Your $25-an-Hour Employee Doesn't Cost $25 an Hour!
Understanding labor burden and the true cost of your workforce.
Let's say you're an emerging landscape contractor, and you've just hired a new employee. He's experienced, dependable, knows his way around equipment, and can get the job done. You're paying him $25 an hour.
Not bad.
Now you're preparing an estimate for a landscape installation, and you figure you'll need him on the job for 40 hours. Simple enough, right?
40 hours × $25 = $1,000.
That's what his labor is going to cost you.
Or is it?
Because that $25-an-hour employee is costing your company considerably more than $25 an hour. And if you're not accounting for those additional costs, you're probably not charging enough for your labor.
Let's talk about why.
The Hourly Wage Is Just the Beginning
When you hire an employee, you agree to pay a certain wage. That's the amount the employee earns for the hours worked. But as the employer, you take on additional financial responsibilities that go along with employing that person.
Depending on your location, business structure, insurance coverage, and benefits, those expenses may include:
Employer Social Security and Medicare taxes
Federal and state unemployment insurance
Workers' compensation insurance
Health insurance or other employee benefits
Paid holidays, vacation, and sick leave
Retirement contributions
Other employment-related expenses
These additional costs are commonly referred to as labor burden. They're part of the cost of employing someone, even though they don't show up in that employee's paycheck. (He certainly won't be thanking you for your unemployment insurance contributions.)
And they belong in your labor calculations.
Let's Do the Math
Suppose your employee earns $25 an hour and is paid for 2,000 hours a year — 40 hours a week for 50 weeks. His annual wages would be:
2,000 hours × $25 = $50,000
Now let's add some illustrative employment expenses.
Annual Employment Expense | Amount |
Base wages | $50,000 |
Employer Social Security and Medicare (7.65%) | $3,825 |
Unemployment insurance | $750 |
Workers' compensation insurance | $3,000 |
Health insurance and other benefits | $3,500 |
Other employment-related costs | $1,425 |
Total annual employment cost | $62,500 |
We've added $12,500 in employment expenses. That's a 25% labor burden.
Keep in mind that these are example figures. Actual payroll taxes, workers' compensation premiums, insurance costs, and benefits vary considerably by company, state, employee classification, and other factors.
But for our example, that $25-an-hour employee actually costs the company:
$62,500 ÷ 2,000 paid hours = $31.25 per paid hour
Already, we're a long way from $25.
And we're not finished.
Not Every Company Works 2,000 Hours a Year
Before we go any further, there's something important to understand about our example. We're using 2,000 annual paid hours simply to make the calculations easier to follow. But landscape contracting isn't the same everywhere.
A contractor in Louisiana may be able to work through much of the year, although heavy rain, extreme heat, and storms can interrupt the schedule. A contractor in Indiana or another northern state may have a much shorter installation season because of winter weather. And some companies operate in regions where seasonal conditions limit outdoor work to seven or eight months a year.
The type of work matters, too. A landscape maintenance company may run on a different schedule than a hardscape installation company. Some businesses keep employees working year-round by shifting into other services. Others employ seasonal crews or go through periods when employees aren't on the payroll.
There is no universal number of annual working hours for landscape contractors.
A company paying an employee for only 1,500 hours a year will have a different annual wage and burden calculation than one paying for 2,000 hours. And if the employee receives paid leave or other compensation during nonworking periods, those costs must also be accounted for.
Use your company's actual or reasonably projected paid hours when calculating annual employment costs. Our 2,000-hour example is simply a starting point.
Paid Hours Aren't Necessarily Billable Hours
Here's where I see a lot of contractors get into trouble. They assume that because an employee is paid for 40 hours in a week, the company can bill customers for 40 hours of productive labor.
That's rarely how things work.
Think about everything that happens during a typical workweek. The crew arrives at the shop. They load tools and materials, fuel the equipment, travel to the jobsite, and unload. Maybe it rains. Maybe a piece of equipment breaks down. Maybe a delivery is late. Maybe the crew has to run back to the shop for something that got left behind — and it's always the one thing you can't do the job without.
All of that takes time, and much of that time is paid. But not all of it is recoverable as direct, billable labor.
Your employees get paid for the hours they work. Your company has to recover those costs through the hours it can actually bill.
That's an important distinction.
How Many Hours Can You Really Bill?
Let's go back to our $25-an-hour employee. We've established that his total annual employment cost is $62,500.
Now suppose that although he's paid for 2,000 hours a year, only 1,600 of those hours are realistically recoverable through project labor charges. That means the company must recover $62,500 through 1,600 billable hours:
$62,500 ÷ 1,600 = $39.06 per billable hour
Look at that. You started with a $25 hourly wage, and the actual cost recovery requirement is now more than $39 per billable hour.
And that's before overhead and profit.
Here's how the number changes depending on the billable hours available:
Annual Billable Hours | Labor Cost per Billable Hour |
2,000 | $31.25 |
1,800 | $34.72 |
1,600 | $39.06 |
1,500 | $41.67 |
1,200 | $52.08 |
Notice something? The employee's wage hasn't changed. The total annual employment cost hasn't changed. But as billable hours go down, the cost that must be recovered through each billable hour goes up.
That's why knowing your actual billable hours is so important.
One caution: this table holds annual employment costs constant to illustrate the effect of changing billable hours. If the number of paid hours also changes, you'll need to recalculate annual wages and burden accordingly.
Not All Nonbillable Time Is Wasted Time
There's another distinction worth understanding. An employee can be doing valuable, necessary work without being directly billable to a particular project.
For example, an employee might spend an hour maintaining equipment, organizing materials, loading a truck, attending safety training, or preparing for the next day's installation. That work may be essential to keeping the company productive, but it doesn't necessarily generate a direct labor charge on a customer's invoice.
Likewise, one contractor may include travel time in a project estimate, while another recovers it through a different pricing method. Neither approach is necessarily wrong. Some contractors include these activities directly in their project estimates; others recover them through their overall labor rates. What matters is that the company accounts for the time and recovers its costs.
The important thing is to recover the cost somewhere, but never twice.
For our example, we're assuming 1,600 hours a year are available to recover the employee's direct labor cost. Your company may have more. Or considerably less.
The important thing is to use a realistic number, not an optimistic one.
Cheaper Labor Isn't Always Less Expensive
Here's something else I'd encourage contractors to think about. When you're hiring, it's easy to focus on the hourly wage.
One applicant wants $20 an hour. Another wants $30 an hour. The first one seems like the obvious bargain, doesn't he?
But let's look at what happens when they perform the same task. Suppose the first employee takes 12 hours to complete a particular installation task, and the second, more experienced employee completes the same task in seven.
Employee | Hourly Wage | Hours Required | Base Labor Cost |
Employee A | $20 | 12 | $240 |
Employee B | $30 | 7 | $210 |
The higher-paid employee actually costs $30 less in base wages to complete the same work. And that's before considering labor burden, equipment utilization, supervision, quality of workmanship, or the possibility of having to come back and correct mistakes.
Of course, experience and higher wages don't automatically guarantee greater productivity. You need to evaluate actual performance. But the point stands.
The cheapest employee isn't necessarily the least expensive employee.
A skilled, dependable employee who works efficiently, produces quality results, and needs less supervision can be a tremendous asset to your company. That's why developing and retaining good employees can be just as important as controlling their wages.
Now Add Overhead
Remember that $39.06 per billable hour? That's the cost recovery rate for the employee's wages and associated employment expenses. It doesn't necessarily include the cost of operating the company.
You still have office expenses, administrative labor, general business insurance, accounting, software, utilities, and other overhead expenses, and those costs must also be recovered through your pricing.
Suppose your company uses an overhead recovery rate of 25% of direct costs. For illustration, let's apply that rate to our employee's direct labor cost.
Labor Cost Calculation | Per Billable Hour |
Fully burdened labor cost recovery | $39.06 |
Overhead recovery (25%) | $9.77 |
Total cost before profit | $48.83 |
Now that $25-an-hour employee represents approximately $48.83 per billable hour in labor and allocated overhead costs.
And we still haven't calculated profit.
One important point: this example applies an overhead recovery percentage to labor for illustration. In an actual estimating system, overhead might be allocated across labor, equipment, materials, or other direct costs. Whatever method you use, don't recover the same overhead expense twice.
And Finally, Profit
Let's assume your company wants to achieve a 15% profit margin on this portion of its work. That doesn't mean simply adding 15% to the cost. A profit margin is calculated as a percentage of the selling price, not the cost.
So we divide our total cost by 0.85:
$48.83 ÷ 0.85 = $57.45 per billable hour
Here's the complete picture:
Labor Pricing Example | Per Billable Hour |
Employee's hourly wage | $25.00 |
Fully burdened labor cost recovery | $39.06 |
Labor plus allocated overhead | $48.83 |
Selling rate at 15% profit margin | $57.45 |
Think about that. You're paying your employee $25 an hour, but under these assumptions your company may need to charge approximately $57.45 per billable hour to recover that labor's share of costs and achieve its intended profit margin.
That's more than twice the employee's hourly wage.
And there's nothing unreasonable about that. You're not charging customers $57.45 simply because you want to make more money. You're charging that amount because you understand what it actually costs to provide the service.
Of course, this is an illustrative labor-rate calculation, not a universal billing rate. Your company's actual expenses, overhead allocation, billable hours, and profit goals will determine the appropriate rate.
What Happens When You Get It Wrong?
Let's suppose you're estimating a project that requires 200 billable labor hours. You use the employee's $25 hourly wage as your labor cost and estimate $5,000 for that labor.
But based on our example, the fully burdened cost recovery requirement is actually $39.06 per billable hour.
200 hours × $39.06 = $7,812
That's a difference of $2,812 — and that difference exists before you've recovered any overhead or earned a dollar of profit.
You might finish the project believing you've made money. But some of the expenses associated with performing that work were never properly included in your estimate.
Repeat that mistake across enough projects, and you can find yourself running a very busy company that doesn't generate much profit. Or worse, one that loses money despite having plenty of work.
Calculate Your Own Labor Cost
Here's a simple calculation you can use to determine your company's direct labor cost recovery rate.
Step 1: Calculate annual wages. Hourly wage × annual paid hours = annual wages.
Step 2: Calculate labor burden. Add applicable employer payroll taxes, workers' compensation insurance, unemployment insurance, benefits, and other employment-related expenses.
Step 3: Determine annual employment cost. Annual wages + labor burden = total annual employment cost.
Step 4: Determine realistic billable hours. Use your actual records or reasonable projections to estimate the number of hours available for direct labor cost recovery.
Step 5: Calculate your hourly cost recovery rate.
(Annual Wages + Labor Burden) ÷ Annual Billable Hours = Direct Labor Cost per Billable Hour
Using our example:
($50,000 + $12,500) ÷ 1,600 = $39.06 per billable hour
That's your starting point. From there, recover the appropriate share of overhead and add sufficient profit to establish your selling rate.
And if you have multiple employees with different wages, benefits, responsibilities, or productivity levels, you'll need to account for those differences when developing individual or blended crew labor rates.
The Bottom Line
Your employees are one of your company's most important resources. They deserve fair compensation, proper training, safe working conditions, and opportunities to grow. But you also need to understand what employing them actually costs your business.
There's an old saying that you can't manage what you don't measure. I think that's particularly true when it comes to labor.
If you don't understand your labor costs, you can't accurately estimate your projects. And if you can't accurately estimate your projects, you can't reliably predict your profit.
It's really that simple.
So the next time you're preparing an estimate and you enter $25 an hour for an employee, ask yourself a question:
Does that number represent what I'm paying my employee, or what that employee actually costs my business?
Because those are two very different numbers. And understanding the difference can make all the difference in building a profitable landscape company.
~Eric
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