How to Calculate Labor Cost Savings?
Use the online tool to calculate financial benefits of people-centric improvement projects with focus on overall process efficiency (OPE). The following video explains how the calculator works, how to determine the impact of labor efficiency improvements on the bottom line.
Creating Value from Labor Efficiency Improvement Projects - Financial Modeling
The financial model works for manual manufacturing, health-care, retail, professional service, business administration, and other labor-intensive functions. Labor efficiency is the product of three factors: human resources availability, performance level, and output quality. Improving manual processes create bottom-line value by either reducing resources (use less) or increasing throughput (make more). Pick your focus:
(A) Cost Savings: produce the same with fewer resources (efficiency focus) or (B) Profit Increase: produce more with the same resources (productivity focus)
What You Need to Know when Using the OPE Calculator
The financial benefit calculator helps managers, engineers, and controllers to quantify improvement potentials, determine the feasibility of a project, and estimate the return on investment (ROI). Please note that these ‘back-of-envelope calculations’ are based on a simplification of reality. The result is illustrative and depends on the completeness and accuracy of the data entered. This cost calculator is for general information purpose only and not intended to provide specific direction or advice. As each situation is unique, there may be conditions that are not factored into the model. Taking into account the limitations, the financial benefit calculations still provide a great starting point to make quality improvement potentials explicit.
Input Data to Calculate Labor Cost Efficiency
- People: enter number of people in scope of the project.
- Salary: enter the median salary of people involved.
- Factor: adjust the burdened labor factor.
- Availability: adjust availability of human resources.
- Performance: adjust average to benchmark speed.
- Quality: adjust first-pass yield or overall quality rate.
- Leverage: adjust value-adding or contribution factor.
- Results: calculate financials for current & future state.
- Benefit: calculate the financial gain = current – future.
Labor Efficiency Cost Model and Formulas
The labor cost model is based on the following formulas to calculate the gap between the current state (with losses) and the ideal state (lossless):
- Efficiency = Availability x Performance x Quality
- Loss = Opportunity = 1 – Efficiency
- A) Cost Savings = Opportunity x People x Salary x Factor
- B) Profit Increase = Cost Savings x Leverage
A benefit is created from (A) reducing labor or (B) increasing throughput.
Labor Performance Data
Labor Improvement Potential
Definitions and Assumptions to Calculate the Benefit of Labor Efficiency Improvements
- Overall Process Efficiency (OPE) for manual operations represents the time a person or a team is generating value relative to the time paid.
- Availability is the percentage of time doing work after downtime (not able to perform work) and idle time (waiting for something of someone).
- Speed represents the average performance relative to established benchmarks, the maximum achievable performance under ideal conditions.
- Quality represents the percentage of work that is complete and accurate (C&A), done right first time (RFT), processed first time through (FTT).
- A) Labor Cost Savings is the labor efficiency loss (1 – OPE) multiplied by burdened labor cost, the salary plus expenses for insurance and benefits.
- B) Labor Profit Increase comes from freed labor hours that have been redeployed, generating incremental profits through leveraged labor cost.
- Example: OPE = 51% means 49% labor hours are not productively used; act: (A) reduce resources ‘use less’ or (B) increase throughput ‘make more’.