In the manufacturing sector, the decision to take on labour-only work can be a slippery slope that jeopardises profitability and sustainability. While it may seem like a quick fix to keep teams engaged during quieter periods, this approach often leads to missed opportunities and financial strain. By applying relevant financial metrics to assess job profitability, manufacturers can make informed choices that prioritise long-term success.
If you find yourself in a position where your business has accepted labour-only work, don't despair; this isn't the end of the world. As a Virtual CFO with a decade of experience, I have witnessed many businesses navigate similar phases. While the challenges are real, there are strategies you can implement to steer your company back on track. If you take the time to absorb the insights I'm about to share, you can emerge from this situation stronger and more resilient. Let’s explore how to turn this experience into a valuable lesson for your future success.
Labour-only work in manufacturing involves performing tasks where the materials are provided by another party, meaning the business only earns revenue from its labour.
This practice is often tempting during quieter periods, but it carries significant financial risks; the most glaring issue is opportunity cost—while keeping staff busy may seem beneficial, the lower profit margins on labour compared to materials can undermine a company’s profitability.
Labour typically has a limited markup, constrained by market rates, while materials allow for higher markups, yielding far greater returns. Without the ability to profit from both labour and materials, businesses risk eroding their margins and, in severe cases, may struggle to cover overheads, jeopardising long-term financial health.
Recognising these dangers and making strategic decisions to avoid labour-only work is crucial for maintaining a profitable and sustainable manufacturing operation.
Key Takeaway: Labour-only work might seem like a good idea during quieter times, however it's far more costly and detrimental to the over-all health of your business than you think.
See More: 7 Ways to Increase Cash Flow, The Learnable Skill Every Business Owner Should Have
Opportunity cost is crucial in labour-only work as it limits more profitable projects involving both labour and materials. Labour-only tasks yield lower margins, causing businesses to miss higher-value opportunities. Understanding this helps companies make better decisions, optimising resources for long-term success instead of merely keeping teams occupied.
Unless it's an incredible good deal (or there is something else you're seeking to gain aside from your bottom line) still maintain a wary attitude towards labour-only work.
Key Takeaway: Think about the opportunity cost if you're going to accept labour-only work. If you need assistance on this reach out to us!
In manufacturing, the profitability of materials is often significantly higher than that of labour. When businesses purchase and incorporate their own materials into production, they have the opportunity to apply substantial markups, sometimes far exceeding 100%. This contrasts sharply with labour, where market rates cap the amount manufacturers can charge. By focusing on projects that include both materials and labour, companies can maximise their margins and overall profitability.
Evaluating this dynamic is crucial—businesses that rely solely on labour miss out on the higher returns generated from materials. Understanding how to balance both labour and materials in production can drive sustainable growth and improve financial outcomes in a competitive market.
Key Takeaway: The markup on materials far outweighs the markup you can apply to labour
See More: Breaking up With Your Stock
In times of economic uncertainty, manufacturing businesses must be particularly discerning when making strategic decisions about project selection. The pressure to keep teams busy can lead to a temptation to accept labour-only work, which typically offers lower margins and higher risks.
However, this approach can jeopardise long-term financial health.
Instead, companies should prioritise projects that provide opportunities for both labour and materials, ensuring they maximise profitability even in challenging conditions. By conducting thorough financial analyses and assessing the potential returns of various projects, manufacturers can avoid the pitfalls of low-margin work. Emphasising strategic decision-making helps businesses remain resilient, allowing them to navigate downturns while securing profitable opportunities that drive growth and stability.
Key Takeaway: Knowing that labour-only jobs have a higher chance of putting your business at risk, look for other genuine avenues to increase revenue.
See More: What it Means to Make Informed Business Decisions
To ensure sustainable success in manufacturing, it is essential to apply financial metrics effectively when assessing job profitability.
Key metrics such as net profit margin, gross margin, and return on investment (ROI) provide invaluable insights into the financial viability of projects. By analysing these metrics, manufacturers can determine whether a job will yield sufficient returns relative to its costs, particularly when considering labour-only versus integrated projects that involve materials.
Establishing clear benchmarks helps businesses identify which jobs to pursue and which to avoid, guiding them toward more profitable opportunities.
Additionally, regularly reviewing these metrics can reveal trends and inform strategic adjustments in operations, ensuring that decision-making is rooted in financial data. Ultimately, leveraging financial metrics empowers manufacturing companies to make informed choices, optimise resource allocation, and enhance overall profitability.
Key Takeaway: Assess projects and bids to the same high-level you already do, keeping specifically in mind, the hidden cost of labour-only production.
See More: Return on Capital Employed, Return on Investment, Gross Profit, Contribution Margin
Situation: A custom furniture manufacturer faced period where demand was slow. To Keep their workforce busy, they took on labour-only jobs where clients supplied the materials. However, the low margins on labour quickly became unprofitable, especially when unforeseen delays or client-supplied material issues arose.
Action: The company realised the opportunity cost of doing labour-only work and shifted focus to projects where they could source and markup materials alongside labour. This ensured higher margins on both fronts.
Result: With a more balanced approach, the company grew its profitability and avoided the pitfalls of labour-only jobs that consumed resources without substantial returns.
Key Takeaway: It's never too late to make adjustments, keep monitoring and protecting the health of your business
Situation: A mid-sized machinery manufacturer in Europe was approached by a company that wanted them to handle only the labour part of production for complex machinery while the client provided the components. Initially, they considered the contract to keep their workforce engaged.
Action: After a detailed financial analysis, they realised that taking on the labour-only work would tie up their skilled workers with little financial gain. They rejected the contract and instead focused on higher-margin work where they supplied both labour and materials.
Result: The decision to turn down low-margin labour-only work protected their profitability, and they eventually secured contracts with better margins.
Key Takeaway: Don't feel bad about turning business down, especially when it was never the right thing to do!
Navigating the complexities of labour-only work in manufacturing can be challenging for business owners. A Virtual CFO brings a wealth of expertise and strategic insight to address these challenges effectively. Here’s how they can support your business:
So, opportunity cost concerns settled, should you accept labour-only work?
Most likely, no. Unless it's a really, really, really, good deal.
Can you compete with the profitability of materials? Are you able to negotiate higher margins? Can you cover yourself in the case of scope increase/time delays?
Evaluate the opportunity cost, make an informed strategic decision - avoid filling low capacity with low-margin work. Pin point your most lucrative opportunities and prioritise projects that incorporate both labour and materials for long-term success.
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