The cost of labor is the sum of all wages paid to employees, as well as the cost of employee benefits and payroll taxes paid by an employer. The cost of labor is broken into direct and indirect (overhead) costs. Direct costs include wages for the employees that produce a product, including workers on an assembly line, while indirect costs are associated with support labor, such as employees who maintain factory equipment
When a manufacturer sets the sales price of a product, the firm takes into account the costs of labor, material and overhead. The sales price must include the total costs incurred by the firm; if any costs are left out of the sales price calculation, the amount of profit is lower than expected. If demand for a product declines, or if competition forces the business to cut prices, the company must reduce the cost of labor to remain profitable. A business can reduce the number of employees, cut back on production, require higher levels of productivity or reduce other factors in the cost of production.