Profit and Productivity

The Relationship between Profit and Productivity 

As highlighted in previous articles on the same subject, production is the not the same as productivity. Productivity in simple terms means producing more with fewer resources while maintaining or increasing the quality of products.  However it is the relationship between profitability and productivity which must be explored for the benefits of all stakeholders.  Productivity analysis provides key insight into business performance that normally is not shown by the ordinary financial analysis.  In this analysis we try to show the dynamics of change in revenue and expenses between two accounting periods (2010 & 2011) expressed in terms of impact of productivity and price recovery. Such a strategic analysis of the company’s financial performance is so vital especially when the company wants to strategise for the next or coming period.

There is a mistaken belief that making a profit means the company is productive. In productivity accounting PROFIT = PRODUCTIVITY + PRICE RECOVERY. The question that then needs to be answered by every executive is: Is our profit growth productivity driven or it is price driven? A more sustainable business model is where profitability is productivity driven. It is important for captains of industry to note that an increase in capacity utilisation does not mean there is an increase in productivity. 

Using an example, I am going to take you through the process of interpreting your financial performance using productivity accounting. The company below produces 2 products; sweets and chocolates. Profit growth for this company from 2010 to 2011 is US $37.00. Of the $37.00 how much was due to productivity gains and how much was due to price recovery?

		Data Period 2010			Data Period 2011
	Value($)	Quantity(tons)	Price($)	Value($)	Quantity	Price($)
Products
Sweets	224.00	127.00	1.76	320.00	165.00	1.94
Chocolates	430.00	210.00	2.05	490.00	225.00	2.18
Total	654.00			810.00
Resources
Labour	252.00	21.00	12.00	328.00	25.00	13.12
Materials	260.00	65.00	4.00	303.00	72.00	4.21
Capital	142.00	550.00	0.26	142.00	550.00	0.26
Total	654.00			773.00
Reconciliation
Revenue	654.00			810.00
Costs	512.00			631.00
Profit	142.00			179.00

Productivity Analysis

		Effect of
	Profit Variance	Productivity Variance	Productivity Variance	Capacity Utilisation	Resources Allocation	Price Recovery
Resources		$	%
Labour	-15.89	-10.34	-3.45	0.00	-10.34	-5.55
Materials	19.02	10.86	3.77	0.00	10.86	8.16
Capital	33.87	21.22	14.94	21.22	0.00	12.65
Total	37.00	21.74	2.98	21.22	0.52	15.26

Total productivity increased by 2.98% with a positive impact on profits of $21.74. This occurred because total output quantities (volumes) increased by 14.95% while resources quantities increased by 11.62%.

Labour productivity declined by 3.45% with a negative impact on profitability of $10.34, while material productivity (or yield, recovery, etc.) rose by 3.77% and capital productivity jumped by 14.94%. The positive effects of materials and capital productivity growth offset the negative effect of labour productivity losses giving increase in total productivity of 2.98%.

The labour productivity loss might simply be a result of staff turnover causing the skills base to deteriorate, or perhaps the appointment of new and less effective supervisors. On the other hand, it might be a strategic act like deliberately employing additional skilled people to manage production line so as to improve material recovery and reduce downtime on the plant. It could be associated with the introduction of a new product line and labour productivity loss will only be temporary. The simple causes of labour productivity losses can be addressed though training while the more complex causes flow from strategic interventions that were designed to trade off labour productivity losses in order to get gains on material and capital.

Profits were further increased because of price –recovery. This came about because product prices increased by 7.75% while total resources prices increased by only 5.89%. This positive profit impact can be seen as either “good” or “bad” depending on circumstances. If the company is simply price gouging then the effect will be to reduce competitiveness or cause people to seek substitutes. Alternately, it might have arisen because the company had endured a period of severe price under- recovery in the past and this was simply redressing the imbalance. It might also be the result of the company’s own accounting conversion of not revaluing capital such that the capital price remained constant.

Of the $37.00 profit growth from 2010 to 2011, productivity contributed $21.74 (or 59%) and price recovery contributed $15.26 (or 41%). This would put the company in the “Awaken” segment of the strategic grid. This performance indicated the best of both worlds where the organisation is improving productivity and price recovery. However, excessive price recovery may create opportunities for competitors to undercut the business’ product prices and thereby reducing the company’s market share. Organisations placed in this category survive through price – recovery because of the nature of their market. It is very likely that organisations in this segment are in a “monopolistic “situation.

We urge organisations to continuously monitor productivity changes to enable them to come up with viable strategies needed to make the business sustainable.

Memory Nguwi is the Managing Consultant of Industrial Psychology Consultants (Pvt) Ltd a management and human resources consulting firm. Phone 481946-48/481950/2900276/2900966 or cell number 0772 356 361 or email: mnguwi@ipcconsultants.com or visit our website at www.ipcconsultants.comor visit our blog www.ipconsultants.blogspot.com

Performance Management

How managers can conduct Performance Reviews that actually result in increased performance

Based on our experience across many sectors, it has become apparent that performance management and performance reviews in particular are hard to undertake. Executives are not committed to it and employees would not care less. The question therefore is: Do they really work? The good news is that performance management and performance reviews work if management takes time to put the right systems in place.

The first step in any good performance management system is to get the commitment of the Board and senior executives. The CEO needs to drive this process. If this important part of the business is relegated to human resources, chances are it will fail. This process must never be viewed as a human resources department issue. The process produces very good results if every manager views this as a tool to get the best out of their people.

The company board must take a keen interest in measuring the performance of the CEO. If the Board is not measuring the performance of the CEO the system will not work. The Board must continuously appraise the CEO against clear targets. Once that is done the CEO is likely to cascade the system to all his/her direct reports who in turn will cascade the system to their subordinates. My advice is if you find your Board and CEO not interested in being measured and being held accountable through an objective performance management system do not waste your time and resources putting a system in place because it will not work.

Once you get the commitment of the Board and CEO you can now start to put the other building blocks in place. A word of caution, Board and CEO commitment means they must all walk the talk.  What worries me when I look at most organisations is that if managers and subordinates are not talking about performance what are they talking about. Organisations are set up so that they can perform for the benefit of the stakeholders.

If your organisation goes beyond the month of April without agreeing on the targets for the year you must know that you are working for an organisation that does not care about performance. How do you get to 4 months into the year without agreeing on the target for the year? There are many cases where managers start running around talking about targets for this year in October and November. This shows lack of seriousness on the part of the CEO and the Board. The time to agree and sign performance contracts is in the first quarter of the year. It is even better to have agreed your targets for the year by end of January of each year.

For you to be able to agree on targets for the year, you need to agree on a way of setting goals and targets. The challenge is in most cases managers want to use sophisticated systems to set goals and targets. Whatever system you decide to use, the goals and targets must be clear. In too many cases managers want to come up with complicated systems and things not measurable in order to fix their employees. When a simple system is used, measurable goals and targets based on outputs for each job can be agreed. I hear a lot of people saying my job is not measurable. That is not true and it just shows that the person concerned does not understand their role. For each job non-controversial goals and targets based on output can be agreed. To be able to come up with the goals and targets, managers and employees need to work together.

In situations where the system is not based on objective performance criteria, you find that accusations and counter accusations are flying around. Personality’s issues come into play and employees generally resent the system. In companies where there is no objective performance measurement system, people are not paid based on their performance. Instead people are paid based on what we call “corridor mileage.” In such a situation those who move around offices talking to people and building relationships (corridor mileage) are rewarded. Again those who talk a lot and are always visible are recognised at expense of those who add value to the organisation. Non- performers normally know how to position themselves politically within the organisational hierarchy to mask their non- performance.

If you want your performance management system to work, stop measuring behaviour and focus on results. If you are still measuring punctuality, decision, teamwork etc. and such other behavioural aspects of performance you are a century behind modern trends and what works in practice. We are not saying you must ignore behaviour, NO. We are saying agree on the objective outputs first and agree on targets. If the person is not delivering on the targets agreed you can then look at the cause of the non- performances as part of your coaching as a manager. This is normally where behavioural issues come in. Maybe the person is not performing because they do not cooperate with others (teamwork). Work on the behavioural aspects and see if performance improves and if not there could be other causes such lack of skill, motivation etc.

With an objective performance management system, managers are able to build trust which is critical for any performance appraisal process. Without trust appraisals are a painful process. You can build trust in the system by building mechanisms that allow managers to give their subordinates feedback more frequently. If managers are allowed to wait until the day of the appraisal, your system will not work. Managers must also take note that appraisals are not a history lesson on what went wrong. Appraisals are futuristic in situations where managers continuously give feedback to their subordinates. Subordinates look forward to the appraisal process in such a situation. Managers must learn to focus on appraising agreed targets and nothing else. If they have other issues with the employee they must be dealt with in another forum. Unfortunately managers love to feel important and show their power so they dig out things that happened five years back. If you do this you kill the whole process. We have also found in practice that managers are terribly short of performance coaching skills. Instead of investing resources in things that do not add value to the organisation, companies can invest in training their managers on performance coaching, the returns are massive.

Trends have changed. Instead of the managers gathering data to support their assessment of the subordinate, it’s now the employee who must keep records related to agreed targets. When the subordinate goes for an appraisal they must carry a file with all their evidence to support their performance. Managers and subordinates must realise that only hard evidence must be used in performance assessments. Also, do not do your appraisals in a hurry. Give subordinates 2 weeks to prepare for appraisals. Do the appraisal in an appropriate place or office and also at the appropriate time. If managers and subordinates dialogue during the course of the time under review surprises will not happen.

My last word of advice to all companies is that even if your system is not the best that you would want the first and more important step is to appraise people quarterly and this must be done religiously. All records of appraisals must be kept in employee files. This is the only way to build a high performance culture.

Memory Nguwi is the Managing Consultant of Industrial Psychology Consultants (Pvt) Ltd a management and human resources consulting firm. Phone 481946-48/481950/2900276/2900966 or cell number 077 2356 361 or email: mnguwi@ipcconsultants.com or visit our website at www.ipcconsultants.com or visit our blog www.ipconsultants.blogspot.com