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I have had the same conversations with so many executives concerning the tight labor market and rising labor costs. There is good and bad news concerning this subject. The good news is that you can be assured that high labor costs and a tight labor market are not only affecting your company, but also your competition. Everyone is dealing with this same issue. The bad news is that if your company suffers from open positions, lost productivity, and continuously increasing labor costs, the problem is mainly due to your company’s labor practices, not the revolving events happening outside your company. Your company must decide whether they wish to address the labor practices directly and meaningfully to achieve better results or keep playing willful blindness games. I have found, time and again, that the companies with the best labor practices have far fewer open positions, less labor cost as a percentage of sales, and much better profits.

Why are the available labor shortages happening? There are several reasons, but the number one problem is that starting in 2020, 400,000 fewer new workers in the U.S. came into the labor market that year than were leaving. For the next decade, the problem will grow upward toward 900,000 per year with fewer workers coming into the workforce than leaving the U.S. labor market, And the problem as a percentage of the total population is even worse for Canadians.

Other reasons that are causing labor shortages include lower participation rates and the mismatch of college-educated versus non-college-educated job openings. So not only do we have a shrinking labor force, but fewer of the remaining are willing to be employed in the available job openings for various reasons.

A True Story of a Company Seeking Applicants
A general manager, who I’ll call John, recounted to me that he stood outside the unemployment office handing out job applications to people needing a job. His location desperately needed to fill many positions, especially in fabrication. This location and company had been in that area for decades, so it was not an issue of a new company seeking new employees for new job openings. And, his location was one of many locations of a large corporation. Even so, not one unemployed individual would fill out the application and apply for a job opening after talking with him for a few minutes.

John was skilled in management practices and treated his employees with dignity and respect. So, what was causing the labor issues for John? There were four main reasons that not only affected John’s situation but are typical for so many companies.

Problem #1 – Bound by too constraining corporate HR practices
Problem #2 – Not paying market wages for the given labor costs market
Problem #3 – Treating employees as disposable
Problem #4 – Unable to recognize and retain higher-performing employees

Problem #4, the inability to recognize and retain higher-performing employees, is a sure sign of poor company employee practices. Using only statistics within any company, let’s take as an example a company with 120 employees in their manufacturing area that has to hire an average of 10 employees per month. This loss rate means they have a 100% turnover rate per year, which is horrible. Typically, this would be shown as one-third of the employees are with the company for three years or more, one-third for one to three years, and the rest are a constant turnover. Of the 10 new employees being hired, let's assume only one is worthwhile and will be retained as an employee. That would mean the company's turnover would be virtually nonexistent if it could recognize and retain higher-performing new and existing employees in less than a few years. Retention of good employees is paramount for best-performing companies. Companies with high turnover rates typically perform at a 60% or less efficiency overall. The cost is far more than simple wage losses or the continual cost of employee hiring. The severe negative impact of lost productivity and the substantial increase in costly errors clearly negatively impact net profits. Why so many are willfully blind to this is a mystery to me.

Problem #3, treating employees as disposable, is an opportunity wasted. When times are tough, and a company has no other options, laying off employees because of a lack of revenues is perfectly understandable because the company must survive. But when new automation equipment is replacing some positions or other better practices are reducing labor in a given area, why are these employees not offered job openings in departments that are needed for the company? (I've seen this more than I care to mention.) Natural attrition will reduce overall employee counts without the need to lay off employees. Other times, when sales slow because of seasonal demands, most managers lay off employees as the very first thing for operation cost savings. Then, management is surprised when sales pick back up, and they cannot fill the open positions within manufacturing for many months. For most companies, the lost gross margins that would have been earned at full capacity in the spring ramp-up would far exceed the lost labor cost of carrying a good percentage of the laid-off employees. Believe it or not, employees have monthly obligations they also need to meet. Word gets around quickly in the job market when companies have zero loyalty toward their employees. Also, this disposable employee attitude is extremely corrosive to employee morale and any perceived loyalty toward the company.

Problem #2, not paying market wages for the given labor costs market, is by far the biggest reason companies cannot find competent and reliable employees. It is also the biggest reason for the retention of good employees when they can simply find higher wages somewhere else. A good rule of thumb is that an entry position within the manufacturing industry should have a starting wage of at least $2 to $4 above the local fast-food chain. Any production manager can vouch that the best-performing and skilled employees are twice as productive as the new hires. So, what do you think their wages and bonuses should be to keep these high performers? Far too many of you think of only labor costs instead of labor costs compared to total sales produced. Higher-performing employees are worth every extra penny because they garner far more margin dollars per hour than their increased labor costs.

Problem #1, being bound by too constraining corporate HR practices can be very detrimental to a company. Whether your group is one of dozens of locations or just one manufacturing location, the HR practices of the company can be devastating to the company’s goals within your department. Labor markets vary from state to state and even by county. Having a major company, such as an auto manufacturer, next to your location will severely impact that location's ability to find talented help. Having a corporate HR group dictate labor wages across the company's broad spectrum is usually counterproductive. Like the greater labor market, different departments within the company can create labor competition. If one department needs higher wages to fill all the positions, then offer those same positions to anyone in the company at those higher wages instead of trying to keep the wages held at an artificially low wage. Wages should always be defined by the local general manager responsible for that location's P/L, never an HR department or a distant corporate division manager.

A second point I would like to mention that HR and upper management should understand is that far too many underestimate the skills and physical stamina needed in manufacturing areas. Too many have the false impression that you only need to hire warm bodies. This attitude towards the manufacturing area is simply wrong and very counterproductive. Just like paying for higher grade lumber, you must pay more for better talented, reliable, and performing employees.

I have found that companies with the best employee practices, low turnover, and very few unfilled positions have the highest profit percentages of sales among their peers, regardless of their manufacturing automation. I have seen their P/L statements, and they are not even close. On average, it is five to ten points better. Conversely, the companies with poor employee practices have the worst net profits of their peers, and yet again, the numbers are not even close by at least five to ten points below the average.

As stated in my article, Including Meaningful Process Improvement on Your Capital Investment Checklist, “Over the coming decade, the companies that survive and prosper will only be those with strong and healthy HR management practices.” This article should convince your company to take best-in-class HR practices seriously. Automation is not going to be good enough.