Cost per unit is one of the most common and effective ways for organizations to track their labor efficiency. As we move into the Next Normal, it is wise for organizations to take a moment and re-evaluate the investments they are making in labor and the associated results.
Cost per unit shows you how productive and efficient your workforce is. It can quickly tell you:
- 1. Whether or not you are hitting your production goals
- 2. Whether or not you are on your labor budgets
It is necessary to keep cost per unit on target to maintain your margins, deliver on productivity and monitor efficiency. Though most companies agree on the value of monitoring cost per unit, a shocking majority are forced to live with only reporting on it.
That’s why in this post, we will do a refresher on cost per unit. We’ll explore how it’s calculated, its key drivers (e.g. reasons it could be up or down), why most companies are reporting not monitoring cost per unit, and the steps that can be taken to change it.
How It's Calculated
Most commonly, cost per unit is calculated as follows:
Cost per unit = direct labor expense/# of units produced
Whether you include indirect or overhead labor in this calculation will vary based on company. For this post, we’ll include direct labor only.
Let’s say you’re a frozen pizza manufacturer. There are 8 workers per line working 8 hour shifts to make 3,200 pizzas per shift. This means each line must make 400 pizzas per hour. Your workers get paid $12.50 per hour which means it costs you $100 per hour. So, your cost per unit is $0.25.
Now, let’s say that you come into work and see that your cost per unit is $0.30. This is great insight but now you need to unpack what is off budget so you can get this output metric back on track.
To do this, you’ll look at the four drivers of cost per unit.
Unpacking the Key Drivers of Cost per Unit
There are four key drivers of cost per unit and each of them can positively or negatively impact your cost per unit. They are:
- 1. Headcount
- 2. Hours
- 3. Overtime
- 4. Productivity
Let’s dig a little deeper into each of these:
- 1. Headcount: This is the number of people you have working at a point in time. Here’s how being over or under your headcount budget can impact cost per unit:
- If ‘Headcount’ is higher than budget – You are likely to overrun your labor budget, but you could produce more due to the additional help.
- If ‘Headcount’ is lower than budget – You could incur additional overtime to make up for not having enough people. You are also at risk of missing your productivity goal.
- 2. Hours: This is the number of hours worked during a time period. Here’s how being over or under your hours budget can impact cost per unit:
- If ‘Hours’ is higher than budget – You will overrun your labor budget, especially if a high percentage of the hours are premium (e.g. overtime, premium, double time, shift differential).
- If ‘Hours’ is lower than budget – You will likely be under your labor budget, but your productivity could be at risk.
A subtle, yet important, nuance to Hours is its translation into labor expense. To properly calculate labor expense, you will need the number of hours worked, the type of hours and the hourly rates for each worker. We’ll explore this in an upcoming post, but these three variables can make calculating accurate labor expense before payroll is processed a pretty big feat on your own… but, easy with analytic.li.
- 3. Overtime: This is the # of hours that are overtime and/or premium during a time period. Here’s how being over or under your overtime budget can impact cost per unit:
- If ‘Overtime’ is higher than budget – You are likely to overrun your labor budget if you are also running over your hours budget.
- If ‘Overtime’ lower than budget – You may still risk overrunning your labor budget if you have more than budgeted regular hours.
Similar to hours, overtime is also a complex calculation due to the variables involved. This is tough to do in spreadsheets yet streamlined in analytic.li.
4. Productivity: This is the # of units produced during a period of time. In our example, we are using “Unit” but a unit could represent a unit, case, widget, service, customer, etc. Here’s how being over or under your production budget can impact cost per unit:
- If ‘Productivity’ is higher than budget – You will likely meet or exceed your Cost Per Unit target if your labor is managed appropriately.
- If ‘Productivity’ is lower than budget – You will likely not meet your Cost Per Unit target. What’s more is if ‘Labor’ and ‘Productivity’ are both low, you could meet your Cost Per Unit target but not meet your Productivity target.
Now Back to Pizza
The reason your cost per unit, or in our example cost per pizza, goes up is twofold:
- 1. Labor is up and production is down, or
- 2. Labor is up and production is even.
Either scenario is driven based on the four drivers listed above. Figure out which are off and you have found your solution.
Best Case Scenario
In a best-case scenario, you’re making the same amount (e.g. hitting your production goal) but your labor is up. An example would be if it took $120 to make our 400 frozen pizzas instead of $100. So, our cost per unit is $0.30. It could be that this is an acceptable variance since the product is still headed out the door to paying customers.
Worst Case Scenario
In a worst-case scenario, you’re not producing enough and your labor is high. In this case, your margins will be highly impacted. An example of this would be if it cost you $120 to make 360 frozen pizzas. Your cost per unit would be $0.33 and you didn’t hit your production goal.
Understanding why your cost per unit is going up is so important. You might be hitting your labor budget perfectly, but if your production is not on target you will drive your cost per unit up and you will potentially be unable to meet your SLAs.
Taking Action for Positive Impact
Keeping cost per unit on target takes proactively managing your key drivers, and lots of current data at your fingertips.
That said, most companies are forced to report on cost per unit as opposed to monitoring and getting proactive around cost per unit.
Here are the top reasons why:
- Data Silos: The labor, production and budget data exists in various systems. Meaning, there is not one common place for this calculation to occur.
- Timeliness: Most of the time, cost per unit is getting calculated after payroll is processed. This analysis is informational, at best. This leaves operations managers with no ability to make changes around the four key drivers.
- Delivery: Getting a report forces busy operations managers to do manual analysis to arrive at their insight.
These three added up mean that operations managers don’t have one central place to manage their day to day.
That's Why We're Here
At analytic.li, we uniquely understand the need for manufacturers and distributors to closely monitor their cost per unit. After all, it is one of the foundational metrics 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 manage cost per unit by alerting leaders of staffing shortages, labor overages, overtime, and productivity trends to manage cost per unit.
If you’d like to learn more about ways to proactively monitor cost per unit or discuss how analytic.li will work for your organization, reach out to us. We’re eager to connect with you. If now is not the time to consider new software but you liked what you read here, subscribe to our blog below.