Two KPI’s to Watch As Labor Costs Rise

Have you noticed lately that you have to spend more to get the top talent in your industry? There’s a war for talent out there and increased wages, signing bonuses and guaranteed commissions can really increase your cost of doing business.

I have several clients in the professional services arena and they are keenly aware that their ability to pass on the increase of their recent hires to their clients in the way of increased fees is an issue that can quickly eat into their profit margin. Having people like that on your bench and unbillable can be a disaster.

There are 2 key performance indicators that all firms should keep in mind, but especially in professional services. That is their labor utilization rate and their net multiplier.

The labor utilization rate is measuring how much of salaries and wages can be attributable to revenue generating activities. It’s calculated as direct labor in cost of services/total labor, which includes wages in overhead.

For example, if you have direct labor of $500,000 and total labor including overhead of $1 million, you have a labor utilization of 50% (500,000/1,000,000). This means that you have half of your labor doing non-revenue generating activities. Obviously, the higher percentage you have to revenue generating activities, the more profitable the business is likely to be.

Also, if your bookkeeper/accountant is not properly allocating your labor costs, your financial reports could be giving you a picture that’s not reality. The way to get this number up is to allocate as much of your labor force as possible to revenue generating activities and allocate the cost correctly.

The net multiplier is a measure of the markup on labor costs and is calculated by dividing net revenue by direct labor. If you’re paying more for talent, but not increasing fees to compensate, this will show up in this KPI. For example, if you’re direct labor is 500,000 and your net revenue is $1.5 million, you have a net multiplier of 3. This means for every $1 dollar of direct labor, you generate $3 of revenue.

The way to drive the net multiplier up is to increase fees and billing rates (price) or increase overall revenue (volume). Creating a culture that promotes good project management and sticking to budgets and timelines is important.

If you’re managing a services company, these two KPI’s and managing them well are critical to your success. Of course, remember that your top talent is your competitor’s prime hiring targets so focus on retaining your top talent because it will be expensive to replace them (in lost revenue, opportunity costs and recruiting fees) if they leave.

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