Manufacturing Labor Challenges and Monitoring Associated Costs

The Strategic Early Warning Network (SEWN) program has been a resource for nearly 40 years to Pennsylvania businesses requiring professional expertise to enhance their business operations and thereby supporting both jobs retained and employment growth. In recent periods, manufacturing companies have engaged SEWN for individualized analysis focused on operational efficiencies as they are experiencing rapid and detrimental impacts to their financial operating margins. Understanding the underlying data trends and practices impacting financial results is a necessary initial step in strategic action planning for improvement in profitability. 

SEWN consultants have worked with numerous manufacturing operations across a broad variety of goods being produced from metal parts to perishable foods and utilizing wood -based materials to plastics – and those entities with many more different inputs and outputs. However, the business processes are all similar in that their production results are ultimately reflected in financial reporting.  We start the analysis from examining financial reports to identify the trends and patterns occurring and then continue to dig deeper into the facts and sources of available information to piece together the driving factors leading to the posted results. 

Certainly, one of the most significant challenges to small and mid-size manufacturing entities - that represent SEWN’s primary base of clients - is balancing their labor requirements and associated costs in a competitively priced market for their produced goods.

The labor challenge, especially following the COVID pandemic period, has been particularly difficult within a manufacturing environment. U.S. Chamber of Commerce analysis of BLS data indicates nationally a labor shortage of about 20% within the durable goods manufacturing sector. 

As of January 2024, estimates were of 622,000 unfilled manufacturing positions nationally. And for the Commonwealth of Pennsylvania, data from Sept of 2023 indicated that for the total labor pool there were about 66 workers available for 100 open jobs.

Future trends lead to expectations of further employee turnover in the manufacturing sector where Bureau of Labor Statistics as of 2023 indicate the median age of manufacturing workers at 44.1 years compared to 42.1 for all U.S. workers and over 25% of manufacturing workers are age 55 and above.

Most all of our clients have discussed at length their challenges and strategies to attract new personnel into manufacturing along with retention tactics that come with associated expenses. Those costs include recruitment advertising and additional HR resources for hiring processes; enhanced benefits and additional paid time off for workers; to on-the job training and mentoring programs put into place for new hires. Along with increasing wages over recent periods (reflected in the chart below) as another factor that a company needs to monitor when examining overall labor expense trends within their organization.

Given all these identified climbing labor costs relayed by manufacturing leadership it is not surprising to see the resulting impact of lower reported gross profit margin trends in recent periods. It is a fast-paced movement in increased expenses and product pricing cannot continue to rise un-checked in a competitive market.

SEWN consulting collaborates hands-on with the business accounting and operations personnel to extract details and then examine the various components of this labor cost – to detail both direct and indirect charges as well as overhead absorption. Certain companies require support in building out a labor costing model that has not been fully established. We assist in providing a sample model customized to meet their appropriate level of need.

Some companies have developed practices for collecting this data but they may not have updated these costing models recently. We are identifying that allocated labor costs used for estimating purposes are understated from 5% to almost 20%. It is a best practice to understand components and continually update the underlying labor cost in this environment in order to then appropriately apply a mark-up for profitable pricing. Proactively monitoring (per the example below) on the estimated labor time to actual results on production runs provides the insight for where immediate attention is required to achieve great labor efficiencies.

A key area of focus is in the identification of total labor hours and associated payroll dollars that are directly billable to the production cycle compared to the indirect costs. This level of detail can be very challenging in estimating for the small and mid- sized manufacturer but it is a best practice associated with key performance indicators to drive a continuous improvement result. Especially given the previously stated challenge in turnover of experienced personnel being replaced by newer employees who are not yet fully trained that may result in higher defective parts being produced or just taking longer to complete their tasks until their skills can be established. Again, as we dive into this data, we are seeing the trends of more labor hours and therefore costs going into indirect time. 

Knowing this trend, we can then move to the next level of identifying where this indirect time is spent and engaging the team to problem solve for creating solutions to address the situations for better outcomes.

Identifying and monitoring the various components of labor cost provides tools for management to utilize for enhancing their operations. Creating a continuous cycle of consistent processes for collecting and analyzing the data supports strategically moving in the desired direction to ultimately have a positive impact on the financial results.