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.