Things to Know about Labor Costs

by Mark Henricks

Whenever proposals to increase the legal minimum wage are being debated, it behooves business owners to understand the potential impact that a higher minimum wage would have on their businesses. The first thing to understand is the different types of labor costs.

Different Kinds of Labor Costs

Labor costs are commonly divided into four types: variable, fixed, direct and indirect. Variable labor costs can change depending on production levels. Hourly employees are usually variable costs. Employers can hire more hourly employees if needed, which will increase variable labor costs.

Fixed labor costs are costs that don't change when production levels change. Managers and supervisors are examples of fixed labor costs. These workers are normally paid salaries that don't change based on the number of hours they work.

Direct labor costs represent the cost of the labor spent on a particular product or service. For example, wages paid to a software developer for work on a new application are considered direct costs. Indirect labor costs can't be traced to a specific product. The salary earned by a bookkeeper is an example of a cost that isn't tied to any particular offering.

The Impact of Minimum Wage

Minimum wage increases most directly affect the lowest-paid workers. These workers usually represent direct and variable labor costs. For businesses that employ lots of low-paid workers, it's natural to expect direct and variable labor costs to rise following minimum wage hikes. And one of the arguments against raising the minimum wage is that, due to higher labor costs, businesses will reduce their workforces and increase unemployment.

However, research studies of the effects of minimum wage increases suggest[1] that, while higher minimum wages do increase the earnings of employees, they don't necessarily increase a business's overall costs very much, or cause employment to decrease. The most likely reason for this finding is that when businesses pay higher wages, employee turnover declines. This reduces the costs of recruiting, hiring and training new workers, and promotes increased productivity.

What Can Businesses Do?

Businesses affected by minimum wage increases can use several methods to accommodate the legal requirements to pay workers more. These include reducing hours worked and reducing benefits. Some may cut costs by reducing training, while others may seek to boost productivity by investing in more training.

Businesses may also raise prices in order to help pay for the wage increases. Normally, this could restrict the markets for their products. However, one effect of increased wages is increased consumer spending, as workers have more money for food, rent, transportation, clothing, and luxuries. Rather than burdening local economies, raising the minimum wage and paying workers more can increase the revenues and profits of local businesses.

The federal minimum wage has been raised[2] 22 times since it was first instituted in 1938, or about once every three years. Prior to 2016, it had not been raised since 2009 and, in inflation-adjusted dollars, the 2015 minimum wage of $7.25 was lower than it was in 1956. As of January 2016, there were 29 states plus the District of Columbia with a higher minimum wage than the federal minimum wage of $7.25.

Business owners need to be prepared to deal with an increase in minimum wage, as well as the possible effect on their labor costs and employment policies and practices when it comes.

About This Author

Mark Henricks

Mark Henricks is a freelance journalist covering business, entrepreneurship, technology, personal finance, health and fitness  for leading publications.


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