Understanding labor burden, and how it impacts the direct hourly cost of your billable labor (for technicians, engineers, programmers, project managers, etc.), may change your business.
When it comes to running a profitable company, labor burden is a crucial concept. It helps managers understand the true costs and resulting profitability of people, projects, and departments. Understanding labor burden also helps you determine how you should be pricing labor – and tells you when you need to hire more people.
For the moment, let’s forget about equipment and materials, and assume that we’re all in the business of selling and providing labor: general labor, expert labor, extraordinary labor, installation labor, engineering labor, commissioning labor, service labor, etc. “Burden,” then, is the heavy weight of company cost that each labor hour must cover in order for the business to earn a profit.
There are five basic elements to understand for this analysis:
- Direct labor cost
- Burdened direct labor cost
- Indirect labor cost
- Overhead
- Fully burdened direct labor cost
These concepts aren’t hard to grasp or communicate, but they are important to capture and monitor – and essential to the management team.
Direct Labor Cost
This one is easy. Direct labor cost is simply the hourly amount you pay an individual to perform tasks toward the completion of a project.
Burdened Direct Labor Cost
Employing someone carries a cost burden above and beyond basic compensation. This element adds all of those additional costs to the direct labor cost, including payroll taxes, vacation and sick days, healthcare benefits, 401(k) matches, training and development (course costs plus training time away from work), other non-billable time, and any other expenses paid on behalf of the company (like a computer, smartphone, or mileage).
Indirect Labor Cost
This includes all labor costs associated with producing the customer outcome that cannot be directly charged to a project. Examples might include project management, administration, procurement, and pre-sales engineering.
Overhead Cost
Overhead costs are the costs required for the business to exist. Facilities, insurance, utilities, IT infrastructure, and software are all good examples. The cost of selling (salaries and commissions, for example) is a special category that falls into overhead costs (sometimes broken out as general, administrative, and selling costs).
Fully Burdened Direct Labor Cost
This last element captures all general overhead and indirect costs that can’t be attributed to the employee or project. These costs are added together and then divided by the total number of chargeable direct labor hours. This new cost per hour includes all of your costs for running the business (with the exception of equipment and material costs attributed to projects). Each chargeable employee has his or her individual burdened direct labor cost.
How This “Lightens Your Burden”
What does analyzing your company in this way allow you to do?
- Price your labor hours for profitability
- Accurately determine your “real” gross profit on projects
- Estimate, schedule, and utilize your labor resources more accurately and efficiently
- Understand your company’s real profit engine
- Determine how efficient your company is per chargeable direct labor hour
Knowing the fully burdened direct labor cost attributed to the labor hours of your company can actually “lighten the burden” of management decisions when it comes to controlling costs. It allows managers to adjust the ratios of direct, indirect, and overhead costs, and highlights many management decisions to improve utilization, chargeability, and profitability.
See? Labor burden shouldn’t put you to sleep! It’s an important, but often overlooked, metric that needs to be calculated at least annually. If you haven’t done it recently, now is a great time. Questions? Other viewpoints? We’d love to hear them. Contact us at answers@navigatemc.com. –David McNutt, Navigate Management Consulting