ORG MAN FINAL PAPER

Learning Objectives

After completing this chapter, you should be able to:

• Define productivity.

• Describe why productivity is the key to an increasing standard of living.

• Discuss how the relationship between productivity and the nature of work has changed over time.

• Explain labor, capital, and material productivity.

• Calculate productivity in single and multiple factor cases.

• Discuss important trade-offs among the factors of productivity.

• Explain the relationship between wage rate and productivity.

• Describe ways to enhance productivity.

3 .Hemera/Thinkstock

Enhancing Productivity

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CHAPTER 3Section 3.1 Understanding Productivity

3.1 Understanding Productivity

Productivity is a term that is mentioned often in the news. It is a term that many believe is important, but they are not sure why. Productivity is often associated with increasing efficiency and lowering costs, which have positive connotations. In fact, increasing productivity is an essential factor for improving living standards. Productiv- ity is the level of output achieved from an activity divided by the inputs consumed to make the output. While productivity is defined by a mathematical equation, efficiency is a general descriptor of the time or effort required to complete work. Generally, efficiency is used to mean achieving an outcome with a minimal amount of effort, that is, no waste; it has a similar meaning as productivity.

Productivity = Output/Input

The above definition, while accurate, does not convey the central role that productivity and productivity improvements have in determining living standards for people in the United States and around the world. To understand this impact, imagine that seven people are stranded on an island, completely cut off from the rest of society. The island has abundant natural resources. The immediate problems are getting fresh water to drink and gathering fruits and vegetables to eat. Appropriate shelter and clothing come next. The amount of water that seven castaways are able to drink (the output) depends upon how much effort (the input) they place on locating, collecting, transporting, and storing it. As the group becomes better at gathering an adequate supply of water with less effort, members of the group have more time for gathering food, building shelters, and making clothes. For

example, rather than going to the water source each time a person is thirsty, the group could build buckets and barrels to transport and store large amount of water that is easily and quickly acces- sible. This investment in design- ing and building tools to make collecting water faster and eas- ier frees time for other activities. Eventually, as shelters are built, they could be designed and con- structed so that the roofs could collect rainwater and funnel it into water barrels. This sys- tem would eliminate the labor required to collect water, thus providing more time for other activities, such as growing a large variety of food, building transportation devices, swim- ming, and devising forms of entertainment.

©John Foxx/Thinkstock

Productivity improvements have a profound impact upon living standards for people around the world. Although completely cut off from society, a group of people stranded on a tropical island would likely employ these same improvements to increase their quality of living.

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CHAPTER 3Section 3.1 Understanding Productivity

As the seven castaways become more productive, they meet their basic needs (outputs) with less time and effort (input). This provides free time, which can be used to create new products, develop better ways to make existing products, and enjoy leisure activities. Put in the simplest terms, the seven castaways can only consume what they produce. The more they produce, the more they must consume. In this simplistic example, the cast- aways clearly benefit by finding ways of “doing more with less,” which is a phase that is synonymous with cost cutting, and may have a negative connotation. Doing more with less is the way to achieve an improved living standard.

A 21st-century economy with more than six billion people is similar to the castaway econ- omy because the concept of productivity does not change. Productivity still measures the ability to produce goods and services (outputs) compared to the inputs or resources used in the process. The primary difference is that most work in the economy is done by groups of people working in organizations. As discussed earlier in this text, organizations exist to meet the needs of society that people working alone cannot. It is through these organiza- tions that people achieve the cooperation and coordination to produce the array of ser- vices and goods consumed each day. First, organizations allow individuals to specialize in work, such as production, engineering, and sales. Second, they support the development and implementation of technology and automation to achieve greater productivity. Third, organizations provide a mechanism to coordinate work toward a common set of goals. Examining and redesigning organizational processes and activities is a key source of pro- ductivity improvement. The following examples illustrate these points.

1. Specialization—Product design for life insurance requires an estimate of life expectancy. This effort is critical to setting the terms and conditions of the policy, including the premium. Actuaries are statisticians who specialize in making this estimate. Their productivity (ability to make the estimate quickly and accurately) is greatly enhanced by specialization. They are well trained in the techniques required to do the job. An employee of the life insurance company with training and education as a general manager, sales manager, or accountant would require significantly more time and effort to do actuarial work, and the estimate would probably be much less accurate. Similarly, the actuary would likely make a poor accountant or manager.

2. Technology and Automation—At today’s universities, students have the option of paying fees using electronic funds transfer (EFT) via the Internet rather than standing in line at the cashier’s office—the approach used a generation ago. Not only is EFT more convenient for the student (improves the student’s productivity by requiring less time to make the payment), it also increases the productivity of the workforce at the university. From the university’s perspective, each transac- tion that shifts from paying in person to paying using EFT reduces the amount of time university employees spend accepting the payment and entering informa- tion into the computer system. This presents an opportunity to cut costs and to do more value-added work.

3. Process Redesign—In many organizations, marketing and sales are responsible for gathering information about customers and their orders. When a customer makes a request that requires special processing, such as a special finish on a piece of steel or a major change to a software module, that information is relayed from the customer through sales to the people who do the work, and takes extra time and effort, thereby increasing the risk of errors. Changing the process so that the

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CHAPTER 3Section 3.1 Understanding Productivity

Real World Scenarios: Procter & Gamble Work With Walmart

Sometimes, process improvements involve working across organizations. In many cases, retailers are working with suppliers to develop innovative ways to improve the replenishment process and reduce the resources devoted to manage this relationship.

Procter & Gamble (P&G) supplies Walmart with disposable diapers—a bulky, inexpensive, high sales- volume and low profit-margin commodity—so Walmart must keep inventory low and product avail- ability high. To accomplish this, Walmart has changed its replenishment process. Rather than placing orders with P&G, Walmart provides sales data for each individual store. It is P&G’s responsibility to track inventory, schedule production, and deliver diapers to the store.

How does this shifting of responsibility improve the process? P&G receives sales data from Walmart each day. P&G uses the data, along with orders from other customers, to schedule its production processes more effectively and generate orders for its suppliers more quickly. P&G can more eas- ily balance its production process to reduce spikes in production, which can lead to higher costs through the need for overtime production and similar effects. P&G suppliers, in turn, can improve their response time and reduce their in-process inventory. Walmart spends less time tracking inven- tory, deciding how much and when to order, and placing the order. As responsibilities shift between P&G and Walmart, overall costs decline, product availability increases, and the amount of unneces- sary communication and interaction between organizations is reduced.

customer can communicate directly with the people doing the work increases the productivity of all participants. This can be accomplished in a number of ways, including having the customer visit the facility and meet with the employees, or sending employees to meet the customer. It can also be done by sharing feedback from customers in a video format and providing “made by” information so the customer know who made the product. Providing customer with the employees’ email or other points of contact is helpful. Employees tend to respond better when the contact with the customer is personal.

Money Versus Productivity Productivity is more important than money when improving the standard of living, because productivity determines the level of output and, therefore, consumption, whereas money measures the value of the output. Money in the form of revenue, profits, and income is a way for organizations and individuals to track performance. Refer to the cast- away example mentioned earlier. Suppose that each castaway landed on the island with $1 billion in gold. The money does not create a single glass of water or one bit of food. It is only through the work of the castaways that these commodities are gathered and produced. Methods to increase productivity, such as specialization of labor, automation, technology, and process improvement, create better living conditions and a society with a higher living standard.

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CHAPTER 3Section 3.1 Understanding Productivity

Initially, the small island economy may use a barter system in which a castaway gathering water would trade water for food with another castaway gathering or growing food. As the economy grows in complexity, a currency will likely emerge to facilitate the exchange of goods and services, because bartering can be cumbersome. Suppose a currency is in place, and it is based on the gold that the castaways brought with them. Now suppose the castaways discover gold on the island. They divide the gold up evenly, so now each cast- away has twice as much gold as before and wants to buy more goods and services. The immediate impact is to increase the price for items because the quantity of available goods and services has not changed. There would be no increase in the goods and services avail- able unless productivity is improved or the castaways work more hours at the same level of productivity. For the island economy, it does not matter whether or not more gold is found, the castaways could do either of these activities: increase productivity or increase the number of hours worked.

As the population grows and the island economy develops, income for each individual would be determined by the value of the work they could do. If medical care, for example, is determined more valuable than education, doctors would receive a higher income than teachers. This would allow a doctor to consume more than a teacher because the value of the doctor’s labor is judged to be higher. If an individual in a developed economy finds $1 million worth of gold in his or her backyard, that still does not generate more output. It does, however, allow the person to outbid others for the outputs of the economy and consume more. Someone else, in turn, must consume less until productivity increases.

Productivity and the Nature of Work Many individuals believe that productivity applies primarily (or exclusively) to the blue- collar workforce. People think of the number of laptop computers produced by workers on an assembly line, or the amount of paper produced in a mill as key productivity data. While the productivity of blue-collar workers is important, blue-collar workers represent a small and declining portion of the workforce in developed countries.

During the 20th century and continuing today, there has been a substantial shift in the nature of work. Early in the 20th century, nearly 80% of the workforce in the United States performed manual work, with the balance doing intellectual work, such as designing, planning, and managing. Today, that percentage has reversed. In addition, about 80% of the workforce in the United States is employed in service organizations. Of those employed in manufacturing, many work in management, sales, and other staff activi- ties, such as quality control and engineering. Like the seven castaways, the productivity of everyone is important because each impacts the living standard of all. Because a large portion of the U.S. workforce does intellectual work, its impact upon living standards is very important. Table 3.1 presents some examples of people doing intellectual work, key measures of their productivity, and possible methods to improve that productivity.

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CHAPTER 3Section 3.1 Understanding Productivity

Table 3.1: Productivity measures and methods of improving productivity

Worker Activity Measure Method of Improving Productivity

University faculty Educates students or educates them better

Student credit hours taught. This does not take into account what students have learned or other duties of faculty, including curriculum design, research, and service.

• Increasing class size leads to more student credit hours

• Assigning more sections per faculty also leads to more student credit hours

• Distance learning provides access to education that may not otherwise be available

• Innovative teaching methods can improve the quality or the quantity of what is learned

Postal worker Oversees the operation of an automatic sorting machine

Number of pieces of mail sorted in an hour

• Equipment improvements that speed up the sorting process

• Job training

Case worker for children’s services

Manages the care of children in foster homes

Number of cases under management at any time. This does not consider the degree of difficulty of the cases, or the quality of the service provided.

• Information systems, including databases that support care

• Communication technology that gives access to foster parents, service providers, and support services

Productivity in Service Organizations Through the last half of the 20th century, as the U.S. economy shifted from a manufacturing-based economy to a service-based economy, productivity improvements lagged because productivity gains in the service sector were more difficult to achieve. With rapid advances such as the Internet, telecommunication, and mobile devices of all types, the ability to improve the productivity of the intellectual labor force has increased drastically. Companies that are able to apply these technologies are gaining a competitive edge. For example, Northwestern Mutual has a processing cost of $.063 cents for each

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CHAPTER 3Section 3.2 Assessing Productivity

dollar of premium collected from its policyholders while its competitors’ costs range from $.15 to $.20. It is logical to argue that these companies have not managed their resources and technology effectively. Costs for telephone access, both wired and wireless, are declin- ing as technology is applied to reduce equipment and labor costs.

The Quality Condition While the importance of quality may be obvious, it is worth discussing. Productivity calculations are based on the assumption that quality levels are maintained. If an orga- nization produces more output with the same level of resources, but the quality of the output is lower, then productivity may not increase. If a company produces more com- puter software, but the software is defective and must be corrected, then the company has gained little. In fact, productivity may actually have been reduced. If a lower quality product reaches the consumer, and the product’s value to the consumer is reduced, or the consumer must spend additional resources to prepare the product for use, productiv- ity is affected. The same ideas apply to a research laboratory or an inner-city mission. If researchers’ output is higher quality, the people that use their work will benefit because the output has more value. If the mission provides better nutrition and preventive health care screening, the people using the services will feel better and the cost of health care should decline. This frees health care resources for others.

Conversely, quality may be another way to boost productivity. If firms find ways to make a higher-quality product, using the same or fewer resources, then productivity increases because the output has greater value. Following the software example, if a firm purchases new software development tools that are easier to use and result in fewer errors, the pro- ductivity of its programmers and analysts increases.

3.2 Assessing Productivity

To calculate productivity, it is essential to define and measure the inputs and the outputs of the activity. In the simplest cases, measure- ment is a trivial problem. If a manufacturing operation makes a single product on an auto- matic machine, calculating the productivity of that machine is simple. The output over a given period of time is measured. It is usually better to measure a rela- tively long period of time, days or weeks rather than minutes or hours. The reason is that the outputs may be greatly affected by a short-term occurrence such as a machine breakdown.

©iStockphoto/Thinkstock

It is essential to define and measure the inputs and the outputs of an activity to calculate productivity. If a manufacturing operation makes a single product on an automatic machine, it is simple to calculate the productivity of that machine.

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CHAPTER 3Section 3.2 Assessing Productivity

Example: Machine Productivity

If a machine can make 200,000 roofing nails in 40 hours, then the productivity of the machine is 5,000 nails per hour. This is a single-factor productivity calculation because only the machine is considered.

Machine Productivity = 200,000 roofing nails/40 machine hours Machine Productivity = 5,000 roofing nails/machine hour

The resulting data become a benchmark that the firm seeks to improve. Suppose the firm invests in a new piece of equipment that automatically feeds metal to the machine so the machine can run faster. Now, the machine is able to produce 210,000 nails in the same 40-hour period. Productivity has increased from 5,000 nails per hour to 5,250. Productivity has increased by 5%. Change in pro- ductivity is the productivity after the new equipment minus the productivity before the new equip- ment divided by the original productivity times 100. Make sure that the sign of that number is kept so it can be determined if productivity increases or decreases.

Percent Change in Productivity = (New Productivity – Old Productivity)/Old Productivity (100) Percent Change in Productivity = (5,250 – 5,000)/5,000 (100) Percent Change in Productivity = 5%

Inputs and Outputs While this simple example illustrates the method for calculating productivity, it does not consider that most operations have more than one input and more than one output. Eco- nomically, the inputs are:

1. Labor by managers and workers (either internally or externally) 2. Capital for land, facilities, and equipment 3. Materials, including energy requirements

The importance of these factors varies widely for companies producing different prod- ucts. For example, steel mills require large amounts of energy while Children’s Services, a social service agency, uses very little. In a steel plant, the significant inputs include managers, laborers, land, facilities, equipment, energy, and raw materials. The inputs for Children’s Services include management and caseworkers. For Children’s Services, the investment in land and facilities would be small compared to labor costs. Equipment investments may be relevant for information technology. Energy and raw material costs would be very small. Material costs would also be low with only small quantities of office supplies required.

Outputs can be more difficult to define and measure. For example, how would the produc- tivity of a fast-food restaurant be measured? Would it be measured by customers served per hour? If so, that calculation is problematic because customers may order different things. Measuring output as the number of items sold also can be misleading because these restaurants sell various items (such as drinks, sandwiches, and ice cream) that have different value to each customer, which is, therefore, reflected in the prices charged.

These examples illustrate two important issues that can complicate how productivity is measured: (1) How can multiple inputs with different economic values be included? In

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the fast-food example, how does the productivity of labor relate to the productivity of capital or materials?; (2) How can multiple outputs with different economic values be calculated? Continuing the fast-food example, a pizza shop may produce hot submarine sandwiches, chicken wings, and bread sticks. How does it value those outputs compared to a pizza? Even if the pizza shop sells only pizza, there are different sized pizzas with different toppings that have different economic value. In cases where there are multiple inputs or outputs with different values, dollars rather than item counts or hours worked are used to measure both inputs and outputs.

Labor Productivity

Labor is the most obvious input in the productivity equation. In fact, some businesses are concerned only with measuring labor productivity because it is easy to calculate and many managers believe it is one factor under their direct control. For many service operations, labor is the largest input. In service operations, such as banks, hospitals, and universities, labor is often 70% or more of total costs. For manufacturing firms, however, it is impor- tant to note that direct labor, people who work in producing goods, usually accounts for a small percent of total input costs—10% or less. Indirect labor, which is labor that sup- ports production such as quality, supervision, and maintenance, can be two or three times the cost of direct labor cost. If indirect labor, management costs, and outside services are added to direct labor costs, the total is usually below 50% of the cost of all inputs. Some service operations may be able to function minimally with only labor productivity, but a broader perspective on productivity may be relevant.

The simplest way to determine labor productivity is to measure output per labor-hour. This approach does not account for variations in pay rates among workers. To calculate such rate differences, many companies use labor costs as a measure of inputs. The equa- tion for labor productivity is:

Labor Productivity = Quantity or Value of Units Produced/ Labor Hours or Labor Cost

The equation for any other individual factor of productivity differs only by its title and its divisor. For example, to calculate material productivity, use material quantity or material costs as the divisor.

Capital Productivity

Another major component of production is capital, which includes all money invested in land, facilities, and equipment, as well as working capital, such as inventory. Capital pro- ductivity can increase when firms invest in new facilities and equipment that increase out- put. Capital productivity can also be increased if a company can produce the same level of output as it previously had while reducing its inventory levels or other working capital requirements. Many firms invest in new facilities and equipment in order to reduce labor costs; however, the benefits of making a capital investment may greatly expand labor productivity and capital productivity may instead decline. These trade-offs are discussed later in the text.

Service and manufacturing firms often have very different capital requirements. Service operations often have relatively small investments in capital. For example, insurance

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companies require office space, furniture, information systems, and working capital, which represent a small part of their input costs. Hybrid service operations, such as retail, often have large investments in retail outlets, distribution centers, and inventory in their network of retail outlets and distribution centers. Manufacturers usually have very large capital outlays to build production facilities.

Material Productivity

Materials and energy are often critical inputs to manufacturing processes, but may be insignifi- cant in most service operations. For manufactur- ing companies, materials often represent more than 50% of the input costs. A university may pur- chase office and laboratory supplies as materials. A hospital’s primary materials include medicine, linens, and food for the cafeteria. For universities and hospitals, materials represent a very small part of the inputs to the organization.

Trade-Offs in Productivity Productivity can increase by maintaining the level of output while decreasing inputs, or by increas- ing output without increasing any input. This is difficult to achieve, so trade-offs are necessary. Companies must contend with trade-offs among the various inputs in order to achieve increases in overall productivity, called multiple-factor pro- ductivity. In this case, some individual factors of productivity may decrease while others increase.

Trading Capital for Labor

For thousands of years, producers of food and goods have traded capital for labor. These trade- offs date back to the time when our early ances- tors first began using tools to make life easier. The

wheel and axle allowed people to carry heavy loads across greater distances. Instead of making many trips to move a certain load, a person could make one trip in a wheeled cart. This trade of capital, the investment in designing and building a wheeled cart, for less labor resulted in substantial productivity increases that are still occurring today. This is why research and development activities that design and develop new technologies and devices are important for economic health and improving living standards. In the devel- opment and application of the wheel and axle to industrial and transportation uses, some- one or a group of people had to take the time to research the concept, create a design, build and test prototypes, and put the idea into production. This investment required a shift of resources from the labor associated with doing the actual work of moving the item to be transported, to research and development on how to move the item more efficiently. This meant that someone had to take a significant risk, but the benefits have been tremendous. The impact of this investment on living standards can be seen everywhere.

©Comstock Images/Thinkstock

Materials and energy are often critical inputs to manufacturing processes, but may be insignificant within service operations. For example, laboratory supplies purchased for universities and hospitals represent a very small part of the inputs required for the organization.

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Trade-offs involving capital and labor have focused primarily on automating activities previously performed by people. In the construction business, trucks and bulldozers move large quantities of dirt and other materials on construction sites. In the automo- tive industry many boring, unpleasant, or dangerous tasks are performed by robots and other automated devices. In retail operations, checkout systems are becoming completely automated as customers check out their items using a scanner, and pay by credit card or cash. The result is high capital costs, low labor costs, and greater overall output—which generate an overall productivity increase. Higher capital costs pay for research and devel- opment as well as equipment production.

At some retail stores, cashiers are being replaced by technology that allows customers to scan items and make payments themselves. While these jobs are lost, other jobs have been created to design the new checkout equipment, develop the software, manufacture the equipment, and install the system. In addition, productivity has increased, and the cost of doing business has declined. New, better-paying jobs are created, and the economy con- tinues to grow. Productivity improvements lower the total number of jobs required. The labor saved can be used to increase leisure time, utilize more people working fewer hours, or design and create new goods and services. This is how economies grow and become stronger.

Trading Capital for Material or Energy

It also has become common to make capital investments that improve material or energy productivity. The concept and issues are similar to those discussed in the prior section. For example, a plastic injection molding company produces parts for Hewlett Packard’s laser printers. By investing in new injection molding equipment that reduces scrap, the company can produce the same number of plastic parts (output) from a smaller number of plastic pellets (inputs). In addition to leading to an increase in material productivity, the investment also reduces the amount of energy consumed because substantial energy is used to melt the pellets prior to injecting them into the molding machine. Because fewer pellets are used to make a given number of plastic parts, less energy is used and energy productivity has increased. It is not always the case that both improvements can be achieved with a single investment, but it is not uncommon.

Substituting Materials for Labor

In some instances, there may be advantages to spending more for materials in order to achieve a reduction in labor costs. Sometimes it makes sense to have a supplier do extra work, which is reflected in the price of the materials. This reduces labor costs or process- ing time for the manufacturer. Outsourcing work has become a common practice in both manufacturing and service operations. Apple’s approach to manufacturing is to concen- trate production to achieve economies of scale and to outsource production to keep costs low and productivity high. Economies of scale refers to the ability to produce more goods at a lower cost by better utilizing the same fixed costs. This can be achieved by making facilities larger, which requires less fixed costs per unit produced. Health care providers use disposable medical supplies to avoid the cost of collecting and cleaning. It is more economical to incinerate or recycle these items than it is to clean and reuse them. In some instances, such as vehicle production, assembly plants want a completely finished sub- assembly delivered by its supply so that the plant’s employees only insert the assembled

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CHAPTER 3Section 3.2 Assessing Productivity

Example: Life Insurance

Freedom Insurance Company processes claim applications. The average output in one week is 600 applications. Currently the staff includes six full-time employees who work 40 hours per week and earn $24 per hour including benefits. Management has invested in computer technology, which has a weekly cost of $1,200. Materials and energy are not used in significant amounts. What is the pro- ductivity of the application process? (continued)

part into the vehicle. An instrument panel is only one example of this. The cost of the component purchased from the supplier is higher, but the in-house assembly costs can be greatly reduced. The net impact for suppliers and manufacturers is greater productiv- ity and lower costs. Many service operations will purchase supplies that cost more, but increase the productivity of their workforce.

Improving Productivity Through Better Maintenance

Anytime equipment is involved, whether it is mechanical devices making automobiles, furniture, or telecommunication equipment moving voice or data, failure in the equip- ment leads to lower levels of equipment and labor utilization. When a pizza oven is not working because it was not properly maintained, the pizza shop loses the ability to make and sell pizza pies. The equipment cannot be used and the labor is idle; therefore, produc- tivity declines. When a software developer must wait for information because equipment is not working, both the developer’s time and the equipment are unused. As a result, a lack of effective preventive maintenance could lead to a reduction in both labor productiv- ity and equipment productivity. Performing preventive maintenance when equipment is idle is critical; otherwise productivity is disrupted.

Multiple-Factor Productivity To cope with the trade-offs that can occur when productivity improvement efforts are made, multiple-factor productivity must be considered. Multiple-factor productivity accommodates more than one input factor and more than one output factor when calcu- lating overall productivity. For example, if the owners of a pizza shop want to increase the productivity of their ovens, they may consider decreasing the time that a pizza cooks in the oven. To compensate for the reduced time, the oven’s heat is increased. A single- factor productivity calculation based on oven utilization would show an increase in capi- tal productivity because more pizzas are moving through the oven in a given period of time. However, there would also be an increase in energy consumption, which would not be factored into the calculation. With multiple-factor productivity, the outputs can be measured in dollars or the number of units produced, provided that all the units have approximately the same value.

Multiple-Factor Productivity = Quantity or Value of Output (Units Produced)/ (Labor + Capital + Materials + Energy + Other (Measured in Dollars))

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CHAPTER 3Section 3.2 Assessing Productivity

Positive Impacts of Increased Productivity Some have argued that productivity has a negative impact upon jobs and the economy because fewer people are needed to complete the same amount of work. This leads to a loss of income for the worker, and high unemployment costs and lower tax revenues for the government and the economy. This would be an accurate assessment if there was no growth in the demand for goods and services and there was no demand for new and innovative products. Developed nations such as the United States have seen substantial growth in demand for goods and services and for new, innovative products. Developing countries including the BRIC countries (Brazil, Russia, India, and China) have rapidly growing economies. Countries such as Vietnam and Thailand are poised for substantial economic growth.

The impact of productivity improvements upon cost can easily be illustrated using the investment in computer technology in the prior example. Productivity increased by 14% because more work was completed using fewer workers due to the new technology. As a result, the cost to process an application was reduced by $1.45 from $11.60 to $10.15 (1.45/11.60), a reduction of 12.5%.

Example: Life Insurance (continued)

Multiple-Factor Productivity = 600 applications/ ((6 employees) (40 hrs/wk) ($24/hr) + 1,200) Multiple-Factor Productivity = 600 applications/$6,960 Multiple-Factor Productivity = 0.086 applications/dollar

In this case, the units of productivity are applications-per-dollar. The number of applications can be used because the value of each application is approximately the same. The inverse of this number, $11.60 per application ($6,960/600 applications), is the cost of processing each application. Suppose Freedom decides to invest in additional computer equipment that will drive the weekly cost of infor- mation technology to $1,800. One of the applications evaluators is leaving the company and will not be replaced. The remaining five processors should be able to complete 650 applications per week with the new technology. What is the impact upon productivity?

Multiple-Factor Productivity = 650 applications/ ((5 employees) (40 hrs/wk) ($24/hr) +1,800)

Multiple-Factor Productivity = 650 applications/$6,600 Multiple-Factor Productivity = 0.098 applications/dollar of input

With the new investment, productivity increased from 0.086 to 0.098 applications per dollar of input costs. The gain in productivity is 14%, which is a substantial gain. The inverse of this number, $10.15 per application ($6,600/650 applications), is the cost of processing each application. To provide a point of comparison, a 3% to 4% increase in productivity per year would be considered strong growth for a developed country.

Percent Change in Productivity = (New Productivity – Old Productivity)/ Old Productivity (100)

Percent Increase in Productivity = (0.098 – 0.086)/(0.086)(100) Percent Increase in Productivity = 14%

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CHAPTER 3Section 3.3 Current Trends in Productivity

The impact on workers is not as clear. If a worker is retiring, that worker has more lei- sure time and the work that was being performed is still getting done, at a lower cost, by another worker. The result is positive for the worker, the company, and the economy. If the same worker resigns to take another job, the worker, the company, and the economy still benefit. The worker moves on to a better job, processing costs decline for the company, and the work is still being performed.

If a worker does not voluntary leave a firm, the situation is not as clear. The company still benefits because processing costs decline. What effects impact the worker and the econ- omy, though? If the right economic circumstances are in place, they will benefit as well. When the business environment is conducive to innovations and an overall growing econ- omy, this job loss is positive rather than negative because it creates slack in the labor force, or unemployment in the economy. Slack in the labor force can be put to work creating new ideas, new products, and new companies. Slack can be used to staff businesses that must hire and train new employees because a company is growing faster than its productivity growth rate. At a macro level, this is precisely what has happened many times as the U.S. economy transitioned from an agricultural, to a manufacturing, to a service-based econ- omy. Information technology, the Internet, cloud computing, and mobile devices are the forces driving the current transformation under which more people will work from home and will change jobs more frequently as the process for creative destruction accelerates. Creative destruction is when new ideas or technologies replace outdated ideas or tech- nologies, as in the case of online video streaming replacing DVDs and DVD rental shops. Typically, during creative destruction, jobs are gained in one area and lost in another. To help with such transitions, governments offer unemployment insurance and federal and state retraining programs. Some colleges and universities reach out to non-traditional students in an effort to increase the education and skills needed to compete in a new job market.

3.3 Current Trends in Productivity

Over time, productivity growth in the U.S. economy has been inconsistent. There was strong growth in the 1960s, followed by low and in some cases negative growth in the late-1970s and early-1980s. As the 1990s began, productivity growth began to accelerate and has continued to show positive growth. The rate of growth in pro- ductivity tends to be stronger when the economy is strong and weaker when the economy slows down.

Increasing productivity often drives business performance. As organizations achieve more output with the same resources, the economy grows. Refer to the island example mentioned earlier in the text; more is produced so there is more to consume. At the same time, profits expand even if the selling price of the product does not increase. For Apple, profits grow drastically even when the selling price of its products declines because the quantity sold increases. The cost structure of the firm (at least the labor portion) does not change, and there is more revenue from increasing sales. Therefore, bottom-line profits can expand drastically. For example, as Microsoft finds ways to produce and distribute more copies of its software while maintaining the same resources used in these activities, it will generate greater revenue and profit.

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CHAPTER 3Section 3.3 Current Trends in Productivity

In many cases, productivity improvements are driven by investments in technology, and these investments drive eco- nomic growth. For example, as retail companies such as Walmart invest in Internet appli- cations for sales transactions, repair parts and service, and advertising, demand for tech- nology from companies such as Cisco Systems and Intel acceler- ates. Cloud computing compa- nies such as Salesforce.com and Brocade offer ways to reduce investment in IT equipment and facilities while providing a flex- ible and inexpensive platform to engage and serve customers. As the U.S. economy continues to shift away from manufactur- ing and toward services, invest- ments in information technology for service operations become more important for pro- ductivity growth and economic expansion.

Productivity and Wage Rates Generally, wage rates and productivity are positively correlated. This positive correlation means that organizations with high productivity can afford to pay their workers better wages because their workers produce more output. This correlation has implications for companies that are selecting locations for their operations. A country with a low wage rate does not necessarily have low unit labor costs because workers in the country may have low productivity. For example, if someone was asked to move a pile of dirt from one point to another and was given a shovel and a wheelbarrow to do the work, the pro- ductivity would be relatively low. On the other hand, if the person was given a bulldozer and proper training, productivity would be much higher. The bulldozer operator is paid a higher wage because the operator moves more dirt faster. Wage rate is not the sole determinant of unit labor cost. The other important factor is productivity, or the number of units produced.

To provide a context for the dirt-moving problem, suppose that a person with the wheel- barrow and shovel is paid $2 per hour and can move 1 cubic yard of dirt in one hour. The bulldozer operator makes $24 per hour and can move 20 cubic yards in one hour. The labor cost to move the dirt by wheelbarrow is $2 per cubic yard ($2/hr) / (1 cubic yard/hr). The labor cost to move the dirt by bulldozer is $1.20 per cubic yard ($24/hr) / (20 cubic yard/hr). The owner of the construction company is able to pay higher wages and achieve lower costs because the investment in equipment and training has boosted productivity drastically. After paying the higher wage, the owner is able to save enough labor cost to pay for the bulldozer, buy fuel to operate it, and pay to train the employee.

©iStockphoto/Thinkstock

Cloud computing companies offer ways to reduce investment in IT equipment and facilities, while providing a flexible and inexpensive platform through which to engage and serve customers.

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CHAPTER 3Section 3.3 Current Trends in Productivity

Productivity and the Workforce Some people would argue that productivity improvements such the one described in the previous section take jobs away from workers. A construction company that once employed 20 manual laborers employs only one bulldozer operator with the introduc- tion of the new technology. Their claim is based on the fact that the construction com- pany now employs one bulldozer operator who does the work of 20 laborers. While this is true, it is only one component of productivity. Refer once again to the example of the castaways; they could only consume what they produced. The same is true for society. If wheelbarrows and shovels had been used to build highways, there would not have been sufficient labor to build the vast interstate systems and other road networks unless work- ers were taken from appliance manufacturing, teaching, medicine, and other occupations to move the dirt. In addition, the highway system would have cost much more to build. Productivity improvements, such as earth-moving equipment, are essential for design- ing and building more goods and services at a lower cost, which increases the standard of living.

In addition, the net job loss in this example is not equal to 19 jobs because new jobs are cre- ated to design and manufacture the bulldozer. Jobs are also created to sell and service the equipment. Workers and equipment are needed to transport the bulldozer from one job location to another. As a result, new jobs are created, and most of these jobs require higher levels of education than moving dirt with a wheelbarrow. Will this substitution generate enough new jobs to make up for the 19 that were lost? The answer to this question is easier to understand when viewed broadly. Society would not have a net productivity gain if the same or more work is required to design, build, sell, and service the bulldozer than was saved by the substitution of capital (the bulldozer) for labor. Society benefits because more work is completed with fewer total resources. Also, the remaining bulldozer operator is paid substantially more than wheelbarrow operators. The jobs created to engineer, manu- facture, and sell the bulldozer are also likely to carry higher salaries than the wheelbarrow operator. Higher wages must offset the savings generated from increasing productivity. As a result, there are displaced workers who become available to create new products that grow the economy.

Productivity and Leisure Productivity increases do not always result in greater output. As productivity in the United States increases, some of the benefits include more leisure time for workers. In the United States, the “nominal” workweek has been 40 hours for several decades. In the first half of the 20th century, however, the workweek was much longer—50 to 60 hours and a six-day workweek was not uncommon. During that time period, time off for holidays and vacation was substantially less than what is considered normal today. Dramatic increases in productivity allowed the U.S. economy to experience an expanding living standard and a contracting workweek.

Today, employees in many countries in Europe have shorter workweeks and more gener- ous vacations than employees in the United States. However, such choices have implica- tions for the people in these European countries. If they want to work fewer hours, there is less for them to consume unless they can find ways to increase productivity.

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CHAPTER 3Section 3.4 Enhancing Productivity

3.4 Enhancing Productivity

Productivity increases sound ideal, but how can a company achieve them? Some managers view productivity improvements narrowly and attribute improvements to attention to the details of the production process. For example, changing the height of a desk so that an administrative assistant has easier access to the keyboard may increase productivity. This adjustment can be an important contribution in eliminating physical stress and reducing fatigue, which could lead to greater output. This narrow view, however, is far from the whole picture. Productivity is affected by:

• Design of operations including the number, size, location, and capacity of the facilities providing the service or producing the good.

• Equipment and methods used. • Detailed analysis of the individual jobs and activities.

Productivity and the Design of Operations The first issue is not as simple as saying that fewer, bigger facilities will result in higher pro- ductivity and lower costs, although that tends to be true and is what conventional economic theory conveys. This is generally referred to as the economies of scale argument. Effectively designing operations matches the capabilities of the facilities to the needs of the customer. For example, health care productivity could be increased and quality could be enhanced if hospitals specialize. Currently, many hospi- tals are merging or forming alliances. These unions permit one hospital to specialize in some areas, such as pediatrics and obstetrics, while another hospital specializes in other areas, such as neurology and psychiatry. In this way, each hospital avoids duplicating the cost of expensive equipment, highly trained staff, and administrative overhead.

©Ryan McVay/Thinkstock

Health care productivity can be increased and quality enhanced when hospitals specialize in different areas such as pediatrics or neurology. In this way, they avoid duplicating expensive equipment, highly trained staff, and administrative overhead.

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CHAPTER 3Section 3.4 Enhancing Productivity

Real World Scenarios: Segway Personal Transporter

The Segway PT is an example of a technology that could revolutionize work and drastically increase productivity. It is the first self-balancing, electric-powered transporter and is designed to enhance the productivity of people by increasing the distance they can travel and the amount of goods they can carry. Segway uses electronic gyroscopes for balance and microprocessors to measure the rider’s intent (leaning forward or leaning backward) for forward and backward motion. Dean Kamen and a group of talented engineers and designers inspired this innovation.

More than 1,200 police departments and public safety organizations around the world use the Segway PT. The Segway PT allows these officers to create innovative community programs, connect better with the residences they serve, and patrol more area in less time. The Segway improves visibility as the officer can see surroundings better and people can see the officer better, and it is flexible enough to be used inside buildings, such as airport terminals, as well as outside. It also has zero emissions.

Segway PTs are currently used to patrol military bases, allowing soldiers to inspect buildings on the post in less time. The Segway PT can cover a variety of terrain, is versatile and maneuverable, and provides effective crowd control. (continued)

Real World Scenarios: Shouldice Hospital

Shouldice Hospital in Ontario has specialized in the repair of hernias since 1945, when Dr. Shouldice experienced a large number of hernia cases and a shortage of doctors and medical facilities. Special- ization allowed the hospital and the doctors to find innovative ways to perform hernia repair surgery. The hospital reduced resource requirements and increased productivity.

The objective of the surgery is successful repair of the hernia(s) with as little discomfort as possible for the patients so they can return to their normal life quickly. Patients frequently return to work in a few days; the average total time off is only eight days.

The hospital’s success has been the benchmark for the medical profession internationally. The hospi- tal has repaired more than 270,000 hernias with a success rate greater than 99%. Shouldice patients can walk out of the operating room, and their postoperative recovery is rapid. By the following morn- ing, most patients can participate in a gentle exercise program. The process, from surgery to recov- ery, is fast and effective for both the hospital and the patient.

Productivity and Equipment and Methods The equipment and methods used to provide a service or produce a good can also have a substantial impact upon productivity. Providing the company’s sales force with software to identify prospects, determine their needs, and track sales makes it a more productive work force, just as providing a factory worker with a newer and faster piece of production equipment. Providing faculty with software to manage instructional materials improves productivity as well; the tool should fit the job. For example, if an employee is asked to move 1 million gallons of water from one point in a facility to another, an electric pump and a hose is much better than a bucket. In turn, neither the bucket nor the pump would be appropriate for moving small amounts of water to make coffee at the corner restaurant.

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CHAPTER 3Section 3.4 Enhancing Productivity

Productivity and Detailed Analysis of Work Detailed analyses of individual jobs and activities focus on making people more pro- ductive. Analysis may suggest a better way to complete more work. For example, most home dishwashers have a removable silverware rack so the rack can be moved to a convenient location and the sil- verware can be easily removed. When given a task such as this, most people will use only their dominant hand. With a small amount of training, a person can be taught to use both hands. This enables the task to be com- pleted in approximately 70% of the time it would take for a per- son using only one hand. When ideas like this are applied to the billions of repetitive tasks per- formed each day in service and manufacturing firms through- out the world, productivity improvements and cost reduc- tions could be enormous.

Summary of Methods Innovation and automation change the way work is done and provide important methods to increase productivity. When organizations increase the number of customers served, there are opportunities to achieve lower cost and higher productivity through economies of scale. Additionally, as organizations gain experience by serving more customers, they learn how to do the work better. This is often called continuous improvement. There are also opportunities to improve how work is done through redesigning business processes, improving how individual jobs are designed, and enhancing a firm’s human resources. The following discussion focuses on several approaches that can be used separately or in combination to increase productivity.

©Roger Wright/Getty Images

When completing tasks, most people will use only their dominant hand. With a small amount of training, a person can be taught to use both hands, enabling the task to be completed in about 70% of the time it takes using only one hand.

Real World Scenarios: Segway Personal Transporter (continued)

Paramedics with the Chicago Fire Department use the Segway PT to enhance response time. They provide shorter response time for medical emergencies, can carry enough equipment to provide lifesaving treatment before an ambulance arrives, and can access upper floors in high-rise buildings.

Segway PT also enables enhanced security in shopping malls in Sonae Sierra, Portugal. The patrols are done more quickly and effectively on a Segway PT than on foot, thereby increasing the produc- tivity of security personnel who patrol the company’s large shopping centers. In turn, shoppers and storeowners notice the security personnel, and feel safer and more secure.

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CHAPTER 3Section 3.4 Enhancing Productivity

• Technology Innovation—Brings new ideas, methods, or equipment to the process of making a product. In banking, computers and information technology have changed the process for reconciling checking account transactions and have greatly increased productivity. Using technology in distribution centers and warehouses has enabled retailers to increase productivity and reduce costs.

• Automation—Substitutes capital for labor. Automation is different from techno- logical innovation because existing automation is merely applied to a new situa- tion. Using conveyors to move parts between points in a packaging operation can increase productivity. Conveyor technology has been available for decades, but it is constantly finding new applications.

• Economies of Scale—Allow firms to increase productivity by making operations larger. Both service and manufacturing operations take advantage of this tactic to improve productivity and lower costs. Consolidation in the banking industry is being driven by the need to spread fixed costs, such as information systems, credit card processing, bank infrastructure, and management, over a broader range of operations. This consolidation is also occurring in accounting firms, brokerage houses, and credit card companies.

• Learning and Experience—Enable firms to achieve productivity improvements because the workforce gains knowledge about the product and work processes. From this knowledge, workers find better ways to organize work. This concept was first applied in the aircraft industry so firms could estimate the cost of future orders. The productivity improvements and the cost reductions were substantial.

• Business Process Redesign—Focuses on the understanding and redesign of pro- cesses that already exist within and between companies. For example, how can a company streamline its product development process to create more and better product ideas in less time than the existing process?

• Job Design and Work Measurement—Enable firms to examine work at a detailed level so that it can be investigated and improved. This examination often occurs at the level of the individual worker or the interface between a worker and a machine. The approach tends to examine individual movement to improve pro- ductivity. For example, the kitchen setup in a fast-food restaurant is laid out so the cook can make items on the menu with ease. This is the same overall objec- tive used in a manufacturing firm to organize the assembly area to put together a speaker or a keyboard.

• Human Resources—Enable productivity improvements without investing in facili- ties and equipment, buying high-quality materials, redesigning jobs and pro- cesses, or spending for employee training. In many organizations, the rate of pro- duction is labor constrained. If labor is motivated to do more work, productivity can increase without additional investments or cost increases. For example, when faculty members sign additional students into their classes, they have increased productivity with no additional costs. When sales managers add another sales territory to their workload, their productivity increases without increases in costs. Motivation is a powerful tool that can be used to increase productivity in any job that is labor intensive.

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CHAPTER 3Case Studies

Chapter Summary

• Productivity is the ratio of the outputs achieved from an activity to the inputs consumed to make those outputs.

• Productivity is a key to increasing the standard of living. Productivity is more important than money when driving economic growth.

• During the 20th century, the nature of work shifted from primarily manual to primarily intellectual. As a result, the productivity of managers, designers, and planners is as important as or more important than the productivity of blue-collar workers.

• Calculating productivity involves: (1) assessing the outputs either by counting the number of outputs, or by determining the economic value of the outputs; and (2) assessing the inputs by determining their value. Single-factor productivity is used when only one input factor changes. Multiple-factor productivity is used when more than one input factor changes.

• Primary inputs are labor (managers, workers, and externally purchased services), capital (land, facilities, and equipment), and materials, including energy.

• In many cases, when firms seek productivity improvement, trade-offs between the inputs occur. Managers may be trading capital for labor, capital for energy, or mate- rial for labor in order to get an overall increase in productivity.

• Wage rates and productivity are positively correlated. Organizations with high productivity can pay higher wage rates.

• Productivity improvements have two impacts on jobs. First, they tend to shift jobs from hands-on labor to behind-the-scenes labor. The hands-on jobs usually require manual work, and the behind-the-scenes jobs tend to require intellectual work. Second, they free labor to seek opportunities to create new services and goods.

• Technology innovation, automation, economies of scale, business process redesign, learning and experience, job design and work measurement, and improvements in human resources are all methods of enhancing productivity.

Case Studies

All-Right Manufacturing Company Nancy Nelligan just received the following memo from her boss, the president of All- Right Manufacturing Company.

TO: Nancy Nelligan, V.P., Finance FROM: Leo Everitt, President RE: Productivity Improvement Program

I am sure you are aware of the importance of productivity within manufac- turing organizations, and All-Right is no exception. However, I am not sure that our company’s productivity is as good as it could be. As such, I would like you to serve as coordinator of a productivity improvement program. As our newest executive, I think this would be a great opportunity for you to become involved and have a substantial impact upon this organization.

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CHAPTER 3Case Studies

I have already sent memos to the other vice presidents and division man- agers directing them to cooperate with you on this activity. Please report back to me in two months indicating the actions you have taken and the results you have achieved.

Nancy just started working for All-Right one month ago. She had previously held a posi- tion in the corporate finance department of a Fortune 500 company. In that position, Nancy was extensively involved in securing capital for expansion and acquisition.

In her previous position, Nancy had not been directly involved in any productivity improvement activities, although she was aware of the productivity reports produced by her previous employer and knew how the data were collected and analyzed. To the best of her knowledge, All-Right does not collect any data or perform any calculations to determine productivity. The president’s vague feeling that productivity could be better supported Nancy’s belief that All-Right was not calculating productivity.

Since joining All-Right, Nancy has met most of the other vice presidents and managers. Some of them she knows fairly well, although Nancy is still regarded as the “new kid on the block.” She has learned from discussions with the vice president of operations that the company had made an abortive attempt at implementing ISO-9000 a few years ago, an attempt which had initially been mandated by a memo from the president. She wondered whether the productivity improvement program would end the same way.

1. Was the president’s approach to productivity improvement the correct way to implement such a program?

2. Was the time frame the president gave reasonable for achieving meaningful results? 3. Pretend you are Nancy and draft a memo to the president suggesting the course

of action that you think should be taken to achieve useful results. In the memo, include a summary of the types of data needed to calculate productivity.

Wholesome House Restaurants Wholesome House Restaurants operates a chain of health-food restaurants located in sub- urban shopping malls. The company has tried to capitalize on increased public awareness about healthy eating by offering low-calorie, low-fat cuisine to its customers. Instead of the usual fare available at fast-food restaurants, Wholesome House offers its customers dishes that include fish and chicken cooked without fat. In addition, the company’s res- taurants provide fresh fruits and vegetables and whole-grain breads. Since it opened, the company has been doing quite well. However, like most start-up companies, Wholesome House is concerned about its future. The restaurant business has become increasingly competitive, and many chains that started out well have gone bankrupt.

Wholesome House’s management is concerned about rising operating costs and the com- pany’s productivity. Presently, its restaurant operations are labor intensive because of the cuisine it offers. Using only fresh fruits and vegetables requires extensive time and effort for food preparation. In addition, the sandwiches and most other meals on the menu are assembled by hand. Wholesome House has not adopted any of the assembly-line tech- niques for producing mass quantities of food that fast-food restaurant chains such as McDonald’s and Taco Bell use. On the other hand, Wholesome House is able to charge more for its products because of its market niche and because most of the restaurant’s customers have average or above-average incomes.

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CHAPTER 3Problems

Wholesome House has collected the following data concerning its operations.

Two Years Ago Last Year

Net sales and operating revenue $473,286,000 $631,987,000

Labor costs 120,470,000 203,405,000

Material and supplies 150,032,000 206,783,000

Services 35,991,000 45,276,000

Capital 127,486,000 250,478,000

1. Based on the information provided, comment on the company’s productivity. 2. Can you identify inputs in which productivity has not followed the company’s

overall change in productivity? 3. Which areas do you think need attention for future productivity improvements? 4. Can you suggest how the company might improve productivity?

Discussion Questions

1. Define productivity and describe why it is important. 2. Describe why productivity is more important than money. 3. Explain how the nature of work has changed, and describe how that affects

productivity. 4. What is the difference between single-factor and multiple-factor productivity? 5. Describe labor productivity. What are its components? 6. Describe capital productivity. What are its components? 7. Describe material productivity. What are its components? 8. What are the important trade-offs involving the inputs to productivity? 9. How are wage rate and productivity related?

10. What are the impacts of productivity upon the workforce? 11. How does quality impact productivity? 12. Describe five ways that productivity can be enhanced.

Problems

1. A junior accountant working for an accounting firm earned $40,000 last year in wages and benefits. The work this person performed was billed to clients at $200,000 for the year. What is the junior accountant’s labor productivity?

2. A certain machine makes various-sized screws that have a market value of $50,000 per year. Materials used to make those screws cost $5,000 per year. The annual cost of owning and operating the screw-making machine totals $25,000. What is the productivity of that machine? What is the productivity of the materials? What is the overall productivity?

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CHAPTER 3Problems

3. A company that manufactures radios had sales of $3,750,000 last year. Total labor costs for the year were $1,500,000, capital costs were $1,275,000, and mate- rials costs were $750,000. What was the company’s productivity based on this information?

4. The New City Hospital has recorded its patient billings and labor costs during the last two years. How has the hospital’s labor productivity changed?

Two Years Ago Last Year

Total billings $10,230,000 $12,450,000

Labor costs 4,375,000 5,200,000

5. The Electro-Lite Electronics Company has recently automated part of its produc- tion process. The labor, capital costs, and value added by this process for the last two years are shown below. Compare the productivity of labor and capital for these years.

Two Years Ago Last Year

Value added $1,365,000 $1,425,000

Labor costs 870,000 375,000

Capital costs 160,000 924,000

6. The company mentioned in Problem 3 is considering substituting capital for labor by purchasing automated equipment to perform an operation previously done manually. This new equipment will cost $200,000 per year to own and oper- ate. What must the labor savings be in order to produce an increase in overall productivity?

7. Michael’s Manufacturing wants to determine the overall productivity of its operations. The company has data for one month last year and good current data. The sales price of the product is $40.00, the wage rate (including benefits) is $18.00 per hour, the resin cost is $.60 per pound, and the energy cost per BTU is $.50. These costs can be applied to both years. What was the productivity then and what is it now? At what rate is productivity changing?

Last Year This Year

Production (units) 2,000 2,150

Labor hours 600 550

Resin (pounds) 100 90

Capital (dollars) 20,000 23,000

Energy (BTUs) 6,000 5,700

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CHAPTER 3Key Terms

creative destruction When new ideas or technologies replace existing products, such as when sales and jobs decline in existing companies and grow quickly in the companies with new ideas.

direct labor People who make a prod- uct or provide services; the hands-on workforce.

economies of scale The ability to produce more goods at a lower cost by better utiliz- ing the same fixed costs. There is a most efficient size for a facility and there is a most efficient size for a firm; building sufficient sales and production volume is necessary to maximize the fixed costs of an organization.

indirect labor Labor that supports the production of a good or service such as quality, supervision, and maintenance.

productivity Output from an activity divided by total input to the activity.

8. Suppose the company in Problem 7 wants to increase productivity by 5%. How much labor savings must occur to achieve this?

9. Witkowski Tax Services processes federal income tax forms. This year in April, the company’s busiest month, the company prepared 4,500 income tax returns with an average revenue of $60 each. In April last year, they completed 3,750 returns with an average revenue of $55 each. Below are the average costs, adjusted for inflation.

Last Year This Year

Labor hours $3,000 $3,200

Management costs 25,000 28,000

Computer technology 15,000 20,000

Rent for office 2,000 2,200

Office supplies 3,000 3,600

a. What is the productivity this year and last year for each factor and overall? b. How has the productivity changed for each factor and overall? c. What can be done to further improve productivity?

Key Terms

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