Unit – I Basic Concepts of Productivity

Basic definition of productivity:

Depending upon who is defining it -whether it is an economist, accountant, manager,
politician, union leader, or industrial engineer -you will get a slightly different definition of
he term productivity. How ever, if we closely examine the various definitions and
interpretations of this term, three basic types of productivity appear to be emerging. For the
purpose of this text, we shall refer to these basic for ms as follows.

1) Partial Productivity: It is the ratio of output to one class of input. For example, labor
productivity (the ratio of output to labor input) is a partial productivity measure.
Similarly, capital productivity (the ratio of output to capital input) and material
productivity (the ratio of output to materials input) are examples of partial productivity.

2) Total-factor productivity: It is the ratio of net output to the sum of associated labor and
capital (factor) inputs. By ―net output,‖ we mean total output minus intermediate goods
and services purchased. Notice that the denominator of this ration is made up of only the
labor and capital input factors.

3) Total productivity: It is the ratio of total output to the sum of all input factors. Thus, a
total productivity measure reflects the joint impact of all the inputs in producing the
output.
In al of the above definitions, both the output and input (s) are expressed in
―real‖ or ―physical‖ terms by being reduced to constant dollars ( or any other monetary
currency) of a reference period (often referred to as ―base period‖). This reducing to base
period is accomplished by dividing the values of output and input(s) by deflators or
inflators, depending upon whether the prices of outputs a nd inputs have gone up or down,
respectively. In other words, the effect of reducing the output and input(s) to a base period
is to eliminate the effects of price variations, so that only the ―physical‖ changes in output
and input(s) are considered in any of the productivity ratios.
We shall take a simple numerical example to illustrate these here basic definitions.

Example: Consider the ABC Company. The data for output produced and inputs consumed
for a particular time period are given below.
Output = $1000
Human input = 300
Material input = 200
Capital input = 300
Energy input = 100
Other expense input = 50
It is assumed that these values are in constant dollars with respect to a base period. Then the
partial, total-factor, and total productivity values are computed as follows:

Partial productivities:
Human productivity = output/human input = 1000/300 = 3.33
Material productivity = output/material input = 1000/200 = 5
Capital productivity = output/capital input = 1000/300 = 3.33
Energy productivity = output/energy input = 1000/100 = 10
Other expense productivity = output/other expense input = 1000/50 = 20
Total-factor productivity = net output/ (labor + capital) input
= total output — material and services purchased/ (labor + capital) input

Source: Productivity Engineering and Management by David J. Sumanth navanth31@yahoo.co.in

Unit – I Basic Concepts of Productivity

Assume that the company purchases all its materials and services, including the energy,
machinery and equipment (on lease), and other services, such as marketing, advertising,
information processing, consulting, etc.
Advantages and limitations of using the three basic types of productivity measures in
companies.

Advantages limitations

Partial productivity measures

1) Easy to understand. 1) If used alone, can be very misleading
and may lead to costly mistakes.
2) Easy to obtain the data. 2) Do not have the ability to explain
overall cost increases.
3) Easy to compute the productivity indices 3) Tend to shift the blame to the wrong
areas of management control.
4) Easy to sell to management 4) Profit control through partial
because of the above three advantages. productivity measures can be a hit-
and-miss approach.
5) Some partial productivity indicator data
is available industry wide.
6) Good diagnostic tools to pinpoint areas
for productivity improvement, if used
along with total productivity indicators.

Total factor productivity measure:

1. The data from company records are 1. Does not capture the impact of
relatively easy obtain. materials and energy inputs.
2. Usually appealing from a corporate 2. The value-added approach to defining
economist’s viewpoint. the output is not very appropriate in a
company setting because it is difficult
for operational managers to relate the
value-added output to production efficiency.
3. Not appropriate when material costs
from a sizable portion of total product
costs since the impact of material input
is not directly shown in this
productivity measure.
4. Only labor and capital inputs are
considered in the total factor input.
5. Data for comparison purposes are relatively
difficult to obtain, although for some specific
industries and specific time periods, the
indices have been published.
Total productivity measure:
1. Considers all the quantifiable output and 1. Data for computations are relatively
input factors: therefore, is a more accurate difficult to obtain at product and
representation of the real economic picture customer levels, unless data collection
of a company systems are designed for this purpose.

Source: Productivity Engineering and Management by David J. Sumanth navanth31@yahoo.co.in

Unit – I Basic Concepts of Productivity

2. Profit control through the use of total 2. As with the partial and total-factor
productivity indices is a tremendous measures, does not consider intangible
benefit to top management. factors of output and input in a direct
sense.
3. If used in conjunction with partial
measures, can direct management attention
in an effective manner.
4. Sensitivity analysis is easier to perform
5. Easily related to total costs.

1.1 Productivity vs. Inflation:

While increased inflation rates in an economy must be explained by the joint effect of
several factors, economists do agree that a lack of productivity growth contributes to the
increase. As expected, this is because price inflation of goods and services results from the
excessive increases in sales prices of products or services. Such increases are mostly due to
the management’s intention to meet their sales revenue targets, even if it means increasing
the selling price just to hold the profits margins. Also, since the path of least resistance is to
pass the increases in input costs on to the customer, many companies resorts to that strategy
rather than consistently increasing total productivity, a practice that can actually reduce, if
not hold, the total cost of manufacture.
Willard Butcher [1979] of the chase Manhattan Bank, in his remarks at the Town hall
of California on September 25, 1979, emphasizes.

The most compelling force we possess to improve our standard of living while at the same time fight
inflation may very well be – increased productivity.

The percent increases in prices and labor productivity are inversely correlated in fig 1 .1 and
1.2, reinforcing the above statement.

Source: Productivity Engineering and Management by David J. Sumanth navanth31@yahoo.co.in

Unit – I Basic Concepts of Productivity

Fig 1.2 Relation between price increases and labor productivity in selected
industries, 1960 to 1978.

For an example of the relationship between productivity and price increases, consider
the case of the Eli Lilly Company, one of the better known pharmac eutical companies in the
world. During the period 1963-1974, by increasing its total factor productivity at a rate of
10.1% years on average. Lilly decreased its prices at an average annual rate of 0.4% [Virts
and Cocks, 1976].
John W. Kendrick, a well-known professor of economics at George Washington
University, is reported by the Chicago tribune (January 11, 1979) to have said that
―productivity could be a potent weapon in fighting inflation.‖
Geoffrey Moore [1973] (Vice President of Research at the National Bureau of
Economic Research, and Senior Research Fellow at The Hoover Institution, Stanford
University, in 1972) also points out in great detail the need for increasing productivity to
combat inflation over the next several years.
Fig 1.3, taken from a recent publication of United States Chamber of Commerce
[1979], points out that the money supply in the United States grew faster in the 1970s than
it did in the 1960s. Faster growth in the money supply and slower real growth in output have
produced higher inflation. In other words, the money supply grew faster in recent years than
did the national output of goods per unit of labor resource (labor productivity).

Gross Money Gross national product

National Supply
Money Product
Supply Inflation Portion

Real growth portion

Fig 1.3 Money supply growth faster than real growth in GNP, thereby causing inflation
Source: Productivity Engineering and Management by David J. Sumanth navanth31@yahoo.co.in
Unit – I Basic Concepts of Productivity

1.2 PRODUCTIVITY VS. THE STANDARD OF LIVING

Source: Productivity Engineering and Management by David J. Sumanth navanth31@yahoo.co.in