What is Meant by Productivity?
Before we can look in to why it matters so much to your business, we need to start with a definition of productivity.
You will no doubt have come across the term many times, as it is a fairly broad concept that crops up in many walks of life. Self-improvement apps that aim to boost your personal productivity, business blogs, political debates about the competitiveness of the UK, technology articles about the future nature of work, debates about flexible working – they all concern the concept of productivity in one form or another.
In its most basic form, productivity is simply a measure of the level of output achieved from a given level of input – and as such is a proxy for the efficiency of the asset or process being measured.
I would refine this definition further by adding an additional word: the level of relevant output achieved from a given level of input.
The more complex your business, the more important it is to make sure that every person, process and asset is working towards the same goal. All outputs at each step of the process need to count towards the ultimate goal of the business otherwise this is not productive work. You may have someone producing a huge amount of analysis on a daily basis, but if it is not useful in helping you to make a decision then they would be better deployed on a more relevant task.
Common Examples of Productivity Measures
Productivity comes in many forms. The following pictures are intended to give an idea of the most common measures at both a national level (as favoured by the Office for National Statistics) and an individual business level:
The key point here is that any business can be broken down in to constituent processes and resources that all turn inputs in to outputs, and therefore productivity is relevant at each and every level of your operation.
You should make sure that you have a range of measures that show you a view of your productivity as a whole (such as Sales per employee, or Gross Margin which can be a useful proxy for productivity) and a view at all of the sub-levels of your organisation (such as volume per hour for a given process).
These should feature prominently on your performance dashboard to ensure you have constant sight of them.
Why Does Business Productivity Matter?
It is impossible to overstate the importance of productivity.
According to the government’s Business Productivity Review launched in 2018, productivity matters because it is a key driver of economic growth, social prosperity and living standards. In the long run, a country’s ability to raise living standards is almost entirely down to its ability to raise productivity. For a business, productivity can increase profits, while for workers it can lead to higher wages.
The government launched this review to try to address the “long tail” of low productivity businesses in the UK. In productivity terms, the top 25% of UK businesses are 2 to 5 times more productive than those in the bottom 25%. The most productive businesses are found across a broad range of industries and in all business sizes and regions. The good news is, considering factors like location, size and sector don’t seem to have an influence, there is an opportunity for all businesses to apply learnings from the most productive.
In order to visualise why productivity is so crucial, it is helpful to think of all the elements of your profit and loss account being linked – with price and volume being the threads that run through the whole thing.
Thinking in these terms, an increase in sales (outputs) by virtue of selling more volume will increase input volumes (purchases of raw materials, labour hours, energy usage and so on) proportionately. Both your sales and costs will increase and it will be hard to ever achieve any uplift in profitability. You will effectively forever be chasing your tail. Productivity can help to break the link between output and input volumes to allow you to increase one at a faster rate than the other.
These, then, are our top 5 reasons why you should focus on increasing the productivity of your business:
1. Reduce the impact of factors outside your control
The more you can bring the forces that affect your business under your control, the more you will lower your risk and increase your ability to plan with confidence.
According to the Office for National Statistics, the current rate of consumer price inflation is 2% (for the 12 months to April 2019), wage inflation is 3.3% (Quarter 1 2019 – excluding bonuses), and factory input inflation is 3.8% (for the 12 months to April 2019 – representing an average of materials and fuels used in production).
All of these factors are outside of your control. All things being equal, this will squeeze your margins and there is nothing you can do about it.
Both your employment cost and your other direct costs will increase faster than the rate that you can increase your selling price. As a result, you will need to increase your sales volume to close the profit gap – meaning you are effectively running just to stand still.
In fact, in the current climate, you need to increase sales volume by 4.1% just to maintain your bottom line.
If you were able to increase your productivity by 25% (in both labour and materials) you would only need to increase sales volumes by 2.0%, and if you could match the top businesses in the UK and increase your productivity by 5 times then you would only need to increase sales volume by 0.2%.
Productivity is something that it is entirely possible for you to influence and can insulate your business from uncontrolled risks both now and in to the future.
2. Avoid a vicious circle
The simplistic example above assumes that you can increase your selling prices in line with consumer inflation and increase sales volume at will, but of course it is never that simple. In reality, you need to commit to one of two strategies – either a cost focus or a quality focus.
Under both strategies, failing to prioritise productivity can quickly lead to a vicious circle and a rapid descent for your business. These effects are amplified in the ‘meltdown’ scenario, whereby your productivity actually worsens as a result of your actions.
Under the cost strategy, you aim to reduce the cost of your product by sourcing cheaper inputs which will in turn support a lower selling price and deliver sales volume. The risk is that the product quality continually declines until no one will buy it at the price you need to sell it at:
To make matters worse, using cheaper materials and labour is highly likely to make you less productive, which will offset any of the unit cost savings you have achieved and erode your margins:
Under the quality strategy, on the other hand, you aim to support a higher unit selling price by investing in higher quality materials and labour. The risk here is that the price will need to continually increase to support the increased input costs and at some point you will reach the maximum price that the market can support and volumes will fall quicker than the price rises:
Accelerating this impact is the scenario where you maintain margin by cutting “non-essential” spending in areas such as product development. The subsequent loss of product innovation leaves your product unable to support a high selling price, regardless of its quality, as the competition surpasses it. Here you find yourself having to lower the selling price but with a high unit cost – a recipe for catastrophic margin declines:
Productivity is the key to breaking the cycle in all cases. If you can improve the amount used per unit of output rather than the unit cost per unit of output, then product quality (and sales volume) can be maintained or increased as appropriate.
3. Prioritise Your People
Given that productivity applies all across your business, it can sound somewhat mercenary to talk about employees in the same way as a key piece of machinery, say. However, far from being a threat to your most valuable resource, employee productivity improvement should be seen as the tool that helps you to attract and retain talent and make sure that they are rewarded appropriately. It can facilitate higher wages, more rewarding work, more opportunities, higher job security, fewer unwelcome long hours, and lower levels of stress.
Think of the amount that you have to spend on your employment costs as a total finite number – you can spend this on a larger number of people at a lower average wage, or a smaller number of people at a higher average wage. A higher average wage helps you to attract the best talent (particularly important when the labour market is highly competitive as it is currently), to have a highly skilled and motivated workforce, and to make sure they are fairly rewarded for the value they bring. This should in itself drive higher productivity, but not only that – more productive people drive productivity improvements in other areas of the business. Whether it’s better processes, systems, more skilled negotiations, better sales techniques, or innovative marketing – you will quickly create a virtuous productivity circle thanks to the adjacent possibilities that every person opens up.
A brief note on “fewer people”. This does not mean having to lose people from your business – it means fewer people doing each particular task per unit of output. In the case of rising volumes, this could simply mean a stable workforce, or it could mean reallocating people to areas such as product development or process improvement to open up future possibilities. This is about achieving productivity in all areas of relevant output and focusing on the long-term future of the business.
4. Reduce Waste
Productivity is not all about people of course – it also applies to the materials and energy that you use in the course of your business. Doing more with less is not just good for your bottom line but it is good for everyone.
More efficient equipment that uses less power, improving your processes to cut material waste, re-using what you can, matching supply with demand to eliminate excess production – all of these things will improve your bottom line, boost your green credentials, and contribute to a more sustainable future for everyone.
5. Boost Your Competitiveness
Smart businesses have a keen focus on productivity for all of the reasons outlined above, which means that you don’t need to do anything actively wrong to lose ground on your competitors – you just need to do nothing.
By improving the productivity of your core business, you free up resources to concentrate on the future rather than just the here-and-now. This is vital, as it allows you to create the space to innovate, to evolve, and to take calculated risks as a business – all without having to incur significant extra cost to do so.
Not only that, but by using existing resource rather than investing heavily in a whole new department, you benefit from the experience of the people, the relevance of the technology, and the continuation of the business culture and goals.
There are many more reasons to concentrate on productivity – these are just our top 5, but when the benefits are so wide-ranging you should make sure that your business is set up to make the most of this opportunity.
If you want an expert to show you how, contact Corner Finance.
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