Companies establish a presence in foreign countries for a variety of reasons. Ranking high on the list is the desire to reduce transportation costs, eliminate tariff barriers, access less expensive labor, and locate near target markets, allowing for quick adjustments to changing conditions.

Regardless of the motive, a primary factor in the location decision is often the cost of labor. Surprisingly, however, many executives fail to adequately research indirect labor costs — a common mistake that can significantly impact your cost of doing business abroad.

Hourly Compensation Is Just One of Many Labor Costs

Average hourly compensation costs, which include direct pay and some benefits, only tell part of the story. When calculating the total cost of foreign labor, some not-so-obvious but potentially expensive indirect costs can mean the difference between a profitable venture and a financial loss.

As a result, you should closely examine all labor costs. Even when you’re simply hiring a foreign sales representative, your indirect costs, including potential legal obligations, must be considered.

Most governments dictate the percentage contribution employers must pay on behalf of their employees for benefits resulting from retirement, disability, death, sick leave, maternity leave, work injuries, and unemployment. And these costs can add up — often exceeding your budget.

European Benefits Are Often Steep

The cost of European benefits are generally considered high to U.S. employers. For instance, in the mid-1990s, on an annual basis, French employers contributed 8.2% of payroll per employee for social insurance requirements.

In Germany, this percentage was 9.3%, and ranged as high as 18.6% if the employee’s income was below a specified minimum. In the United Kingdom, this percentage ranged from 3% to 10.2% contingent on income. There’s more.

Sickness and maternity leave are additional expenses that require comprehensive research. Thus, French employers contributed 12.8% of payroll; in Germany this ranged from 4% to 8%. Qualifying conditions and time requirements differed in each country. And that’s not all.

Being unfamiliar with the legislative and regulatory environment governing foreign employment is another common mistake many new employers make.

Termination Regulations Can Be Costly

Outlays associated with mandatory severance can be a major cost. In some countries employers are required to provide a minimum termination notification for employees who have worked a certain period of time. If work stoppage is uncontrollable, this can be a problem. In addition, a lump sum termination payment could be mandatory. The penalty for failure to obey these rules can be stiff.

And the management-labor relationship should also be examined. If preexisting problems existed, a new owner could possibly inherit expensive judgments.

Mexican Labor Laws May Surprise You

Mexico has stringent labor laws on the books that foreign employers do not always anticipate. For example, by law employees:

  1. Are entitled to many national holidays each year;
  2. Working on holidays must be paid twice their hourly wage;
  3. Are entitled to a progressive number of vacation days each year;
  4. Receive a bonus during vacation days equivalent to 25% of their salary; and
  5. Have a right to share a percentage of the profits of each establishment. (These laws may have changed).

Adjust for Productivity Differences

The wage disparity between workers in the United States and workers in developing countries largely reflects the disparity in productivity. Based on per capita output, the average productivity of U.S. workers is substantially higher than that of developing country workers.

As a result, greater levels of productivity resulting from factors such as higher education, state-of-the-art technology, better transportation, communication and overall infrastructure must be weighed against lower labor costs.

Many executives have found that costs associated with low productivity, as well as high absenteeism and problems related to long distance management, greatly exceeded their expectations. And in some cases these unexpected costs forced them to move back to the United States.

Be Sure You Can Find the Necessary Management Skills at a Reasonable Price

Even if a country’s employment laws and related factors are found to be satisfactory, other unforeseen problems can still plague you. For example, if you find that Malaysia’s regulatory environment is not too cumbersome, you still may be unable to find the local managerial skill you need.

Consequently, you may be forced to bring in a U.S. manager or management team — a costly undertaking if unanticipated. You would think it’s not very expensive to provide a U.S. citizen with the same standard of living in a developing country. However, to the surprise of many, it can cost you several times more.

Due Diligence Is Essential

Establishing a presence abroad has its advantages. However, when calculating the cost of doing business, it’s essential to research all indirect labor costs before committing to a particular country. And keep in mind that lower levels of productivity can result in greater costs than anticipated — eliminating a sought after labor cost advantage.

This strategy will not only keep your mistakes to a minimum and save your company a great deal of money, but can pave the way for further global expansion while reducing your risks.

This article appeared in April 1997. (PN)

John Manzella
About The Author John Manzella [Full Bio]
John Manzella, founder of the Manzella Report, is a world-recognized speaker, author of several books, and an international columnist on global business, trade policy, labor, and the latest economic trends. His valuable insight, analysis and strategic direction have been vital to many of the world's largest corporations, associations and universities preparing for the business, economic and political challenges ahead.

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