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