When you think about your business operations and the resulting income statement, all expenses are not created equal. There are expenses you can control throughout the year and others you cannot.
As an example, in our last blog, we discussed the 4 key drivers of cost per unit. There are controllable costs within CPU, like labor. If you can control your labor expense in the short-term, you can easily manage your cost per unit. What you can’t always control in the short-term are pre-determined costs for things like packaging, raw materials and rent.
Some examples for not being able to control costs include:
Markets: The business has little to no impact on market-driven components like price of gas, price of raw materials, etc.
Infrequent Buying decisions: The business makes a decision that is unlikely to change frequently like benefits, office space, etc.
Annual Agreements: Similar to Infrequent Buying decisions, these are annual agreements and/or contracts, that the customer cannot change day to day like software, salaries, pay rates.
So today, we are going to explore the difference between controllable and uncontrollable costs and why it’s important to stay on top of your controllable costs.
Defining Controllable vs Uncontrollable Costs
Controllable cost refers to a cost that can be altered based on a business decision or need. These costs have a direct relationship with a product, department or function and can be altered in the short-term.
- Direct labor
- Training Costs
This is a cost that cannot be altered based on a personal business decision or need. These costs are allocated by the top management to several departments or branches and are usually altered in the long-term.
- Direct Materials*
- Administrative Overhead
*Materials can be seen as both controllable and uncontrollable costs. In most cases, the cost of direct materials is determined by long-term contracts and cannot be controlled day to day, so in this case, we consider them uncontrollable costs
Let’s imagine you are an operations manager at a frozen pizza manufacturer and your key metrics are labor expense, cost per unit produced, and packaging costs. Start by determining:
- Which of these costs are controllable?
- Which of these costs are uncontrollable?
Right away, you’ll likely notice that labor expense and cost per unit produced are controllable and packaging costs are uncontrollable. This means that as the operations manager, you are able to easily impact the first two on a day-to-day basis. Managing packaging costs per pizza is uncontrollable since it is determined by upper management on a long-term basis and will not change daily.
It’s important to understand the differences between controllable and uncontrollable costs since it can make a major impact on profitability and performance.
Why it's important to monitor controllable costs
In many cases, these expenses can be ‘make or break’ in terms of driving profitability. If you cannot easily manage and make decisions to positively impact your controllable costs, there could be a huge loss in profitability, worker productivity and labor efficiency.
Labor can be one of the largest costs incurred by a business. Typically, labor cost percentages average 20 to 35 percent of gross sales. Percentages vary by industry, but most manufacturers will try to keep their labor cost percentage under 30 percent. So, if our frozen pizza manufacturer made $50 million of gross sales, our labor cost could be anywhere from $10 to $17.5 million.
Operations managers need the tools to be able to manage all controllable expenses… but, most likely don’t have the time or resources to do so. Most companies are forced to manage productivity, efficiency, labor and safety “after the fact” due to the number of systems, spreadsheets and people involved. For instance, let’s say your cost per unit is above its threshold on Wednesday. But the report will not be available for 10-14 days after the initial occurrence. It becomes nearly impossible to make a positive short-term impact on an expense you know you could have controlled if you had the right tools.
Controlling costs cross-functionally
It is not only up to an operations manager to worry about controlling costs. Think about how HR or Sales can impact controllable costs.
HR can partner with operations to monitor headcount. Let’s say there aren’t enough people on the pepperoni pizza line to hit their production goal. This means that they will have to drive up labor expense and incur overtime. But, if HR works with the operations manager to monitor staffing levels and headcount, the HR person is directly impacting controllable costs.
Sales can also impact controllable cost of labor by better communicating with operations when there are going to be spikes or sledges in the number of units sold. If the operations manager knows when they will need to staff more or less, they will be able to control their labor costs much easier.
Controlling costs with analytic.li
You may be thinking, This is great! I want to better manage my controllable costs… I want my operations managers to have the tools to control their costs… and I want my departments to work cross-functionally to drive productivity and profitability… but how do I start?
Imagine if your cost per unit is above its threshold on Wednesday, and you were alerted on Wednesday to make a change. Imagine if you didn’t have to wait for 10-14 days to see what went wrong. Imagine if you could make game-time decisions to positively impact your controllable costs, all day.
With analytic.li, you don't have to imagine. Here’s how we do it…
- 1. Understand the business challenge you are trying to solve (e.g. managing labor expense)
- 2. Aggregate your relevant labor and business data
- 3. Analyze your data with Ask analytic.li
- 4. Provide timely insights through metrics, dashboards, and alerts to impact the bottom line
We uniquely understand the need for manufacturers and distributors to closely controllable costs. After all, it is one of the foundational ideas that impacts labor efficiency and productivity.
With our first-ever, cross-functional labor efficiency and worker productivity platform we break down data barriers and organizational barriers to set up operations managers for success. This means businesses can arm their leaders with real-time insights to better manage controllable costs by alerting leaders of staffing shortages, labor overages, overtime, and productivity trends.
If you are looking to manage your controllable costs, and want to impact your productivity and profitability... connect with one of our solutions consultants to schedule a free 30-minute consultation. If now is not the time to consider new software but you liked what you read here, subscribe to our blog below.