The changing nature of business (pt 4): Sources of profitability
Oct 18, 2012 7:15:00 AM
Our research shows that in the FTSE-350, labour consumed on average 12.9% of revenue in 2011. In contrast, non-labour costs consumed 68.3% of revenue. The difference between these two percentages suggests that bringing non-labour and third-party costs under greater control represents an opportunity for leaders to make more meaningful improvements to their profits than the traditional focus on labour cost.
The table below highlights that the disparity between labour and non-labour is widening, suggesting that the trend, driven in part by organisations increasingly outsourcing their cost base over recent decades, continues.
Labour cost as a % of revenue
Non-labour cost as a % of revenue
Even modest reductions in non-labour costs could generate significant increases in profitability. Any savings that are made, if captured, go straight to the bottom line. And these are not just one-off savings: they are removed from the cost base permanently (as long as effective management of the cost base continues).
Averaging all sectors over the three year period, our research suggests that just a 1% reduction in non-labour cost produces, on average, a 3.6% increase in EBITDA. The equivalent reduction in labour costs produces, on average, only a 0.8% rise.
Certain sectors present greater opportunities for profit enhancement than others
The below table (click the image to enlarge) breaks down labour and non-labour costs as percentages of revenue for each FTSE 350 sector and the impact on profit of a 1% reduction in both labour and non-labour costs, to illustrate the scale of the opportunity.
As you can see from the table, there are certain sectors that stand to gain the most from a 1% reduction in non-labour costs. These sectors are core economic barometers. For example, the UK's GDP figures for the second quarter of 2012 highlighted a notable impact on the construction industry, with output down more than 5%. Against this backdrop, improving non-labour costs can provide a compelling answer to the question of how companies can protect the value they deliver to shareholders when conditions are challenging.
Ultimately getting non-labour costs under control has a far greater impact on profitability than labor cost reduction. So why aren't senior executives (and shareholder activists) paying more attention to non-labour and third-party costs?