Published September 2005

Change in productivity
can affect many other things

Productivity growth in the U.S. economy slowed in second quarter, according to the recent report by the U.S. Department of Labor, but still came in at an annualized rate of 2.2 percent.

Hearing this, you might ask, “How does that affect me?”

Well, consider the number itself. Last quarter businesses across the United States improved their efficiency by 2.2 percent. If your business didn’t improve its efficiency that means you are now 2.2 percent behind your competition. That isn‘t a good place to be.

Productivity is a measurement of resource efficiency. The most commonly used — because it is the easiest to calculate — is output per hour of work. If, for example, last year Franz (your best worker) was able to make 30 cheese sandwiches per hour and this year, after the installation of the “ElectroPulse II” chair cushion, can make 36 sandwiches, that’s a physical productivity increase of 20 percent.

The increased output that came from the “ElectroPulse II” chair cushion (now, sadly, declared illegal in most states) is an example of the kind of productivity increase that comes from a technological advance and is acquired through a capital investment. There are other sources of productivity increases, though, not the least important being organization and management.

Suppose, for example, your business involves preparing, packaging and shipping the aforementioned cheese sandwiches, along with other luncheon sandwiches. You have a staff of seven people who start work at 6 a.m. and finish at 10 a.m., when the last delivery truck leaves.

Each sandwich sells for $4.50, the ingredients cost $2, and each member of your staff earns $10 per hour. (We’ll ignore taxes and benefits issues for the sake of simplicity.)

If a total day’s output is 280 sandwiches, or $1,260, that represents an output of $45 per hour of work. Suppose, though, that by your motivational skills and brilliant reorganization of the work flow — having everybody prepare, then wrap and package, then ship as a team, for example — you could increase output to 300 sandwiches, or $1,350. That would be a productivity increase of just over 7 percent.

This kind of efficiency increase is a good thing, but a good manager does not just let it go at that. Productivity increases raise issues that management has to be prepared to address.

In the business we used as an example, increased productivity means that you can now produce 20 more sandwiches per day. What that productivity increase doesn’t tell you is how to deal with the increase.

If you can sell the additional sandwiches at the usual price, there will be some addition to net profit after deducting the cost of ingredients and other expenses. And at that point the choices of what to do with profit are:

(1) Give it to the owners.

(2) Give the workers a raise.

(3) Give management a raise.

(4) Invest in some new equipment to increase productivity further.

(5) Lower prices to increase sales.

(6) Pay off debts.

(7) Save the cash.

The choices are not mutually exclusive, and it is certainly possible to divide up the increased profit, if it is large enough, and allocate it to achieve more than one objective.

For managers, though, it is important to remember that each of these choices has significant implications, and each, over time, will change the company. A company that is quick to share its profits with workers, for example, will have a very different trajectory from, one which lowers its prices, one which invests in new technology, or one which rewards its investors.

Choosing what is best for your company demands an assessment of where your business stands with respect to the market and where you want to be. If you are planning an expansion, for example, it isn’t a good idea to have unhappy investors or creditors. And if you are losing good workers, it may mean that you need to increase your wages.

Whether they come from investment and technology or from better management, productivity increases are good for a business, and they are necessary in order to survive. Just as “there’s no crying in baseball,” there’s no standing still in business.

James McCusker, a Bothell economist, educator and small-business consultant, writes “Your Business” in The Herald each Sunday. He can be reached by sending e-mail to otisrep@aol.com.

Back to the top/October 2005 Main Menu