Companies define the cost of labor as the sum of all wages paid to employees plus the cost of employee benefits and any payroll taxes paid by a company. The cost of labor for companies is broken into two separate types of costs, direct and indirect.
Direct costs for companies are costs that include wages for the employees physically making a product. Direct costs are calculated by multiplying the total number of hours worked by the wage rate. Indirect costs are all of the costs that are associated with support labor, which includes employees that serve functions other than physically making the product. These include administration, personnel, security and any other costs that are not directly related to production. Overhead costs are also sometimes considered indirect costs, although often overhead costs can be attributed directly to a specific project and then are considered direct costs.
When companies set the price of a good the cost of labor is a major factor take into account since the price charged must be more than the good’s total cost of production. Sometimes when demand for a good falls, companies have to adjust their labor costs accordingly to ensure that the product is still making the company a profit. Common changes to lower the total cost of labor include reducing employees, cutting back on production and diminishing indirect labor costs.