Regulation: Understanding the cost impact to your business

Regulation by the federal government of our manufacturing businesses is an insidious problem. No one argues the need for reasonable environmental and worker protections, but unquestionably, regulatory costs are significant and they are inhibiting the relative health and growth of industry companies.

Federal regulatory costs include not only environmental and worker protection, they also include tax compliance, licensing and permitting, the health insurance mandate, energy, transportation (freight), financial and regulatory consultants and advisors. These costs are direct, but they are also indirect since all our suppliers incur similar costs, which they in-turn, pass on to their customers. These costs, while hidden from our view, are nonetheless real, proportional and pile on non-value-added costs.

For this reason, it is difficult to measure precisely the impact to our cost-of-goods or to the bottom line. Nonetheless, the costs are real and they inhibit our competitive capability especially against products coming from countries where regulation is less burdensome.

That said, while the average cost per company can be easily calculated, the degree to which businesses are negatively impacted is an aspect of their business understood by few owners and leaders. Consider this: according to data from the Small Business Administration, an agency of the U.S. government, in 2012 every manufacturer in the U.S. with fewer than fifty employees spent $34,671 per employee. Yes, per employee!

**Occupational Health and Safety, Homeland Security
Sources: National Association of Manufacturers, Small Business Administration
Small wood industry manufacturers hard hit

If your company has fewer than fifty employees the impact is indeed severe. Consider for a moment that in 2012, small wood products manufacturers (<20 employees) employed 62,931 workers. That means small wood industry firms spent on average, about $2.2 billion or $166,989.

That year, there were 13066 wood products producers with fewer than 20 employees that employ 62,931 workers, so the average company size for those firms is about 5. For companies with 5 employees, $173,355 was spent on direct and indirect regulatory costs in 2012!

Of greater concern than the regulatory cost per company is the fact that payroll per employee for the group having fewer than 20 employees averaged $32,930 for the same year. So the cost of regulation per employee was actually higher than the cost of the employee. On an hourly basis, the cost of regulation is higher than the average hourly payroll cost: $16.69 compared to $15.83. In other words, we spend more on regulation than we do on employee compensation!

Revenue impact:

If the numbers from the SBA are indeed accurate, and admittedly there is some disagreement among economists about the calculations, but if we consider the total regulatory costs (what we pay plus what our raw material and service suppliers pay) the numbers are interesting and offer some insights to why we struggle to compete with offshore producers.

In 2012 U.S. wood industry companies with fewer than 20 employees posted receipts of $7.5 billion. The aggregate regulatory costs of $2.2 billion then amount to 28.9% of revenue. The hidden costs of regulation that are added by each contributor to the value stream artificially inflate our costs as well as the market price of the products we produce.

Furthermore, we take these hidden costs and margin them, forcing our customers and end-users to pay for the disproportionate cost of regulation, a cost that adds little or no value to the product, its quality or experience in their eyes. No wonder we lose the competitive battle when products of perceived equivalent value are available to our customers. They are simply unwilling to pay for waste. Much of the cost of regulation ultimately is complete waste because the value of regulation is not apparent to customers.

So now what?

There is little to be done about regulation in the immediate term. Unless and until our leadership in Washington understands that it is not greedy CEO’s taking jobs offshore, but reckless regulators driving up cost through regulation while driving down price competitiveness, the problem will not abate.

Educating your employees, your vendors and advisors about impact of the cost of regulation, will help you build awareness of the real challenges at work invisibly against the health and growth of the business.

With no meaningful relief in sight, manufacturer’s must sharpen their focus on reducing costs: bring down expenditures on raw materials, driving productivity in the front office and the shop floor, increasing revenue and managing gross margins and net income aggressively.

Spend time reviewing your costs and make certain you have a clear and accurate understanding of your total and actual costs. Surprisingly many owners and leaders do not. Make sure your gross margins and net operating income are sufficient to contribute to the growth of the business.

Review your pricing regularly. Look for opportunities to capitalize on moving prices upward strategically. A small price increase pays better dividends than an equivalent reduction in the cost of your raw materials.

Finally, there is significant opportunity to improve the financial health of all manufacturing companies including those in the wood industry of we can reduce the cost of regulation in a meaningful way. A meaningful reduction impact would affect the entire supply change and improve the competitive fitness for all.

Amid the discussion about reducing the federal income tax rate we should be wary not to believe this will have much impact since it falls short in two ways: first, it only effects the taxes corporations pay on their earned profits so only corporations making profits benefit. Secondly, a lower tax rate will only reduce the amount corporation will pay in taxes, but will not positively impact a companies’ cost-of-goods, which would improve its competitiveness as well as its profitability.

It seems inherently wrong, but also very dangerous that the direct and indirect regulatory expenses per employee should be equal to or greater than the annual wages we pay the employees that actually produce value and wealth in our manufacturing companies. This needs to change quickly if we truly wish to reverse the trend in manufacturing in America.

If you need help improving the performance of your business, I can be reached at 608.270.8089 or dshultz@jemoran.com.