‘Productivity isn’t everything,’ wrote economist Paul Krugman, ‘but, in the long run, it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.’
Productivity is simply a ratio of outputs to inputs. We would all like to learn how to get the maximum output for the least amount of input. Productivity improvement is not merely cutting costs, as some corporate toe-cutters would have you believe. There is both a numerator and a denominator in the equation. You can increase the numerator, decrease the denominator or do some combination of the two.
[Listen to audio version, read by David Hodes]
Usually, the impact of increasing the numerator will far outweigh a reduction in the denominator. But in a world where we have finite planetary resources, does it make sense to recklessly pursue ever more GDP without paying attention to the need to be frugal with our use of the resources required to create it? What is our response when those resources contribute so massively to greenhouse gas emissions which turn the metaphor of rising tides lifting all ships from a paean to productivity into an environmental alarm signal?
Thus, even with the wicked problem of climate change, improvements in productivity are going to be how we make progress and give ourselves at least a fighting chance to continue to prosper on all this good earth. How else would we be able to go from the current global renewable energy consumption of around 5% of the total (80% fossil fuels, 10% biofuels and 5% nuclear making up the balance) to ultimately replacing fossil fuels? How will we be able to square the circle of an increasingly prosperous developing world demanding access to the kind of life we in the OECD take for granted, tied as it is to ever increasing energy requirements? The record shows that over the last fifty years we have indeed been getting more productive in terms of the carbon intensity per dollar of GDP. But we have also produced more GDP and therefore more greenhouse gases.
“Systemically improving productivity is a necessary condition of our species’ ability to continue to make progress on the planet we call home”
I am not like the misanthropists who suggest that the way out is to depopulate the planet. I often wonder if those who advocate such a solution would be willing to go first? As for those who exploit every convenience of our modern age to rage against the machine and then call for an extinction rebellion to avoid a climate Armageddon, I wonder what their response would be to an hours-long power failure on the way home from a rally, halting their trains and silencing their phones.
At heart, I am a practical man, and whether the measures we need to take are about mitigation or innovation, I believe that systemically improving productivity is a necessary condition of our species’ ability to continue to make progress on the planet we call home.
My epiphany about the power of productivity occurred when I first took the Theory of Constraints (TOC) out for a drive. I was the Managing Director of a national commercial refrigeration company and, through the use of Critical Chain Project Management, my team took 26 days out of a 71-day project. I was astounded that I then had 26 days of virtually free labour available, as I had already costed their full recovery, and some profit, into the winning bid on that contract. My immediate thought was that I could sell a job that used 26 days of the whole crew’s labour at their standard rate and the only cost would be the materials. The rest would be pure profit. Productivity improvement had already paid for the workers.
My mind searched for an analogy to explain to people what I had discovered. I told them it was as if the general public was used to taking twenty-four hours to fly from Johannesburg to London (I was living in Jo’burg at the time), and someone had come up with an invention that would replace a turboprop with a jet engine, the effect of which would be to halve the travel time between the two cities. Why would anyone ever want to travel in a slow turboprop again?
More than twenty years later, there has been no dimming of my enthusiasm for the power of innovations in productivity to change the world for good. Much of this year, I have been working in the aluminium industry. It is an energy-intensive business and also fundamental to the wellbeing of the region to which it belongs. Every day, over 3,000 people go to work at one of the operations of a global player in the aluminium market. Many more than those 3,000 have an indirect dependency on the business through the provision of goods and services to the company and its employees. The corporation of which it is a part has committed to being carbon neutral by 2050. Even then, the investment community marks down their shares because of the centrality of energy to the viability of the business and the environmental challenges this brings.
There can be no doubt that the more productive the business, the more profitable it will be. But what are the dimensions of productivity? How might we measure it? I like to look at productivity in two fundamental ways, using the basic building blocks of the constraint accounting framework.
I start with the assumption that all investors are fundamentally interested in maximising the return on their investment, and we formulate that in TOC in the following way:
ROI = return on investment
T = throughput, or sales less truly variable costs (referred to by cost accountants as contribution margin)
OE = operating expense, defined as labour plus overheads
I = investment, defined as equipment, fixtures, buildings, etc, that the system owns as well as inventory in the forms of raw materials, work-in-process and finished goods
Since Throughput less Operating Expense is a measure of the profit of a business, I call the ratio of Throughput to Operating Expense (T:OE) the operating productivity. It provides the answer to the question: what margin am I making for every dollar it costs me to open the door? The ratio of Throughput to Investment (T:I) is the capital productivity and answers the question: what margin am I making for every dollar I have invested in the business?
Given these formulations, what levers do we have to increase productivity?
More revenue: There’s an old saying that sales are vanity, profit is sanity and cash is reality. More income can produce more profit if the combination of margin and operating expense stay the same. In some cases, more revenue could mean knocking out or weakening a competitor by taking sales away from them. And, of course, we must also think about the effect of pricing decisions on volume and margins.
Faster speed to market: The faster you can get a product to market, the more likely you will spend less doing so. You will also generate a first-mover advantage, and have a head start in being able to iterate the next improvement to stay ahead of your competitors.
Shorter turn-times: the shorter your turn-times, from order through to fulfilment, the less inventory there is in the supply chain, the more responsive you are to actual demand and the more willing your customers will be to pay a pricing premium. Your capital productivity will also improve as a result of having less inventory in the system.
Dependable due dates: The more reliable you are as a provider of goods and services, the less your customers have to make ‘just-in-case’ contingencies and the more likely they would be open to paying a price premium.
Higher margins: Being able to sell at higher prices, because you have a demonstrable value benefit for your customers, means you will achieve higher margins, all else being equal. Furthermore, if your processes are increasingly predictable, your suppliers can more readily find ways to reduce their costs and pass the savings into your margins.
Lower OPEX: The more productive your workforce, the fewer people required to produce your product or service offering.
Lower unit cost: The more volume you have running through your organisation—assuming you can keep your operating expense either the same or increasing at a rate that is slower than the increase in volume—the lower the unit cost of your sales.
Less inventory: The faster your speed to market and turnaround times, the less inventory you have in your pipeline. The less inventory, the lower the working capital, the better the return on shareholder funds.
Less work in process: If you’re completing your work ever faster, there will be less work in process, and more of your labour and other inputs will become cash sooner.
Effective CAPEX: The quicker you are in planning and executing your projects, the less cash they burn and the quicker they deliver the value contained in their business case. Also, you can redeploy your resources sooner to realise the value of the next big idea. Getting the most from your existing assets means deferring CAPEX until it is unarguably necessary.
Better quality: Better understanding of just-on-quality requirements means less gold-plating on the one hand and fewer rejects on the other. Thus, besides reducing operating expense through wasted effort, your reputation is enhanced. Your customer has the chance of delight with every encounter with your product or service.
Less rework: Doing rework for a product or service that should have been right the first time is costly and unproductive. Reduce your rework and you improve ROI.
Higher engagement: If the organisation is scoring goals, and the work you do to get there follows the principles of Just Work, your people will naturally feel more engaged. You will likely be making more money and will be better placed to invest in their potential and willingness to learn and grow.
More innovation: More engaged people have more energy and are more willing to give of themselves and their capacity for discretionary effort. Furthermore, high engagement is an indicator of a healthy culture, where competition and collaboration find an energising balance, acting as a propellant of innovation.
Competitive ROI: Not every industry can produce a player whose ROI outperforms all other players in all other industries. There are structural reasons why specific industries produce lower returns than others. Thus one mustn’t look to demonstrate the highest ROI overall, but one that is competitive to the discerning portfolio manager. Productivity that is higher than your sectoral competitors will deliver a higher ROI, and thus a premium share price.
Applying TOC across the four core capabilities of Asset Constraint Management gives you the opportunity to design business outcomes that you would otherwise think were neither reasonable or possible. Every one of the attributes of productivity improvement listed above is improved by learning how to know the whole but focus on the constraint. Theory of Constraints is the tide that can lift all ships.
The means do exist to create a step-change in productivity and hence maximise the net present value of your assets. Imagine what good would come of this innovation in productivity if you became the dynamo, energising your team and generating outsized results. What hard problems could you solve? What benefits could you bring to the world and the community you serve?
The change from standard thinking to Theory of Constraints (TOC) is both profound and exhilarating. To make it both fun and memorable, we use a business simulation we call The Right Stuff Workshop.
We’d love to run it with you. To learn more:
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