When the Rate Should Not Be Used
Six questions a labour rate cannot answer, what to use instead for each, and the two lines on the rate card that prevent most misuse.
A labour rate answers one question well: what does an hour of this kind of work cost on average, at normal volumes. Six other questions get asked of it regularly and it answers all six badly.
The calculation in “When the Rate Should Not Be Used” depends on reliable source records as well as a documented accounting rule. For organisations researching employee monitoring data security, open the current product overview can supply consistent time and project context, while the allocation basis and financial interpretation remain decisions for the organisation and its advisers.
Each has a better instrument, and naming them on the rate card prevents most of the damage.
As an outside benchmark for “When the Rate Should Not Be Used”, see OWASP security resources. Keep the source record, calculation rule, approval and resulting decision visible as separate steps.
One: what will this cost us if we do it?
The rate gives the average absorbed cost. The decision needs the marginal cost, or the displaced margin where capacity is tight.
Use: the marginal calculation, with a named approver.
Two: should we outsource this?
The rate includes overhead that will not leave. Compared with a supplier quote it is biased toward buying.
Use: costs that stop against costs that start, which has its own note here.
Three: what should we charge?
The rate is a floor and a check. It contains no information about value or about what anybody will pay.
Use: a price from the market, with the implied margin computed at the rate afterwards.
Four: how many people do we need?
The rate's divisor already removed non-chargeable time. Planning capacity with it double-counts the deduction and produces a plan about twenty per cent short.
Use: attended hours, not chargeable hours.
Five: is this person expensive?
The rate is a group average. Applied to an individual it is wrong by the amount they differ from the group, and the comparison it invites is not one a costing system should support.
Use: nothing. This is not a costing question.
Six: did this job make money?
The rate says what the job absorbed, not what it changed. In a period of under-recovery, every job's absorbed overhead is understated relative to what was actually spent.
Use: the job's contribution — price less the costs that varied with it — alongside the absorbed figure.
Contribution as the second number
Price less direct cost, before overhead. It answers whether the job was worth doing at the margin, while the absorbed figure answers whether it paid its share.
Both, side by side, on every job of any size. Neither alone is enough.
The two lines on the rate card
This rate is an average absorbed cost at normal volumes. It is not a marginal cost and is not valid for make-or-buy, pricing or capacity planning without adjustment.
Two sentences. They do not stop a determined misuse and they stop the accidental ones, which are most of them.
Why people misuse it anyway
Because it is the only number available. A rate exists, is published, and has an air of authority; the alternatives have to be calculated.
The remedy is to publish the alternatives too — marginal cost, attended hours, contribution — so that the right instrument is as easy to reach as the wrong one.
The three numbers worth publishing together
The full absorbed rate. The marginal rate. Attended hours per head.
Three figures on one card. Between them they cover every question in this note, and the card is no harder to produce than the single figure most organisations publish.
The seventh question
What should this person be paid? The rate contains employer costs, absence, equipment and a share of overhead, and bears no relation to anybody's pay expectation.
It appears in pay conversations anyway, because it is the only number with the word "hour" attached to it, and it produces an unrecoverable misunderstanding every time.
Making the alternatives easy to reach
The misuse is a supply problem. Where the marginal rate, attended hours and contribution are all published on the same card as the absorbed rate, people use the right one most of the time.
Where only the absorbed rate exists, they use it for everything, and no amount of caveat changes that.
The question it answers better than anything
Which of our job types absorbs most cost per unit of output. The rate, applied consistently across a year's jobs, answers it well and nothing else does.
That is a real and valuable use, and it is worth saying alongside the six misuses, because a note that only lists failures invites the rate being abandoned rather than used properly.
Keeping the caveats short enough to survive
Six warnings do not fit on a rate card. Two do, and they should be the two that cover the most frequent errors: not marginal, not for capacity planning.
The rest belong in the costing policy, where somebody designing a process will find them, rather than on the card where they would crowd out the figure itself.
What this collection has been about
That a labour rate is built from layers, divided by a chosen denominator, and used for decisions it was not built for. Each of those three is ordinary and each is usually undocumented, and the documentation is a page.