Reducing Labor Costs

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Shutterstock_297650201Reducing Labor Costs

(to the lowest possible without reducing customer satisfaction!)

The most important thing for every business owner to remember is that there are only three reasons for a business owner to hire employees:

  • The job is required to sell and deliver your product to the customer. Examples are sales staff, production, delivery, etc.
  • The job results in decreased cost, thereby increasing the bottom line. Examples are safety officers (reducing insurance costs/claims) and internal auditors (reducing theft).
  • Finally, the employee frees up time for the owner and key sales employees to generate additional and more profitable sales.

The first step for every business owner is to calculate your business salary cap.  This calculation will quickly show you if your business has more labor costs than your current business can justify.

Even if the calculation indicates that you are under your salary cap, that doesn’t mean you are running as lean as possible.  In fact, almost every business I have reviewed has been able to reduce their labor costs without affecting the customer experience.

Why are most businesses over-staffed?

So why do most business owners allow payroll to creep above what the business requires?  There are a number of reasons, but here are the most common I see:

  • The owner has bought into the idea that they should be “managing” the business rather than “working” in the business. This is the goal, but it should happen slowly as profit grows.  One of my clients jumped back into managing their retail store.  Eliminating the store manager position saved about $50,000 per year.  But more importantly, being directly involved in store operations and customer service allowed him to to adjust his operations in a way that increased sales and profits.
  • Employees are hired quickly without putting the effort into listing all the job duties and not making sure that the employee adds to the bottom line. I see this when a company has no systems and doesn't ensure each job meets the three goals listed above.

          I worked with one business owner who spent time documenting their systems and writing out profit-related roles for each job.  This resulted in a savings of over $500,000 per year               while allowing the remaining employees to produce roughly twice the amount of work as the previous staff.

  • The owner has not reviewed the roles or actual work being performed by employees. If you don’t actually set expectations as to what work is to be done and how long a task should take, employees will protect themselves by expanding the work to fill their time.

          You as the business owner must remember that doing something unimportant well that doesn’t add to profits does not make it important.  Just because a task takes a lot of time does           not make it important to increasing the profits of the business.

  • Selling items with low profit margins. I was guilty of this mistake.  When I stopped offering bookkeeping services I was able to cut two employees.  My sales went down by $40,000 but my profits increased by almost $90,000.  Not having the bookkeeping services allowed me to focus on highly profitable work.
  • The business operations are run inefficiently. This usually happens because the business grew but procedures never changed to reflect the increase in sales.  I personally reviewed every step when I was working at Coca-Cola and was able to downsize staff while adding the accounting for three other locations.
  • Untrained and unqualified staff messing things up.  Most business owners are quick to hire but slow to fire.  I have been guilty of this, too!  Don’t hire until absolutely necessary.  Hire only superstars.  Train your staff to do the job you hired them to do, and fire those employees who, once properly trained, can’t do the work efficiently.
  • Hourly wage creep. I have seen bookkeepers at businesses making $50,000 per year.  The going rate for a bookkeeper in El Paso is between $27,000 and $31,000 per year.  So why was the business owner paying $50,000 per year?  The bookkeeper was hired 20 years ago and has received consistent annual raises.  If a job is only worth a certain amount, you must cap that job at that pay rate.
  • Doing work that should be outsourced. I have a rule—if a task isn’t part of the sales process and doesn’t directly affect the customer, it should not be done by you or your staff.  Things that business owners do that they shouldn’t include: Almost all business owners can outsource this for less than the cost of hiring a bookkeeper.
    • Computer work.
    • Be careful here!  Don’t outsource your responsibility to set the marketing and sales strategy.  I had a marketing person on staff, but once she left, I hired someone to do what she was doing at about 1/3 of the cost!  And since this was all they did, they were an expert at their job and did the work better than we ever could. 
    • Drop ship instead of delivering the product yourself.
    • Anything else that doesn’t directly improve bottom line.

How to fix and lower labor costs. Fixing all of the items listed above would take a ton of time. But this is what I recommend you do in the order I have found to be most effective:

  1. Get the owner back into the operations in the area that will have the quickest and largest increase in profits.
  2. Evaluate every employee and determine if the work they do is vital to the company’s profits. Eliminate any employees that don’t lead directly to higher profits.
  3. Determine if there are any jobs that could be outsourced at a lower cost than what the employee costs without affecting the customer experience.
  4. Eliminate (or at least reduce the emphasis on) the 80% of products and customers that only produce 20% of profits. The goal is to focus your labor hours on the 20% of products and customers that represent 80% of your profits.
  5. Improve efficiencies by easily creating and documenting your systems.
  6. Create a pay scale for each job and never make an exception. If an employee hits the cap, the only way for them to get a raise is to add a job duty that directly leads to increasing the bottom line.
  7. Make sure you have competent well trained employees. Review every employee and fire bad employees now.  Next push your mediocre employees to become superstars.  The worst employee for an organization is a mediocre employee.  The bad ones you fire.  But the mediocre employees do just enough to stick around.  Don’t accept anything but superstar work.

Yes it is a ton of work but since labor is either your largest or second largest cost item it is one of the most important jobs of a business owner. 

So until next time—let’s make this your most profitable year ever!