What is indirect labor cost?

Indirect labor cost is the compensation expense for employees whose time is not directly charged to client projects, including administrative staff, management, and non-billable portions of consultant time. For professional service firms, indirect labor is part of overhead that must be recovered through billing rates on direct labor. Understanding indirect labor enables appropriate overhead allocation and pricing decisions.

Key characteristics

• Compensation not directly charged to clients

• Includes admin, management, and non-billable time

• Part of overhead requiring recovery through pricing

• Should be tracked separately from direct labor

• Higher indirect labor increases the overhead rate

• Target: minimize while maintaining necessary support

Why it matters for professional service firms

Indirect labor is necessary but non-revenue-generating. Every dollar of indirect labor must be recovered through markups on direct labor. A firm with $200K in indirect labor and $600K in direct labor has 33% in indirect labor overhead requiring recovery. Professional service firms should track indirect labor carefully, ensuring it provides necessary support without excess. High indirect labor relative to direct labor compresses margins unless pricing adjusts.

Real-world example

Chris's firm had high overhead without understanding the composition. Analysis: direct labor (billable staff) $520K, indirect labor (admin, management, non-billable time) $285K, other overhead $140K. Indirect labor accounted for 55% of direct labor, above the industry benchmark of 35%. Investigation: Admin was appropriate, but indirect management time was high (partners billed only 30% of time), and non-billable time was excessive (utilization issue)—actions: increased partner billable targets to 45% and improved utilization of consulting staff. Indirect labor dropped to $215K (41% of direct labor), reducing the overhead rate and improving margins.