Is Labor Margin the Key to Financial Success?
In this issue…
The misunderstood profit component
648 words, a 3+ minute read
After observing over 400 CI companies, some truths have become self-evident. One of these is that Labor Margin is likely the biggest determinant of overall financial profitability in CI companies. Simply stated, companies who have do not have great labor margins; do not perform in the top echelon of CI companies.
With so much emphasis on the product side of the business, this often gets lost. Products are important to the business model. In fact, half of the gross margin dollars should come from product margins.
Where companies miss it is that the other half is derived from labor and consumable parts (the bulk and less trackable items in the install).
Here is why Labor Margin is important. Typically, over 60% of your headcount are billable employees who the product margin goes out on their backs as they install the client’s total solution. Let’s assume these employees are paid $30/hour. You would think if you charged $75/hour (or 2.5 times their wage) that you would be safe. That’s a 60% gross margin in theory, a good level of margin, right?
The problem is their cost to you unlike the products you buy, is not fixed to the selling (billing) price. Because most CI companies work with fixed estimates and because not every hour of each billable employee gets billed to clients, the margin is much maligned in the process.
In a perfect world, when you estimate projects flawlessly, (never overrun a single project), or, where you bill for every payroll hour; you can get by with a lower billing rate.
In fact, when you fail to bill for every payroll hour, and when you overrun the project estimated hours; you drain the margin. Realistically, at 2.5 times your wage rate, you are almost guaranteed to lose money.
So how you bid (estimate) projects (# hours) and how you bill (charge) employees time to the project becomes the operational levers for realizing adequate margin on labor.
Most CI companies do not bill more than 24 hours of the 40 hours they pay their billable employees.
Most CI companies over time will exceed the total estimate for labor on projects.
So how do you avoid these negative forces in the business? Here are the fixes:
change your charging strategy to bill for 8 hours for every 8 hours work (no free delivery, truck stocking, game planning, work performed off site, drive time, etc.).
raise your estimates on every project until you have no deficit hours in any given period of time (monthly, quarterly or annually).
raise your mark-up from 2.5 times the average wage rate to 4 to 5 times the wage rate (granted market conditions may limit what you can do here).
Look for waste and inefficiencies that zap productivity and fix them.
Oh note, we have said nothing about the mix of revenue that should come from Labor Revenue. Avid coffee readers would know that 30% has been our minimum forever.
One of my friends argues that he sells very expensive stuff (some two-channel as well) and it is hard to make or charge 30% labor. I get it. But here is the undeniable truth: whatever you are paying in payroll expense to billable employees needs to return a high margin; much higher than equipment. To get there you need great management of the billable resource in your business. Every hour paid needs to contribute a multiple of margin.
In all our years, we are yet to see a sub 30% labor mix company be a Top 10% performance company.
Our conclusion: do whatever it takes to maintain 60% or better Labor Margin. It will make your company much more successful and guarantee employment for your valued employees. By under pricing their work you are devaluing your company.