Updated: Dec 22, 2021
In 1982 Huey Lewis and the News released a single called Workin’ for a Livin’ and it did pretty well on the popular music charts of the day. In it there is a lyric where Huey sings, “I’m takin’ what they’re givin’ ‘cause I’m workin’ for a livin’...” When Huey was working (i.e., was not yet a pop music star), somebody somewhere was calculating what to give him for the work. They had to base that on the type of work he did, the market for that labor, and how his pay factored into the overall cost of the operation. This article is all about Huey’s employer(s) looking into that last item - the cost of an operation and the question of how to run the operation, given the pay Huey demands.
Ox Road Partners recently completed some work for a client who offers a service in two formats: (1) in-person at their office and (2) via video conferencing app. This client’s operations provide a good lesson for understanding the importance of good cost structure modeling. For the sake of demonstrating the importance of the topic, we’ll translate this client’s experience to that of an imaginary tutoring company (the client was not a tutoring company, but that’s okay).
The company’s general manager has been excited by the growth in tutoring via video conferencing, especially since the COVID-19 pandemic made so many customers hesitant about coming into the office (not to mention time saved in transit). The general manager has brought on new tutors dedicated to remote delivery. Each is paid hourly - the more students they book, the more they get paid. The new hires are supported by the company’s central scheduling and administrative staff and they have all the same training and qualifications as the tutors working in the office, but they don’t incur the cost of the physical office space. The general manager has been so excited by the reduced cost basis for the remote tutors, she has told them, “You can tailor your work to your own desires - as much or as little as suits you,” thinking that basically any work from the remote tutors was pure profit given the fact the remote tutors do not incur the expense of a physical space.
Here’s what the company had to pay to keep the operation going:
The company tracks revenues and profits on a monthly basis. All the tutors get paid $30 per session and the company charges $60 for an in-person session and $50 for a remote session.
The company kept their ten full-time tutors in the office, but added four part-time tutors who delivered via the remote, video conferencing method. The general manager had encouraged these remote employees to work however much suited them. After six months of this dual-mode delivery, the company’s office manager approached the general manager:
Office Manager: “We can’t keep allowing these remote employees to work however much they want. They’re only booking a few sessions per week. They’re losing us money.”
General Manager: “That can’t be true. They’re basically free, so anything they book brings a profit.”
Office Manager: “I’ve crunched some numbers. The fact they’re losing us money is an undeniable truth. Take a look at this plot from my analysis. These remote tutors don’t have the costs of the office, but they do need to cover their training, taxes, processing fees, and software licenses. They’re not free.”
The Office Manager’s plot shows the profit, per session, for each delivery method given the costs attributable to in-office staff and remote staff. The General Manager failed to recognize the fact that remote tutor costs do exist. In fact, because the in-person experience commands a slightly higher fee ($60 versus $50) the in-person delivery method is actually more profitable than the remote delivery method once a tutor is booked sufficiently (20 sessions per week and higher). At lower student volumes, the high cost of the physical space makes the in-person format less profitable...but then again the office space is what allows the tutor to book more time. The General Manager’s principle is correct - remote tutors are a lot cheaper and therefore the business can allow them to continue with far lower numbers of students - but there is a limit to this way of thinking. In fact, the General Manager should require that remote tutors maintain an average of at least 10 or so bookings per week and in-person tutors should maintain at least 20 or so per week to meet minimum profitability.
Business leaders should take a page out of the Office Manager’s playbook. In order to set your strategy and your policies, you need to understand your costs. Huey Lewis is taking what his employer is giving, but that employer had better know whether the business is worth it.