Understanding Labour Costs: Key to Setting Sustainable Service Rates

By Jaye Mankelow
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For many new and established business owners, understanding the true cost of labour is essential for setting sustainable service rates.

Labour costs extend beyond an employee's wage and include entitlements, superannuation, workers' compensation, and even non-productive time, all of which can impact pricing. This is particularly relevant for businesses in service-based and labour-intensive sectors, where pricing can make or break profitability.

Though it's easy to apply for an ABN and start a business, creating a successful, sustainable business requires getting the fundamentals right and this often comes from a commitment to good mentors and advisers. Here's a breakdown of the key factors in understanding labour costs, their impact on service rates, and common pitfalls to avoid.

The Components of Labour Cost

1. Direct Wages: This is the hourly wage paid to employees, but it's only a baseline.
2. Employment Entitlements:
   • Annual Leave (a/l) and Long Service Leave (lsl): Leave entitlements alone can add approximately 8–10% to an employee's cost, with some awards requiring additional redundancy schemes, covering almost any separation type except misconduct.
   • Expected Sick Leave and Training Days: Budgeting for unproductive days, such as training or sick leave, ensures your hourly rate covers costs even on days when employees aren't billable.
3. Superannuation: With contributions rising to 11.5% from 1 July 2024, this compulsory addition is a significant labour cost. For every $1 in wages, another $0.115 is added to cover superannuation.
4. Workers' Compensation: Rates vary widely by industry, with an average around 5%. Higher-risk industries face rates up to 14%, particularly in construction services and trades. Calculating an accurate workers' comp cost per employee ensures the business is protected and pricing reflects the industry's risk level.
5. Non-Productive Time: Not all working hours are billable. Training, meetings, and downtime can reduce billable hours to 75–85% of total time. Non-billable time needs to be factored into rates, as these hours contribute to the overall cost but don't directly generate revenue.
6. Additional Overheads: Payroll taxes, uniforms, and tools contribute to the cost. Some industries have extra compliance or training requirements, such as certifications or protective equipment, that add to employee costs.

Labour-Only Businesses: Covering Overheads

For businesses that are labour-only, such as consultancies, trades, or other professional services, the rate you charge for labour must also cover your business's overhead costs. Without the sale of equipment or inventory to add revenue, these overheads are typically absorbed into the hourly or project rates. For a professional services firm, overheads may add up to 30–50% of total revenue, covering essentials like rent, technology, utilities, insurance, and administrative support.

Common Pitfalls in Labour Costing

1. Overlooking Non-Productive Time: Assuming full productivity can lead to underpricing. Not accounting for meetings, leave, and other non-billable hours reduces profitability.
2. Misunderstanding Entitlement Costs: Many business owners forget to include leave and redundancy accruals. Unaccounted-for entitlements can eat into profits when leave is taken or employees separate.
3. Setting Rates Based on Competitors: Competitor pricing doesn't reflect your unique costs. Relying on competitors' rates without assessing your own overheads risks underpricing and compromised profits.
4. Failing to Update for Legislative Changes: Superannuation and leave requirements change regularly. Failing to keep up with legal changes can lead to outdated rates that no longer cover all costs.
5. Neglecting Training and Compliance Costs: Some industries require certifications and ongoing training, adding to the cost of labour. Ignoring these costs in pricing results in under-recovered expenses over time.

The Importance of Sound Foundations in Business

While starting a business can be as simple as applying for an ABN, building a successful one requires careful planning and attention to detail. Setting accurate labour rates that cover all costs is crucial to long-term viability. Businesses that excel in this area typically have a solid foundation of support, often achieved through investment in experienced mentors and professional advisers.

Success rarely happens by accident. Understanding and incorporating labour costs into service rates is key to sustainable business growth, protecting your margins, and ensuring profitability.

Aspira works with clients to understand the full scope of their labour costs, helping to set service rates that support business sustainability and growth. Setting rates based on actual costs, not estimates, ensures businesses are protected, competitive, and profitable.

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