Tracking the Wrong Thing

By Peter DeHaan

October/November 2009

I’m a numbers guy.  I like to look at statistics and track data trends.  I enjoy making spreadsheets, calculating ratios, and viewing time-sequenced facts graphically.  It is great fun – and a waste of time when I’m tracking the wrong thing. 

A case in point is the owner of a mid-sized medical answering service who boasted that his labor cost was down to 28%.  He was seeking affirmation of his results, which he worked hard to achieve for several years.  As gently as I could, I informed him that a labor rate of 28% implied his overhead was 72%.  This would suggest that his answering service had a bloated overhead, needing to be quickly brought under control.  My message was received, but it wasn’t appreciated.

The truth is that when answering service managers focus on labor percentages, they are often looking at the wrong thing for the wrong reason.  Yes, it is correct that unchecked labor costs can quickly escalate, threatening to run out of control.  As such, skyrocketing operator expense is the most likely cause of the fiscal demise of an answering service.  On the other hand, too aggressively reducing labor costs is the most likely cause of the quality demise of an answering service. 

Therefore, a requisite balance is called for between cost and quality.  Should it become out of balance, customer service is often sacrificed on the altar of cost-containment.  For the sake of illustration, let’s fabricate a fictitious, yet nonetheless realistic, typical mid-sized medical answering service (the concepts will be applicable to any call center). 

The Situation: To keep the math easy, we will assume that the answering service has annual expenses of $1 million and spends 50% of its budget on operator labor.  For simplicity’s sake, we will lump everything else into the broad category of overhead.  This assumption is not unjustifiable, as it is an answering service’s labor that directly provides the service, and everything else, albeit important, is ancillary or indirect.  In summary, the answering service’s financial picture looks like this:

Labor:                            $500,000         50%

Overhead:                       $500,000         50%

Total Expenses            $1,000,000       100%

Therefore, we have a $1 million answering service that is spending $500,000 (50%) on labor and $500,000 on overhead.  To ensure profitability, it has been determined that overall costs need to be reduced by 10%.  Now what?

Scenario 1: According to conventional wisdom, you address the biggest cost area, which is operator labor.  Additionally, labor is a variable expense, which means it can be cut relatively easily (fixed expenses are much harder to scale back).  In addition, the effects of labor adjustments will be quickly recognized, whereas reductions in non-labor related expenses take longer to materialize. 

In any operator schedule, there will be some gray areas.  These include the number of operators required at specific times and the length of certain shifts.  Even after eliminating these disputable items, there is still considerable, and painful, cutting to do.  Eventually, the sagacious scheduler will make the required cuts, resulting in the targeted goal of a 10% reduction.  The annualized results look like this:

Labor                             $400,000         44%

Overhead                        $500,000         56%

Total Expenses:              $900,000       100%

The targeted 10% cost reduction has been accomplished, profitability has been restored, and things are good, right?  Not necessarily so.  The cutting was completely realized by attacking operator labor.  Since the overhead remained unchanged, operator labor was actually subjected to a 20% reduction.  This will produce a noticeable drop in customer service levels, both measurably by the answering service and perceptibly by the callers.  An increase in complaints will result, increasing work for supervisors and managers, while further taxing the operators, who are now working even harder.  It is also likely that some clients will cancel, causing income to fall, taking some of the newfound profits with them.  This scenario exemplifies the old saw of “winning the battle, but losing the war.”

To extend this unwise scenario, achieving the preceding and overly ambitious goal of 28% labor cost, operator labor would need to be reduced an additional $205,556!  This would result in:

Labor                             $194,444         28%

Overhead                        $500,000         72%

Total Expenses:              $694,444       100%

Scenario 2: The prudent manager will realize that the answering service’s carefully devised schedule is essentially correct.  The operators (labor expense) are the main factor in determining the quality of service offered and the resulting client satisfaction.  Once the operator schedule has been verified as appropriate, the cost reduction efforts should focus on overhead – that is, those activities that do not directly affect the provision of quality service.

It is noteworthy that while operator labor is highly monitored and closely scrutinized, overhead, or non-operator expenses, receive much less attention and require attention considerably less often.  Therefore, these areas are much more likely to be inflated.  That is not to suggest that cutting overhead will be easy.  It won’t; it will be difficult, especially since these reductions reside much closer to upper management.  Perhaps unneeded fluff has crept in; these can be axed without a detrimental effect on service.  Likewise, some expenses may no longer be necessary, but they have continued unabated.  Other costs, left unchecked, have escalated over time, needing to be trimmed to a reasonable and appropriate level.

Lastly, there is a labor component in the overhead category as well.  This applies to management at all levels and support personnel.  It could be that a certain position is no longer needed but retained because everyone likes the person in that position.  Other jobs became bloated with unnecessary effort or busywork that produces no real benefits.  Bureaucracy and self-preservation activities are also prime targets for elimination.  Finally, there is the possibility that complete departments or management levels might warrant elimination.

These types of cost reductions are not easy to make, and they are often harder to spot.  However, they can be made with the least impact on the callers – the reason that the answering service exists.  Through reducing costs, other than operator labor, the provision of service is not affected.  The annualized numbers now become:

Labor:                            $500,000         56%

Overhead:                       $400,000         44%

Total Expenses:              $900,000       100%

The Other Extreme:  In the first scenario, we looked at reducing the labor percentage.  In cutting labor by $100,000 and then by another $205,000, a resultant 28% labor figure was realized.  There is, however, another way to accomplish this same target.  Quite simply, by holding operator labor constant and increasing overhead by $780,000, a 28% labor figure can also be achieved!

Labor:                            $500,000         28%

Overhead:                    $1,285,714         72%

Total Expenses:           $1,785,714       100%

In conclusion, here are two ways to reach a 28% labor figure: detrimentally slashing labor or obscenely increasing overhead.  However, the wrong target is being tracked for the wrong reason in both cases.  Instead, the intent should be to establish an operator schedule that will produce the proper service level to callers and then shrink overhead to a minimal level.  This will effectively increase the labor percentage, while decreasing the overhead percentage – a right and worthy goal for any answering service to pursue.

To read other articles written by Peter DeHaan, go to Vital Signs or check out his blog at blog.peterdehaan.com.  In addition to publishing AnswerStat and Connections Magazine, Peter offers custom publishing and Internet publishing (Article Weekly).  He may be reached at dehaan@answerstat.com or www.PeterDeHaan.com.