Organization Management can Balance Overhead Labor and Direct Labor

Abstract

The aim of this paper is to examine ways that an organization management can balance overhead labor (OL) and direct labor (DL) to meet the defined goals. This paper will consider the use of IT and how managers can utilize different strategic and tactical success to balance OL and DL without undermining the core function capability required to keep the organization moving and ultimately achieving the defined goals.  The paper shows the importance of integrating IT in cost estimation and other critical decision making.  Even if managers need to learn the interrelation between the labor activities and cost, it is important to consider the IT infrastructure in place to have a successful strategic plan to meet organization goals.

Introduction

Today, more than ever, work processes and management has become more knowledge-intensive than ever before.  Managers require high levels of formal education as well as symbolic skills, but more importantly, they must understand how to use information technology (IT) especially when making critical decisions. IT has direct relevance to the worker performance because it is the foundation of healthy and work environment in any given organization whether small or large.  Of course, no single technology is capable of guarantee a competitive edge by itself, however, by utilizing a single technology one can put human capital in the best possible use. On this note, companies across the globe are reassessing their business model and redesigning them from within using IT to improve efficiency and productivity. Overhead labor (OL) and direct labor are the primary and the persistent target on these changes.  However, in any given situation, it is important to approach cost and labor reduction challenges from both sides to unlock full benefits to the organization.

DL is classified as a variable cost because it differs relatively to the organization revenue. It is tied to the income, while OL goes to the bookkeeping, or facility maintenance, and other work that may not translate directly to the revenue or production (Horngren et al., 2012).  Essentially, OL is encompassed of employees who are not directly involved in the production of good or services, such as the accountants, security guards, the production supervisor and supervisors.  While these employees support the production process, they do not help convert raw materials into finished goods. They are also not usually assigned a specific task in one day. However, an organization needs overhead labor because the business may not effectively deliver results.  For instance, it cannot meet its goal without maintaining the facility or the information systems.  

Therefore, it is important to have a balance between DL rate and OL for an organization to meet its desired objective (Horngren et al., 2012). OL may seem to be unimportant because it is not directly involved in the production process, but it is an important parameter when estimating costs. Precisely, it is more complex than direct labor because it can include everything such as the support production, traditional back-office processes and is generally used to maintain the entire organization. Essentially, this complexity means that the manager must at all times learn the interrelation between the labor activities and cost and the option these can present when reducing cost, which could be effective in achieving competitive advantage.

Literature Review

It is important to control overhead labor (OL) more than direct labor (DL).  From the manufacturing perspective, labor costs related to the production are considered as DL cost, while other costs that are not linked to production are considered as the OL cost.  In essence,decisions in an organization related to cost estimations are not often taken using the linear model. Managers must make decision-based not on a simple model, but on a well-articulated model and by considering other departments in an organization.

“Product Costs as Decision Aids: An Analysis of Alternative Approaches (Part 2),” Review

Balakrishnan et al. (2012), in their article notes that traditional costing does not offer an effective way to estimate the costs. Precisely, the cost estimation and accounting decision were traditionally done by allocating overhead labor cost to cost objects based on direct labor hours. In essence, this assumption is problematic because allowing overhead when there are different product lines, where each of these product lines demands resources can be difficult. Therefore, Balakrishnan et al. (2012), suggests that it is important to use other approaches that capture cost dynamics and relationship.

Essentially, labor is direct when wages and work are identified with different cost units like the product or sale contract, and the employee who cannot be traced to the costing units are considered as the overhead labor.  The focus on the direct labor cost is straightforward because it is associated with direct payroll record and connected directly to the product, but the overhead may require allocation because it cannot be traced economically. Accountants, supervisors,  IT technicians and other support personnel that constitute of OL make production possible indirectly. It is through them that the management knows what it takes to manufacture a product and without them, a business can flounder.  Nevertheless, support services can be too large and can reduce the profit margin, which can make labor allocation necessary to keep operation efficient.  Clearly, this explains the importance of controlling OL in any given organization.

“Controlling overhead in public sector organizations” Review

In this article, Van Helden and Huijben (2014) states that overhead enables an appropriate and smooth execution of processes and help organization find a balance between the cost and the benefits needs to underlie the design as well as organization positioning. The authors particularly focus on applying ideas in management control literature on issues of overhead.  They claim that overhead must be controlled and how each overhead element is controlled is related to internal and external circumstance.  The authors claims that managers, especially the de-central managers should decide the overhead that will need to be controlled and take responsibility of the costs involved.

Van Helden and Huijben (2014) offer a viable control mechanism that can work on different levels of management.  First, managers need to define the overhead that can be distinguished, then benchmark the cost of overhear relative to other organization in the same sector and lastly undertake a cost-benefit analysis that will align with the identified overhead.  This strategy can be very useful in internal control, and where there are adequate administrative functions.  It could for example, lead to different levels of IT support among the OL. With this mechanism, there is a guarantee of responsibility and accountability.  Although the mechanism proposed by Van Helden and Huijben (2014) lacks informality and is focused on public organization is demonstrate the importance of controlling overhead when making cost estimation decision making.

“Computing productivity: Firm-level evidence” Review

IT adoption costs are often related to productivity slowdown¸ Brynjolfsson and Hitt (2013) claim that adoption of IT averagely takes years before real benefits are realized.  Using computers as an example of technological innovation, Brynjolfsson and Hitt (2013) notes that the effect of technology could be detrimental to the organization productivity if not properly utilized. Examining a number of studies, the authors note that even if there has been a positive relation between IT investment to the organization productivity, the elasticities for computers often exceed the estimated capital costs, which ultimately lead to data limitation.  Brynjolfsson and Hitt essentially examine studies that date back in 2000 years, and since then technology has improved a lot, however, their assumption indicates that it is important for managers to consider the negative impact of the technological innovation and implementation of IT with the aim of increasing firm’s productivity.

It Capabilities, Business Processes, and Impact on the Bottom Line Review

In recent studies, numerous authors have shown that IT has an immediate impact on the company overall bottom line. In particular, it plays a significant role in reducing production and transaction costs in the organization. King (2012) in this article explains productivity paradox for clear failure on IT investment. King agrees that firms today do not use IT to enhance their productivity.  However, this does not mean that IT when utilized appropriately cannot enhance business performance.  It according to King has more capability, but a majority of the firm fails to utilize these capabilities fully.  It is important for the firm, therefore, to use IT capability in their business processes and decision making.  The authors claim that utilizing IT capabilities is not about replacing the old technology with emerging one; rather, he argues that full utilization is about redesigning business process by new look and creation of goals that will put organization ahead of the competition.

Brynjolfsson and Hitt (2013) have shown that IT plays a critical role in improving the corporate bottom line and none among the manager and the IT can succeed without consulting the other. When implementing IT in an organization, the IT department must consider the engineering and the technical point of view. This essentially includes the software used to process and produce information; the hardware process used to store and retrieve information and human resource.  Raw data and information are also required, and the communication system must be present.  However, these dimensions cannot work alone otherwise a project or management plan may not be a success. Thus, it is important for the IT department to consider the managing point of because Decision support system and decision management system cannot work effectively without the help of IT and other departments.

The IT competence of managers has become critical in defining the organization success and performance. Managers’ today has become more knowledgeable in the application of IT principles and strategies particularly in recognizing how technology, in general, has transformed their role from the traditional approach to ones that are effective in today’s business environment. As a result, effective utilization of IT has significantly enhanced organization productivity and increased business performance as organizations strive to achieve a competitive edge in the new challenging market.

Organization structure is often integrated with its strategy, technology and organization structure must be considered together for an organization to meet its goal. Therefore, if a manager in an organization decides to compete by efficient operation and to become a low overhead producer in the market or industry, he or she must use production automation that will reduce the cost.  For instance, the organization could use an electronic customer-supplier relationship, this way; it can be easy to process electronic order from customers and process every aspect, and this means using less overhead labor.  Additionally, to minimize overhead, the company could use electronic communication and link it to the sales force, and proving them with electronic devices.

Brynjolfsson and Hitt (2013), notes that insisting that manager use technology in decision making may be marginally easier, but it often practically difficult and the cost of failure is high.  The authors show how firms integrating IT in their decision making have reported a slowdown in productivity. He found evidence that productivity benefits after integrating enterprise system took up to seven years to be fully realized. In particular, this was due to the organization and process changes were needed to make full use of accompanying hardware and software investments.  It is, therefore, the responsibility of the management to integrate technology with business decision making. Integration means that the manager must be aware of how any new technology or tool can be used to create an opportunity or change ways in which a firm do business.  Concomitantly, it is essential for a manager to be aware of the impact of decision making after integrating technology.

Using IT in management can allow an organization to continuously assess and improve the corporate bottom line as measured against clearly defined goals and targets, but this should be done on a short-term basis. The noted importance of  IT in the transformation of managerial functions implies that it is important for business managers to have a unique set of IT experts and tacit knowledge that will not only enable them to stay a  head but also will enable them to integrate IT related aspect in their decision making. Primarily, this means that IT plan should be facilitated by the manager through a planning process. In essence, the plan should be short, because changes in IT are revolutionary and rapid; therefore, it would not be practical to spend time on the plan. Nevertheless, to approach succeeding, it is important for a manager to include the IT plan in any given process.  Effective IT planning could help part the manager to make an effective decision and be realistic about costs and labor.

“Implementation Plan Design of Labor Cost Management System” Review

A high efficiency of labor is a critical aspect of competitive edge for an organization, and high efficiency of labor depends on the enthusiasm of the workers and input levels of the labor cost.   According to XIAO (2015), labor enthusiast primarily emerges from the wages paid to the workers.  Therefore, a lower level employee in an enterprise may not have the labor enthusiasm when he is paid less, and this is, in turn, can inevitably result in loss of talent. In other words, XIAO (2015) argument is that an enterprise effort to improve the income of worker improves the worker enthusiasms and unconsciously promotes quality of skills.  Additionally, his argument is that low cost is an important factor in expanding the market share and opening a new space for more revenue, however, it is important for an enterprise to adopt the transition using necessary tools.

XIAO (2015) proposes the use of  local cost management system in a modern organization because it can be externally focused,  and because it reflects all dimensions of strategic cost management from benchmarking to established better communication with  IT division in the organization. Using labor cost management system can be essential in implementing a practical plan for the management.  This implies that IT has a long way to go when it comes to integrating accounting system so it can meet the business needs of the organization. It is important for IT department and managers to ensure that Proper design system is designed and implemented to ensure economic efficiency and ultimately control labor costs. On this same note,  XIAO (2015) claims that labor cost management is a weak link, therefore, it is also important for managers to strengthen the problem strategically, and recognize how these problems are related to the enterprise in different market in order to survive the competition.

Scenario analysis

In this scenario, the Student Branch is has 6 years working in a mid-size company with over 1000 employees and overall corporate 10% OL and 90% DL rates. The corporate is looking for ways to grow new markets without losing customers. The upper management is willing to hear of opportunities to become more efficient to reduce the OL. As part of technology department and are corporate IT experts Student branch are responsible for identifying IT related tools that will support current business efforts of the already established corporation’s infrastructure as well as global system. The goal of corporation’s recurring fiscal goals it to increase the corporate bottom line and become more efficient particularly reducing the overhead percentage. The Student Branch works both under OL and DL due to internal and external requirements.  The upper management needs to grow external based and Branch employee count twice within the first fiscal year.  The Branch on the other hand, needs to reduce the OL percentage which is at 11.5 % to less than 7.5%.  The Student Branch has the goal to build the revenue by 2% DL and each contract with existing or new external customers.

In this scenario, Student Branch has to formulate a well-articulated model because simple model may not work. OL is often driven by reaction to service failure and without knowing, OL could be more all the time, even then there is no need for it. Simple model cannot work because the corporate wants to grow to new markets without losing existing customers. The upper management has an established IT infrastructure but they want more opportunities to become more efficient and this means reducing the OL but also growing an external base. At the same time the Student Branch need to reduce their OL rates and Branch employee twice within the fiscal year. All these efforts need not just a strategic and technical decision, which involves managing the internal and external IT projects, and providing expertise and support.

A surprising amount of cost is associated with OL, and the key goal of the manager to meet the defined goals is to look whether the organization has IT tools to determine the OL he is she needs.  Without the tool, then there are chances that there are more OL than required. Maybe the Student current OL rate of 11.5% is more than anticipated because they seems to do more internal corporate support.   Having more internal support as a DL is helpful, but it is an inexpensive approach for upper management. The overall goal of the upper management is to reduce OL percentage and increase DL rates. DL is straightforward and will not be controlled; therefore, increasing DL may not achieve their revenue goal within the fiscal year. If DL support team working internal could be reduced, and allowed to work OL tasks, DL revenue may reduce and OL increases.  To meet the goals of the upper management, the manager will need to hire several inexpensive OL who will work on external tasks, thus freeing more expensive work of the DL, which will allow it to meet the DL revenue goals.

Student Branch current OL rate of 11.5% and needs to be reduced to 7.5%.  The Branch needs OL in every line hour it operates, but if the line is not working, then there is no need of having more body count as OL. Reducing OL to 7.5 % seems ideal, however, having inexpensive OL at a reduced manner means that the OL tasks may not be carried effectively and this will reduce the enthusiasm of the DL labor as stated by to XIAO (2015). Failure to perform OL tasks when it’s needed the most, the DL will not actively do their job and this ultimately means that the corporate recurring fiscal goals to increase the corporate bottom line and becoming more efficient will not be achieved.

To reduce OL, the Branch can use different IT infrastructure to ensure that the extra internal effort to the corporate is still function but without need much DL support.  It is said that managing IT infrastructure especially through outsourcing can significantly decrease cost to as much as 80% (Henry & Lucas, 2009).  In the past, IT infrastructure involved asset-based transformation.  Nonetheless with emergence of SaaS and cloud computing, as well as utility computing model, the Student Branch can offload their IT asses without having to be directly involved in internal support.

Making a decision between these IT infrastructures is not to be taken lightly. A manager will have to integrate short term business objective to these infrastructure, because technology often changes with time. It is also important that the manager understand the technology and infrastructure full potential, otherwise, failure to understand the infrastructure could to increase of OL and wastage of resources.  For instance, if the company decides to use cloud technology, it is important to realize the advantage and build infrastructure and server strategies that will alight with the defined goals.  Understanding and efficiently utilizing IT knowledge is vital to manager’s defined goal. Henry and Lucas (2009), defines this knowledge of integrating IT elements in organization culture and organization IT infrastructure along with organization of store of people and collective experiences.  A manager will need to use IT to plan, to control costs and labor, organize resources, control processes, and lead employees to achieve organization goal.

Managers Strategic Plan

In concept, OL and DL rates analysis is not complicated. The manager will only need to determine the performance criteria of the workers and then devise a method to have better OL rates and DL, while at the same time meet overall organization goals. Using this approach, the manager can easily analyze activities that make up overhead, and therefore identify area where cuts can be made without affecting other areas.  Cutting overhead labor does not demand wrenching decision, the only thing the manager will need to understand is how to integrate IT infrastructure implemented (King, 2012).

An alignment between IT strategy and corporate is crucial for two reason. First, proper incorporation of IT into a strategic plan allows having sufficient capital as well as human resource to fund an IT program and second, a carefully planned IT initiative can contribute to the successful execution of defined corporate strategy.  So, the first question the manager will need to ask him or herself is, will this IT infrastructure help this organization achieve our corporate strategic goal.  The figure 1, below is an IT contribution model to the success of the corporate strategic goal.  The figure includes the critical inputs and process an organization will need to lead a successful IT output in the provided scenario (both internal and external).

Figure 1: IT Contribution Model

INPUT

PROCESSES

OUTPUT

OUTCOME

External Environment

IT strategy

Overhead Labor

Direct Labor

Value capture

Increased DL revenue

Corporate Revenue

Manager’s Leadership

Corporate strategy

Resources

In this model, the IT success depends on various inputs, which includes the resources, the corporate strategy and external environment. All these affect the formulation and implementation of an IT strategy.  Leadership, present IT structure, and IT processes also have an impact on different IT output classified as internal input and this is where OL reduction and DL rates falls into. In order for an IT initiative to work, the manager must consider these elements. The most important thing is to decide which element will be the most influential driver of IT success. In others words, if the manager strategic plan to improve the corporate bottom line aligns with the IT strategy, then there is a potential of having increased productivity and reduces labor costs.

In this case, the manager may need to consider shifting expensive support staffs working in corporate internal tasks and turn them into OL. Involving inexperience OL support staffs means that OL work would be inefficient, therefore, the manager would have to include an IT infrastructure that can ensure the corporate revenue goals are realized.  For instance, having an SaaS system or cloud computing means that corporate tasks directly linked to production can be outsourced and this reduced OD and giving a space to have less inexperienced OL, without losing the customers, production and revenue.  Increasing DL twice may be an inexpensive approach although may help reach the defined fiscal revenue goal.

Manager’s Tactical Plan

 It is important for the manager to evaluate the external environment, corporate resources, structures, strategies and system in order to determine whether an IT infrastructure put in place fit well with the established infrastructure and predict the likelihood of success.  People and financial capital are the most critical resources that the manager will need to consider.  In this case, hiring new people to increase DL body count, may be ideal and will meet the DL revenue goals, but it is critical for the manager to determine whether an IT infrastructure put in place will fit well the new structure.  In addition, adding inexpensive people,  who will do OL task ultimately means that DL will improved and revenue goals will be met, and OL will be reduced accordingly.

Conclusion

In the provided cases scenario, the Student Branch as a technology department and IT experts must formulate a well-articulated model because simple model may not work. Overhead labor is often driven by reaction to service failure and without knowing, thus it could be more all the time, even then there is no need for it.  Enormous cost is often associated with OL, and without balancing it with the DL rates to achieve the defined goals; the company may not be productive leave alone improving the bottom line. The key goal of the manager in order to meet the defined goals is to look whether the organization has IT tools to determine the OL he is she needs.   It is important to integrate IT in the business decision in order to reduce the OL rates internally and externally, and to improve DL. This involves having an IT infrastructure like SaaS or cloud computing that will reduce OL support termed as DL. Replacing these supports staff with expensive OL support means that DL will increase the DL revenue will be achieved, and at the same rime OL will be reduced.  It is important for both the IT department and managers to ensure that Proper design system is designed and implemented to ensure economic efficiency and ultimately control labor costs.

References

Balakrishnan, R., Labro, E. & Sivaramakrishnan, K (2012). “Product Costs as Decision Aids: An Analysis of Alternative Approaches (Part 2),” Accounting Horizon, vol. 26(1), p.21-41

Balakrishnan, R., Labro, E. & Sivaramakrishnan, K (2012). “Product Costs as Decision Aids: An Analysis of Alternative Approaches (Part 2),” Accounting Horizon, vol. 26(1), p.21-41

Brynjolfsson, E., & Hitt, L. M. (2013). Computing productivity: Firm-level evidence. Review of economics and statistics85(4), 793-808.

Brynjolfsson, E., & Hitt, L. M. (2013). Computing productivity: Firm-level evidence. Review of economics and statistics85(4), 793-808.

Henry C. & Lucas, J. (2009). Information Technology for Management. Switzerland: Jacob Foundation.

Horngren, C., Datar, S. & Foster, G (2012). Cost Accounting- A Managerial Emphasis, Prentice Hall, Upper Saddle River, NJ.

King, W. R. (2012). It Capabilities, Business Processes, and Impact on the Bottom Line. Information Systems Management, 19(2), 85.

Van Helden, G. J., & Huijben, M. (2014). Controlling overhead in public sector organizations. The International Journal of Public Sector Management, 27(6), 475-485. doi:http://dx.doi.org/10.1108/IJPSM-07-2013-0102

XIAO, J. J. (2015). Implementation Plan Design of Labor Cost Management System. In Proceedings of the 5th International Asia Conference on Industrial Engineering and Management Innovation (IEMI2014) (pp. 435-439). Atlantis Press, Paris.

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