How to Operationalize and Manage Labor-Based Contract

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Let’s say you’re a procurement professional working to manage spend for labor contracts. You’ve broken down the hours, and you even understand the allocation of cost. You’ve done your homework to make sure money isn’t being hidden. Everything looks good, so you get a contract in place. The problem is—even if you’ve done it all on the front end—managing a labor-based contract at a site-based level is a significant nuisance.

If it’s a time and material-based contract, the number of hours being lost—because it isn’t being managed effectively—can be significant. It’s shocking to me how many companies just let it go or, even worse, are unaware of it. From what Matt Smith and Rich Ham have seen, 25–40% of businesses mismanage labor categories.

How to operationalize and manage a labor-based contract

When you have a gap between the contract and the actual billings and want to operationalize and manage that contract, what do you do? Rich notes that you have to have control over the data and the time-management component. From there, you have to break down each employee’s hours further. You need access to the payroll system to assess overtime, holidays, meal and break hours, etc. Because of this, you need a system that can handle that line-by-line detail. Rich points out that most companies have time and labor management systems; they’ve just never been asked to properly use them.

You want to drive an expense to optimal and keep it there. Very little time is spent on the continuous management of expenses. Yet so much time is spent on reportable saving initiatives that may not come to fruition. Suppliers have learned that they can give it all away in the contract and make it back in the execution!

Separating the labor hour from the operation of the labor hour

Another issue? People don’t separate the labor hour from the operation of the labor hour. Let’s just say that there’s going to be inflation on the dollar-per-hour that you’d pay someone. As long as you’re comfortable with the amount within the buckets, you can make that statement. But the operation of the labor hour in the field is where the spend is lost. If you spend $1 million on labor, there could be upwards of 25% savings if you just looked at the operation of that labor hour on a day-to-day basis.

There’s so much focus on the price and labor rate, but what about the things you’re multiplying that number by? Like overtime or pay and a half? Or markup percentage? The multiplier effects matter. There are instances where the price is an issue, but it’s the management of the multiplier effects that is really where the money is being spent.

This is why it’s so important to include a vendor audit clause in this type of contract. If you don’t have the operational capabilities to carry out the management, the audit can save you. I ran a vendor audit team on labor categories to assess the money that was actually spent. The amount of money we clawed back after the fact was insane. There’s no way we could’ve done that without audit clauses in labor contracts. It’s essential.

What can procurement teams do to be proactive?

As important as it is to audit your vendors when you find you’ve been overcharged, you’ll never recover 100% of those dollars. Rich and Matt advise procurement teams to conduct deep-dive audits from time to time. But what’s really important? To keep dollars from flying out the door in the first place. You must put solutions in place that promote continuous dedicated and vigilant management of expenses that tie procurement effort to true P&L performance. That is the key.

It’s complex, but there are a host of solutions out there. You have to find ways to multiply your efforts. Put tools in place that help you enforce those agreements. Learn more about labor-based contracts by listening to episode #233 of the Negotiations Ninja podcast!