Source: Managing a Small Business

The aim of this guide is to provide small business owners and managers with an overview of how company productivity can be improved. It covers what productivity is, how it is measured, and what a company can do to increase it.

Why should productivity growth be a national concern? It is because, if too low, the Nation can neither improve its standard of living at home nor compete successfully abroad. Productivity growth affects wage negotiations, inflation rates, business decisions, exchange rates, a host of other economic, political and social conditions, and, therefore, every small business owner and manager.

The factors affecting both National and individual firm productivity are many and diverse. Nationally, changes in employment, hours worked, the educational, age and sex composition of the work force, levels of capital investment and savings, government regulations, capacity utilization, inflation, among others, all can affect, favorably or unfavorably, productivity rates.

Recent studies indicate that the quality of management is the key to increasing business productivity. It is up to the managers to identify productivity problems and develop an appropriate program to solve these problems. In the past several years, many of the Nation's most successful, larger corporations have started Productivity improvement Programs (PIP). With profits slipping, their managements realized that improving productivity was the key to improving income; that only through an efficient and effective utilization of resources could they remain competitive and profitable.

The following Productivity Improvement Program outlines the key elements of programs successfully used by many companies including such giants as Honeywell, Westinghouse, GM and Ford.

Key elements of a Productivity Improvement Program (PIP):

1. Obtain Upper Management Support. Without top management support, experience shows a PIP likely will fail. The Chief Executive Officer should issue a clear, comprehensive policy statement. The statement should be communicated to everyone in the company. Top management also must be willing to allocate adequate resources to permit success.

2. Create New Organizational Components. A Steering Committee to oversee the PIP and Productivity Managers to implement it are essential. The Committee should be staffed by top departmental executives with the responsibilities of goal setting, guidance, advice, and general control. The Productivity Managers are responsible for the day-to-day activities of measurement and analysis. The responsibilities of all organizational components must be clear and well established.

3. Plan Systematically. Success doesn't just happen. Goals and objectives should be set, problems targeted and rank ordered, reporting and monitoring requirements developed, and feedback channels established.

4. Open Communications. Increasing productivity means changing the way things are done. Desired changes must be communicated. Communication should flow up and down the business organization. Through publications, meetings, and films, employees must be told what is going on and how they will benefit.

5. Involve Employees. This is a very broad element encompassing the quality of work life, worker motivation, training, worker attitudes, job enrichment, quality circles, incentive systems and much more. Studies show a characteristic of successful, growing businesses is that they develop a "corporate culture" where employees strongly identify with and are an important part of company life. This sense of belonging is not easy to engender. Through basic fairness, employee involvement, and equitable incentives, the corporate culture and productivity both can grow.

In an informal sense, productivity is getting more bang for the buck or doing the right things right. But these definitions do not help much when actual measurement is required. For that, a more mathematical approach is needed.

Productivity is a ratio, a comparison of what is produced and what is used to produce it. It compares outputs with inputs, that is, it divides outputs by inputs. Output is a physical entity - a car, a lightbulb, a typed page, or a processed pay voucher. For measurement, an output must be countable over time, a direct result of identifiable activities, and homogeneous (don't mix apples and oranges). Inputs can be classified into four types: labor, materials, capital and energy.

Each input can be used as the basis of a partial measure of productivity, depending upon circumstances. Labor productivity, for example, is measured by dividing output by hours worked, number of employees, or labor cost. Capital productivity is arrived at by dividing output by money invested or machine hours used. Materials productivity is output divided by units of materials used, units of scrap, or money spent. And energy productivity is output divided by units of energy consumed (like BTU's), or money spent.

Labor productivity (output = hours worked) is used by the government as the measure of the Nation's productivity. Many large, diversified companies, however, now use all four inputs to determine what is called Total Factor Productivity. In a purely office environment, since labor is the key input, some organizations use what is called the Administrative Productivity Index (API). It divides work output such as typing, loans serviced, clients interviewed or invoices processed by total hours worked to produce the administrative output. So the API essentially is a labor productivity measure.

Outputs and inputs can be measured in physical units or values or both. For example, an input unit for labor is hours and for value is dollars. A unit of output is the physical count of something and its value is its base selling price. If value (the dollar) is used as the basis of measurement, inflation must be accounted for to maintain a true value over time in constant dollars. Thus, all input and output values usually are tied to the Producer Price Index of each input and output (this compensates for the impact of inflation) to maintain valid input-output and value relationships in constant dollars over time. In other words, if revenues from product A increased 20% over last year, but its price increased by 8% to account for inflation, the real increase in dollar output was 12%. Yearly comparisons must be done using constant dollars. If the company mixes dollars and units, it still must deflate the dollars to maintain a valid relationship between physical quantities and value.

Another complicating aspect of measuring productivity is that not all inputs are equal and not all outputs are the same. Some production processes are more labor intensive than others; some use a variety of different labor skill (value) levels. Output products also change in quality and composition over time. So the process of weighing inputs and outputs to account for their relative values must be done before a truly accurate productivity measure is possible.

The point to remember is, whether employing a partial or total productivity measurement, whether for service or industrial application, or whether the business is large or small, all inputs and outputs must reflect constant values and true mixtures. To do this, all factors must be deflated and weighed.

One final technical consideration, productivity measurements should be indexed to facilitate comparison. Index each input and output measure to a base year and assign each measure the number 100. This makes it easier to calculate percentage changes over time.

So much for theory and mechanics. In practice, how have various businesses and industries actually gone about improving productivity? In the banking industry, for example, there has been revolution in productivity in the past decade. Through the use of computers, magnetic ink character recognition equipment, and mechanizing various repetitive operations, there has been a 50 percent reduction in labor requirements for check handling between.

Studies on the cosmetics industry show that through improved technology and by utilizing larger plants, it maintained a solid 4% annual manufacturing productivity increase. Economies-ofscale seem to have been the key factor here since plants with 500 or more employees were 37% more productive than the smaller ones. Studies on administrative productivity programs indicate that improved productivity comes from standardizing administrative procedures, streamlining operations, and increasing computer applications. These examples illustrate the importance to productivity of both advanced technology and proper management.

Different businesses use different measures of productivity. Airlines traditionally have used passengers boarded per employee and revenue tonmiles per employee as partial productivity measures. The Bell System has developed a sophisticated productivity program and integrated it into its overall budgeting and planning activities. The Bell program is worth a closer look.

Bell uses two Partial Productivity measures-volume of business per employee and number of phones served per employee. Both measure labor productivity. Bell also uses three Total Factor Productivity (TFP) measures to determine overall corporate performance.

One TFP measure emphasizes total output, the others gross and net value added.

Bell's TFP inputs are capital, labor, and materials. All are reported in current dollars, deflated, weighed, averaged, and indexed to arrive at a single Total Input Index. Hecause of the great variety of Bell products and services, output is measured in current revenues, not physical units. Again, the revenue dollars are deflated. All categories of revenues are then summed to arrive at a total dollar output figure. That total is indexed to arrive at a single Total Output Index. Finally, the output index number is divided by the input index number and the resulting figure is the Total Factor Productivity Index for the company. The percentage change over time in the TFP Index is Bell's key measure of the entire company's productivity.

Bell uses this TFP model to track productivity trends, to compare them with industry norms, and to plan long term. They also combine productivity with traditional financial analysis to determine the impact on net income of productivity growth, price change, and many other variables.