Setting a standard | How to determine whether an employee's costs outweigh her profits
Do you know what production standards your employees need to meet to maximize the profitability of your business? The only way your business will be sustainable is if your employees generate more profit than the combined cost of their wages, benefits and other overhead expenses.
A service provider I recently worked with wanted to reward their employees for behaviors that drove the company’s bottom line. We used the following process to achieve both increased profits and improved employee morale.
Know the profit drivers of your business. What employee activities drive the productivity and profitability of your business? If you are a manufacturer, the driver is the number of widgets produced each hour. For service providers, the driver is usually the amount of time needed to deliver the agreed-upon service. My client’s revenue was generated by jobs priced by the project rather than by the hour, so a way to increase profits was to provide the same great service in as few hours as possible, without scrimping on quality and customer service.
Set standards based on your drivers. Once you know the drivers of your business, set realistic standards for each. A manufacturer may determine that each employee needs to produce 28 widgets per day. My client determined that the wages for each job should be 50% of the job revenue.
Confirm that the production standards support your business model. Make sure the production standards provide enough gross profit to support both your administrative expenses and profit goals. After reviewing these expenses with my client, we determined that the company experienced a net loss if wages exceeded 60% of job revenue. This analysis confirmed that the 50% standard was realistic for both the employees and the business owners.
Decide if the standard will be applied to individual or team performance. My client sent teams out on each job, so the standard was applied to overall team performance rather than individual performance. This encouraged the team to work together.
Communicate the standard to all employees. Make sure all employees know what the standards are and how they will be calculated. Simple examples help demonstrate how different behaviors affect whether the standard is reached.
Before beginning each job, the service company gave the following information to all employees on that team:
Revenue for that specific job
Total labor costs calculated for the job in order to meet the 50% standard. For example, a $4,000 job should involve $2,000 in labor.
Example of how this standard could be met. With five people on the job earning an average of $20 per hour (or a total of $100 per-hour for the five-person crew), the crew members could each work 20 hours and still meet the standards.
We created a simple Excel spreadsheet so updating only a few variables could easily provide this information.
Track employee results against the standards. Create a system to monitor employee results against company standards. Since the client used Quickbooks to manage their business, we used the timesheet function of the program to track jobs and hours for each employee. This allowed us to view the profitability of each job by employee, client, type of service provided, etc.
Let employees know how they are doing compared to the standards. Employees need frequent updates on their results so they know where they stand. These results should be readily available and distributed on a regular basis. Using Quickbooks, the service company provided job costing reports each Tuesday morning so employees could see the results of their performance the prior week.
Implement a plan to help employees reach standards. There will invariably be employees who don’t meet standards. While everyone has an off week, not meeting standards on a regular basis is an indicator that something needs to change. Have a plan in place to help employees reach their standards and communicate this plan to the affected employees.
Have celebrations when standards have been reached. Provide frequent, inexpensive and enjoyable incentives when standards are met. The service company knew by Monday afternoon whether the jobs for the prior week had met the company standard. If they did, the company bought a pizza lunch for everyone on Tuesday. At a cost of $30 each week, it was a small price to pay and well worth the profitability gain it inspired.
The only way your business will stay profitable is if your employees are creating more profit than cost. The only way you can be sure you are meeting this goal is by understanding what the standards should be, tracking them, and providing rewards when the standards are met and assistance when they’re not.
Alison Hinson, owner of Alison Hinson MBA, LLC, can be reached at alison@alisonhinsonMBA.com. Read more Profit Motives here.
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