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When Labor is Less than 5% of Production Costs

June 15, 2011

“Our labor is less than 5%, why should we focus on the workforce?”

This is a common question I receive from companies when I’m speaking about Lean Labor.

On the surface it makes sense. If the company was able to reduce labor costs by 5%, the impact on overall cost would only be ¼%.  Surely there are more important projects to work on that will return more than 1/4%?

Unfortunately, this statement is based on an assumption that only the cost of production labor has an impact on production.  If this assumption were true, then I would agree, look elsewhere for opportunity.  But production labor is often only a fraction of total labor cost in a company. Secondly, controlling cost is only one aspect of effectively managing a workforce.

To illustrate this point, I’ll go to a public source, The U.S Economic Census, to highlight an example of a company with low labor costs. Some examples of low labor industries are beverage manufacturing, dairy product manufacturing and resin manufacturing.

To really understand what is occurring in these industries, I’ll need to also pull some information from The Bureau of Labor Statistics (BLS). The BLS conveniently provides occupation and wage information for most industries. Below is a chart listing the major occupations for a 1300 person beverage manufacturing company. (Any occupation less than 2% is left out for simplicity).

With this data in hand, the labor opportunity begins to present itself.  While beverage manufacturing has a small percentage of labor in its direct production costs, 32% of their total headcount is moving materials or maintaining the production lines. In most companies these labor costs are applied as overhead.

From purely a payroll perspective, labor involved in production has an annual payroll of $12M while transportation and maintenance roles have a combined annual payroll of almost $15M. At $27M for all three occupations that have a role in production, the true labor cost to produce a can of juice just doubled and is now more than 10% of production costs.

So where does a company with “5% labor” look for workforce improvements? Here’s a couple of ideas.

Production:

Are lines starting/stopping and changing over as expected? Do employees stop and start lines in unison when they go on break? “Unofficial” staggered breaks can leak throughput as stragglers coming back from break slow down a line starting back up.

Unplanned absence is a productivity and moral killer for those that arrive on time.  In addition to lost capacity if lines don’t start on time there is also the overtime expense as people are called back or in to cover.

Distribution and Material Movement

At 24% of total employee count, this is the second largest category of employee within the beverage organization. Is their utilization, performance and quality being measured at the same level as direct employees?  Often companies don’t know how to measure indirect roles, but this is an indication that the work isn’t standardized which is a bigger problem. This becomes a good opportunity to apply Lean principles to these supporting processes.

Maintenance

At 8% of the workforce, the percentage is smaller, but the wages jump by more than 25%. Is maintenance treated like a fire department or do they have an appropriate ratio of preventative maintenance to shrink “machine down” situations?

Are production employees capable of resolving small issues quickly, maybe incorporating “point of use” tools so a walk to the tool crib doesn’t turn a five minute issue into a 30 minute hole?

Overtime is a good indicator that the staff is working hard to make sure everything is running, but the real cause of overtime could be anything from the wrong skill sets to poor scheduling of maintenance personnel against production plans.

Administration

My focus so far has been in production, but let’s also not forget about administrative and support roles. At 10% of the labor within the company, this is a significant labor cost. When employees start earning salaries, a mistake is made in thinking their pay is fixed. The variable component in this type of employee’s pay is Paid Time Off (PTO). This applies not only to administrative employees but also engineering, management and sales and even to production employees. People not reporting their PTO hours or miscalculations in what is due is a quiet killer of labor budgets because this labor cost goes to hours that aren’t planned as productive and therefore aren’t missed.  These payroll costs accrue and are usually recognized as turnover occurs.

 

I recently heard a phrase that will stick with me for a while.  “Our margins are so thin that pennies look like manhole covers.” “Low-labor” manufacturers typically have thin margins on high volumes of product. As material prices are market driven and capital equipment costs are fixed, labor becomes their most controllable cost and issues like unplanned absenteeism and the resulting overtime costs or lost throughput can have a large impact on single digit margins. It doesn’t take much movement on $43M to make an impact when margins are razor thin.

Applying the Lean techniques outlined in Lean Labor could easily identify 2-3% of waste ON A $43M payroll (about $1M) let alone identify opportunities to address improvements in work practices that could increase productivity. For a 1300 person organization, the opportunity to drop $1M into net profits sounds like labor should make the priority list even if it only accounts for 5% of production cost.

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