For expanding and improving businesses that have the capital for the investment in new equipment or processes, attempting to become or remain competitive, the level of investment is not as important as the return on that investment. This consistent practice of determining where to best place capital for the highest return should apply to labor. What is “paid” for labor is not as relevant as the value it adds to the operation and, ultimately, profit; the return on worker investment.
The lack of appreciation for the difference in “training cost” and “training investment” is understandable because it is rarely contrasted. The college textbook entitled Financial Accounting: An Introduction to Concepts, Methods and Uses, defines “direct labor cost” as the “Cost of labor (material) applied and assigned directly to a product; contrast this with indirect labor cost.” Indirect labor cost” is defined as, “An indirect cost of labor (material) such as supervisors (supplies).” There is no mention of an expected return on investment. Generations of cost accountants have been taught that there is no good that comes for higher labor costs, which to them is determined by the level of staffing and wage levels. There is no differentiation between strategic labor costs and uncontrolled labor costs.
The profit from, and value of, most worker’s labor comes from task-based work, so all inputs that drive workers to high-performance, high-capacity output are investments.
As discussed in many articles in past issues of the Proactive Technologies Report, although labor costs are considered direct costs from an accounting standpoint, they should be more importantly considered as an investment in the operation’s overall level of competitiveness. Operations may vary as to the level of return on investment from labor, but each worker’s cumulative expertise gained while employed becomes an asset to the operation akin to intellectual property and, therefore, wages and compensation paid to develop a worker are an investment.
As many operation managers have found out, drastic moves like reducing the wage rates by 20%, 30% or more, while expecting to maintain the same output quantity and quality, chases off the workers with the gained technical expertise…because they can leave. The investment is lost and so are any returns. Furthermore, it is difficult to find new candidates who are willing and able to “hit the ground running” for an unreasonably low wage rate. And if a good candidate for employment is found and selected, bringing their productive capacity up may be delayed or hindered by the fact that the remaining “subject matter experts” are not as capable of transferring expertise as the technical experts that were driven away.
Scores of competitively run global corporations in the past few decades have withered away chasing short-term numbers to appease shareholders and activist investors, which in the longer run undermined their capacity, purpose, level of service and brand.
Unlike equipment and processes for which empirical data is routinely available to make smart investment decisions, the concepts of “level of investment in workers” and the corresponding “return on worker investment” remains illusive and foreign to most employers. While data-driven capital investment in facilities or equipment decisions are straight-forward and specific, adjustments to labor are usually general; a layoff or addition of 10%, 20% of staffing. Some significant outcomes from undervaluing or overvaluing labor are:
- Ill-informed termination of vital, experienced workers can cut overall labor costs for the short-run, but it often starts the erosion of organizational capacity and technical expertise, as well;
- Hiring workers attracted to a low wage job posting, but lacking the prerequisite core skills, may soon burn through any money saved by lower wages when training the worker to vital tasks takes longer, doesn’t produce results, the employee is dismissed and the process starts again;
- Voluntarily expelling technical expertise without taking inventory and having a strategy for conveying all of it to a replacement can severely impact an operation in the short and long-term;
- Departments or cells required to operate with marginal performers not only impairs their ability to reach quality output goals but morale suffers, as well, when the workers realize the targets cannot possibly be met and the heat is felt from above.
On the other side of the issue:
- The decision to hire one more worker is often made without understanding that there might exist unused capacity in incumbent workers who have not mastered the entire job (because no one knew that they had not been trained on all tasks of the job) for which they were hired;
- Intentionally or inadvertently driving off a skilled “subject matter expert” during a period of expansion leaves fewer or no trainers for the new-hires, so people on payroll with no or little capacity draw wages with little or no output.
- Many new-hires on-boarded during anticipated expansion, with no training structure to quickly transfer expertise from incumbents, can drain an operation’s budget for expansion by the unproductive labor expenditures for diminished capacity;
- Younger workers with a good general core skill base upon which to build task-based training can be driven off if the organization does not have a clear training strategy. Or they may stay and eagerly attempt to teach themselves the procedure for critical tasks – leading to an unpredictable outcome.
The profit from, and value of, most worker’s labor comes from task-based work, so all inputs that drive workers to high-performance, high-capacity output are investments. The minute the trainee has been trained and has mastered a task, they have increased their capacity and are adding value to the company’s operation, which cannot be said for completion of any related technical instruction course. Each worker’s capacity should be inventoried periodically (just like a physical inventory of equipment, components, subassemblies that have value) to determine its value, and any gaps between expected and real value identified and closed.
There are times when staffing levels have to be adjusted for sure, but it should not be the first choice. Every company has a tremendous amount of capital invested in each worker and would know this if they knew how to value it. There is also an inherent multiplier affect; for every dollar strategically invested in the worker there is a ## times return (based the how critical the mastered tasks are to the operation and the value added to the operation). In a November, 2015 article of the Proactive Technologies Report entitled “Costs Associated with Unstructured, Haphazard Training Part 2 of 2” I offer a simple formula to conceptualize the cost of transferring expertise – the skilled performance of required tasks – from one worker to another. Extending the concept to the number of years of successful performance for one subject matter expert to all subject matter experts yields a staggering number that would make any decision-maker reconsider the loss, if aware. And if that expertise is lost during a hasty, but necessary, layoff the replacement cost should at least be considered prior to help expedite a return to normal after.
For any organization curious to understand how to recognize their cumulative worker value, especially before making critical organizational decisions that may come back to haunt, the December, 2015 Proactive Technologies Report article entitled “Enterprise Expansion/Contraction and Worker Development Standardization” offers a simple, logical approach to taking each worker’s expertise inventory. The investment necessary to do this is not that large, and every bit of data and information gathered can be used to plan how to increase the capacity of each existing worker and increase the cumulative return of worker investment as a potential alternative to classic cost-cutting. And for those managers that like to hedge, the option to reduce staffing levels remains if getting more capacity for each worker wage dollar does not solve the problem.