How to Reduce Labor Costs: 11 Simple Strategies

Labor costs can be a silent killer — if not of your business altogether, then certainly of your profitability and ability to scale. Labor costs have been increasing across industries, with the Bureau of Labor Statistics finding that in 2023, 26 out of 30 of their selected industries experienced a rise. 

Yet according to a survey conducted by Paycor, HR Professionals only spend 15% of their time managing the cost of labor.

This guide will walk you through everything you need to know to reduce labor costs, from understanding what they are and their impacts to 11 proven strategies for managing them.

What are labor costs?

Labor costs are the total amount an employer pays to cover employee wages, benefits, and payroll taxes.

Labor cost is not equivalent to employee salary, and in fact, the annual labor cost of an employee tends to be 1.25 to 1.4 times their salary. This means that if you’re paying an annual salary of $50,000 to an employee, their labor cost may fall within $62,500 to $70,000 range — or even higher.

The difference between direct and indirect labor costs

Labor costs are divided into two categories: direct labor costs and indirect labor costs.

Direct labor costs are immediately tied to the function of your business, such as employee salaries, taxes, and benefits. These costs contribute directly to the creation of a product or service for your business to generate profit.

Indirect labor costs are the costs of services or supplies that contribute to your business’s labor and production but are not directly tied to it, such as your legal advisers, quality control staff, or human resources department.

Another way of looking at it: a business can function through direct labor costs alone, but no business can generate profit with just its indirect labor costs. 

What affects labor costs?

Labor costs are highly variable depending on numerous things in your workplace, including:

Employee wages

The primary factor relating to your employee labor costs is how much you’re paying them. For this reason, some business owners may choose to limit and control wages as tightly as possible to ensure they have better margins. However, this is counterintuitive.

The more your employees are paid, the more likely they are to have improved productivity and efficiency — two factors that will improve your profit margins on goods created and services rendered. 

You’ll want to keep this in mind when determining hourly wages and bonuses for your team members — and when considering tampering with them to lower labor costs.

Training and onboarding

How long does it take for a new employee to get into the full swing of things at your company? Depending on your turnover rates, this can be a critical concern when it comes to labor costs. 

In most scenarios, your employees start receiving payment from the moment they sign an employment contract. This means that any weeks spent training new staff is time they’re being paid for work they’re either not doing or not doing properly.

The idea of compressing the training and onboarding process into a shorter time period may seem like a shrewd move, but it can easily backfire if new employees are not given proper training. 

For example, imagine hiring a new construction worker who isn’t properly briefed on how to operate the specific machinery your team uses. A hasty onboarding process can lead to them causing damage to equipment or setting back progress on the job site, costing you time and money.

Turnover rates

Hand-in-hand with training and onboarding are the overall turnover rates at your company. If your business has a high turnover rate, this can have an interesting effect on your direct labor costs. 

On the one hand, the average annual salary you pay your team members may be less (due to new employees tending to start off with lower salaries). However, these new, lower paid employees are also likely to be working less efficiently as they learn your processes and have less attachment to the business. 

Meanwhile, high-quality talent — the sort of workers that can demand higher starting wages at a new company — tend to have work histories and skill levels that offset their increased salary.

In other words, high turnover rates and the naturally-accompanying lower average employee salaries may not be as beneficial to a business as lower turnover rates and higher employee salaries going to efficient, skilled, and experienced workers.

Sick days

The Fair Labor Standards Act (FLSA) does not require employers to give their employees any time off for holidays, vacations, or sick leave. Only companies subject to the Family and Medical leave Act (FMLA) are required to give employees time off. Even then, this is typically unpaid sick leave.

Yet many business owners offer paid time off anyway. For one, it helps them stay competitive in the job market as they seek out high-performing workers. 

Additionally, paid time off can be helpful in letting an employee rest for various reasons (from taking a mental health day to genuinely needing a break to recover from illness or stress) so that they can come back to work with renewed vigor.

That said, sick days are paid days where employees receive a full day’s worth of wages to not work. These days accumulate, sometimes drastically depending on your paid time off policy, and can in rare situations be abused by employees. 

Balancing your allotment of paid sick leave so that your employees have the freedom to take breaks when necessary to keep up their morale, while ensuring they aren’t taking advantage of your offerings, is an important part of managing labor costs.

Overtime

Of all the factors that can impact labor costs, overtime is regarded as one of the most significant. Overtime is defined as any time an employee is required to work exceeding the standard 8 hours in a workday or 40 hours in a workweek. 

The FLSA requires that any such hours must be compensated at a minimum rate of one and half times an employee’s regular rate of pay. This makes overtime extremely costly for employers.

And yet, for some industries and work scenarios, overtime is unavoidable. Staffing shortages, compressed deadlines, and seasonal fluctuations can all force a business to resort to overtime to continue meeting demand.

Some business owners may be at ease with the idea of paying out overtime from a monetary sense, so long as it allows their operations to continue unimpeded. But it’s important to take into account the invisible impact of overtime hours. 

Frequently working overtime hours has a direct impact on employee morale, often increasing burnout, raising turnover rates, and lowering employee satisfaction. These factors bleed into the productivity of your workers, hurting profit margins.

These are just a few of the most common factors that impact labor costs across industries, but it’s important to note that this is a general overview.

11 strategies for lowering labor costs

Managing your labor costs is the most important step a business owner can take in order to achieve greater profitability. Here are a few shrewd strategies business owners across industries can take advantage of.

1. Identify and analyze your labor costs 

As we said above, the factors we listed as commonly impacted labor costs were just a general overview. Before you take steps to lower your labor costs, you need to properly identify and analyze what is contributing the most to yours: 

• Does your business have high turnover rates? 
• Are new employees slow and efficient due to deficiencies in your onboarding process? 
• How common is overtime in your workplace? Does it vary with the seasons, and if so, which ones, and to what degree?

Every business is unique, and there is no one-size-fits-all approach to optimizing your business’s operations. Make sure you take a logical, analytical approach before adjusting your labor costs. 

2. Encourage greater productivity and engagement on the clock

Increasing employee hours, especially to the point where overtime comes into play, does not necessarily have a direct correlation with improved productivity, efficiency, or quality. 

If anything, the opposite is true, with overworked employees being more likely to make mistakes or let quality fall to the wayside as they struggle to keep up with workloads.

A better way to improve labor costs is to improve the quality of work employees complete while scheduled by working to improve their efficiency and productivity while on the clock. 

Better training, offering incentives such as bonuses, perks, or rewards programs, and keeping the team members accountable for tracking jobs and projects are all ways that you can make employees more effective with the time they’re given.

After implementing strategies that encourage greater engagement, you can even look at reducing the hours employees are scheduled once they show they’re capable of doing higher quality work within fewer hours.

3. Enforce proper attendance

This strategy goes hand-in-hand with encouraging greater productivity since having employees arrive at work on time can get them started on the right foot when it comes to task completion. 

However, employee attendance falls under its own category of management and has a few specific strategies to get a handle on it, including:

• Properly enforce or outright upgrade your time tracking method. Whether you’re using manual paper timesheets, time card readers, or digital time clocks to track employee time, you want to ensure that employees are working when and where they’re meant to. 
• Incentivize proper attendance. Make use of the carrot as well as the stick, encouraging team members to make the most of their attendance in order to be considered for bonuses or other rewards.
• Make sure your attendance policy is updated. These company documents should include information on your expectations for employee attendance, how employees are meant to come to work each day, and what disciplinary actions you may take to correct tardiness and absenteeism.

4. Reduce employee turnover

While new employees tend to be paid lower wages than long-term employees that have earned raises and bonuses over time, the cost of onboarding and training new talent takes a bite out of your labor costs. 

The Society for Human Resource Management estimates that it costs around $7,500-$28,000 in hard costs to find and onboard a new employee due to job board fees, background checks, and training for your new hire. 

Then, when you take into account soft costs such as lost productivity as you get them up to speed, you’re looking at up to 60% of the total cost to hire a new team member.

It is much more cost-efficient long-term to keep employees at your company so long as they’re capable of completing tasks efficiently. 

Long-term employees get a feel for your workforce management style as well as for the unique workflow of your business. They nurture relationships with fellow team members which can help increase productivity. And if you’re a consumer-facing business, their unique touch may even become a critical component of your company’s customer satisfaction. 

The people that make up your workforce are worth investing in.

Strategies to reduce turnover include rewarding high-performing workers, offering growth and nurturing opportunities for team members to improve their skills and rise through the ranks, and approving breaks and paid leave for workers who need a moment to reduce burnout. 

The benefits you offer workers, such as health insurance and retirement fund contributions, can also improve employee retention rates.

5. Be strategic with paid time off (PTO) offerings

While some employers believe that offering less PTO to employees is the best way to ensure they’re more productive, this is actually false. Employees that feel forced to work despite a skewed work-life balance, illness, or issues in their personal lives are only going to complete subpar, inefficient work. 

The longer they push towards burnout, the more the quality of your business’s goods and services suffers.

Instead, you want to manage a balance of being generous with paid leave without allowing absences to lean into excessive absenteeism. 

Consider how you allow PTO to accumulate. Some business owners choose to let it accumulate and carry over as a reward for time spent working, while other business owners allow unlimited PTO and allow employees more freedom. 

Also, check into your team members’ understanding of your PTO policy. Do they know how to request time off? Are those leave requests then approved or denied in a timely manner by you or your human resources administrators? 

6. Introduce automation into the workplace

Sometimes the way to find cost savings is to look at your business from a different angle. Which tasks in your company are essential to be done manually, and which tasks could be aided by automation?

There are plenty of tasks that can be automated in today’s modern age without a degradation in your business’s quality. 

Email responses to customer queries (especially the more common ones) can be automated, project reporting can be automated to allow you and your administrators access to metrics on demand, and automated cloud storage can help prevent any data losses and setbacks for companies that rely on tech usage.

Automation can come into play to save time and money on the administrative side as well. Running payroll becomes a lot less tedious of a task for you or your HR team if you use payroll software with automated features to handle it. 

7. Consider flexible scheduling

There is no law stating that your business has to stick to the standard 9-5 work schedule that’s common across most businesses. 

So long as you ensure that employees are compensated for time worked in excess of 8 hours a day and 40 hours in a workweek, you can implement a different type of schedule for either your entire team or for specific team members, depending on the unique needs of your business.

Doing this can open up your options for talent to hire and tasks to assign them. For example, construction workers that have to work evenings and nights to get around city regulations and hours of traffic, where day traffic would drastically impede the amount of work your workers could complete during normal hours.

8. Cross-train your employees

Cross-training employees is the process of teaching your workers to perform new skills, even if they are related to a job an employee was not initially hired for. This can be a natural part of building up an employee’s skills for professional development, or it can be an employee productivity tool in your favor.

For example, if you manage a gym, you can teach a gym attendant the necessary computer skills required for them to also cover for an employee at the reception desk. Then, after they get the hang of it, you suddenly have two employees you can schedule to work reception if the other is out sick or on vacation leave.

Though cross-training is more common in small businesses where the condensed team size almost makes it necessary, companies of all sizes can take advantage of this strategy to increase the flexibility of their existing workforce to handle tasks, cover for each other, and cooperate better.

That said, be conservative and thoughtful in how you approach this. Eager employees may agree to tasks that are beyond their abilities and hide the fact that they’re overwhelmed, up until the moment when things collapse or they experience burnout and have to take a break — if not outright quit.

9. Consider outsourcing

While attempting to train up your employee’s skills is great, there’s also another alternative you can consider, depending on the structure of your company: outsourcing. This can take the form of handing off tasks to a third-party business or hiring a freelancer to take over assignments on behalf of your in-house team. 

Freelancers are not salaried, full-time employees, which means you can work with them as desired, paying set fees or hourly rates as specified. Bring them on board part-time to handle difficult tasks or to make a temporary workload more manageable (for example, during a busy season or when members of your core workforce are occupied). 

The cost of hiring a freelancer temporarily tends to be much more affordable than onboarding and training a new employee from scratch.  

10. Cut down on overtime

Considering that overtime tends to have the biggest impact on a business’s labor costs, limiting overtime hours is critical. 

Many of the previous labor cost reductions tips will actually have the added benefit of reducing overtime (such as using cross-training to improve labor flexibility and using automation to streamline tasks). Here are a few additional strategies that specifically target overtime:

• Forecast demand levels and labor needs. Either manually track data or make use of tools to help monitor job costs, foot traffic at your business, or any other fluctuating data that will impact how you schedule employees. Then, use this data to predict future labor needs and avoid having to go into overtime due to subpar scheduling.
• Distribute work hours to team members equally and fairly. Are you scheduling one employee too often? Take a look at how you’ve been scheduling your team members and make sure you’re giving everyone appropriate work time as well as break time between shifts.
• Set budget and overtime limits. Overtime can be as simple as team members not realizing how much you’d prefer they didn’t go over set hours. Establishing clear rules when it comes to time and labor expenses may be enough for employees to be more mindful with their time.

11. Use time tracking and scheduling software 

Our last strategy for reducing labor costs is actually one of the most effective methods of achieving every other strategy on this list. 

Through using automatic time-tracking and employee scheduling software, you get access to detailed insights into job costs and project management, can enforce attendance rules, and can use automation in areas such as time tracking, scheduling, and even payroll.

For an example of this in action, look no further than Buddy Punch. Our software comes with numerous features designed to help reduce labor costs.

Overtime alerts

Use email, mobile, or in-app notifications when employees are approaching overtime so you can shift their schedules around and avoid unplanned overtime wages. Set up daily or weekly alerts, and send the alerts to the scheduled employee, managers, or even HR administrators simultaneously.

Punch limiting

Use punch limiting to restrict when your employees can clock in or clock out, eliminating their ability to rack up unscheduled hours. 

Specify how many hours before or after a shift you want employees to be able to clock in, or establish a time range they can clock in regardless of if they’re on the schedule. Cut down on overtime and enforce timeliness in the same stroke. 

Punch rounding

Buddy Punch allows you to decide whether punches will be automatically rounded up, down, or to the nearest predetermined interval of your choosing. You can set this to anything from 2 minutes to 30 minutes. 

This feature helps to enforce grace period rules for clocking in and out, and is also useful if your employees are clocking into a singular device on-site (such as if you set Buddy Punch up as a kiosk).

Notifications

Buddy Punch allows you to set up numerous notifications, alerts, and reminders to improve how your team handles attendance and overtime. 

Set reminders for team members to punch in and out or submit their time cards, send notifications if a shift is about to start or if an employee appears to have forgotten to punch in, send notifications when a team member’s time off request is responded to, and much more. 

There are more features Buddy Punch has that help reduce labor costs, such as GPS tracking and geofencing to ensure that off-site workers are efficient even at remote job sites, drag-and-drop scheduling for easy visualization of shift distribution and fairness, and even a built-in payroll system that streamlines and automates the entire process for business owners.

The importance of lowering your labor costs

Your labor costs are one of the primary factors that determine the overall profitability of your business. As such, getting a handle on them is critical for the longevity and growth of a company of any size.

That said, you never want to go about lowering labor costs without proper consideration of the strategies you’re implementing and how that will impact your employees. 

This is why it’s important to develop an understanding of your workforce before going about reducing labor costs. Time tracking tools like Buddy Punch, with their automatic features and real-time data insights, help greatly with this.

Bottom line: Every business owner and HR administrators should make it their business to understand and actively monitor labor costs.