A TCO Approach to Labor: Understanding Billable Wages

By Leviticous “Vic” Cleveland, CPSM

In my line of work managing service agreements for an oil and gas company, it’s vital that my team and I understand the internal and external demand for industrial craft labor. Market analysts have forecasted a steady increase in demand for industrial craft in the Gulf Coast region — where our company is located — through the year 2020. Simply put, demand in the region continues to outpace the available supply of craft laborers. As I am sure we all learned in Economics 101, the net effect of this undersupply is that it drives up the price of labor.

To counter the rising costs, we have undertaken a total cost of ownership (TCO) approach to influence our demand for labor: We are dissecting our existing cost models and deepening our understanding of the associated cost drivers. In addition, we are (1) evaluating our contracting models (time and materials, fixed-fee, lump-sum and the like), (2) revising key performance indicators and (3) engaging suppliers earlier in the planning and scope definition phases of the desired work. We’re also continuing to explore methods to grow the pool of available supply of craft laborers in the area. I’ll be sharing our progress through several installments.

First, let’s look at the basic considerations for understanding and dissecting labor rates: specifically, the components of billable wages for contract labor and how to evaluate them. It is important to understand these components to properly determine whether or not you are overpaying for services.

These are bare wage, markup and billable wages:

Bare wage. The bare wage is defined as the dollar amount per hour paid to a contractor’s employees. Simply stated, this is amount per hour the employee puts in his or her pocket.

Markup. This is the amount per hour, per employee added to the bare wage to cover such items as employment taxes, insurance and fringes. It can be expressed as a percentage, a fixed dollar amount or both.

Billable wage. The billable rate is the combination of the two: bare wage plus markup.

Understanding Billable Wages

To evaluate billable wages, you need to understand the three elements and their details. It is quite common to find contract labor agreements for services based on all-in rates or pay bands, but my preference is to insist on rate transparency.

All-in rate: Similar to the billable wage, some agreements utilize the all-in rate structure.  This is the amount paid to contractor per hour, per employee (bare wage plus markup).  But contrary to the billable wage, the all-in rate does not provide transparency to indicate the amount of the bare wage nor the contractor’s markup.  Those amounts are “all-included” in the rate.

Pay band:  Other agreements utilize a pay band structure to compensate contractors.  This is the agreed-to wage range (band) paid for certain job roles.  Rather than indicate a specific bare wage to be paid per job role, a wage range is established.  The intent is to allow supervisors discretion to attract & retain talent, and reward good performance.

Understanding Markup

Evaluating the markup, however, can be more involved due to the number of factors to consider:

●Payroll taxes: There are two statutory taxes, Social Security and Medicare taxes, which are also known as FICA taxes. This makes up the bulk of payroll taxes you must pay as an employer. Social Security tax rates are 6.2 percent of employee salary/wages, up to a maximum wage of US$128,700 in 2018 ($127,200 in 2017). Regarding the Medicare tax rate, you must pay 1.45 percent of employee salary/wages; unlike Social Security, there is no salary/wage cap.

●Employers are also required to pay unemployment insurance at both the federal and state level for each employee. These are known as either federal unemployment tax (FUTA) or state unemployment tax (SUTA).

●SUTA rates are set by the state for each employer. For example, in Texas, the SUTA rate ranges from .46 percent to 6.46 percent in 2018; it was .59 percent to 8.21 percent in 2017. The wage base is capped at $9,000 for 2017 and 2018.

●FUTA is 0.6 percent (except in California and the U.S. Virgin Islands, where the rate for each is 2.1 percent.) FUTA tax is assessed only on the first $7,000 in wages for each employee, so this would be $42 per employee ($7,000 times 0.006) in all other states.

●Workers’ compensation insurance. In addition to the payroll tax obligations, employers are also required to carry workers’ compensation insurance, which covers employees in case they are injured on the job. Every state except for Texas requires employers to carry workers compensation insurance. In general, workers compensation insurance costs are based on industry — the riskier the job, the higher the rate.

●Fringes and overhead/profit. Unlike taxes and insurances, which are stipulated by federal or state mandates, fringes and overhead/profit are much more fluid. These components are markup driven. Fringes are medical, dental, vacation and retirement benefits.

The next installment will delve into ways to evaluate billable wages, plus recommendations.

Leviticous “Vic” Cleveland, CPSM, is a senior category manager for services contracting at Motiva Enterprises LLC in Houston.