Labor Costs

What are Labor Costs?

Labor costs are the total expenses of employing people to do work, including salaries, wages, benefits, payroll taxes, bonuses and the cost of contractors and outsourced staff.

Updated November 2026 · 5 min read

Labor costs are what an organization spends on the people who do its work. They include base salaries and wages, benefits such as health insurance and retirement contributions, payroll taxes, bonuses and incentives, and often the cost of contractors, consultants and outsourced staff. In many organizations, labor is the single largest category of cost.

Technology is no exception. Staff costs are usually the largest part of an IT budget, covering engineers, operations teams, support staff, architects and managers, along with contractors and managed service providers. For IT financial management, understanding labor costs is essential for budgeting, service costing, capitalization and decisions about whether to build capabilities in house or source them externally.

Definition of Labor Costs

Labor costs are the full costs associated with people who perform work for an organization. For employees, they include salaries or wages plus fringe costs such as benefits, payroll taxes, paid leave, bonuses and equity compensation. For external workers, they include contractor and consulting fees and the labor component of managed service contracts.

The fully loaded cost of an employee is typically well above base salary once these additional costs are included. A common rule of thumb places it at roughly 1.25 to 1.4 times base salary, although the ratio varies with location, benefits and seniority.

Direct and Indirect Labor

Direct labor is the cost of people who work directly on a specific product, service or project, such as engineers dedicated to one application. It can be traced to that cost object as a direct cost.

Indirect labor is the cost of people who support many cost objects, such as managers, service desk staff and shared infrastructure teams. It must be allocated using a basis such as time spent, headcount supported or tickets handled.

Internal and External Labor

Internal labor covers employees, whose costs are largely fixed in the short term. External labor covers contractors, consultants and outsourced services, which can usually be scaled up or down more quickly but often cost more per hour.

In the TBM taxonomy, these appear in separate cost pools, Staffing and Outside Services. Separating them shows how much an organization relies on external capacity and helps compare the cost of building versus buying capabilities.

Importance of Labor Costs in IT Financial Management

Because labor is the largest share of most IT budgets, decisions about staffing have more effect on total technology cost than almost any other. Labor also determines the capacity to deliver change.

Accurate labor costs are needed for service costing, project costing, capitalization and sourcing decisions.

They are also among the most sensitive costs to report, so most organizations present them in aggregate rather than by individual.

Service and Project Costing

The cost of a technology service or project depends heavily on the labor it consumes. Assigning labor costs accurately, using fully loaded rates and realistic estimates of time spent, gives service and project costs that reflect reality.

Using base salary instead of fully loaded cost understates labor by a quarter or more, which makes internal services look cheaper than external alternatives and projects look cheaper than they will be.

Labor is also the main constraint on change. The share of staff time spent running existing systems versus building new capabilities shows how much capacity is available for new work, and is often a more telling measure than the share of the budget.

Capitalization

Labor spent building internal-use software can often be capitalized under ASC 350-40, moving it from operating expense to an asset amortized over time. Labor is usually the largest capitalizable cost in software development.

Capturing which labor qualifies requires tracking time or allocating team costs to capitalizable projects. Accurate tracking affects reported profit and, for tax, the treatment of research and development costs under Section 174.

How to Track and Manage Labor Costs

Managing labor costs involves calculating fully loaded rates, tracking how labor is spent and making deliberate choices about the mix of internal and external staff.

Labor data often comes from HR and payroll systems, which must be linked to the cost model.

Calculating Fully Loaded Rates

A fully loaded rate combines salary, benefits, payroll taxes, bonuses and sometimes a share of overhead, such as equipment and facilities, into an hourly or annual cost per person or role. Rates are often calculated by role or level rather than for individuals, which protects privacy and simplifies costing. Rates should be refreshed at least annually to reflect salary increases and benefit changes.

These rates are used to cost services and projects and to compare internal labor with contractor rates. Comparing a contractor's hourly rate with an employee's base salary alone gives a misleading picture.

Tracking Time and Managing the Mix

Time tracking, team assignments or periodic surveys show how labor is spent across services, projects and activities. Even approximate data, such as the share of each team's time spent on run versus change work, is valuable. Many organizations collect it through quarterly estimates from team leads rather than detailed timesheets, which keeps the effort low while still supporting service costing.

The mix of internal and external labor should be managed deliberately. Core, ongoing capabilities often benefit from internal staff, while specialized or temporary needs may be better met through contractors or managed services, as discussed under IT outsourcing.

Examples of Labor Costs in IT Financial Management

The examples below show labor costs in technology costing.

Both use illustrative figures.

In each, using fully loaded costs rather than salaries changed the comparison, which is why the loaded rate matters so much.

Comparing Employees and Contractors

A company needs a data engineer. An employee would earn a base salary of $160,000, with benefits, payroll taxes and bonus bringing the fully loaded cost to about $210,000 a year, or roughly $110 an hour across 1,900 working hours.

A contractor charges $135 an hour. For a long-term role, the employee costs less. For a six-month project, the contractor avoids hiring and onboarding costs and may be the better choice despite the higher rate. Over six months, the contractor costs about $128,000, while recruiting an employee for a short need would add recruiting fees and the cost of reassigning or releasing the role afterward.

Labor in Service Costing

A service desk has 20 staff with an average fully loaded cost of $85,000, a labor cost of $1.7 million. It handles 60,000 tickets a year, so the labor cost per ticket is about $28.

When the company considers outsourcing at $32 per ticket, the internal service looks cheaper. Adding tools, facilities and management overhead raises the internal cost to about $36 per ticket, and the outsourcing proposal becomes more attractive. The company still weighs service quality and knowledge of its systems, but the comparison is now made on a like-for-like basis.

Conclusion

Labor costs are the total costs of employing people, including salaries, benefits, payroll taxes, bonuses and external labor such as contractors and outsourced services. They are typically the largest cost in technology organizations.

In IT financial management, labor costs drive service and project costing, capitalization and sourcing decisions. Calculating fully loaded rates, tracking how labor is spent and managing the mix of internal and external staff deliberately help organizations understand and control their largest cost.

Direct Costs

Direct costs are expenses that can be traced specifically to a single product, service, project or department, such as dedicated staff, licenses or hardware used only for that purpose.

Cost Pools

Cost pools are groups of costs that share the same type or purpose. In TBM, they form the finance view of technology spending, such as staffing, hardware, software and cloud services.

ASC 350-40

ASC 350-40 is the US GAAP standard for internal-use software. It sets the rules for when software development and implementation costs are capitalized as assets or expensed as incurred.

Section 174

Section 174 is the US tax code provision governing research and experimental expenditures, including software development. Since 2025, domestic costs can again be deducted immediately under Section 174A.