How productive is your labor?
There’s a good chance you’re not calculating it correctly.
In our last blog on finding cash, I started by asking the following questions:
1. What are the key elements of your business’ economic engine and how is it doing?
2. Are there changes to make to improve, optimize or increase its output?
3. How can you tune your core business engine to scale your company’s growth?
As you look deeper at your economic engine, you will find that one of the most important components to optimize is Labor Productivity. Why? Labor is consistently the highest cost in almost all business models. By optimizing Labor Productivity, you will have tuned up the most important expense in your business to help ensure profitability.
A good metric to use to monitor and optimize Labor Productivity is the Labor Efficiency Ratio (LER). LER is defined by Gazelles International Faculty Member and Thought Leader, Greg Crabtree. Greg is the author of the powerful book, Simple Numbers, Straight Talk, Big Profits! For years, Greg has pursued his passion to help entrepreneurs in high-growth companies identify a handful of simple metrics to help drive and monitor profitable growth. Greg defines the LER as Gross Profit divided by Direct Labor (expense). This will become an important number for your business in order to keep Labor Productivity as high as possible.
In order to calculate your LER, you need to refer to your company’s most recent two years’ financial statements, specifically your Income Statement(s). Greg believes the new break-even metric for companies is 10% net income. At 5% or less, he believes companies are on life support (unless you are burning cash to capture market share, as many funded start-up companies do).
What does the Labor Efficiency Ratio (LER) do for growth companies? It measures the productivity of your labor force through time and can be used to optimize your economic engine for maximum profitability. Also, you can focus the LER on sub-categories of labor within your company – the most common being Management Labor and Sales Labor.
Using the Scaling Up – Four Decisions framework, there are three primary means to increase LER:
1. Increase the level of your Team Talent; that is, intentionally improve your team profile to an increasing number of A-Players – top performers who live your core values and get things done well.
2. Strengthen your Execution Disciplines of setting Priorities, using Key Performance Indicators (KPIs) to measure progress, and maintaining effective Communication Rhythms – a combination of energetic, productive meetings to get things done and stay highly aligned as a team.
3. Review, strengthen and measure your Brand Promise, beginning with a very clear definition of your Core Customer – the customer most likely to purchase your product or services at your price on a consistent, ongoing basis.
For some of you who are using the Scaling Up – Four Decisions framework, these three items are familiar. For those of you who are just learning them, keep reading my blogs and “learn as you go,” or contact me if you want to go faster.