This is your comprehensive guide to understanding productivity in a manufacturing context.
We’ll cover the basics, including:
- The role of productivity in the wider economy
- The common methods of measuring productivity
- Comparing productivity and efficiency
- Calculating productive efficiency
What is productivity in a manufacturing context?
Defining the basics
Before we begin, we need to clarify two important terms: input and output.
Inputs are any resources — such as people, raw materials, energy, information, or finance — used in a system, such as an economy or manufacturing plant, to get a desired output. Resources are often financial, but things like time and expertise are also considered inputs.
Outputs are the goods or services, energy or work produced by a machine, factory, company, or an individual in a given period.
Defining productivity
Productivity is defined as outputs ÷ inputs. Productivity increases when the same quantity of inputs results in more outputs, or when you get the same output quantity using fewer inputs.
When calculating productivity at a whole economy scale, economists often measure the ratio of gross domestic product (GDP) to labour hours.
Similarly, productivity in manufacturing measures the number of units produced or net sales, relative to employee labour hours.
It’s important to note that measuring labour hours as the sole input is only a partial measure of productivity. In practical terms, this is a useful benchmark, as labour is an input to almost all production. However it does not capture the full productivity picture, and other measures including Capital Productivity, Multifactor Productivity and Total Productivity are also used (see below).
There are four main kinds of input that can be used to determine productivity:
- Physical capital. The equipment and structures workers use to create goods and services
- Human capital. The knowledge and skills that workers gain through education, training, and experience — all the relevant know-how accumulated during their life
- Natural resources. These are inputs derived from nature, including renewable resources (e.g. plantation forestry, solar power) and nonrenewable resources (e.g. oil, minerals)
- Technological knowledge. Technological progress within the economy. Technological knowledge can be public or proprietary. Public knowledge is openly available and used by all firms, while proprietary knowledge is secret and only known to the company that discovers it
Productivity and the wider economy
Productivity is a key source of economic growth and competitiveness. Economists use productivity to model what their country can produce, which contributes to forecasting business cycles and predicting future GDP growth. High productivity leads to:
- Lower unit costs. Consumers get these cost savings in the form of lower prices, which can encourage demand, more output and an increase in employment
- Improved competitiveness and trade performance. Businesses with high productivity and lower unit costs can be more competitive in global markets
- Higher profit. More productive companies typically generate higher margins and more profit. This can be reinvested in the company to support long-term growth
- Higher wages for staff. Businesses can afford higher wages — attracting better staff — when they use their resources more efficiently
- Economic growth. Greater productivity and national output trends go hand in hand
All of the benefits above apply equally to the business world, making high productivity a critical goal of business leaders, and manufacturers in particular.
The productivity gap
A productivity gap is a sustained difference between a country’s productivity levels, measured in GDP per person employed, and that country’s main export competitors.
Many factors contribute to productivity gaps between countries:
- Access to technology
- The skill level of the labour force
- Quality of management
- Quality of national infrastructure
- The country’s training and education standards
- How much competition there is within markets
- Cultural factors such as attitudes and aspirations
How to measure productivity
Now that we’ve established the importance of tracking productivity in a business and in the wider economy, let’s go over two methods of measuring productivity: labour productivity and multifactor productivity.
Labour productivity
Labour productivity is the most commonly used productivity measure. Labour productivity measures how efficiently a business uses human inputs to produce outputs. At a corporate level, labour productivity is calculated by measuring the number of units produced (or net sales) relative to employee labour hours.
The labour productivity ratio is simply output over input, where labour input is normally measured in hours worked or dollars, while the output is usually measured in units.
Measuring labour productivity:
Mary’s burger bar
Where inputs are in the form of labour, production is Mary’s staff grilling to result in the output — burgers.
Mary owns a burger bar that specialises in grilled burgers. She employs two staff members to help her. They work eight hours each, a total of 16 hours, and produce 80 burgers. Mary’s inputs in the form of labour help her sell burgers — her output.
In a given day, they make 80 burgers using 16 hours of labour. Labour productivity for the burger bar that day is therefore 5 burgers per hour:
Multifactor Productivity
In the real world, labour is not the only factor that affects productivity. Multifactor productivity (MFP), also known as total factor productivity (TFP) or the Solow residual, compares the amount of output to the number of combined inputs used. Inputs can include capital, labour, energy, materials and services.
Most businesses use the MFP ratio to determine if productivity has changed from one period to another:
Using this method results in a more accurate ratio than using labour alone because changes in capital and materials used in production may also increase or decrease labour costs.
Measuring Multifactor Productivity:
Mary’s burger bar
Where inputs are labour in the form of staff, capital in the form of ingredients, energy in the form of electricity, materials in the form of a grill, and services in the form of an accountant. Production happens when Mary and her staff grill the burgers, resulting in the output — burgers!
Let’s look at how to calculate multifactor productivity for Mary’s burger bar. Mary needs ingredients like burger buns, meat, cheese and lettuce. She also needs equipment like a grill, as well as kitchen staff and an accountant to manage her finances. These resources are her inputs. With this, she will serve up some tasty burgers.
One year later, a leading food magazine mentions Mary’s burgers and it grows in popularity. To keep up with demand, she buys more ingredients, upgrades her machines and hires more staff.
Remember, we’ll be using indexes to calculate MFP. Suppose that year one is the base year when an output index and a combined input index for the burger bar are both set to equal 100. In year two, Mary’s output index increases to 150, as she is now producing 50% more burgers, and her combined input index increases to 120.
The MFP in year one is
The MFP in year two is
The growth from year to year is calculated as:
With all her factors of productivity considered, Mary has increased productivity by 25%.
Find out more:
Difficulties in measuring productivity
There are a few challenges associated with measuring productivity:
It doesn’t include all industries
Not all government statistics departments will measure the entire economy. For example, New Zealand’s Stats NZ only measures 25 industries and excludes industries such as education and training, health care and social assistance.
Estimates vary with time periods
Due to the volatility of short-run estimates, productivity is usually measured over long periods of time that span multiple economic cycles.
It doesn’t measure all inputs and outputs
Some natural resources and intangible capital inputs are hard to measure or not measured at all. Things like by-products and work-in-progress are hard to quantify.
Productivity versus efficiency in manufacturing
While productivity and efficiency are closely related, in a manufacturing context the terms tend to be used differently.
Productivity in manufacturing
When measuring labour productivity, the number of output units over a set period of time is important. However their quality, or the amount of waste they generate is not. Thus a workforce that rushes out twice as many products in the same amount of time is considered more productive – even if those products are so poorly made they lead to more returns and customer complaints.
Efficiency in manufacturing
Efficiency is the ability to produce something without wasting materials, time or energy. It is often expressed as a percentage, with 100% being the ideal target of maximum efficiency. In the scenario above the workforce is considered less efficient because they wasted materials, time and energy producing low-quality products.
Similarly, it’s possible to run a much more efficient factory – say, where time was taken to pick up every dropped screw or component and return it to the production line – but at the expense of productivity.
Balancing productivity and efficiency
It’s important to strike a balance between productivity and efficiency. Imagine if a business focused solely on increasing the number of units they produce in an hour but neglected costs and quality. They might have achieved their aim but at the cost of wasted materials and lower quality items.
On the flip side, if a business focuses solely on increasing efficiency, they might end up with the most cost-effective products that are of high quality but won’t have enough stock on hand to meet customer demands, which can end up hurting the bottom line.
Finding the right combination of productivity and efficiency allows you to optimise your output while minimising losses.
The importance of productivity
Productivity is a key source of economic growth and competitiveness. Economists use productivity growth to model the productive capacity of economies. This helps build better forecasts for business cycles and predict future levels of GDP growth, and assess demand and inflationary pressures.
What is productive efficiency?
Productive efficiency, or production efficiency, describes a level in which an economy or business can no longer produce more of one product without lowering the production level of another product. It refers to the level of maximum capacity where the business or economy makes full use of all their resources to generate the most cost-efficient product. Productive efficiency typically happens when production occurs along a production possibility frontier.
To measure productive efficiency, divide output over a standard output rate and multiply by 100 to get a percentage. This is used to analyse the efficiency of a single employee, groups of employees, or sections of an economy.
The standard output rate is a rate of maximum performance or maximum volume of work produced per unit of time using a standard method. Reaching 100% productive efficiency means you have achieved maximum production efficiency.
Maximum production efficiency can be difficult to achieve. Many businesses try to find a balance between using their resources, the rate of production and the quality of goods produced — without reaching full production capacity.
A closer look at the production possibility frontier
You’ll need to know about the production possibility frontier (PPF) to understand production efficiency. The PPF is a graph that shows all the different combinations of output of goods that can be simultaneously produced using all available resources.
- Points that lie on the PPF curve (A) illustrate combinations of output that are productively efficient
- Points that lie inside the curve (B) are productively inefficient
- Points outside the curve (C) are not attainable with the current resources
The law of diminishing returns and productivity efficiency
The law of diminishing returns is closely linked to productivity efficiency. Production managers take this into consideration when improving variable inputs for increased production and profit.
What is the law of diminishing returns?
The law of diminishing returns is a theory that suggests after you reach an optimal level of capacity, then all things remaining constant, adding an additional factor of production will actually result in smaller increases in output.
The law of diminishing returns is also known as the law of diminishing marginal returns, the principle of diminishing marginal productivity, or the law of variable proportion.
The law of diminishing returns in action: Joseph’s orchard
Joseph has a kiwifruit orchard and he has all the required factors of production: land, vines, workers, fertiliser and water. He has decided how much of each input he will need but he hasn’t yet decided how much fertiliser he will use.
Joseph knows that if he increases the amount of fertiliser, the output of kiwifruit will increase. However, it may reach a point where too much fertiliser will poison the plant and decrease his output.
The law of diminishing returns states that there will be a point where the additional output of kiwifruit gained from one additional unit of fertiliser will be less than the additional output of kiwifruit from the previous increase in fertiliser.
This table shows the output of kiwifruit per unit of fertiliser:
Going from one to two units of fertiliser increases yield by 175 kiwifruit. However, going from two to three units of fertiliser yields less than before. This is the point at which adding one additional unit of fertiliser yields less than the previous increase in fertiliser.
Knowing this, Joseph has decided it’s optimal to use only two units of fertiliser and has a successful season!
Why do productivity levels change?
There are a wide number of reasons why productivity levels change but we’ve narrowed them down to seven main factors:
1. Technical factors
Imagine trying to sew 100,000 shirts without a sewing machine from your bedroom — it’s not the right environment to enable productivity! Technical factors can include having the proper location, layout and size of the plant and machinery, the design of machines and equipment, research and development, automation and more.
2. Production factors
Production should be properly planned, coordinated and controlled. This involves getting the right balance of inventory stock, using the right quality of raw materials or components, having a simplified and standardised process and more.
3. Organisational factors
Each individual should have their responsibilities clearly defined in order to avoid conflict and overlap between tasks. There should also be specialisation and a division of labour to make sure the production line moves smoothly and quickly.
4. Staff factors
Choose the right person for the job, and ensure they have proper training and development. Along with extrinsic motivators like wages, staff also need a positive working environment that boosts engagement.
5. Management factors
Many small businesses fail from poor management. Good managers make best use of the available resources to get maximum output at the lowest cost, use modern processes and techniques of production, develop good relationships with employees and more. Efficient management is among the most significant factors in increasing productivity.
6. Financial factors
If the business’ finances are properly managed, productivity will increase. This involves control over fixed and working capital, undergoing financial planning, controlling expenditure and ensuring the business gets proper return on investment.
7. Location factors
Depending on where manufacturing happens, businesses need to take into account geopolitical issues, infrastructure facilities, how close they are to raw materials and their customers, availability of skilled labour and more.
Why productivity is important
Businesses don’t lift productivity for the sake of it. Higher productivity leads to better financial performance, and specifically to greater profit margins. In a Harvard Business Review article from 2017 titled ‘Great Companies Obsess Over Productivity, Not Efficiency’, the authors claim comprehensive research links companies with high productivity with “operating margins 30% – 50% higher than industry peers”. Similarly, writers for Business Insider have linked global profit margins trends directly to labour productivity figures.
In short: increasing productivity is one of the most important challenges in business.
Find out more:
- BI in Manufacturing: 3 Realistic Steps to Data Mastery in 2020
- Lazer Lamps: Achieving rapid growth with the right cloud apps
Now that you understand the basics of manufacturing productivity, learn how to improve manufacturing productivity.