How to Use LER to Measure Productivity Return on Digital Investment
How to use LER to measure productivity return on digital investment.
In recent years, investing in digital technologies has become increasingly ubiquitous in the business world. According to a report published by the Australian Computer Society (ACS), businesses have been increasing their investment in technology by 7% since COVID, driven by digital transformation projects, cybersecurity, data analytics and artificial intelligence.
Despite the increase in digital initiatives, measuring the impact of these investments on productivity and profitability can be challenging. Working with CEOs and Leadership teams, often I hear the question:
“Are our people more productive after our digital transformation?”
This is where Direct Labour Efficiency Ratio can help.
The concept of Labour Efficiency Ratio (LER) was popularised by Greg Crabtree in his book “Simple Numbers, Straight Talk, Big Profits!: 4 Keys to Unlock Your Business Potential.”. Crabtree presents LER as a measure to determine the margin return for each dollar invested in labour.
Let’s see a P&L example of a service delivery company, ACME.
From our example, we can identify two measures, Direct LER (dLER) and Management LER (mLER). We’ll consider Direct Labour Costs where people spend more than 50% of their time directly involved with the delivery of services to clients.
Direct LER (dLER) = Gross Margins / Direct Labour Costs
Admin-Management LER (mLER) = Contribution Margin* / Admin-Mgmt Labor
*Contribution Margin = Gross Margin – Direct Labour Costs
I’m often asked, “What if I’m including Salaries in my COGS?”. If you have salary costs within the cost of goods section of your profit and loss then please consider separating Direct Labour Costs and Admin/Management Labour Costs as separate line items, allowing for a more detailed analysis of labour costs and productivity.
In the ACME P&L example above, the Direct LER tells us that for every dollar we invest in Direct Labour, we generate $2.75 in Gross Margins.
Management decisions can also have a significant impact on the efficiency of labour resources. From our ACME example, we can calculate the effectiveness of their management practices and decisions with the Management LER (mLER). At ACME, for every dollar they invest in Management, they generate value of $3.5 (a.k.a. Contribution Margin).
The value of LER in making data-driven decisions
When we measure LER regularly, we can create a data trend, and observe the impact of our investments on our team’s productivity.
One of our clients, a consulting company in Australia, made a commitment to track and review LER every quarter and identify opportunities to improve productivity. The Figure 1 graph shows the dLER trend from July 2021 to March 2023.
In July 2021 their Direct Labour Efficiency Ratio was 1.3, meaning that for every $1 invested in Direct Labour (their consultants), they were generating $1.3 in Gross Margins. Things were not looking good.
As we mapped and analysed their end-to-end money-making process, we identified different process and digital improvement opportunities we prioritised quarter on quarter. By April 2022 (after three quarters of improving some of their software systems), they noticed a dLER uplift of $1.99 in GM for every $1 invested in their consultants.
Figure 1. Consulting company – Direct Labour Efficiency Ratio from July 2021 to March 2023
After a period of hiring and onboarding people between May 2022 and August 2022, they identified a new system that would replace five independent systems being used at the time. The new system would be implemented module by module, over 8 months (including data migration and training).
Every month the consultants would use the new system, instead of the other five independent systems, finding time-saving and less amount of errors as the main productivity improvements. Measuring dLER every month became a vital habit to measure the productivity return of that big investment. By December 2022, they had noticed a dLER improvement from $1.68 to $2.9 of Gross Margin per $1 invested in consultants.
During their quarterly review and planning workshop in March 2023, and with 4 extra months of system implementation to go, they noticed no further improvements were realised. They are currently assessing whether they should keep investing in the implementation of new modules or they should stop and reallocate their investment to other initiatives with more productivity improvement potential.
With a clear understanding of productivity return, mid-market companies can unlock new opportunities for productivity and profitability in the digital era.
To learn more about how you too can measure productivity return on your digital investments, please contact us.