeing taking advantage of this credit led to an additional $145 Million in earnings for the quarter. In 2009 the total credit earned by all companies was $5.6 billion. Not too bad for filling out some paper work.

Of course it’s not that easy. The article goes on to say that the R&D Tax credit is taken advantage of primarily by large corporations. That leads me to believe that many smaller or mid sized companies feel that it’s too hard to earn the credit.  For those that have not explored this credit it can be a significant opportunity to counter the effects of relatively uncontrollable costs such as commodity costs or increasing healthcare costs for their employees.

Additionally more states are also enacting R&D credits to encourage companies to move high paying jobs within their borders. This is in addition to the federal credit.

Take a look at Ceradyne, a high performance ceramics company recently acquired by 3M. According to their 2011 annual report, they earned $2.9M in tax credits on revenues of $400M and earnings of $29M in 2010. That’s right, they increased their annual net income by 10% through this credit.

Why did I select Ceradyne as an example? Because I worked with them in the past and they clearly understood that in order to accurately track wages spent on qualified R&D expenditures….and keep the credit through an IRS exam…that they needed solid record keeping. In their case they extended their use of their existing timekeeping system to include their engineers.

How did they get their engineers and other employees who were working on qualified research to start accurately collecting time? They explained the value of the record keeping to them in terms of profits which directly impacted the engineer’s employment.

Sure there are other ways to collect the records, but it’s going to be a quite a negotiation when the IRS examines your records. Especially if you try and claim wages based on your general ledger’s cost centers. The first thing the IRS will do is to look at the roles allocated to that cost center and pull out the wages paid to managers and administrators. Even though in today’s flattened organizations it’s likely that many people are performing multiple roles, some of which probably are eligible for a tax credit.

Next Steps

If you are in Operations or HR, go spend a couple of minutes with your in-house finance or tax expert. There are also consultants such as Hackett or Deloitte that have specialists in this area. Ask them if collecting accurate time records would help increase your company’s credit. Discuss what activities are eligible and make sure these are all being tracked to ensure you get full credit.

If you all agree it makes sense, then you can justify increased data collection. This data will not only ease the IRS examination and likely increase your tax credit but it can also be re-used to help project performance. Would it be helpful to know on a daily basis who is (or is not) working on a project, what phase it’s in or how many dollars have been invested to date?

Before you start collecting the data, spend the time explaining the personal benefit of this tax credit to your employees (increased share price/profit sharing/bonuses, stable employment/more investment in projects that interest them) and your change management job will be a simpler too.

Want to learn more about R&D tax credits (by the way, you can claim more than wage expenditures)?

Here’s a couple of good links:

http://www.irs.gov/pub/irs-pdf/f6765.pdf

http://www.journalofaccountancy.com/issues/2010/mar/20092122

http://www.statetaxcredits.org/

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.

http://www.compensationforce.com/2011/12/could-new-regs-salary-connection-put-health-premiums-into-talent-play.html

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?