How to Use Benchmarks in Workforce Cost Analysis

Labor costs are often one of the biggest numbers on the P&L Statement. This number is important for finance leaders to manage, which means a lot of analysis for the FP&A team. But when leaders want to understand if their workforce spend is high, low, or about right, it’s time for benchmarks.

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Many finance teams add up salaries, bonuses, and benefits, but they never ask the most important question which is “What does good look like for companies like mine?” With external benchmarks, you’re adding another point of view to your analysis that results in better decision-making.

Table of Contents

• What Is Workforce Cost Analysis?
• Three Types of Benchmarks
• Choosing the Right Peer Group
• From Benchmarks to Analysis
• Interpreting Variances and Outliers
• Wrapping Up

What Is Workforce Cost Analysis

Workforce cost analysis helps you understand the real price of labor inside your company. When you break the cost into clear categories, you can see what drives spend and where change will make the biggest impact. This type of cost analysis usually includes these items:

• Pay (salary, bonuses, and commissions)
• Benefits
• Overtime
• ontractor spend
• Training and support
• HR tools and software
• Extra internal costs such as turnover and absenteeism

The goal is simple. You want to understand what you spend today, why you spend it, and what you can change tomorrow to create an efficient organization. Benchmarks fit into this picture because they show what similar companies spend on their workforce.

Three Types of Benchmarks

Different benchmarks help you evaluate different parts of the workforce. Here are the most relevant types:

1. Functional benchmarks - These benchmarks allow you to compare the size of specific functions based on headcount, such as finance, sales, marketing, or operations.
2. Cost benchmarks - These compare how much of your spend goes into base pay (a.k.a. salaries), variable pay, benefits, and contractors. For standardization purposes, they are often presented as a % of revenue and can also be prepared by function.
3. Compensation benchmarks - This involves comparing the pay of employees in specific roles to people in similar roles at comparator companies. It can also include comparing variable pay and benefits depending on the depth of the analysis being performed.

In short, if the question is about a specific team or department, choose functional benchmarks. If the question is about costs (such as in this case), use cost benchmarks. Then lastly, if the question is about job roles, use compensation benchmarks!

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Choosing the Right Peer Group

The right benchmarking peer group will make or break your workforce cost analysis. An irrelevant or broad peer set may give you answers that look clear, but can be misleading and even harmful. Meanwhile, a highly relevant sample set will give you and everyone else involved insights that can be trusted. The best peer groups often have three traits:

1. They are in the same industry as your company.
2. They are close to your company in size (either based on revenue, headcount, or both).
3. They are in the same region or country (even better).

For example, let's assume that your company is a software company based in the US with 700 employees. The ideal sample set for you will include other software companies headquartered in the US with between 250 and 1,000 employees. We always recommend that you have a sample set of at least five companies (ideally 10 or more). Otherwise the insights won't be meaningful.

From Benchmarks to Analysis

Benchmarks only create value when you use them to enhance your workforce analysis. The goal is to take the outside world and connect it to your own numbers. When teams add benchmarks to their workforce cost analysis, they usually follow these steps:

1. First, gather all of the internal workforce data - This includes headcount, salaries, bonuses, benefits, contractor spend, and so on.
2. Structure the internal data in a format that aligns to benchmarks. For example, this could involve aggregating the salaries by function and then dividing them by the company annual revenue to arrive at the metric: function salary cost as % of revenue.
3. Compare your newly structured internal data to the benchmarks. Look at where you are above, below, or inside the expected range. Spend time to double-check that everything is aligned and then note down the key differences to benchmarks.
4. Build scenarios that show how changes would shift your cost, such as adjusting team size, reducing overtime, or changing the mix of roles to be more in line with benchmarks.

Remember that benchmarks don’t tell you the answer. Every organization is different. Benchmarks help you ask the right questions and allow you to see what could be possible when you change the structure of your teams.

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Interpreting Variances and Outliers

Variances to benchmarks are not necessarily a bad thing. Some are to be expected based on the company strategy. While other differences may point to real issues. The task is to understand which ones matter. Here are questions that help you judge each variance based on the context of your organization:

• Is the difference linked to a known business choice, such as a high touch service model?
• Is the gap caused by temporary projects or short term work?
• Does the gap show up in more than one team or function?
• Does the gap connect to performance issues, such as slow output or low quality?

Outliers can be even more useful. They show where your structure is very different from others. Sometimes that is your advantage, but at other times it can be a warning sign. When you see an outlier, pause and ask what story it tells. If the story is clear and intentional, keep going. If the story is unclear, look deeper and talk to the people responsible such as the department head. It’s the qualitative side that often has the true answer, not the benchmarks themselves.

Wrapping Up

The most important idea to take away is that benchmarks can turn your workforce cost analysis from a simple accounting exercise into a strategic tool. They will help you to see what normal looks like in terms of people spend relative to similar organizations. They help you ask better questions, and help you explain decisions to leaders in a way that makes sense.

Workforce cost analysis without benchmarks is like planning a trip without a map. You may still reach your destination, but you will rely on guesswork. When you add the right peer group and the right types of benchmarks, you see the full picture. What are you waiting for?

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