- June 14, 2010
- Posted by: admin
- Categories: Blog, Business Dynamics, Enterprise Agility, Human Resource Management, Requirement Analysis
Human resource budgeting and planning is a crucial activity to achieve strategic goals. To start with, an understanding about the whole budgeting process is required which can help in identifying resource allocation to various divisions.
Let’s consider two scenarios, scenario # 1: if a company assigns a greater percentage of its revenue to its payroll (across all departments), it would definitely be able to hire better resources. However, there’s a possibility that in the future it might not be able to expand its business, increase its profitability or retain resources by maintaining their expectation levels. Retention via further monetary increments over the years would further reduce profitability over time.
Scenario # 2: Let’s take an example of another company who is maintaining a strong percentage of its turnover as revenue. Let’s assume it minimizes its payroll to 1/4th of its turnover. This places them in a far better position to expand their business, increase capital and profit margin which can facilitate them to reward employees with perks and various other benefits, nevertheless, making certain that they don’t surpass that threshold %. However, this scales down initial payouts to employees, which makes it difficult to hire/retain good resources during the preliminary years. It also somewhat reduces growth possibilities for resources due to the threshold scale.
What according to you should be a company’s ideal payroll percentage over its revenue considering today’s world economy and its financial limitations? Please support your answers with personal experiences/facts.
Payroll has two components, one is fixed cost another is variable cost. As the company moves along its productivity/revenue curve, variable cost (absolute amount) also increases proportionately while the fixed cost (absolute amount) remains unchanged. the total cost therefore reduces in terms of percentage of the revenue.
Another aspect in determining ideal percentage of payroll vis a vis revenue is the effect of innovation and technology. By innovation I mean not only technological innovation but also process innovation, marketing innovation, service innovation etc which may reduce the payroll cost.
Third aspect is nature of industry (labour intensive or capital intensive, service oriented or manufacturing oriented).
Fourth aspect is geographical location. Branches of the same company may have different percentage. Those which are located in less developed countries may enjoy lower wages. This is usually the consideration for outsourcing.
Fifth is the type of managerial structure. A flat structure will tend to have lower percentage as compared to tall pyramid of hierarchy which will have higher percentage of payroll as there will higher number of managerial positions.
Sixth aspect is the size of the company. This aspect will bring into play either “economies of scale” or “de-economies of scale”.
There are a great number of variables that are at play. I have run a law practice for more than 20 years. Net income has always been roughly 50% of gross billings. Payroll probably has been in the vicinity of 25% of gross. However, that is misleading as it is such a specialized field.
I will submit for you a twist on your question. I have often argued that trust by employees to management and by management to employees has eroded. How do we tie payroll (including bonuses) to performance? The more vested employees are in the performance of the organization the more likely that they will be more productive. Management often complains that they go home at night worried about the business. Employees who are vested in the success of the business will be more likely to feel the same way.
Does that connection serve as a step towards realizing mutual trust? This will likely only work in non-union positions.
David Gabor also suggests these experts on this topic:
* Kim Huff, SPHR
* Lonnie Sciambi
I have seen similar ways to link payroll with the company performance. Unfortunately most of the studies show that money are just one of the motivators for performance and they are not the first one. From my experience linking payroll with the company revenue will work for some positions (such as sales) but will not work for others. Especially in worsening economic conditions (which are external factors and are not influenced by the effort the employees are putting in) the link between payroll and the company revenue will get you on a death spiral and you will end loosing your best performers and loosing your competitive edge.
I would use something else. I would link the headcount with the revenue generated by the company, but this will be specific to one industry. For example one of the companies I worked with, form the IT sector used to have a new hire only if the company turnover was higher than $100k/employee. I don’t know how this would be for other industries and other countries.
Also, your suggestion above, allocating 1/4th of the revenue for payroll may work in the service industry but for production or retailers may not work.
Another thing worth mentioning here is what you include in the payroll. If you include all the expenses related with your employees or you have some that are kept aside or that cannot be allocated.
I think that the idea that by limiting the payroll you cannot hire/retain god resources, is not quite accurate. If your company is in the startup phase, you do not need very specialized resources and these can be found with lower pay. It is very interesting how some companies (i.e. Zappos ) have managed to retain talent while still not paying a lot. You can find it explained in Delivering Happiness by Tony Hsieh (link is below)
Turnover in terms of revenue is good. However, in terms of employee turnover, that is just bad. A company should always, always try to not lose good employees. Ofcourse , a good salary is important, however in the long run, it is only attention, recognition and the chance to learn new skills which retains good employees. The latter factors infact deter a good employee from resigning and moving on to another job, even if it pays well and much better.
You may not be able to reward them with a better salary, but if you make an employee feel that he/she belongs to the organization, and is part of the ‘family’ – that his/her opinion matters, that he/she is focal to achieving the company’s goals and that the organization values them, then that in itself is a bit motivator.
You may not be able to offer a promotion, but you may be able to give the employee a new role, with added responsibility and which demands more trust and empowers the employee. You may be able to ‘recognise’ an employee by appreciating his/her efforts publicly and personally.
Nowadays, most company also outsource their payroll functions, so as to reduce cost and channel the skills of employees on more productive things.
Disclaimer: I am not HR person and therefore my observations are only based on personal observation and experiences.
IMHO, payroll should not be more than one third (33.334%) of the turnover annually, for any service oriented firm.
For any business, service or production, there’s always a 15 to 25% marketing/promotional cost attached, + the annual inflation/interest on credit(approx 32 % in all), which is usually left unconsidered in primary feasibility and yearly projections.
So, we have 20%(avg) avg. promotional, and 30% approx inflation+ interest, that makes around 50%. infrastructure/operational expenses is another 15%,leaving us with just 35% of the pie to spare.
So it is safe to assume that any firm that wants even a remote chance at surviving annually at a margin that helps it stay competitive and save over rising inflation and interest rates, needs to curtail its payroll(for service industry- for production based business it would be COGS+ payroll) to less than 35% of its turnover.
How to do this?
1. Increase sales (what most companies focus on, and don’t achieve 2/3 times)
2. Decrease costs (the real issue, often left unattended)
It is imperative to understand that payroll is supposed to be a percentage of the turnover. Sadly, most business plans today finalize payroll firsts, and turnovers are ‘projected’ over time.
Impossible to say, because it depends so much on the industry – for two examples –
1) I’ve worked in retail where there is quite a lot of staff but they are mostly on low pay, and most of the money is tied up in stock turnover and premises – probably less than 10% of turnover is payroll.
2) I’ve also worked in legal services, where apart from rather fancy offices almost all the turnover is dedicated to the high-paid professional staff, typically 80%+.
Perhaps my answer will seem rather simple but if we look at the overall picture and where we are in today’s job market, we would be far better off focusing on getting the proper talent and pay them what they are worth. Trying to balance between payroll percentage vs. company turnover wouldn’t be that much of an issue if we started with the right employee to begin with. I feel that we are selling our nation’s talent down the drain with so called modern business practices. If the reports are right and true that 80 percent of americans dislike their work and over 70 percent are a mis-match in their current job function…we have a lot of work ahead of us folks to get it right!
There is no ideal percentages of business for all the industries.
However on broad levels there can be two possible categories:
For Manufacturing businesses it is 20% to 25%
For Service Industry it comes to 70% to 80%
In general, pay attracts the best employees to work at the companies.
There is very good example to look at it.
It is Southwest Airline.
Southwest Airline main goal is attaining the best employees.
Most of service sector of his or her main goal is making his or her customers to happy.
Customer becomes first.
Employees become second.
There is no ideal percentage. It would be foolish to aim for such a thing. No-one with an understanding of how business works would ever do such a thing.
Scenario 1 is flawed. For example, it states that more pay acquires better “resources” and yet also states that these resources reduce profitability.
In scenario 2 you refer to “maintaining a strong percentage of its turnover as revenue”. Turnover IS revenue.
I’m not sure you understand business.
You don’t pay people according to an “ideal percentage” of anything. You pay people what you need to in order to gain and retain. This may be subject to budget constraints but the reality remains.