Construction Today
Cost of Labor
You pay your employees to perform a full day’s work, but are they actually earning
a full day’s pay? Learning real productivity can save you money.
By Richard Fineman
Year after year, one of the largest expenses a construction company has is labor.
Yet, many contractors neglect to invest the time and effort necessary to learn
exactly what encompasses the true labor rate. Instead, they merely hope a few
extra dollars above what they are already paying their employees will cover
everything, including items such as taxes and insurance. Yet, the reality is,
some projects have cost overruns because the labor costs were not bid accurately.
How can construction company owners eliminate this dilemma? The answer is simple.
First, learn how to calculate an accurate labor rate—one that is more than salary,
taxes and insurance. Second, implement strategies to reduce labor costs and increase
productivity, allowing the labor savings to go directly to the bottom line.
True Labor Costs
True labor costs include the hourly wage or salary, taxes (federal, state, social
security and unemployment), worker’s compensation, overhead and benefits. Benefits
include holidays, vacation, sick time, overtime, compensation time, actual insurance
costs and other fringe benefits such as the use of a car after work hours. Many owners
understand how to calculate these costs or, if they do not, have a payroll service or
an accountant to handle this aspect of business for them.
What’s trickier is computing how employee productivity impacts true labor costs. Owners
pay employees for eight hours of work per day, but do they actually do a full day’s
work for a full day’s pay? In some cases, employees might be only 75 percent productive,
which computes to six hours of work per day, even though the employee is being paid for
eight hours.
Similarly, although some employees may be working the full eight hours per day, their
productivity may not be as high as the output of other employees. Therefore, true labor
costs need to include unproductive hours or activities, or other personnel inefficiencies.
Labor Cost Mistakes
Ignoring the unproductive hours when creating a budget or a job estimate is a common
mistake when computing labor costs. Additionally, benefits such as vacation and
compensation time must be counted as nonproductive hours. Examining this in more
detail demonstrates how using an arbitrary labor rate vs. a true labor rate impacts
labor costs.
Take a typical workweek of 40 hours. If Monday is a holiday, the employee is only going to
work four days or 32 hours. Out of those 32 hours, the employee is really only working
about six hours per day. This means the employee is merely productive for 24 hours that
week (six hours per day x four days = 24 hours). Yet, the employee is being paid for 40
hours.
To determine the real productive time, take the number if hours the employee is actually
working (24) and divide this into 40 hours. This employee is only 60 percent productive
for the workweek. If the job requires a true 40 hours to complete, the owner will pay
this employee 40 hours (even though he or she worked only 24 hours), plus will need to
pay an additional; employee for another 16 hours of work just to complete the job.
Because the owner budgeted only 40 hours for the job at the arbitrary labor rate, the
owner will lose money on this job. To illustrate: 40 hours (job completion) x $15/hour
(arbitrary labor rate) = $600.
Employee No. 1 worked one week on the job, which cost the owner $600 (40 hours x $15 per
hour = $600), but did not finish the job. He or she productively worked only 24 hours on
the job, requiring another 16 hours to complete it. Employee No. 2 worked productively
on the job for 16 hours and finished the job. However, this put the job over budget, and
the owner had to pay employee No. 2 out of company funds. This error in labor costs was
a $240 mistake (16 hours x $15 per hour = $240). Thus, the total cost to complete the job
was $840 ($600 + $240 = $840).
If the owner had used a true labor rate, the company would have saved money. By determining
an employee would be productive only 60 percent of the time, an owner could use an hourly
labor rate of $24 instead of $15 ($15 per hour x 60 percent productive time = $24 per hour).
Then, the owner would have budgeted 40 hours (job completion) x $24/hour (true labor rate)
= $960. By calculating the job estimate in this way, the owner would have budgeted more than
enough money to complete the job.
500 Unproductive Hours
When creating job estimates, contractors generally use a true labor rate (including non-
productive time) and divide that rate by the hours the employee actually worked that year.
If owners haven’t been tracking this information, a true labor rate can still be calculated.
A normal work year is 2,080 hours (40 hours per week x 52 weeks per year). Although this
hourly figure includes the usual 10 days of vacation, various holidays, sick days and
compensation days, it doesn’t differentiate between productive and non-productive time.
If employees are only productive an average of six hours a day, this amounts to 10 hours per
week. Excluding the two weeks of vacation, this is 500 hours (10 hours per week x 50 weeks)
that employers are paying for non-productive time. Therefore, the true productive rate an
owner should be using is 2,580 hours (2,080 work year hours plus 500 unproductive hours).
By using this rate when preparing job estimates, an owner will be better prepared if the job
takes more time than anticipated.
Strategies to Reduce Labor Costs
Labor costs cannot be changed or reduced; taxes and worker’s compensation are fixed rates.
However, the labor burden can be reduced by creating a program to increase productive time
per day, resulting in a lower cost per hour. Because it’s no unusual for an employee to be
productive only 60 percent of the time, a program to increase productivity by 15 percent
will dramatically and positively influence the labor costs.
Construction companies can use any of several strategies to increase employee productivity.
These include:
- Incentive plans – A good incentive plan should be easy to understand, implement, follow
and measure for both the employees and employer. Incentives are not necessarily monetary.
Many employees are motivated by personal time off or specific items of interest. For
incentives to be successful, the outcomes must be measurable and attainable. Also, the
owner and employee need to agree on the incentive. Give feedback to the employees to keep
them motivated.
- Gain-sharing – This is sharing the improved productivity profits with the employees.
For example, if a particular job was completed in less time than was actually bid for, the
remaining unused hours are considered profit. Share this profit with the employees as a
reminder of the benefits of being productive.
- Managing the job/accountability – Require a supervisor to be accountable for the time
it takes to complete the job and also for reporting progress on each stage of the job.
Ensure the supervisor understands how much time is allotted for the job and what the
expectation is in terms of how long it should take. In this way, the supervisor will
require his or her team to also be accountable for the day-to-day work they are completing
to stay on task and complete the job within the required parameters.
More Productive Employees
Losing 500 hours a year or more to non-productive work is costly for many construction
companies. Although little or nothing can be done to decrease labor costs, creating and
implementing productivity plans can have positive effects on the work force.
In addition to changing the way the work is completed, an additional and possibly
unforeseen outcome is increased morale. When companies reinforce higher productivity
and share the results with employees, the employees can see how their performance impacts
the company.
Richard Fineman is a consulting services director for International Profit Associates and
Integrated Business Analysis (IPA-IBA). For more information, call 847-495-6786 or visit
www.ipa-iba.com.
