The Right Stuff (December 01, 2003)

Last week I stopped by Libre Engineering, one of my larger clients, to review the company’s financial statements. When I entered the boardroom, Ken Brinkley, the company’s chief executive officer, was grinning.

“You look happy,” I said.

“Revenues are up. We figured this would be a good year, but our expectations were exceeded.”

“How did you feel about profits I asked. “I see there was a decline this year, compared to last.”

“Well, we grossed $12 million with a profit of $900,000. That’s a record sales figure.”

“What about the profit percentage? It went down to 7.5%. That’s a substantial fall from last year’s number.”

“It’s not something I like to see,” Ken said, “but I don’t think the board will be disappointed with these figures. The growth in our top line is very gratifying.”

“I wonder if you’ve given much thought to the origins of the profit problem.”

“Hank, I don’t think there is a problem. We had some cost increases as a result of expansion. Over the year we hired eight engineers and two additional support staff. We needed those hands to deliver on our contracts, and you know it takes some time for new people to become really productive.”

“Something still worries me,” I said. “Last year you had 75 employees, and your average revenue per employee was about $153,000. Your average cost per employee was about $85,000.”

“That seems a little low,” Ken said.

“I took your people costs and divided by the number of your staff. Your employee costs were just under $6.4 million — that includes professionals and administrative staff, and even a couple of interns. Maybe that’s why the salary figure seems low to you.”

“That must be it. Our average engineer earns $90,000 plus.”

“From my analysis, looking at your revenue increase of $500,000, I thought your labour costs should rise by the cost of three or maybe four employees.”

“How do you figure that?”

“Your revenue per employee was about $150,000. Three employees should generate revenues of $450,000. Four should generate $600,000.”

“On average, Hank that might be right. But we’re dealing with incremental costs and benefits. Averages may not apply.”

“O.K. Ken, but hear me out. At $85,000 per employee your costs should have risen from about $250,000 to $340,000, say $300,000. Instead they rose by $730,000. That’s a big discrepancy. It’s about 2 1/2 times what I would have expected, and if my guess is accurate, you have a profit leakage of about $400,000.”

“That’s a nearly half our profits this year!”

“Exactly. So I wonder, have you hired people who haven’t met expectations?”

“I meet with our team leaders every two weeks, and one of the things we talk about is staffing needs and performance. Nobody’s been waving a red flag at me.”

“Probably no-one wants to say their team is underperforming,” I suggested.

“Sure, but there also may be a financial reason. The more people a senior manager has reporting to him, the larger the manager’s salary and bonus. The problem may be that some managers aren’t motivated to do a better job as long as their performance looks good enough.”

“It could be that your people don’t have the skills to choose candidates and develop employees,” I replied. “Hiring the wrong people tends to make processes less efficient. Each person mistakenly hired is terribly expensive, and since many costs are hidden it’s difficult to develop an accurate number for the damage.

Also, your training costs and office expenses have risen. People who were efficient on their own have been pulled off projects to mentor the newcomers.

“I think you have to establish a careful process,” I continued. “You need to understand why your top performers are your top performers and why your poor performers are your poor performers. You may be surprised with the information that you discover. Doing an assessment of their fitness for the job before you begin interviewing will save a lot of money, and will protect you from spending time with the wrong candidates. The problem isn’t difficult or expensive to fix, but it’s horribly expensive to leave alone.”

Hank Bulmash, MBA, CA is a principal of Bulmash Cullemore, chartered accountants of Toronto. Contact him at e-mail: hbulmash@bulmashcullemore.com. Readers can obtain a free newsletter dealing with hiring issues through www.HiringSmart.ca