Get a handle on your direct labor costs and worry about the free doughnuts later.

Several months ago, we discussed the Big Five expenses when it comes to managing the costs of our business. If you can manage these expenses well, you will have a profitable business (“The Big Five,” December 2008).

As a reminder, the Big Five are:
  • Direct labor. The wages and benefits we pay the people doing the work in the field.
  • Material expense. The net cost of the materials we sell to customers.
  • Office/overhead salaries. The wages and benefits we pay the people who support the people in the field.
  • Advertising. This is typically a cost for only service contractors rather than new construction specialists.
  • Vehicle expense. All expenses including lease/depreciation and interest, maintenance, repairs and fuel.

There is no doubt that the economy has hit most PHC companies hard. That is a blinding statement of the obvious. Firms doing residential new construction have taken the hardest hit, but even pure residential service firms are feeling the pinch.

Revenue declines of 10 percent, 25 percent, even 35 percent or higher are not uncommon through the first quarter of 2009. As a result, many companies have had to take a hard look at their business expenses for ways to reduce expenses and become more efficient.

So let’s talk about your company right now in this economy. If your company is looking for ways to reduce expenses and become more productive, where should you start? Should you look at your cell phone bill? How about your landscaping expenses? Should you discontinue free donuts at your Wednesday service meeting?

If you’re a plumbing contractor, no doubt the largest number of the Big Five as a percentage of sales is direct labor. Focusing on reducing this number as a percentage of sales will have the greatest impact on profitability! If you are looking for ways to save money, start here.

Direct, Not Fixed

Direct labor by definition is a cost the company incurs to install a product or perform a service. The basic premise is that if a product is not installed or a service is not performed, this cost would not exist, hence the name - direct.

Unfortunately, what I see with many companies is this expense is fixed, meaning that on any given day, week or month, the company’s direct labor costs are only minimally impacted by sales. As an example, let’s use a typical service company with five service techs and two apprentices to see how dangerous this can be.

The service techs in a typical week make $35 per hour x 40 hours = $1,250 per tech and the apprentices make $12 per hour x 40 hours = $480. Total payroll for the week is as follows:
  • Five techs x $1,250 per week = $6,250

  • Two apprentices x $480 per week = $960

  • Total direct labor = $7,210

For that same week, the company sold and installed $27,740 in revenue. Direct labor for that week is 26 percent ($7,210/$27,740).

So far, so good. Now what happens next separates the highly profitable companies from the rest of the pack. What happens in a week where sales are only $20,000?

For many, many companies, direct labor remains the same - $7,210. What happens to our direct labor percentage now? It balloons to 36 percent of sales ($7,210/$20,000), making it virtually impossible to make money. Forget the other four of the Big Five; if you don’t hold your direct labor percentage in line, you are sunk.

What To Do

If you are unable to manage your direct labor to a low and consistent percentage of sales, you have no chance at creating a business with sustained profitability.

The challenge with managing direct labor to a more direct, as opposed to a fixed, percentage is that you have to do one of three things - all of which most managers find very difficult to accomplish:

1. Increase the sales production and efficiency of your techs.As a management team, you need to imbed in the mind of your field employees that in order to pay them the wage they want to make, they have to create a minimum amount of revenue. If the calls and the revenue are not there, they can’t expect to earn a consistent wage.

This is a management challenge and is normally consistently accomplished with a pay plan that rewards performance more than straight hourly pay. Without benefit of a favorable pay plan, it takes aggressive, daily management attention through training, skills practice and tight service and sales management. This area is so important that entire training courses have been created by Nexstar and other similar organizations to accomplish this important goal.

Helping the techs learn how to become more efficient is the first and best way to accomplish the goal of consistently low direct labor percentages.

Warning: It also takes a long time to change the productivity levels of employees and it will not be possible for all employees to reach the minimum levels of productivity you require. So if you are in a short-term cash crunch and need to improve the performance of the business quickly, you may not have enough time to accomplish this. Read on …

2. Immediately cut the hours your field employees work when work is not available.Field employees are like every other member of society; if they are accustomed to earning a certain wage every week, they likely have a lifestyle along with personal expenses that require them to make that much.

And a funny thing happens in business; even without the work at hand, employees will find a way to generate hours to receive the wages they need. When work is slow, jobs that during busy times may take a day to complete now take one and a half days. Jobs that could be done alone now require the capable assistance of an apprentice or a fellow technician, etc., etc.

Your job as a manager is to prevent this from happening. It sounds tough. It sounds mean. I would much rather help develop the skills of an individual where together he and the company can create revenue that will allow both the company and the employee to grow in compensation and earnings.

However, if there is no work available and the chances are slim on any given day or week that billable work will be available, you have to make tough, unpopular decisions that are in the best interests of the company.

Right here is where most companies that are losing money miss the mark. They are unable or unwilling to manage the unproductive time of their technicians and when work slows down, the company gets killed with extra payroll.

3. Cut the lowest performing techs and or apprentices.Here is another real tough thing to do for most managers - reduce the workforce. They know the employees’ families. They empathize with the challenges of being out of work. They hold out hope that the volume of work will turn around any day now. They remember how tough it was to find techs when times were good and are loath to ever be caught short-handed again. So, they keep more techs on hand than are necessary.

When work slows down, the best defense to maintaining profitability and the health of the company is to have the fieldwork done only by the most productive employees. Here you will see the biggest production gains and you will be rewarding your very best people with top pay for top efforts.

“Swallow the ugly frog first.” I heard this saying at a seminar years ago. What it means is that, as a manager, you need to attend to the tough but necessary jobs first before you go to the easier to complete but less impactful management tasks.

Nowhere is that more applicable than when managing field labor and at no time has it become more important than now.