May-June 2001

Overtime: The Effect on Cost

Overtime refers to those hours worked beyond eight hours per day or 40 hours per week. In some cases, overtime might be planned into a job. For example, some managers might schedule their better operators to work an extra hour or two each day or might even put them on a schedule where they work six days a week. In other cases, overtime is limited to an occasional extra hour here or a day there. It is only required during unusual, unplanned circumstances. In this section, we’ll discuss some of the pros and cons of overtime.

The cost of overtime includes both fixed and variable costs. Using the fixed and variable costs, we’ll go through an example of how to determine the optimum number of hours that an employee should work (in terms of cost). As you will see in later sections, there are physical, emotional, and psychological aspects of overtime that must also be considered. At this point, however, we’ll address overtime only in terms of economics.

First, let’s make some assumptions as to the cost associated with both fixed and variable costs. Again, keep in mind that this example is based on specific assumptions. Most landfills are unique in terms of wages, benefits, and other labor cost-related items, so you’ll want to adjust this example to fit your site.

Fixed Costs

The fixed costs are not dependent on how many hours an employee works. Instead, fixed costs are incurred as soon as an employee is hired. For example, health insurance is often a fixed cost. In some cases, immediately upon being hired, an employee is covered by health insurance. Thus, the cost of health insurance (say $3,600/yr.) must be spread over the number of hours the employee works per year.

Obviously the types and terms of fixed costs can vary from one employer to another. For our example, however, we’ll assume that the fixed costs include insurance, sick leave, and vacation. These are discussed in the following sections.

Insurance. Insurance costs are assumed to be $3,600/yr., regardless of the employee’s annual income. This is a fixed cost that must be amortized over the number of hours worked each year.

Sick Leave. Sick leave is assumed to be two weeks (80 hours) at a value of $15/hr. In this example, it is a fixed cost of $1,200 amortized over the number of hours worked per year. It is assumed that all new employees are eligible for sick leave, regardless of how many hours they work per year.

Vacation. Like sick leave, vacation is assumed to be two weeks (80 hours) at a value of $15/hr. In this example it is a fixed cost of $1,200 amortized over the number of hours worked per year. Similarly, it is assumed that all new employees are eligible for two weeks of vacation, regardless of how many hours they work per year.

Based solely on the fixed costs, it appears that there is no increase in the cost per week as the number of hours worked per week increases. But as with other optimizations, there is another side to this story that is covered under "variable costs," shown below.

Variable Costs

The other type of employee costs is variable costs. Variable costs depend on how many hours an employee works. In general, the more hours an employee works, the higher the variable costs. For example, wages are a variable cost.

If an employee is paid by the hour, it follows that the more hours worked, the more wages cost. As with the fixed costs, variable costs can vary from site to site, depending on benefits and tax rates. For our example, however, we’ll assume that the variable costs include the following:

Wages. In this example, wages are assumed to be $15/hr. for straight time. Hours worked beyond 40 per week are paid at $22.50/hr., and hours worked beyond 60 per week are paid at $30/hr. As you can see, the cost of wages accelerates as the number of hours worked per week exceeds 40 and overtime pay is required.

Retirement Costs. Retirement costs are directly related to wages. Based on 8% of the wages, retirement costs increase right along with wages as the number of hours worked per week increases.

Employment Taxes. Similar to retirement costs, employee taxes are directly related to wages. Based on 20% of the wages, employee taxes increase right along with wages as the number of hours worked per week increases. Therefore, $15/hr. really costs $18/hr., and overtime at $22.50/hr. really costs $27/hr.

Figure 1 shows the aggregated weekly fixed and variable costs. What is interesting is that while the aggregate costs increase to reflect overtime rates above 40 hours, the relative contribution of fixed costs to the total is less.

Optimum Weekly Hours

Based on the previous sections, the fixed costs are a minimum of approximately $125/week, regardless of how many hours an employee works. Conversely, to have an employee work overtime costs an additional $27/hr. per week. Thus, up to a point, it makes economic sense to have employees work overtime rather than bring in another employee to work one hour. Figure 2 shows the weekly cost of overtime (those hours beyond 40). Note that the break-even point between working the overtime or hiring another person occurs at around 54 hours. Based on this analysis, it is most economical to let an employee work up to 14 hours of overtime per week to meet overtime needs. If the overtime needs exceed 14 hours per week, it is most economical to hire another employee, even if he works only 15 hours per week.

As you can see, hiring another employee to avoid overtime results in a large jump in costs. This is a result of the fixed costs being incurred, even for a minimum of overtime (i.e., one hour). Because the new employee is able to work at the normal wage (i.e., $15/hr., which is really $18/hr.), however, the cost increases slower than the overtime employee who, at 40-plus hours per week, is earning $22.50 or $30/hr. (which is really $27.50 or $36/hr.). Note: This analysis is shown as an example only. You should determine your own break-even point based on site-specific data.

Effect on Productivity

In addition to the economics of overtime, there are other factors that affect productivity. Throughout the day, an individual’s productivity will vary. In general, a person’s productivity will peak during midmorning and again in the early afternoon. The amount of change throughout the day is greater when the work is more strenuous.

Similarly, production will gradually decrease over a period of 10-12 weeks if an employee is asked to work overtime on a continual basis (Figure 3). Based on these data, scheduled overtime might make sense on a short-term basis. Over an extended period of time, however, the productivity of workers who work overtime might actually be less than those working a normal 40-hour week. In summary, it appears that while short periods of occasional overtime make sense in terms of economics and productivity, extended periods of overtime do not.