The Biggest Cost of Doing Business: A Closer Look at Labor Costs

Many organizations are feeling the pressure to do even more with less—fewer employees, fewer resources and smaller budgets. So, as an HR leader you might be wondering what you can do to confront the labor cost issue head-on and find solutions.

Labor costs can account for as much as 70% of total business costs; this includes employee wages, benefits, payroll and other related taxes. Yet, according to a Paycor survey, HR professionals only spend 15% of their time managing the cost of labor. 

However, keeping an eye on the annual operational costs (especially now) could help you prepare for the financial future. To be an asset as an HR leader, you need to think like a financial executive, but also be creative with ways of reducing costs.

How to Reduce Labor Costs During a Recession

As a recession sweeps the nation, many companies are left wondering how to reduce annual costs of labor without gutting their workforce. slashing employee hours, or making other unpopular decisions. 

While there is no one-size-fits-all answer to this question, there are a few strategies that can help you get started. Here are four tips for reducing labor expenses during a recession.

1. Cut back on overtime
   If your employees are working more than 40 hours a week, consider cutting their hours back to 40. This will save your organization money on labor while still allowing your employees to earn a decent wage.
2. Offer incentives for employees to work their allotted hours
   You could offer a bonus for employees who stay within their allotted hours. This will help to motivate your employees to work fewer hours, which will in turn cut costs.
3. Carefully hire the right candidates from the beginning
   The average cost of turnover can cost up to 30% of an employee’s first-year wages, so this is an important strategy for reducing annual costs of labor in the long run.
   
4. Use temp labor during busy times
   If you have peaks and valleys in your business, consider using temp labor during your busy times to help with the workload.

Having access to labor information allows you to plan for the future and help your organization make more informed decisions. Armed with the right data and advanced technologies, like Paycor’s Time & Attendance software, you can create a strategy to correct the problem and more easily predict when you might need additional staff in the future, which will enable better budget forecasting.

Which Industries Have The Highest Labor Costs?

A June 2022 report from the Bureau of Labor Statistics, showed the average cost of labor of 30 different industries in 2021 compared to 2020.

What’s interesting about this report is that we were at the height of COVID-19, and you’ll see some big changes. Travel Arrangement and reservation services went from 73.7% to -7.3%. And the air transportation industry had the highest increase in 2019 at 106.9%, and fell to 7.6% in 2021.

2023 Labor Costs

Salary budgets are the highest they’ve been in over 20 years. Why? Attracting high-quality talent is extremely competitive right now; and, inflation is at an all-time high, making the bump necessary. That’s why it’s important to know how to strategically establish salary ranges.

The Consumer Price Index increased 8.5 percent for the 12 months ending in July. This means that companies are having to revise their pay budgets.

According to Consultancy WTW’s July Salary Budget Planning Report:

• On average, companies are planning to increase pay by 4.1% in 2023.
• In 2022, the average pay increase was 4%.
• Inflation is at 8.5% at the time of this report.
• Around 96% of companies globally increased salaries (compared to 63% in 2020).

Employer labor expenses also include benefits. According to AON, average costs for employers in the U.S. will increase 6.5 percent to more than $13,800 per employee in 2023. This is a huge jump from 2022 when the costs rose 3.7% from 2021.

How can HR & Finance Departments Work Better Together?

HR and finance teams can work better together if they take a walk in each others’ shoes. To start thinking like a CFO when approaching business expenses, you might want to start with these questions:

Are We Overspending on Labor?

Check overtime. There may be hidden costs that you need to watch out for.

According to a survey from Qualtrics, 57% of employees said they “want the opportunity to work overtime or extra shifts” to bring in more money as inflation continues to rise and we go into a recession.  

Are We Underutilizing Our Workforce?

If HR isn’t tapping into the full spectrum of talent in your company, you’re leaving money on the table. By not taking full advantage of your employee’s potential, disengagement and lack of motivation soon follow.

This can lead to a dramatic decrease in productivity and high turnover rates, which in turn can negatively impact your company’s bottom line.

Are We Accurately Capturing and Recording Time Worked?

HR can lead the way by championing a time management solution that accurately tracks and manages hourly workers, eliminates duplication errors, and reduces payroll losses.

Are We Looking At Labor Costs in Silos?

If you’re not adding non-employee (freelancers, contract workers, consultants) and contingent labor into the labor cost equation, your numbers will be way off.

You run the risk of potentially misclassifying employees and non-employees, which can result in harsh fines if the company is audited. 

Now that you are thinking like a CFO and working alongside them, it is important to understand labor expenses, what is normal, and how to optimize your company’s budget.

What is An Acceptable Labor Cost Percentage?

An acceptable average cost percentage is 25-35% of gross sales. This can vary greatly depending on the business, industry, and location. 

For example, a retail store in a small town may have labor percentages less than 25%, while the manufacturing sector may have labor percentages higher than 35%.

There are many factors that contribute to the total labor cost percentage for a business, including the type of business, the industry, the unit labor cost, location, and the number of employees. 

The type of work, and the wage rates can also affect the total labor cost percentage for employees.

What Percent of A Business’ Costs Are Labor?

The percentage varies, but labor costs include employee’s salaries, cost of benefits, and taxes. They are often broken up into direct costs and indirect costs.

The sales price of a product or service takes into account the labor costs, and any other overhead expenses, including materials. When these prime costs are taken into consideration, then they are able to see if the cost of labor is too high or too low.

If the company has to lower its prices, then they are going to have to cut labor costs as well so that they are not running in the negative.

The restaurant labor costs are lower as many of the staff receives tips, and the lower wages reduce the cost.

Direct Costs vs. Indirect Labor Costs

Direct costs are tied to the production of a product or service such as a production line worker in the manufacturing sector, or a salesperson.

Indirect labor costs are not tied to production and could be classified as someone in security.

Fixed vs. Variable Costs

Salaries paid to your workforce are fixed annual costs, as they don’t change based on production.

Over time, temporary staffing, commissions, and bonuses are all considered variable labor costs since they will change depending on many different factors.

Variable cost is often hard to predict, but it’s an important component of determining your company’s annual labor cost. In the manufacturing sector, the costs are variable as the output of machines can change.

Labor Cost Percentage Formula

Calculating labor costs is pretty straightforward. To find your labor cost percentage, divide your labor cost by gross sales and multiply by 100.

Labor Cost Percentage = (Total Labor Cost / Total Gross Sales) x 100

Be sure to include the cost of all bonuses, commissions, benefits, and all taxes you pay.

For example: If your labor costs total $250,000 and gross sales equal $500,000, the labor cost formula would look like this: 250,000 ÷ 500,000 x 100 = 50%.

How Paycor Helps

Having a good understanding of your current labor costs and trends is essential for keeping spending in check. Companies that integrate disruptive, HR advanced technologies will increase revenue and productivity by up to 9% while lowering HR costs by 7% (HBR). Whether you are in the manufacturing sector or the airline industry, your CFO will really like the sound of those statistics. Paycor Analytics can help. Discover how our simple reporting provides insight into hours and costs to optimize your spending.