Should Labor Be Included?

Oct 09, 2015

We are currently working with a client who is in negotiations with a customer regarding the pricing of products. Our client is an automotive-related business and their customer is demanding information concerning their cost structure. This all part of a long-term agreement the customer is attempting to negotiate with our client. The deal is supposed to help set and maintain prices, in addition to an agreement related to cost sharing on future raw material price adjustments.

Clearly, the customer is used to transparent information including their suppliers data presented in a format of material, labor and overhead. In addition, they utilize machine rates for comparative purposes between their suppliers.

As a result, we are having great difficulty segregating labor from the machine rates, as is the case with many suppliers. The increasing impact of technology and automation on the manufacturing processes is causing a decrease in labor as a percent of sales. In this specific case, direct labor is now under 5% of the total manufacturing cost of a typical part for this customer. Thus, we have merely rolled the direct labor in as an indirect cost associated with some part of the machine rate, which includes both fixed and variable costs identified by each machine. The customer wants to compare our client to their other suppliers and use this as a lever to further reduce selling price.

Our clients cost system and its data accumulation process does not view direct labor as an individual component of cost, but rather as an indirect cost associated with operating the machine. Having observed their manufacturing operations, I believe labor has become an indirect cost of running the machine and they are properly accounting for this as part of the machinery.

I believe our only course of action is to attempt to make some reasonable estimate as to what labor is associated with the machine rates and then segregate those machine rates into labor and overhead for the customer’s request. None of the apportionments will be precise, but rather reasonable estimates based on our best knowledge at the time. Has anyone else ever dealt with this before or have any ideas?

Categories: Cost Accounting