Productivity and Efficiency - Principles of Management

In the last section we noted that managers strive to reach the efficiency frontier in their industry and that doing so requires operational excellence. The key determinant of efficiency in most organizations is the productivity of two key inputs, labor and capital. Productivitycan be defined as the output produced by a given input: Productivity _ Output/Input

The productivity of labor is typically measured by unit output divided by some measure of labor input, such as hours worked or number of employees. For example, managers in automobile companies often look at the number of employee hours needed to build a car.

In 2004 it took Toyota 20.6 employee hours to build a car in its United States assembly operations. This compares to 23.6 hours at General Motors, 25.4 hours at Ford, and 26.0 hours at Daimler Chrysler. 2 Thus we can conclude that Toyota had higher labor productivity than its three rivals and should therefore have lower costs and greater profitability, which indeed seems to have been the case. In 2004 Toyota made more profit than the other three companies combined.

The productivity of capital is usually measured by sales divided by the total capital (money) invested in a business. Often referred to as capital turnover, this measure tells managers how many dollars of sales are produced for every dollar of capital invested in the business. In 2005, for example, Wal-Mart’s capital turnover ratio was 4.16, meaning that every dollar Wal-Mart invested in its stores, distribution centers, information systems, and inventory generated $4.16 of sales.

By way of comparison, Target had a capital turnover ratio of just 1.86, which implies that Target was less productive than Wal-Mart in its use of capital and thus would probably have a higher cost structure and higher profitability. This was the case in 2005, when Wal-Mart’s profitability, measured by its return on invested capital, was 14.5 percent compared to 11.5 percent at Target.

The key point is that the productivity rates of labor and capital are major determinants of efficiency and thus the cost structure of an enterprise. The task facing managers is to improvelabor and capital productivity over time, thereby lowering costs and boosting performance.Doing so is important irrespective of whether the business-level strategy of the firm is one of low costs or differentiation. Even the differentiated firm has to configure its operations asefficiently as possible, given the constraints imposed by its choice of strategic position, if it isto reach the efficiency frontier in its industry.

The operating strategies we consider in the rest of this chapter all improve the productivity of labor and capital and thus the competitive position of a business. For example, by reducing labor time wasted building defective products that subsequently have to be repaired or scrapped, quality enhancement methodologies such as six sigma improve labor productivity. By managing inventories more efficiently, operating strategies can reduce the amount of capital tied up in inventory, thereby improving capital productivity.


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