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Stabilizing Costs:

How Fixed-Cost Labor Pricing Can Save the Day

The fight against rising costs is as old as business itself. Since the first cavepeople established the first cave-companies (and successfully litigated the first cave-trademark lawsuits), their eternal struggle to keep costs low has been passed down to every corporate generation since.

For some businesses, that struggle can be won with careful consideration of every purchasing decision. They are the lucky ones. For other businesses, especially those that rely on large human workforces, it’s simply impossible for leadership, management, or even individual employees to “stop the presses” when it’s time to send money out the door.

Companies with large workforces  must rely on systems and practices that do the most good for the most number of users within the organization. But no system is perfect, and any practice can be misapplied. When you’re part of an operation that makes hundreds (or thousands) of purchases every day — for parts, material, maintenance, direct labor, indirect labor, and more — it doesn’t take much before a given cost gets completely out of control.

This explains why so many organizations are constantly hunting for the next big cost advantage. Not only is there immense pressure to lower costs in absolute terms, there’s also a pressing need to make costs predictable and stable. Otherwise, constant spikes in expenses rob you of hitting your targets. And greater profitability becomes a lofty dream. 

But it doesn’t have to be this way.

One way that nGROUP helps our clients achieve lower, more stable costs is through our fixed-cost labor pricing. This model exists in opposition to traditional transactional labor cost structures. Our fixed-cost labor makes it incredibly easy for our clients to accurately predict their labor costs based on output. We call this “Cost-Per-Unit” pricing, or CPU. 

But before we dig into nGROUP’s approach, let’s take a look at some of the research that’s out there regarding the eternal struggle to rein in costs.

Hidden Factories and Real Costs

In 1985, the Harvard Business Review published an eye-opening article called “The Hidden Factory.” It examined a phenomenon that was sweeping through the American manufacturing sector at the time: the explosion of overhead costs.

The article’s authors demonstrated how overhead costs were rampaging away to become the biggest percentage component of “value added”. Indeed, by the 1970’s, overhead costs made up well over 70% of the total value added to a finished product. That represented a massive change in barely over a century, since the days when direct labor accounted for most of a finished product’s value added.

But what was the source of the problem? Were expenses becoming more expensive? Or was something else at play?

Perhaps surprisingly, the authors identified transactions as the main culprit of the overhead explosion. To them, a “transaction” was any exchange that took place (including internal transactions, purely within the bounds of the factory or business) that moved along the production process, but that didn’t result in finished products.

For example, a company manufactures high-volume electronics. Each finished product uses 700 parts. The normal production methods at the time called for the parts to be purchased, then stored in a “parts inventory.” When more parts were needed, they were withdrawn from that inventory, and taken to the production line. When finished, products went into a “finished products inventory,” from which they were again withdrawn and sent out to customers.

That method resulted in some 14,000 transactions per month, and resulted in ballooning overhead costs. However, when that same production line was reconfigured to produce items on a “just-in-time” basis (a newer concept to the United States at the time), the number of transactions was reduced by almost half!

Could it be that transactions really are the driver behind some rising costs?

Declining Productivity

More recently, the Bureau of Labor Statistics at the US Department of Labor released a report called “Productivity and Costs by Industry: Manufacturing and Mining Industries – 2019.” This brief report contained some interesting (and sobering) news about the productivity in America’s manufacturing sector.

Across the 86 four-digit NAICS industries belonging to this category, some 77 showed real productivity decreases. For many of these industries, the decline was caused by rising hours and dropping output. For some, output rose as well, but was outpaced by the increase in hours. 

Going deeper into the numbers, we see that productivity has increased dramatically since 1987. However, the rate of increase has slowed since 2007. In fact, between 2007 and 2019, hours worked increased more than output rates (though total productivity still went up).

Are rising costs once again squeezing the American manufacturing sector?

CPU and You

Could it be that transactions really are the driver behind some rising costs? Yes.

Are rising costs once again squeezing the American manufacturing sector? Yes.

Is there something you can do about it? YES.

Fixed-cost labor pricing addresses these problems in a way that traditional temp labor, with its transactional pricing model, simply can’t. So, what is CPU?

Cost-Per-Unit pricing is the practice of calculating a single price (cost) for every individual unit of finished product. To do this, fixed costs like depreciation are evenly allocated, and direct costs like labor are factored in. What results is a dollar figure that can be multiplied by the number of finished units. Find the sum, and you’ll have your costs.

Fixed-cost labor pricing allows nGROUP clients to evenly allocate that cost across their production line. With help from our labor management experts, our clients are able to calculate their margins based on how much product went out the door, instead of basing it on how much work was performed.

That’s a key distinction. Transactional temp labor relationships are all about the transaction, the amount of work performed. It doesn’t matter to a traditional temp labor provider how many products you’re able to sell, or what kind of contribution their laborers made. All they want to know is how many hours did their people put in on your factory floor?

With CPU, nGROUP’s performance is measured by your success. If more products go out the door to be sold, our compensation rises. If they don’t, it doesn’t. 

For us, simply logging more and more “transactions” is no way to run a manufacturing or distribution operation. As we’ve seen, it’s often those transactions that bog the whole system down. And with technology now helping maximize what human laborers can do, the incremental increases in sales don’t necessarily support the huge jumps in hours worked.

CPU fixes all that for nGROUP’s clients. Not only are our insourced workforces productive, they’re much less expensive than internally-hired teams. 

Adding fixed-cost labor pricing, and developing a CPU-based system, makes our teams an even more attractive — and predictable — option for your logistics, distribution, or light manufacturing operation.

Does nGROUP move all clients to CPU-based pricing? No. We understand that every business is unique, and we customize our approach to your business’ specific needs. But if we can save you more, predict your costs more accurately, and help you produce more at the same time through CPU, we want to do it that way.

For more on nGROUP’s transactional pricing model and  services, please go here.