This is your comprehensive guide to understanding productivity in a manufacturing context.
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.
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:
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:
All of the benefits above apply equally to the business world, making high productivity a critical goal of business leaders, and manufacturers in particular.
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:
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 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.
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:
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.
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%.
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There are a few challenges associated with measuring productivity:
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.
Due to the volatility of short-run estimates, productivity is usually measured over long periods of time that span multiple economic cycles.
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.
While productivity and efficiency are closely related, in a manufacturing context the terms tend to be used differently.
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 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.
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.
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.
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.
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.
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.
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.
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!
There are a wide number of reasons why productivity levels change but we’ve narrowed them down to seven main 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.
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.
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.
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.
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.
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.
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.
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.
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Now that you understand the basics of manufacturing productivity, learn how to improve manufacturing productivity.