Creative Value Productivity: the missing link for competitive manufacturing

Economic theory promotes the view that:

• All economic activities aim to directly or indirectly satisfy human needs.
• Human needs are satisfied through the consumption of goods and services, produced via the engagement of economic activities.
• Human needs are satisfied to a greater extent when more goods and services are available for consumption.
• Satisfaction is greater when the cost of commodities (goods and services) is lower.
• The cost of goods and services can be lower when their production is more efficient.
• Productivity is a measure of the efficiency of production of goods and services, or the ratio of outputs to inputs in the production process:

Productivity = Production Outputs / Production Inputs

• Higher productivity is generally considered to be a source of competitive advantage.

Productivity is generally viewed as a macro-economic measurement. However, the principles can also be applied as a micro-economic measure of an industry or an individual business.

“Production and wealth creation occur at the level of firms. Lifting the productivity of a nation therefore ultimately depends on the performance of the individual businesses operating within it.” Productivity Commission 2009

If an enterprise or a nation is more productive then the ratio of output value to input cost is higher. Production input costs are derived from capital (K – land, plant and equipment) and labour (L – man hours employed multiplied by the pay and conditions attached to each unit of labour).

Economists then talk about increasing productivity by lowering the costs of production. This is achieved by making improvements to a series of ‘productivity drivers’, which include in part:

• Economies of scale (Enterprise improvement).
• Labour efficiency (Skills improvement).
• Mechanisation and automation (Capital investment improvement).
• Reduction of waste (Process improvement).
• Competition (as a stimulus to the other productivity drivers rather than a means of improvement in its own right).

Collectively, the sum of all these productivity drivers is referred to as Multi-factor Productivity.

Sadly, however, in most business journalism “Productivity” is equated only with Labour Productivity. Indeed, when Jack Welch – then the CEO of General Electric Corporation – was asked about the potential for people to be more productive, he said: “There’s an unlimited amount of juice in that lemon.”

We don’t subscribe to the theory that labour can be continuously squeezed by management to work harder for less reward. However, we do believe that productivity improvements can be made within most companies if we look holistically at all the productivity factors and consider the responsibilities of investors and management as well as those of the workforce.

The many ways to be productive

New technology drives constant improvement in the efficiency of production equipment, and manufacturers almost anywhere in the world are able to access the new equipment as soon as it is released to market. It’s easy to fall behind in the race to adopt the latest technologies and old equipment quickly becomes uncompetitive.

Australian manufacturers need to make critical decisions about the amount and frequency of capital investment they make in order to maintain their competitive efficiency. In an interesting article posted on the ABC website on 10 March 2014, the ABC’s Business Editor Ian Verrender gave the example of the relative productivity of a man with a shovel versus that of a new earth-moving machine. The productivity of the capital invested in the machine far outweighs that of the man with the shovel, and no permutation of his pay and conditions will enable him to bridge that gap in terms of tonnes of earth shifted per day.

The ability of capital investment to transform the productivity of a business, an industry or a nation should not be ignored. Yet the level of business investment in plant & equipment fell 3.5% across 2013-14 and is forecast to fall by a further 10.5% across 2015-16.

There’s no doubt these cost-focused productivity drivers are important factors if we are to achieve globally-competitive manufacturing, but there is another productivity driver that is worthy of more consideration than it has been given to date. If we reduce the productivity equation to financial terms, we see:

Productivity = Value of Production Outputs / Cost of Production Inputs

This clearly shows that increasing the value of production outputs is just as important to improving productivity as the importance of reducing the cost of production inputs. It is critically important for Australian manufacturers to understand this point.

It is unlikely that Australian manufacturing companies will ever be able to match the low input costs of manufacturers in Third World countries, where labour and regulatory compliance are cheaper. However, Australian manufacturers can still be competitive in industries and markets where the value added through their production process is high.

That high added value will be generated by capital investment in:

• Innovation across all facets of the business.
• Research & development (R&D).
• Creation and protection of Intellectual Property.
• Automation of production processes.
• Application of new technology.

Continuing with the breakdown of the productivity equation, the value of production outputs is determined by the number of units produced and the selling price of each unit. (For the sake of simplicity, it is assumed that the business only makes one type of commodity and that every unit sells for the same price. Reality would be more complicated.) So the equation can now be shown as:

Productivity = Number of Units Produced x Selling Price per Unit / Cost of Production Inputs

If we examine the impact on productivity of each of these factors in isolation, assuming the other factors remain constant, we see that:

1. a) Number of Units Produced.

Productivity will increase if the volume of production is increased in a given period. Production outputs are more commonly constrained by customer demand than they are by production capacity. Since our example deals with a modern company practising Lean Manufacturing principles, the business will not manufacture excess volume of products to stockpile in inventory. Therefore volume of production must be directly linked to sales.

Customer demand will be driven by improving the attractiveness, or customer benefits of the goods and services, through innovations in product or service design. This higher level of customer demand may provide economies of scale through increased production volumes, thus lowering the cost of production inputs. The business will therefore have the option of setting lower, more attractive, more competitive selling prices, with the prospect that this generates even greater customer demand and further increases in production volume.

1. b) Unit Price

Productivity will also be improved if the Unit Selling Price is increased. Aside from imbalances in supply and demand that cause scarcity of the commodity, increased prices are achieved by innovations that improve the benefits provided by the product or service, such that the buyer is prepared to pay a premium price for it. Improved benefits may result from the goods or services providing:

• Better solutions to the customer’s needs.
• More features or higher specifications.
• Higher quality.
• Faster delivery.
• Better user information, packaging or presentation.
• More satisfying customer experience through the buying process.

What causes people to be more productive?

In Forbes Magazine back in August 2012, Jack Zenger posed two important questions:

• What causes some people to put forth extraordinary discretionary effort?
• What is it that some leaders do to create a climate in which people go the extra mile and perform at remarkably high levels?

These questions tie back into the principles of effective leadership – of vision, culture and innovation. Countless examples exist of people putting in extraordinary effort if they believe they are engaged in a worthwhile challenge and if they believe there is a realistic chance of success. The most effective leaders seem to be those who can envisage that worthwhile challenge and convey it passionately; who are able to communicate emotively; and who provide continual energy, direction and encouragement. They create a culture of esprit de corps, a “can do” attitude and an expectation of successful achievement. They demonstrate self-discipline. They inspire people to join the cause.

Thus we can see that both factors of the value of production output – Price and Volume – are driven by the ability of the business to create improved customer value through innovation. We can also see that increasing the value of production outputs is just as important to improving productivity as it is to decrease the cost of production inputs.

At Roaring Success, we’ve started using the phrase Creative Value Productivity to give focus to this aspect of productivity and the impact it has on the ability of Australian manufacturing to compete internationally. At a time when Australian manufacturing is undergoing significant structural change, we urge all business leaders to give thoughtful consideration to how they can improve three factors to gain increased business productivity:

• Leadership that inspires people to willingly commit themselves to the strategic objectives of the business, and in doing so to increase their productivity.
• Capital investment in productive plant and equipment that enables improvements in production volumes and reduced unit costs.
• Innovation in technology, process or product that creates unique benefits for customers and generates increased demand at higher price-points

By taking a more balanced view of productivity and the factors that drive it, we believe that there is a viable future for Australian manufacturing. Furthermore, we believe that a viable manufacturing industry should be a national priority because of the range of employment opportunities the industry creates and the real economic wealth it generates.

Chris Thomson is a Director at Roaring Success, a management consulting practice specialising in accelerating business growth. Chris is a Certified Management Consultant (CMC) and a Fellow of the Institute of Management Consultants. He is a member of the Australian Institute of Company Directors and co-author of the book ‘Dominating Your Niche’.

www.roaringsuccess.com.au