At what point should business managers accept the fact that they have allowed personnel-related expenses to creep up into the danger zone? This is the kind of thing that is easy to allow while you sit back and attempt to manage a relatively people-intense business.
Many owners I have worked with over the years have used the previous 12-month’s year-to-date people expenses compared with the current year as their benchmark. Old- timers just watched for when too many of their people were not busy.
If you are serious about reducing operating expenses, the place to begin is by making some tough decisions about the number of people on your payroll.
Even in the best of economic times—at least for highly profitable building supply businesses—managers strive to hold personnel-related expenses to no more than 45% of the gross profit the company is generating. But in years when the housing economy is less than robust, it’s easier for managers to let their emotions cloud their judgment and to allow people expenses as a percentage of sales and gross profit to get out of control.
Since every expense on an income statement is best measured as a percentage of sales, it’s critical to reduce operating expenses by at least the same percentage as sales have decreased. And since people-related expenses make up the great majority of all lumber companies’ total operating expenses, it just makes sense to prune people when the forecast for increased housing activity does not look promising for the next 12 months.
Over the years, I have noticed the closer personnel-related expenses (salaries, commissions, group medical, payroll and workers comp) come to 70% of total expenses, the nearer the company is to just breaking even or even losing money. Looking at personnel-related expenses as a percentage of total expenses isn’t as good a measurement as looking at them as a percentage of gross profit dollars, I still believe it is a worthwhile benchmark to consider.
One of the primary reasons managers give for their reluctance to downsize the work force to be more in line with the company’s overall productivity is that they feel responsible for their people. This can even be true for employees who are not pulling their weight in the organization.
Whether you call it “downsizing” or “rightsizing,” it’s an action step that must take place if a business is to remain profitable in spite of what’s going on in the local housing market.
An early mentor straightened me out on this issue, especially with employees who are falling far short of management’s expectations. “Bill,” he said, “you’re not doing these people any favors by not terminating them. Just think about it … by keeping employees on the payroll you’ve given up on, you’re depriving them of the opportunity to get a job with another company where they might have a bright future.”
This advice is just as applicable today.
Most sectors of the North American economy are performing quite well. Many industries are in a hiring mode, so the people who may not be in your company’s future will not likely be out of work very long.
Many of my clients were highly profitable several years ago when their sales were only a fraction of what they were at the peak of the housing market. Whether you call it “downsizing” or “rightsizing,” it’s an action step that must take place if a business is to remain profitable in spite of what’s going on in the local housing market.
If history has taught us anything, it’s that the housing industry will likely always go through periods of feast and famine. The good news is that regardless of what’s happening to your company’s sales, you can still make a satisfactory bottom line profit by controlling operating expenses to the same percentage of sales.
The place to begin is with people-related expenses.
