Cost And Effect

Costs By Category

It's no surprise that employee costs are a major burden on small businesses. Al White, owner of a Form You 3 Weight Loss Centers in Tallahassee, Florida, found it so burdensome that last December, she laid off the last of her nine employees. While White is now working harder as a nonemployer, she's getting more out of her business.

Other small-business owners appear to be getting more as well. Of the 28 percent of revenues devoted to employee compensation, 60 percent went to pay executives. This seemingly high proportion is explained by the responding firms' small sizes rather than by excessive pay rates for the executives, experts say. And, along those lines, the percentage of revenues consumed by executive pay was smaller among larger firms, amounting to less than 38 percent of total pay for firms with more than 20 employees.

Employee compensation doesn't have to suck up all your capital. Employers can control costs by using incentives to encourage savings, says Tom Gillis, a management consultant and author of Guts & Borrowed Money (Bard Press). Pay your employees, especially managers, a percentage of savings resulting from any cost-cutting ideas they come up with, Gillis suggests. To be most effective, the amount should equal 5 percent to 20 percent of the employee's base pay, he says.

You can also control employment costs by using temporary workers, who can be brought on to respond to growth and dismissed when not needed. Similar flexible spending approaches can be applied to many other areas such as by outsourcing for professional services and using leased facilities and equipment. These strategies are especially important for controlling costs in a business's early years, says Murray Low, director of the entrepreneurship program at Columbia University in New York City.

Few entrepreneurs are taking this advice to heart, however: Less than 1 percent of sales is spent on outsourced labor, according to the survey. And while most firms outsourced legal and accounting work to professionals, only a minority used outside help for marketing, consulting, credit and collections, and payroll.

Entrepreneurs should also try to use nonfinancial compensation, says Low. That may include anything from simple praise to opportunities for advancement. Knowing your employees well is key. "You have to figure out what is most cost-effective to provide and in what combination," Low says.

Just as larger firms devote smaller percentages of revenues to executive pay, they devote more money to employee benefits. In fact, three out of 10 small companies offered no benefits to employees. The fact that women-owned firms trailed in offering health benefits can probably be explained by the fact that women-owned firms tend to be service companies, which, as a group, offer fewer benefits, according to Karl Egge, an economics professor at Macalester College in St. Paul, Minnesota.

Small-business owners who don't offer benefits may be losing out, however, because of their inability to attract high-quality employees, warns Doescher. "If prospective employees have to choose between a job they like and one with benefits, they'll go with the one that provides benefits," he says.

However, Doescher adds that it's not necessary for small-business owners to attempt to match the benefits provided by large employers. Instead, he says, they should aim to match what other small businesses provide.

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This article was originally published in the January 1998 print edition of Entrepreneur with the headline: Cost And Effect.

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