In my role as a ‘Profit Coach’ I work a great deal with trade based businesses who are characterized by delivering products or services which require a significant amount of direct labour such as plumbing, plastering, painting, electrical, air conditioning and manufacturing.
In these types of business, direct labour cost are a significant component of ‘total direct costs’, also known as ‘total cost of goods sold’ (COGS). These can be up to 50% of their direct costs which is a major cost centre and must be controlled closely if a business is to make a profit, as these costs are variable, not fixed, unlike most material costs.
Not many businesses measure productivity in a formal manner, it is more typical for mangers to directly oversee work and from their experience monitor productivity. However as a business grows larger this becomes harder and businesses start to suffer from labour overruns which can be significant and have a direct impact on the profitability of the business.
Did you know any productivity measurement process when implemented can yield a 10-30% improvement in productivity?
So why isn’t everybody measuring productivity?
The problem with productivity is that there isn’t an accounting system or software that manages labour productivity and any business that wants to implement a productivity measurement system has to develop their own.
Therefore in today’s article I have outlined a few points to considering so that you can implement a productivity measurement system for your business.
Let’s start by asking the question, what is productivity? A simple definition I like because it reflects the work I do is “the effectiveness of productive efforts, especially in industry, as measured in terms of rate of output per unit of input.”
To be able to drill down let’s look at a more wordy definition- Productivity is “a measure of the efficiency of a person, machine, system etc. in converting inputs into useful outputs. Productivity is computed by dividing average output per period by the total costs incurred or resources (i.e. capital, energy, material, personnel) consumed in that period.
The key words here are output over input! In this article we will focus on using labour based delivery business and output could be measured by either what has been installed or simply the labour hours allowed.
I like to call this work value therefore output equals work value. To measure output or work value you have to be able to measure what has been installed and this is where it gets difficult for most companies. From my experience, a simple starting point is that most companies have the hours that’s allowed in their estimate, so in effect your allowances become your work value and if you finished a job using the number of hours allowed you would have 100% productivity. Unfortunately in most cases this is not what actually happens.
To influence productivity you have to measure on a progressive weekly or monthly basis. If you wait until the end of the job it is too late. I recommend the following simple method to measure output /work value on a progressive basis.
Take your job and break it down into a number of different work types and give them a work code, then break down your estimate into how many hours per work code. This becomes the basis of your work value. If you then measure on a weekly basis the percentage completed for each of the work codes and apply the percentage to what was allowed you have the work value for the week.
I.e. 1000 hours allowed against work code (A) and for a week the work type is measured by your site person as being 20% complete, the work value would be 20 hours.
The next step to calculate productivity will be to determine how many hours were used during the time period. This is done by the time card so your people code their time to job number and work code. You can then get a weekly report of hours per job and work code.
Say in this example the hours for the week totaled 40 hours spent against 20 hours work value achieved. Expressed as a percentage this shows a productivity of 50% which is clearly not good. It does however provide management with the awareness and therefore the opportunity to do something about it as it is being measured progressively.
The system could initially be done using spreadsheets to understand where your productivity is at now which is step one. Step two is understanding what your productivity should be which as a starting point should be 100%, however you can get more sophisticated with this in time. Step three is to review the reports and identify where the major variances are and take corrective action such as modifying your estimate allowances or renewing your site methods or supervision. Once you are aware you can do something about it, however the problem with most labour intensive businesses are they are not aware of what the productivity is.
There is enormous profit growth potential which can be realized by implementing a simple productivity measurement system. If you would like to peruse the opportunities however need assistance, please contact me to arrange a no obligation discussion.
Simply Business Australia
Philip Coombs “The Profit Coach”
0419 834 678