Week 9_LanreGiwa_Company Overhead and Labour Rates

Problem Recognition / Identification

In an engineering company, top management during the weekly meeting explained to senior managers that the company has consistently lost jobs bided for due to the high all-inclusive charge out rates / Labour rates of the Engineers for design projects. Therefore, top management directed the project controls manager to come up with feasible alternatives to address the problem and figure out a way of reducing the labour rates of the Engineers.

Root Cause Analysis

Analysing the reason for the high Labour rates, the Project Controls manager compared the rates of engineers from the current year to 5 years ago and came up with possible reasons for the high labour rates as listed below:

1. Yearly national inflation leading to yearly review of staff emoluments
2. The company moved its main office from a smaller, cheaper building to a bigger Building in a more prestigious location. Invariably, the rent payable shot up in multiples of the previous building.
3. Five years ago, the company ran a monopoly of the business of engineering design, currently, more companies do engineering design, hence, the jobs are split amongst the companies now.
4. Currently, there are more staff in management cadre compared to 5 years ago. The company pays for more people that do not charge on projects thereby forming part of the company’s overhead.
5. The ratio of direct labour to indirect labour (Operations staff: Services staff) ideally should be 10:1 for an engineering design company. However, the current ratio is about 1:1

All these points drastically shot the indirect (Overhead) cost very high and when added to the labour rates, the final charge-out rate was high.

Figure 1:Overhead Costs displaying Direct Cost

Development of Feasible Alternatives/Solutions

The Project Controls manager came up with the following alternatives to address the problem and reduce the overhead rates:

Alternative 1 – There should be no increase in the salaries or total emoluments for the next couple of years so that Labour rates can relatively remain the same over a longer period of time.

Alternative 2 – Main office building should be relocated to a cheaper area, smaller place or the company should acquire a permanent building.

Alternative 3 – Company should be more aggressive at getting jobs that will level out or minimize the overhead.

Alternative 4 – Company should reduce the overhead by reducing the number of staff at managerial positions by any means that would be fair.

Alternative 5 – Company should review its CAPEX and OPEX to reduce the overhead.

Alternative 6 – Reducing the ratio of services staff (Indirect Labour) to Operations staff (Direct Labour

Possible Outcomes and Cash Flow of Alternatives / Solutions

Alternative 1: This option would generally demoralise staffs working in the company and this may have negative impact on the quality of deliverables and productivity and would cost the company more by going through re-work.

Alternative 2: The rent/lease payable on the prestigious building is seriously shooting the value of the overhead. While it is agreeable that the building is spacious and attractive to clients, on performing a cost / benefit analysis, it would be better for the company to either get its own permanent building or move to a cheaper office accommodation.

Alternative 3: This is a very critical an inevitable decision to be made by the company. Re-engineering of the company will ensure that business development department and other staff are more aggressive at getting jobs. Every department will be tasked with looking for jobs for the company and a revenue target will be applicable to every department. With this method, more jobs will be earned and this will reduce the overhead.

Alternative 4: Allowances paid to senior management is a large chunk of what is spent annually. A good way of reducing the overhead is to reduce the number of staff at the management cadre or maintain the staff and ensure that the senior managers all work on projects to earn money for the company.

Alternative 5 – Generally, reduction in expenses (CAPEX & OPEX) would reduce the overhead and filter down to the reduction of the Labour rates.

Alternative 6 – Reduction in the ratio of indirect labour to direct labour will reduce the overhead and ultimately reduce the labour rates of engineers

Selection Criteria of best solution

• Decision must not affect the smooth running of the company
• Decision must be a permanent and dynamic solution to the problem of high labour rates
• Decision must have a human face by considering the staff welfare and not to demoralize staff
• Decision shall be aimed at creating more jobs for the company.

Analysis and comparison of the Alternatives/Solutions

Reviewing all the options, options 1 would affect the company because the general staff would no longer be motivated and this would affect their productivity. Option 2 and 5 are primarily aimed at reducing cost by relocating to a smaller building or reducing everyday operating cost.

Another way of analysing the situation is that instead of reducing cost, the company can proffer ways of increasing revenue. This brings the analysis to option 3 which is focused at getting more jobs. To re-iterate this approach, the higher the number of engineering man-hours expended by the company, the lower the value of overhead and the lower the Labour rates.

Option 4 can be used as a double sword. Senior managers can be either be posted back to the parent company or the managers can start to do consultancy jobs that will generate revenue for the company. Option 6 would reduce some of the inefficiencies within the system by making people more productive.

Best Alternative to be Selected

Based on all these analysis, I would suggest that option 3 should be chosen to reduce the overhead and later option 4 should be integrated by letting the senior managers also generate revenue by using their vast experience for consultancy services.

Performance Monitoring / Post evaluation

The outcome of the action points can be monitored by evaluating the trend of things as per comparing the company’s rates with other design companies to see how competitive the rates are and the volume of jobs that would be won and executed by the company against the estimated hours planned per annum.

References:

1. AACE International. Skills & Knowledge of Cost Engineering, 5^th Edition Revised.Chapter-8, P.8.2-8.8 Edited by Dr. Scott J. Amos, PE. 2010. AACE International. Morgantown, WV, USA.

2. Sulliven, W. G., Wicks, E.M., Koelling, C. P., et al. (2009). Engineering Economy (14^th ed.), P.27 table 1.1. New Jersey: Pearson Education.
3. Gary Cokins, Activity Based Cost Management, www.wiley.com
4. www.accountingcoach.com/online...course/36Xpg01.html