I recently read “Simple Numbers, Straight Talk, Big Profits: 4 Keys to Unlock Your Business Potential” by Greg Crabtree, where he offers useful business insights that can help increase your profitability. I wanted to share some of these insights with you.
Crabtree devotes an entire chapter to the subject of labor productivity, which is a frequent topic of concern for managers and business owners everywhere.
Is your team as productive as they can be? How can you track and measure productivity? What do you do with employees who aren’t productive? How do you make sure that you yourself are as efficient and productive as possible?
Crabtree offers some important insights to address these questions and more. Here is a deep dive into some of the wisdom he offers business owners.
Focus on Gross Profit over Increasing Labor
Crabtree gives an example of a past client he worked with who focused on increasing labor to support growth before ever focusing on driving gross profit.
The company, Company A, technically doubled its revenue within a short period of time, but its pretax profit did not grow with its revenue. This is because it spent money on increasing labor to support its growth trajectory.
While productive labor can certainly support gross profit, this particular company hired unproductive labor that was inefficient, subpar, and underperforming.
To show a contrasting example of doing things better, Crabtree talks about Company B. Company B had a slower revenue increase, but its gross profit grew with its revenue. This is because it followed Crabtree’s recommendations regarding leaving money in the business until it reaches target equity levels rather than spending that money on increased labor.
Avoid the “Labor Creep”
Crabtree coins the term “labor creep” to describe what happens when companies start hiring in order to offload little jobs here and there rather than restructuring the distribution of labor within the team already in place.
If you hire smartly, you can avoid labor creep. Hiring the right people includes hiring individuals who know how to manage their time efficiently while performing a variety of roles and functions to support the company.
Where I see labor creep occur often in small businesses is within the area of HR. A company will feel like they need to hire a full-time HR Manager when they’ve reached a certain number of employees. It’s usually not long after that I notice the same company is posting for an HR Generalist or Assistant position, because the HR Manager feels too overwhelmed with the administrative burden that HR can bring or they want to focus on talent attraction and retention, and not get pulled into the administrative minutiae of HR. Bottom-line, before the organization realizes it, they have added significant HR overhead costs.
Another way to avoid labor creep is to not hire employees to perform functions that you can do yourself (or that someone else within the business can do).
For example, perhaps you don’t enjoy the sales aspect of your business. But you were the one who got your business to this point in the first place. If you can continue handling business development – a vital component of your business – instead of offloading that responsibility by hiring a new salesperson (who may underperform), then you can avoid the proverbial “black hole.”. Now, you can and should still have a plan to eventually transition the sales role to another employee, but wait until you hit a specific, predetermined level of profit before you take on this additional overhead cost.
Where to Outsource Labor
There are some functions/roles that make more sense to outsource rather than to hire full-time employees, especially within a certain number of employees. For example, it likely makes more sense to outsource IT support for the occasional one-off issue rather than hiring a full-time IT resource and the additional overhead burden of their salary, benefits, and insurance.
Likewise, outsourcing HR is another way to reduce labor costs. While HR professionals can be a key resource for helping your business attract, develop and retain better employees, the investment to hire a full-time equivalent in-house often does not make sense until your business surpasses 150-200 employees.
Along the same vein, one job you should never outsource is the CEO position. C-suite professionals are not cheap, and if you can function as the CEO yourself, that surfaces some much bigger questions to address.
Stay Accountable with a Salary Cap
One way to avoid getting into the “black hole” is by establishing a salary cap. This is essentially a system where you allot a certain amount of company money toward paying salaries. Many are familiar with the salary caps that exist for teams in professional sports like the NFL. The best coaches are able to maximize their output for each labor dollar they spend within a designated salary cap.
Crabtree offers the following example. Say you have a business with $1 million in revenue. Your goal for your business is to have a 10% profit pre-taxes.
After reviewing your non-salary business costs, you have $500,000 left to spend on labor. Every year, the sum of all the W-2s you pay, whether for full-time or part-time work, cannot exceed $500,000. That’s a salary cap.
By determining and sticking to your salary cap, you can help keep yourself and your company from falling into a “black hole” as a result of unnecessary and unproductive labor costs.
Be Careful with Labor Costs
Managing labor costs within your company in order to maximize pre-tax profitability involves avoiding labor creep, not making unnecessary hires for jobs you yourself can do, outsourcing where it makes sense, and refining or restructuring your current team to make it more efficient.
While it is tempting to want to hire more folks to offload work from your current team (including yourself), you need to avoid that temptation until you reach specified profitability goals.
About the Author
MBA, SHRM-SCP, Business Development Manager
Clint Parry has a passion for business growth and personal development. In his current role as Business Development Manager for Focus HR, he helps small business owners accelerate their growth through HR outsourcing.