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Cutting Costs? Make Your Changes Stick

Helen Luketic

On February 13^th, Business Week posted an online news story about The Secret to Making Cost Savings Stick.  Results from a Corporate Executive Board study showed that “nearly 90% of companies that make cuts fail to sustain those cost reductions for more than three years.”  On the cutting board were variable spending items such as:  capital projects, travel, discretionary spending and headcount.  Only 11 per cent of organizations, considered to be "Elite Cost Cutters", managed to keep their costs in check by the three-year mark.

So what’s the secret behind managing those costs long-term and ensuring that they don’t creep back up?  The Elite Cost Cutters didn’t cut costs quickly or indiscriminately; they were thoughtful about which areas they were going to cut spending.  In fact, they spent more on overhead than their peers, in such areas as IT and travel.  This group also kept control of their costs by monitoring for increases.

Judging by Statistics Canada’s release of February’s Employment Insurance figures, B.C. organizations laid-off a significant portion of their staff as a way to manage costs.  When B.C. comes out of the recession, it’s likely that organizations will be more wary of increasing spending to the level that they did in the past.  This new frugal mentality means that organizations will want to ensure that costs, including headcount, are closely monitored.

HR should be proactive and strategic in advising the organization on how to spend their salary budgets by calculating a few simple metrics.  Communicating these stats to the executive team on a monthly or quarterly basis and developing action plans when required will ensure that the layoffs were not a pointless exercise.  The following are common best-practice metrics:

• Labour Cost per FTE
  Definition:  The average labour cost (salary and benefits) to the organization for each FTE
  Formula:  Labour Cost / FTE
  How to use:  Monitor your labour cost trends over time and compare them to your competitors’ labour costs.
  
• Benefits as a Percentage of Total Compensation
  Definition:  The total cost of benefits as a percentage of the total compensation costs.
  Formula:  Benefits/Labour Costs
  How to use:  Benefits are only one part of total compensation.  Analyze Labour Cost per FTE by tracking this metric and checking if benefit costs are driving total labour costs up.
  
• Labour Cost Revenue Percent
  Definition:  The total labour costs as a percentage of organizational revenue
  Formula:  Labour Costs/Revenue
  How to use:  Ensure that Labour Costs are not growing at a faster pace than revenue.  Labour Costs should decrease over time as organizations gain efficiencies through improved technology, processes and innovation.
  
• Human Capital Return on Investment
  Definition:  As a measure of productivity, it’s the rate of return for each dollar invested in employee pay and benefits.
  Formula:  {(Revenue – (Operating Cost – Labour Cost))/Labour Cost } - 1
  How to use:  Low labour costs (as a result in lower spending on salary or benefits) do not always have a positive result.  For example, the organization still needs to be competitive to attract and retain staff and get the highest level of productivity from them.  To ensure your organization’s compensation philosophy results in a better bottom line, measure return on investment.

Once these metrics are tracked on a regular basis, HR can start watching for trends within the organization and in the market with external benchmarking.  If your organization sees its labour costs soaring while the competition is trending downwards, you know it may be time to recommend an intervention.

Monitoring labour costs and productivity is a great way to start building a partnership with your finance team as most of these metrics will require their input.  Accountants can provide you with the financial data but they generally don’t have access to these human capital formulas.  The mark of a strategic HR department can be a positive relationship with finance folks.

Monitoring labour costs and the impact of layoffs on productivity may have one other benefit:  proving that layoffs aren’t always the best route to go in future tough times.  If you can show the business the ultimate impact of layoffs and cost cutting measures, you will get a seat at the strategic table; or if you’re already there, a bigger one.

To find out more about these metrics and obtain the detailed data definitions, see the HR Metrics Standards & Glossary.

About the Author:
Helen Luketic is the HR Knowledge and Research Associate at BC HRMA. She is the winner of the 2007/2008 Rising Star award for her significant contribution to the developing field of HR measurement. Helen is focused on sharing this knowledge with BC HRMA members through a range of activities and services.

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