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TRUE PRODUCTIVITY: THE KEY TO PROFITABILITY

by Rene T. Domingo (email comments to rtd@aim.edu)

When costs rise, the knee-jerk reaction of many companies is to assault their customers with higher prices and/or their employees with lower wages or layoffs. Customers strike back by buying less or from somewhere else, and employees by working less or starting unrest. As a result, costs further increase, profits further decline. The problem is compounded and the vicious cycle begins. Not a few companies have self-destruct with such easy and thoughtless approach to contain costs.

It is the fundamental job of managers to absorb costs by increasing productivity, not by sacrificing the company's most important stakeholders: customers and employees. World class companies have shown that any increase in almost all costs - man, material, machine, money (4M's) - can be diffused and dampened by productivity gains. What sets them apart from mediocre companies is that most of thinking and working time of their managers and executives are spent on continuously raising productivity throughout the organization. This non-stop company-wide effort continue whether cost is increasing or decreasing. Productivity gains serve as an invisible buffer ready to absorb costs increases if and when they come from any direction.

WORLD CLASS AND CONVENTIONAL PRODUCTIVITY

The universal definition of productivity is OUTPUT/INPUT; the higher this ratio, the better. It is a measurement of how efficiently you convert inputs or resources into useful outputs, products, or results. Another way of looking at it is RESULTS/RESOURCES. Mathematically, you can increase the ratio by raising output, decreasing input, or both. But in terms of operating decisions, what you really change are 1) the amount of input and 2) the process that converts input to output. Output is not actually manipulated; it is just a result of and the target for your decisions in 1) and 2). In practice, productivity is raised by improving the process rather than by adjusting the input quantity. Only after the process is improved are input requirements eventually reduced or output increased. Productivity is finding ways of doing things smarter and better. It is not as simple as adjusting input quantity or achieving economies of scale by operating at high volumes to increase input yields.

Two schools of thought on how to improve productivity have emerged:

CONVENTIONAL:

"Getting the most output from the available input"

OR

MAXIMUM PRODUCTIVITY = MAXIMUM OUTPUT/AVAILABLE INPUT

WORLD CLASS:

"Getting the required output with minimum input"

OR

MAXIMUM PRODUCTIVITY = REQUIRED OUTPUT/MINIMUM INPUT

OUTPUT IS USER-DEFINED

Before we examine the difference, let us see what we really mean by "output", the more important variable in our productivity ratio. As the term deceivingly connotes, it is something that is "put" "out" by any process - man or machine. It could be cars assembled, documents filed, hamburgers cooked, holes drilled, words typed per minute, etc. Not surprisingly, "output" is part of the engineering mind-set; output/input is the engineer's definition of machine "efficiency" until it was borrowed by business and renamed "productivity". As far as the engineer is concerned, anything that comes out of his machine is an output.

The problem starts when the concept is transplanted into the business setting, more precisely, the market place - where not all outputs are useful or have value. How is this so? In business, an output has value if it is a saleable or usable product, finished or in-process. All products are outputs, but not all outputs are products. Something does not become useful just because it comes out of a process. An output acquires value if and only if it is taken in - used or bought - as an input by another process - another worker, machine, or customer, whatever the case may be. We have to increase productivity in the context of coming out with outputs or products which a particular user desires. In short, it is making the right thing the right way. The next process, an internal customer or external customer, will accept an output of a preceding process as a input if it is of the right quality, quantity and arrives at the right time.

PRODUCTIVITY IS NOT ABOUT PRODUCTION

The danger with the conventional approach of maximizing output to raise productivity is that it tends to disregard the right quality and quantity which the user - the next process - will accept. The tendency is to overproduce, overstock and sacrifice quality for the sake of quantity. Even during times of lean demand due to product seasonality, tough competition, or product obsolescence, the factory is made to run at high gear, full capacity, in the name of "productivity." The problem worsens as productivity in this context is tied up to workers' compensation or to managers' bonus schemes. In effect, you are actually paying and motivating your employees to produce piles of inventory, wastes, defects, and increase carrying costs - productivity in reverse gear.

While conventional productivity is production-oriented, the world class approach is market-oriented. It starts with the requirements of the customer - output quantity and quality- and then works back to improve all processes and minimize all inputs. Since the productivity program started with the user or customer in mind, all outputs are guaranteed to be usable. Nothing is wasted in output or input. The world class productivity philosophy is consistent with the just-in-time or JIT manufacturing system which requires any process to produce only the quantity withdrawn or used by the next process.

It may appear that in a buyer's market, world class productivity, like JIT, would be more effective than the traditional approach. Question: In a seller's market, wouldn't conventional productivity be better than world class productivity? If all goods produced can be sold, wouldn't maximizing output be better than restricting output. Naturally, in such a situation, maximizing output is the best decision, but world class productivity is still the better option. How is this? In a seller's market, the "required output" in the world class productivity ratio becomes the "maximum output" because that is what is required by the market. It is however better than the conventional approach, because the latter just maximizes output with the available input, but a world class company would maximize output and minimize input at the same time in a seller's market, thus achieving much higher productivity and profitability. During high demand, a typical company would be excited and contented with high sales at the same cost, but a world class company will be one step ahead with high sales and lower cost.

APPARENT AND REAL PRODUCTIVITY

Suppose 10 workers can assemble 100 radios per hour. If your can increase their efficiency through training, methods improvement, or kaizen by 20%, what will be the new set-up? The typical approach would be to let the 10 workers produce 120 radios. Since nobody is sure to buy the extra 20 radios, they would just stay as unplanned inventory - idle and costly. If the 20 radios are treated as useless output, then there was no change in real productivity. The more pragmatic world class approach is to let 8 workers produce the same 100 radios - without disturbing the market.

TWO APPROACHES TO 20% INCREASE IN PRODUCTIVITY

 

20% increase in output (conventional approach)

20% decrease in input
(world class approach)

Current: 100 radios made by10 workers

120 radios made by 10 workers

100 radios made by 8 workers

Productivity 12 radios per worker 12.5 radios per worker

Remember, customers will not increase their demand and budgets just because you increased your output and productivity - they could not care less. You cannot force them to buy and absorb your extra output just because you became smarter and more efficient. What happens to the two extra workers? They do not have to be laid off; they can be reassigned to some other jobs or lines and you could recruit less people next time. Their fate should not affect the implementation of productivity plans. Productivity will not increase if there is no decrease in labor inputs; if the same number of people just works faster, then there is no change in labor costs.

From the table above, you would notice that even in a seller's market, (all production are sold) ,conventional productivity would yield a productivity ratio of 120/10 or 12 radios/worker while the world class ratio is higher at 100/8 or 12.5. Decreasing input always yields higher productivity than increasing output by the same percentage. In fact, to raise the productivity ratio through kaizen, an input can be reduced continuously until it becomes zero and unnecessary.

IDLE OUTPUT VS. IDLE INPUT

Another difference between traditional and world class productivity is that the former tends to favor idle output while the latter, idle input. World class companies believe that it is always cheaper, wiser, safer, and more flexible to carry idle inputs - idle men, machines, raw material inventory - than to carry idle outputs in the form of finished goods inventory. The latter, which is high-value added outputs, would entail high carrying costs, not to mention the other hidden costs like risk of obsolescence. It is not unusual for world class companies to shut down entire lines and factories during times of lean demand; they have discovered that it is cheaper to pay workers salaries to do nothing than pay them to make radios that will not be sold.

WASTE ELIMINATION

Productivity is increased by elimination of all waste - defined as anything unnecessary - input or output - that entails costs or investment. The first to tackle is unnecessary output, the next is unnecessary inputs. The following input-output grid shows the map to true productivity.

ROADMAP TO HIGH PRODUCTIVITY

 

necessary input

unnecessary input
necessary output A B
unnecessary output C D

There are only two steps:

Step 1. Stop making unnecessary outputs - thus ridding of C and D. C means something valuable is used to produce waste. D means wastes to produce more wastes. Never produce something not needed by the next process, the internal customer, or the buyer, the external customer.

Step 2. Improve the process, and then eliminate all unnecessary inputs used in making necessary outputs - thus ridding of B. Only A should remain in the final stage in which there is no waste in either input or output.

Warning: Never start with eliminating unnecessary inputs, for you may be trying to eliminate the unnecessary resource used for an unsaleable product (D). An example is doing value analysis on a widget that nobody will buy. This is similar to improving the fuel efficiency of your car by adding gadgets, without cutting down on unnecessary trips; this will not really reduce total fuel expenses.

FINDING THE RIGHT OUTPUT

How do we determine necessary outputs? Outputs include all products and services to satisfy an external or internal customer. "Necessary" means the right products and services at the right time as specified by the external or internal customer. The following quality-delivery grid shows the guide to determining necessary outputs.

QUALITY-DELIVERY GRID
  right time wrong time
right quality A B
wrong quality C D

The right quality means the desired product with the desired specifications of the user or customer. The right time means neither early or late - just in time for immediate usage by the customer. The right time also means the right quantity or amount - no more, no less - as required by the customer. For practical purposes, products delivered on time with the wrong quantity, insufficient or excess, is considered delivered at the wrong time. There are only two steps in determining the right output:

Step 1. Eliminate all products and services unwanted by the external or internal customer because of wrong quality- thus ridding of C and D.

Step 2. Avoid the early or late delivery of the right products and services - thus eliminating B. Only A should remain as the necessary output.

Warning: Never start solving delivery problems; you may end up delivering the wrong products at the right time - another waste of time.

RESOURCE ABUNDANCE NOT AN EXCUSE

Abundance of resource and inputs is often used as an excuse to waste them and run operations unproductively and inefficiently. Unproductive companies proliferate in economies endowed with cheap labor and abundant natural resources. World class companies makes full and efficient use resources, regardless of their cost and availability, and regardless of the location of their operations. With cheap inputs, they earn much more profits than unproductive companies using the same resources.

World class productivity lowers total cost by focusing on the minimizing the usage of inputs, not by lowering the acquisition or purchase price of inputs. For instance, it does not justify low and exploitative wages. Japanese firms which have high productivity pay very high wages, but have low total labor costs. My "Productivity Ode" summarizes this principle:

High wages with low productivity is charity
Low wages with high productivity is exploitation
Low wages with low productivity is suicide
High wages with high productivity is progress

PRODUCTIVITY LINKS CAPITAL TO SALES

Productivity is the black box that converts capital to sales and profits. It is the missing link that has been neglected and overlooked by those who think that business is all a matter of raising and increasing capital to buy more or better inputs, and expect sales and profits to naturally happen. These companies always discover that they are always starved for capital while profitability continuously decline. Infusing capital into wasteful operations is like feeding fire with fire or throwing good money after bad. Of course, productivity cannot be bought by capital; there is no short-cut. It is a result of hard-work, change of corporate culture, management outlook, and if necessary, the change of the entire management.

The crux of world class productivity is to reduce resources (inputs) without sacrificing results (outputs) by improving and streamlining the conversion process. World class productivity will soften, if not neutralize, the effects of any increase in inputs costs in the 4M's through reduction in input quantity required, thus preserving profitability. Companies which continuously improve productivity are virtually immune from cost increases and inflation. They can maintain competitive prices while unproductive companies have no choice but to price themselves out of the market.


 

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