John M. Rhodes, Senior Principal, Moran, Stahl & Boyer, LLC (Feb/Mar 07)
Labor Cost vs. Productivity
The current average manufacturing labor rate in the United States is about $24 per hour, which is more than 10 times the 1955 rate. During the mid-50s, the United States was the manufacturing center of the world, while Europe was recovering from World War II, and Asia, Mexico, and South America had not emerged as significant manufacturing centers. In the current global market, the cost of labor in the United States is positioned below Western Europe, on a par with Japan and Canada, but significantly higher than Mexico, Eastern Europe, and the rest of Asia. Although China is currently the low-cost producer and building its manufacturing expertise, it is gaining wage pressures as the supply of qualified workers tightens and the work force matures and commands a higher standard of living.
The ability to compete in the global market requires not just low-cost labor but access to the required skills that deliver the needed quality and productivity at a given level of process technology. When a technology-based product is first developed, it requires a highly capable work force to support manufacturing, and the product usually commands high margins. As the product matures and profit margins are reduced, the company relies on more automated production techniques, and skill requirements shift from highly trained technicians to moderately trained labor. In contrast, a commodity industry such as food processing may start with simple processes and lower skilled labor and seek to achieve a higher productivity over time through process automation and an upgrade of labor skills.
A good example of productivity shift is in the United States' steel industry. From 1975 to 2005 the steel industry lost over 300,000 jobs, while its output remained steady at approximately 100 million metric tons. How is this possible? Having to face very aggressive foreign competition, the industry made two major changes that resulted in a phenomenal shift in process productivity. First, the steel-forming process was transformed from a fully integrated production line utilizing raw material input into a traditional steel furnace, to the use of electric arc furnaces that primarily require scrap steel augmented with refined ore. In addition, the industry made a substantial investment in automation technology to increase throughput, reduce labor-intensive operations, and improve overall quality. In order to run the new process, employees were encouraged to obtain further technical training to operate the more sophisticated equipment. The end result was fewer, higher skilled jobs staffed with individuals that could respond to changes in production requirements.
The need to make constant improvements and sometimes quantum shifts in productivity is paramount to staying competitive. As the gap between the United States' and China's technical capabilities narrows, the ability to use technology as the sole differentiator will diminish. However, at the same time, the standard of living in China continues to rise and the supply of qualified labor tightens, while the escalation rate of the average U.S. manufacturing wage has decelerated. During the 1980s, the average annual wage rate increase for manufacturing jobs ranged from 5 percent to 10 percent per year, in contrast to the last 15 years when it has been closer to 3 percent per year - essentially just keeping up with inflation.
The Significance of Labor Cost in the Service Industries
In certain service industries and types of operations where capital investments are relatively low, the cost of labor can be 70 percent or more of the overall operating budget followed by real estate, taxes, computer and telecommunications equipment, and other costs. Typical operations with high labor content and lower capital investment include customer service centers, software development, accounting and other back office operations, and sales offices. With the cost of labor being a major portion of the operating budget, reductions in labor cost can have a significant impact on the bottom line.
For example, if a financial services company in a major metro area has a customer service operation of 300 employees with an average salary of $37,000 per year at a cost of $11 million, that same operation located in a nearby suburb or smaller metro area may achieve a cost savings on labor of over 25 percent along with a substantial reduction in real estate costs.
Labor Quality vs. Productivity
Based on numerous company interviews, the definition of labor quality is a combination of skill from education/ training and experience reinforced by work ethic. The definition of work ethic is expanding as the demands of the workplace change. In addition to the traditional qualities of punctuality and hard work, there is a strong emphasis on hiring those individuals that can work effectively in teams, have the ability to identify and solve problems, and have the flexibility to adapt to ongoing change in the job and the organization. These qualities become critical when process technologies, job scopes, and organizations remain in a constant flux as world markets shift rapidly and product life cycles shorten.
Competing for Labor
the overall labor market tightens, having access to lower-cost labor is
based on a company's ability to compete for labor. With the loss of the
social contract between employer and employee, i.e., of "employment for
life" that permeated the culture of previous generations, the employee
loyalty factor has been greatly diminished. Essentially, employees will
stay in a given position at a particular company only as long as there
is not a better opportunity elsewhere. In order to address this
phenomenon, companies need to be aware of how employees "rate" their
employers and how well they are competitively positioned in the local
There are five common factors - the five "C's" -
that employees and prospective job candidates consider when evaluating
a particular job situation:
1. Compensation and benefits:
These include base compensation, pay for performance, bonuses,
incentives and commissions, as well as the benefits package.
Compensation and benefits packages have become more comprehensive and
flexible to attract a labor force with diverse needs. In tight labor
markets, job candidates will rank benefits high, particularly features
like 401(k) plan options, access to stock options, and elimination of
waiting periods for insurance coverage and other benefits.
2. Career opportunity:
Job experiences that allow the employee to demonstrate and expand
competency of skills are regarded highly. Titles are less important to
younger workers, but working on "hot projects" and new technology is
much more valued.
3. Company image and culture:
This includes brand recognition and image, company reputation, type of
work environment, approachability and style of leadership, dress code,
and other operating norms. Image and culture perceptions are formed by
the website presentation, office and building design and maintenance,
access to healthcare/fitness and daycare facilities, and flexibility of
The common ideal commute time is up to 20 minutes in small and
mid-sized areas and 45 minutes or more in major metro areas. When a
commute exceeds 30 minutes, employees frequently will seek options for
employment to reduce commute times. Employers entering a community may
seek locations that intercept longer commute patterns for existing
employees as a potential recruiting strategy.
5. Community attributes:
Consideration of community quality of life is critical when hiring and
relocating talent from outside the area for functions such as
headquarters, R&D, software development, and highly technical
production. Primary considerations are the availability and cost of
housing, the overall cost of living, quality of local school systems,
cultural and recreational options, parks and meeting places, and
healthcare facilities. Evaluation of an area is highly subjective and
will vary by the life stage, life style, and special family needs of
the prospective employee.
How Communities Can Help Companies Address Labor Costs
best approach to sustaining existing companies is to know their needs
and their position within the product life cycle for locally produced
products and/or services. To enhance a company's productivity, the
community can partner with a local or state-level university to provide
free or low-cost process-technology improvements - particularly for
smaller or mid-size companies. In addition, the community can survey
labor needs of local companies and assure that local students and the
labor force are aware of pending and future skill needs and that local
colleges and training facilities offer courses related to the skill
requirements. Communities that become more active partners with their
local companies have a better chance of meeting needs early rather than
trying to offer incentives too late in the company's decision to
relocate from the area.
As labor becomes a much higher
proportion of a company's operating budget, the need to seek locations
that offer high productivity at a competitive wage rate becomes even
more critical. Communities that understand their wage positioning,
become familiar with company needs vs. life cycle stages, and promote
their level of productivity and technology support will ultimately be