Prepared by Douglas Cloud Pepperdine University

1. Productivity Measurement and Control Prepared by Douglas Cloud Pepperdine University

2. Objectives After studying this chapter, you should be able to: 1. Explain the meaning of productive efficiency, and describe the difference between technical and allocative efficiency. 2. Define partial productivity measurement, and list its advantages and disadvantages. 3. Explain what total productivity measurement is, and name its advantages. 4. Discuss the role of productivity measurement in assessing activity improvement.

3. Productivity: Measurement and Control Productivity is concerned with producing output efficiently, and it specifically addresses the relationship of output and the inputs used to produce the outputs.

4. Productive Efficiency Total productive efficiency is the point at which two conditions are satisfied: (1) For any mix of inputs that will produce a given output, no more of any one input is used than necessary to produce the output. (2) Given the mixes that satisfy the first condition, the least costly mix is chosen.

5. Inputs: Outputs: 4 Labor 6 Capital Improving Technical Efficiency Technical Efficiency is the condition where no more of any one input is used than necessary to produce a given output. Technical efficiency improvement is when less inputs are used to produce the same output or more output are produced using the same input. Current productivity

6. Inputs: Outputs: 3 Labor 6 Capital Improving Technical Efficiency Same Output, Fewer Inputs

7. Outputs: 8 Inputs: 4 Labor Capital Improving Technical Efficiency More Output, Same Inputs

8. Inputs: Outputs: 3 8 Labor Capital Improving Technical Efficiency MoreOutput, Fewer Inputs

9. Inputs: Outputs: 3 Labor 8 Capital Total cost of inputs = $20,000,000 Improving Technical Efficiency Technically Efficient Combination I:

10. Inputs: Outputs: 2 Labor 8 Capital Total cost of inputs = $25,000,000 Improving Technical Efficiency Technically Efficient Combination II: Of the two combinations that produce the same output, the least costly combination would be chosen.

11. Productive Measurement • Productive measurement— • is a quantitative assessment of productivity changes • can be actual or prospective • is forward looking • serves as input for strategic decision making • allows managers to compare relative benefits of different input combinations

12. Partial Productivity Measurement • Partial Productivity Measurement: Measuring productivity for one input at a time. Partial Measure = Output/Input • Operational Productivity Measure:Partial measure where both input and output are expressed in physical terms. • Financial Productivity Measure:Partial measure where both input and output are expressed in dollars.

13. 2003 2004 Number of frames produced 240,000 250,000 Labor hours used 60,000 50,000 Materials used (lbs.) 1,300,000 1,150,000 Partial Productivity Ratios 2003 Profile 2004 Profile Labor productivity ratio 4.000 5.000 Material productivity ratio 0.200 0.217 Profile Productivity Measures No Trade-Offs 250,000/50,000 250,000/1,150,000

14. 2003 2004 Number of frames produced 240,000 250,000 Labor hours used 60,000 50,000 Materials used (lbs.) 1,200,000 1,300,000 Partial Productivity Ratios 2003 Profile 2004 Profile Labor productivity ratio 4.000 5.000 Material productivity ratio 0.200 0.192 Profile Productivity Measures With Trade-Offs 250,000/1,300,000

15. Profit-Linked Productivity Measurement Profit-Linkage Rule: For the current period, calculate the cost of the inputs that would have been used in the absence of any productivity change, and compare this cost with the cost of the inputs actually used. The difference in costs is the amount by which profits changed because of productivity changes. To compute the inputs that would have been used (PQ), use the following formula: • PQ = Current-period Output/Base-period productivity ratio

16. Profit-Linked Productivity Measurement 2003 2004 Number of frames produced 240,000 250,000 Labor hours used 60,000 50,000 Materials used (lbs.) 1,200,000 1,300,000 Unit selling price (frames) $30 $30 Wages per labor hour $15 $15 Cost per pound of material $3 $3.50

17. Cost of labor: (62,500 x $15) = $ 937,500 Cost of materials: (1,250,000 x $3.50) = 4,375,000 Total PQ cost $5,312,500 The actual cost of inputs: Cost of labor: (50,000 x $15) = $ 750,000 Cost of materials: (1,300,000 x $3.50) = 4,550,000 Total current cost $5,300,000 Profit-Linked Productivity Measurement PQ (labor) = 250,000/4 = 62,500 hrs. PQ (materials) = 250,000/0.200 = 1,250,000 lbs.

18. Profit-linked effect = Total PQ cost – Total current cost Profit-Linked Productivity Measurement = $5,312,500 – $5,300,000 = $12,500 increase in profits The net effect of the process change was favorable. Profits increased $12,500 because of productivity changes.

19. Profit-Linked Productivity Measurement (1) (2) (3) (4) (2) – (4) (PQ x P) – Input PQ PQ x P AQ AQ x P (AQ x P) Labor 62,500 $ 937,500 50,000 $ 750,000 $817,500 Materials 1,250,000 4,375,000 1,300,000 4,550,000-175,000 $5,312,500 $5,300,000 $ 12,500 250,000/4 250,000/0.200

20. Output and Input Measures Output/Input Profile and Profit-Linked Analyses Activity Productivity Model Input (Resources) Activity Output

21. 2003 2004 Number of purchase orders 200,000 240,000 Material used (lbs.) 50,000 50,000 Labor used (number of workers) 40 30 Cost per pound of material $1 $0.80 Cost (salary) per worker $30,000 $33,000

22. Profile Analysis 2003 2004 Materials 4 4.8 Labor 5,000 8,000 (1) (2) (3) (4) (2) – (4) (PQ x P) – Input PQ PQ x P AQ AQ x P (AQ x P) Labor 60,000 $ 48,000 50,000 $ 40,000 $ 8,000 Materials 48 1,584,000 30 990,000 594,000 $1,632,000 $1,030,000 $602,000 Activity Productivity Analysis Illustrated

23. Output and Input Measures Output/Input Profile and Profit-Linked Analyses Process Productivity: Activity Output Efficiency Input (Resources) Process Output

24. Productivity Data: Sales Process, Carthage Company 2003 2004 Number of sales orders 20,000 25,000 Activity data: Making sales calls Number of calls (output) 50,000 40,000 Labor used (hrs.) 100,000 80,000 Materials used (lbs.) 200,000 200,000 Cost per pound of material $6 $5 Labor cost (per hour) $30 $30 Activity rate $84 $80 Continued

25. Productivity Data: Sales Process, Carthage Company 2003 2004 Number of sales orders 20,000 25,000 Activity data: Handling objections Number of objectives handled (output) 25,000 10,000 Labor used (hrs.) 30,000 15,000 Materials used (number of samples) 25,000 5,000 Cost per sample $40 $40 Labor cost (per hour) $30 $30 Activity rate $76 $76

26. Resource Efficiency Component A. Making Sales Calls Profile Analysis 2003 2004 Labor 0.50 0.50 Materials 0.25 0.20 Profit-Linked Productivity Measurement (1) (2) (3) (4) (2) – (4) (PQ x P) – Input PQ PQ x P AQ AQ x P (AQ x P) Labor 80,000 $2,400,000 80,000 $2,400,000 $ 0 Materials 160,000 800,000 200,000 1,000,000 -200,000 $3,200,000 $3,400,000 $-200,000

27. Resource Efficiency Component B. Handling Objections Profile Analysis 2003 2004 Labor 0.83 0.67 Materials 1.00 2.00 Profit-Linked Productivity Measurement (1) (2) (3) (4) (2) – (4) (PQ x P) – Input PQ PQ x P AQ AQ x P (AQ x P) Labor 12,048 $361,440 15,000 $450,000 $ -88,560 Materials 10,000 400,000 5,000 200,000 200,000 $761,440 $650,000 $111,440

28. Profile Analysis 2003 2004 Making sales calls 0.400 0.625 Handling objections 0.800 2.500 Profit-Linked Productivity Measurement (1) (2) (3) (4) (2) – (4) (PQ x P) – Input PQ PQ x P AQ AQ x P (AQ x P) Calls 62,500 $5,000,000 40,000 $3,200,000 $1,800,000 Objections 31,250 2,375,000 10,000 760,000 1,615,000 $7,375,000 $3,960,000 $3,415,000 Activity Output Efficiency A. Activity Output Efficiency

29. Quality and Productivity Improving quality may improve productivity. If rework is reduced by producing fewer defective units, then less labor and few materials are used to produce the same output. Reducing the number of defective units improves quality; reducing the amount of inputs used to improve productivity.

30. End of Chapter