Direct Labor Efficiency Revisited

Direct labor efficiency has been one of management’s primary performance measures as far back as any of us can remember. It’s considered a measure of how efficiently a workforce accomplishes a task compared to the standard in that industry or setting. Organizations use direct labor efficiency to identify weak points in the labor force and determine where they have room for improvement. Calculating direct labor efficiency is fairly simple; divide the standard labor hours by the actual amount of time worked. Figure 1 shows the calculation of one year’s direct labor efficiency at a manufacturer with three manufacturing operations.

Figure 1 – Traditional Direct Labor Efficiency Calculation

The indication here is that the labor force’s overall efficiency is 82.7% with the efficiency by operation ranging from 67.1% when operating at Machine A to 97.7% when operating at Machine C. Obviously, there must be some serious labor performance issues when workers are operating Machine A. But is that true? Is the story as told by direct labor efficiency complete enough to draw such a conclusion. Let’s look a little deeper.

Members of this manufacturer’s labor force operate equipment. They do not add value directly by performing manual tasks. That equipment represents a significant investment for the organization so perhaps it would be informative to measure how well the organization is putting that investment to use. Ideally, an investment would be providing the investor a return twenty-four hours per day, seven days per week, three hundred and sixty-five days per year. That amounts to 8,760 hours annually. Figure 2 shows how the actual usage of the company’s equipment compares to that annual capacity.

Figure 2 – Equipment Utilization Percentage

As can be seen, overall equipment utilization is just slightly more than one-third of the available time. Not a very effective use of the company’s investment. It’s comparable to a bank that only pays interest on its customers’ deposits from midnight Sunday until Tuesday afternoon. I’m sure a depositor wouldn’t be happy with the management of his or her funds if they are only put to use a little over one-third of the time. Investors in our manufacturer shouldn’t be happy with the utilization of their funds either. Perhaps equipment utilization should be a metric regularly monitored as a performance measure; something not measured by the traditional direct labor efficiency calculation.

Measures related to the equipment shouldn’t be limited to its utilization. How effectively it is use while in operation should also be a concern of management. Figure 3 adds a calculation of how efficiently the equipment is used to the equipment utilization measurement by taking the standard number of equipment hours that should have been required to produce the parts produced with the actual equipment hours that were needed.

Figure 3 – Calculation of Equipment Efficiency

As can be seen, equipment efficiency varies considerable among the manufacturer’s three operations. Obviously, Machine A has problems producing the standard number of parts each hour while Machine C can actually perform better than standard. Its issues may, or may not, have anything to do with direct labor’s efficiency, but without such a separate measurement the equipment problems lie buried in the traditional direct labor efficiency calculation.

Now that our manufacturer knows the efficiency of its equipment, it can finally measure the efficiency of its direct labor force while operating that equipment. Figure 4 adds that metric to our manufacturer’s analysis by comparing the standard labor hours that should have been required to operate the equipment for the actual hours it was in operation and arrives at a better measure of direct labor efficiency and a more complete picture of its three manufacturing operations.

Figure 4 – Calculation of Direct Labor Efficiency

Where traditional direct labor efficiency is considered a measure of how efficiently a workforce accomplishes a task compared to a standard it actually represents a combination of issues that are buried in a single metric. Additionally, it does not really measure the effectiveness of the labor force itself. In my five decades working with manufacturers, I’ve found that management’s effectiveness in using its available labor force is a much bigger factor in direct labor efficiency than the work performed by that labor force.

Perhaps its time to revisit the simple metric of direct labor efficiency and uncover additional information that is critical to the effective management of an organization.