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Is Labor a Fixed or Variable Cost?

If you talk to your local cost accountant, they will tell you that labor costs (along with materials and supplies) are recorded as variable costs.  In reality, they should be treated as fixed costs.  Why is that?  Because, in the short run, it is not easy to turn this asset into costs that can vary with revenue which is the definition of a variable cost.  It is very difficult to lay off people in a low revenue month and then rehire them in a high revenue month.  If you try to do that, hiring costs, training costs and cost of quality all increase usually to the degree that they more than offset keeping the people through the downturn.

Many companies will try to furlough people or send them home early in an attempt to turn this fixed cost into a variable cost.  While this works in the short run, people will get tired of the lower income and unpredictable work schedule and eventually will look for a new job.  This again raises the cost of hiring, training, etc.

The only true variable labor cost is the use of temps and overtime.  If your company is in a volatile market, it is best to plan for a level of temps and overtime to create a variable environment.

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5 thoughts on “Is Labor a Fixed or Variable Cost?

  1. I find in my experience that by having staff on flexible contracts with minimum hours built in, you get the best of both scenarios. Staff feel safe that they will be able to pay the bills, you get the variable hours when needed through same pay overtime and you have confidence that the staff you have are all fully trained and committed to the company. A fail safe is to work with an agency that provides you with the same group of people every time.

    • That is another innovative approach to staffing. An opportunity related to that is many states have Work Source programs that will supplement payments to those staff to help increase their income on a temporary basis.

      Rick

  2. I am little confused on this section (labor cost) particularly. I have witnessed different perception for the definition of the labor costs. We have seen a lot of cases when firms -not just manufacturing but service industries where labor is the major raw material- were laying off employees, when the demand is low and vice-versa. This pattern basically shows a variation in labor cost with demand (or a direct component of direct costs), and hence is more qualified for Variable cost.
    However, there are some subsections in an industry where cost of labor stays stable -like R&D, Aviation industry (pilots) etc.
    So, is it right to say that the definition of variable cost varies from one industry to another?
    Singh

    • Singh:

      Thanks for your comments and you are correct that management of labor costs varies a bit from industry to industry. However, the best measure of labor productivity is revenue per labor dollar. What a company should look for is improvement. Since in the short run if you do layoffs and then later need to bring in more people, the training costs and quality can suffer. Thus trying to keep labor more variable through consistent use of temporary workers and overtime can help improve productivity in the long run.

      Rick

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