Why labor isn’t working (as a way of boosting struggling earnings)
Apple is the world’s largest company – and happily, for those who care about such things, it’s both an innovator and a manufacturer. A symbol, if you like, for progressive capitalism in the 21st century: neither pure-play service business nor industrial-age dinosaur.
Apple doesn’t just get a pretty number in a ranking. With all of its manufacturing outsourced – like tens of thousands of other companies – it gets flexibility, speed and low costs. The red tape burden is minimized. And the people it does hold onto? They’re the high-value ones. They create (and, probably in hundreds of cases, defend) the intellectual property that makes it a successful business.
So what’s the catch? Well, actually there are two.
First, successfully executing this strategy demands real discipline. The supply chain is complicated and your reliance on your key suppliers absolute. If that reliance turns into blind dependence, you can be storing up trouble. If you get complacent either your competitors or suppliers can eat you up.
Second, these kinds of businesses are generally very lean. That’s good. But it means if things don’t go so well – you have a run of poorly-performing products, the market shifts against you or a competitor ups their game – your options are limited.
Forty years ago, traditional companies had a simple choice when problems emerged. Cut headcount.
Demand is down? Close a production line.
Agile new competitor emerges? Target managers to boost productivity and make redundancies. Cutting the payroll was a fast and reliable way of protecting the bottom line and sending a message to the markets.
But now? Those same cuts will often be jeopardizing muscle, not fat. Apple is riding high, but if it came under earnings pressure sometime in the future(?) those direct employees – the innovators, the designers, the Apple Store Geniuses – are its route out of trouble, not the source of a few million in lower costs.
Many companies have committed to that kind of long-term strategy. So they need long-term, sustainable solutions when they’re looking to improve earnings. Labor should be lean – and at just 12% of annual revenues (that’s an average across the FTSE 350) they are. So the future of enhanced earnings has to mean efficiency elsewhere.
That can be tough. Supply chains are complex – and opportunities for optimizing them look limited to those who were instrumental in their design. But when you know where to look, there are always openings.
Back in 1987, American Airlines saved $40,000 a year by taking one olive out of its first class salad. That wasn’t a random saving. Someone had noticed what no-one in the procurement or catering functions had: there were lots of olives in the waste being carried off the aircraft. The passengers weren’t even eating them.
That holistic, long-term view of the supply chain is the best way for today’s businesses to make sustainable improvements to earnings. Cutting headcount – with that relatively small share of revenue taken by labor – might give you a tiny nudge next quarter. But the long-term consequences could be dire.
Our latest research reveals that businesses spend, on average, two-thirds of their revenue on non-labor costs – 68.3% in 2011. This far outstrips their collective labor costs, which averaged just 12.9% of their revenue. Yet headcount reduction is traditionally seen as the best way to tackle cost. This raises a number of questions:
- Are businesses ensuring that their non-labor cost base is being effectively managed?
- If not, why not?
- And what are the potential benefits of making that investment?