Tracking work efficiency can be the smartest move you make in this inflationary environment, revealing whether your growth is actually generating cash or quietly eroding.
In 2023, I received a call from a $100 million travel agency based in Florida. Out of the pandemic, their revenues rose 40%, up from $100 million to $140 million. Despite the increase, they found themselves “growing.”
Like many scale-ups, they began to throw more expensive people into the matter, even while they were guarding some kind of labor. As inflation became rampant it put even more pressure on wages and charged the company's vacation products faster than it increased prices.
Critical Ratio
To highlight the situation, I suggested that they are important in a critical ratio: the total margin dollars were divided by the total compensation. It includes not only total compensation including benefits and bonuses below the gross profit margin, but also total load compensation. As a baseline, this ratio was calculated from 2019.
By 2023, this ratio had fallen by half! The ever-increasing labor costs were consuming the ever-increasing margin.
They made this ratio a key figure for 2024, began working with one of their coaches and used the cash flow story tool to analyze which levers they would move to improve their cash. The results were dramatic. The company has grown from $140 million to $200 million in revenue, and more importantly, it has brought this important ratio back to its 2019 level. They've returned with a considerable amount of cash generated.
Inflation stays here
Global pricing expert Hermann Simon says he faces an average annual inflation of 5% for the rest of the decade. And many companies are still working on higher transportation costs due to interest rates and ongoing wage pressures. In many cases, salary is the biggest expense. With accumulating modest tariffs, businesses are expected to see rising costs over the years.
This is why this labor efficiency ratio is so important, and I report it at the top of the finances that there are companies that I serve the committee. I encourage all companies to use 2019 as a baseline. It's a golden year for business when we've passed the Great Recession and came before the pandemic.
As far as you go in the right direction, that's not a problem. If not, here are three immediate actions:
1. Focus on pricing strategies. The commercial landscape and maintenance company in St. Louis began considering this ratio several years ago. As a result, they focused on the aggressive escalation clause of the three-year contract that begins in 2023. Despite wage pressure, the labor efficiency ratio has increased from 113 in the first quarter of 2024 to 131 in the first quarter of this year. And they are focusing on increasing this ratio to 165 over the next two years through increased labor productivity.
Don't know where to find efficiency? Check for Dan Heath reset. Six chapters to identify constraints to address, as well as some that fix them in just five days.
2. Fewer people paid more. In many cases, businesses cannot raise prices quickly enough to keep up with inflation. At the same time, when revenues spike, they are often adopted without proper onboarding or structure. It creates inefficiency.
You want to focus on getting less and less of all players. It really helps the denominator of our ratios. You can find someone who is three times more effective and pay twice as much. It's Costco's magic. Costco has now reached $30 per hour, but is the most efficient in generating revenue per dollar of salary in the industry.
3. Don't automate confusion. Use AI to make labor more productive, but learn from Elon Musk's mistakes and don't make the bot too fast. Remove the stupid things, streamline them, and automate them only at the end.
The most important thing you can do is pay attention to the total total margin dollar divided by the total reward. Place your company to start printing cash, like in 2019.
