Magazine article Industrial Management

Exaggerating the Importance of Labor Savings

Magazine article Industrial Management

Exaggerating the Importance of Labor Savings

Article excerpt

Today, there is a widespread belief that the manufacturing industry is overstaffed. Companies are now demanding that the number of direct workers they employ be reduced, and they are asking industrial engineers, who already spend a significant portion of their time reducing costs, to concentrate their efforts on labor savings. The misuse of costing information has given them a greatly exaggerated view of the value of labor savings. As a result, financial and management resources have been wasted on uneconomical efforts, many of which create unnecessary industrial relations problems.

The incorrect use of costing information

To the uninitiated, accounting appears to be an exact science. This is because companies use exact, detailed bookkeeping systems that record all cash transactions, no matter how small the sum. These systems produce annual accounts for shareholders and determine tax liability, and the way they are kept is governed by rigid rules and legislation. However, most manufacturing companies also have internal cost management systems for product costing. These systems are both inexact and flexible, and their rules can be varied to suit each company's needs.

When the early cost systems were being developed, direct labor often was the largest single cost factor. As a result, direct labor became the basis for measurement.

This led managers to believe that improving department efficiency meant reducing direct labor. For example, if labor costs $5 per hour plus 400 percent overhead allocation, the cost rate is $25 per hour. Thus, it appears that replacing a direct worker who works 2,000 hours per year would save $50,000 per year, and investing $150,000 in automation to achieve this would create a three-year payback. However, because most factors that comprise overheads are likely to be unchanged by such an investment, the actual saving may be little more than $10,000 per year. The investment in automation then is less profitable. Misinterpretation of costing information also creates the false impression that it is economical to employ two or more indirect workers to replace the original direct worker.

Studies show that approximately 30 percent of surveyed companies (including several large companies in the aerospace industry) use a single hourly labor rate for all direct workers. Therefore, some workers, such as those in assembly where capital costs are low, have their time costed at an exceedingly high rate, while operators of expensive equipment have a rate that is too low.

For example, it may take ten minutes to turn a component on a manual lathe but only three minutes on a Computer Numerical Control (CNC) machine. If both machines have a labor rate of $30 per hour, using the CNC machine appears to reduce the cost from $5 to $1.50. Pressure builds for unnecessary, and uneconomical, investments to replace the manual lathes with automation. Plans are made for the components to be produced on expensive, hightechnology machines that provide the shortest operation times. Their high capital costs are not reflected. As a result, the most expensive machines become overloaded.

Companies that use a single labor/hour rate also tend to subcontract simple operations, such as pillar drills and capstan lathes, because it is easy to find subcontractors that can perform the operations for less than their standard cost rate. At the same time, they will take on subcontract work for sophisticated machines, such as multi-axis machining centers, because other companies will pay a cost rate that is too low. The result is an uneconomic move from being labor intensive to being capital intensive.

Make or buy decisions

Companies use standard costs to decide whether they should make components inhouse or buy them outside. Unfortunately, the use of standard costs consistently biases the decision against in-house manufacture. For example, if a component can be bought for $90 and the standard cost for manufacturing it in the company is $100, the obvious decision seems to be to buy the component. …

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