How to Handle Rising Labour Costs in Your Business

Jump to the transcript of this video here.

In many of our videos, we focus on positive decision-making and steps forward to achieve business goals. Today, however, we need to address some negative trends we’re observing in the marketplace and prepare you for the challenges ahead as a business leader.

Stagnant Revenue and Increased Labour Costs

The first dynamic we’re seeing is that many businesses are experiencing stagnant revenue. Compared to the same time last year, businesses are either performing at the same level or slightly worse. Few are hitting their budget targets. Meanwhile, labour costs have increased as businesses have hired more staff to prepare for anticipated growth that hasn’t materialised.

For instance, if a business generated $100 in revenue last year, it might still be generating the same amount this year. However, the labour costs that were $20 last year might have increased to $24 or $25 for the same revenue. This has led to increased capacity without the expected growth in revenue.

Personal Financial Pressures on Employees

On the personal front, employees are feeling the pinch due to the increased cost of living. Many employees have become accustomed to higher wages through overtime. For example, someone employed at $80,000 per year might have been earning $110,000-$120,000 with overtime. This additional income has become necessary for them to meet mortgage payments, rent, and other living expenses.

The Clash Between Business Efficiency and Employee Needs

These two dynamics—businesses struggling with inefficiency due to increased labour costs and employees facing personal financial pressures—are creating significant tension. Business owners are finding themselves in a difficult position.

If your business isn’t performing efficiently, you either need to make changes or risk losing money. One critical metric to monitor is labour as a percentage of revenue, both currently and historically. Additionally, consider future revenue projections versus your current labour force.

Strategies for Managing Labour Costs

To manage this situation, you might need to take a hard look at your labour budget. For example, if you project $1 million in revenue over the next six months and aim to keep labour costs at no more than 17.5%, you cannot spend more than $175,000 monthly on wages and benefits. This approach is akin to a family on a tight budget at the grocery store — you have to make every dollar count.

Another important step is evaluating your current employees and categorising them into three groups:

1. “Ones” – Essential employees you cannot afford to lose.
2. “Twos” – Employees who could be elevated or might fall back depending on the situation.
3. “Threes” – Employees who should be let go immediately.

This evaluation helps you align your labour force with your revenue expectations, ensuring that you don’t overspend.

Final Takeaway

In conclusion, navigating these challenging times requires a balance between managing business efficiency and addressing the personal needs of your employees. By closely monitoring your labour costs and making tough but necessary decisions, you can steer your business through these turbulent times.

The Brutal Reality of Rising Labour Costs

“A lot of the videos we do are around positive decision-making or positive steps forward within your business and getting to a place where you want to go. Today is a negative conversation, but it's what we're seeing in the marketplace and what you need to be ready for as a business and a business leader.

There are two dynamics we're seeing at the moment that are impacting the business and impacting the individual employees within that business.

Firstly, the business itself. From a business point of view, what we are seeing is that this year, so many businesses, at a revenue line, are only just doing as well as what they were doing at the same time last year. Maybe they're doing a little bit worse, maybe they're doing a little bit better, but they're no better than what they were last year as a general rule; let alone hitting their budget targets. Very few businesses are hitting their top-line revenue budget targets. But what have they done in the meantime? They've also loaded up on their labour, trying to get the capacity for what they thought the growth was going to be in their business.

For example, if a business had $100 in revenue last year, they're still doing $100 worth of revenue this year. The difference is that last year, they might've had $20 of wages, superannuation or pensions; this year they've got $24, $25 in wages for that same hundred dollars output. This means businesses have loaded up on their capacity and what they're capable of doing.

This also includes overtime by employees. For example, businesses might employ somebody for $80,000 per year, but in reality, their wage for the last three, four years has been $110,000, $120,000, because of the magnitude of overtime they've been doing. And the employees have gotten used to that level of wage for their personal circumstances.

This now moves me to the dynamic of what we're seeing on a personal front. And this isn't just coming from what we see in the news. This is coming from business owners we work with and the anecdotes that they're sharing with us from the employees that work for them.

And that is they need to continue doing the overtime; they need to keep their wage at that, for example, $110,000-$120,000 level rather than the $80,000 level. Because otherwise, they can't meet their mortgage payments, they can't pay the rent, they can't put food on the table for their families. There's a lot of pressure on the individual working within the business.

These two dynamics of the business becoming inefficient with its labour and the employees having personal cost-of-living challenges around the wages they earn and the costs they incur at a personal level have got to come to a head. And that's what we're seeing at the moment, which leaves the business owner in a pretty brutal position.

You would've heard me say this before in other videos, but if the business isn't performing at the level it needs to be, it either needs to make changes or you as a business owner are losing money out of your pocket. That is the brutal reality of running a business that isn't running as efficiently as what it should.

One of the numbers you need to be looking at is your labour as a percentage of revenue currently versus what it has been historically. And, to take it one step further, what you are projecting your revenue to be versus the labour you are currently employing.

The second side of what you need to be looking at, especially if you're looking at a project-based business or a manufacturing business, or even a warehouse where you're distributing a certain amount of packages or a certain amount of output per day, is looking at a project or per unit basis - how efficiently they're being delivered.

Because one of the things we raised with a team recently in manufacturing is they're saying, "Hey, the guys are getting the work done just as efficiently as what they had previously." So, for example, if they had 60 hours to complete a job, they might be completing that job in 58, 59, 60 hours. Brilliant. They're doing it in the expectation of what they're required to do.

But what are they doing when they're not working? We are finding a lot of places, and a lot of employees are working in that second, third gear, and there's no sense of urgency because they're trying to stretch out their days. And the phrase I'm saying is they're trying to squeeze five hours of work into an eight-hour day. (And I've had some people push back and go, "Five hours is pretty generous at the moment.")

As a business owner or a business leader, what do we have to do in this scenario? Well, there's two things. The first one's going to sound really brutal and really crass. You probably know, and you might've even done this yourself, but when a family's on the bones of its backside and it goes to a grocery store and they go, "I've got $150 to feed my family this week, and I have to make this $150 work"... you actually need to do the same thing with the labour in your business.

So, for example, if you know that you are only going to do a million dollars' worth of revenue over the next six months, and your target is to have a labour percentage no higher than 17.5%, you can't spend any more than $175,000 in wages and superannuation on a monthly basis. If that's the expectation of your output, you have to find a way to keep your number at that level or below.

That's the equivalent of being that family that only has $150 to spend on a week's worth of groceries to get through that week. You need to look at your budget that way. A budget quite often can just be a reference point. It can be a number that you just refer to and go, "Okay, we thought revenue was going to be a million dollars, it was 970,000; and we thought wages were going to be $150,000; and they're $170,000." So what? No, you need to work backwards. You need to go, "I cannot go above this number."

Which leads to the final step: going through your existing employees and grouping them: ones, twos, and threes. The 'ones' are the people that you can't afford to lose, and in the worst-case scenario, those would be the last ones you'd want to get rid of. The 'twos' are those in-betweeners. They could be elevated to a one; they might fall back to a three, depending on the environment they're in. And the 'threes' are the people where you should be cutting off immediately. The reality, especially if you're working in project-based businesses or manufacturing businesses, is somebody who might be a two or a three, but can be deployed in multiple areas within the business, might be more valuable than somebody who's a one but only specialises in one area. So all these kinds of questions you need to ask yourself.

You need to fit your labour into the revenue your business expects to be over the coming months. Otherwise, unfortunately, it's money out of your pocket and you are going to be having a team that's going to be walking around in second and third gear.”

Learn everything we teach our clients free

Join 400+ business owners & leaders who receive practical business & accounting tips, delivered free to your inbox every week. No fluff, just high-level expertise. Sign up now.