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  • Duncan McLeod

S&OP and the Financial Plan- Labour is a Fixed Cost

Updated: Nov 17, 2022

For a full, printable PDF version of the article, click here.


The last article in this series dealt with the relationship between fixed and variable cost. Some of the key points from that article were:

  • Contribution Margin” is the difference between revenue and variable cost.

  • The “Contribution Margin” should be managed at the “Family” level of the S&OP plan.

  • Fixed costs do not change within their “Relevant Range

  • The “Relevant Range” is determined by the maximum output capability at a given fixed cost level.

  • Fixed costs are variable at some time in the future. The key is the horizon.

  • Fixed costs should be managed at the “Site” level of the S&OP plan.

  • We can not project profit without combining fixed costs and volume.

Looking back, there was a lot in that article. Looking forward, I am going to look at some of the major cost elements and outline how I fit them into the model. In this article I am going to look at labour cost.


Let’s start with some controversy. Labour is a fixed cost.

My industrial engineering training was based on the premise that direct labour was a variable cost. We focused on calculating and improving the time it took to make a unit and then multiplied that time by the labour rate to calculate the direct labour cost of the unit. The assumption was that this cost varied directly with output and when workers were not making units, they were not getting paid.


A long time ago, this approach may have had merit, and maybe there are some remote examples where it still does but I have not seen one for a long time. Let’s look at why it does not make sense to treat labour as a variable cost:

  • Today’s workforce is more skilled and there is a significant investment required to develop these skills. Most organizations do not want to lose skilled workers when there is a short-term shortage of direct work to be done.

  • Adding new direct employees adds cost before they become productive. This added cost does not fit the variable cost characteristics

  • In most economies there are significant costs associated with laying off or terminating workers.

  • A large portion of the work done in today’s factory is “Indirect”. Equipment maintenance, quality management, material handling, supervision, training, scheduling and planning are all Indirect. The ratio of indirect to direct labour has continued to increase reducing the importance of the pure “Direct” labour content. Many people in today's factory will be doing both direct and indirect work, making it difficult and irrelevant to account for the direct time as the person will be paid either way.

  • Batch sizes are much smaller. As a result, workers work on many different parts through the day. In many cases it just is not practical to track the actual labour by item.

In my experience, the factory head count does not change within a time horizon. This horizon is at least a month, and typically three or more months. Changes in the size of the workforce must be planned well in advance and this should be a function of the S&OP process.


When we look at this headcount, we don’t need to distinguish between direct and indirect labour. The total head count of the site should be considered in this cost pool and the cost pool should be treated as a fixed cost.


Except there is a twist. Overtime is variable and can be added or subtracted with relatively short notice. I have wrestled with the overtime issue for a while now and I believe the best way to deal with it is to treat it as a fixed cost with a very short horizon for change. My reasons include: