How Does Productivity Affect Profitability?
October 26, 2011 4 Comments
We all know there are several factors that affect profitability. One of my favorite considerations is productivity. Increasing productivity levels can dramatically increase profitability. Typically, profitability is evaluated from a financial statement prospective, and labor is measured as a percentage of sales. Often, the natural inclination is to decrease labor costs through lay-offs and work force reductions.
However, rather than reducing our work force, productivity provides a platform to increase the output of our current work force and thereby increasing profitability. A key starting point to uncovering the potential profits hidden within productivity is asking questions such as; “How productive is our work force?” and, “How do our current productivity levels affect our profitability?”
Often, there is difficulty in determining a method to answer these questions due to the complexity of our manufacturing operations, ERP systems and reporting systems. Simplifying the process with productivity models helps to gain insights on the potential Return On Investment involved with the pursuit of increasing work force productivity.
The productivity model below illustrates the effect of productivity on profits. The first table explains the basic assumptions behind the model.
| Assumptions | |
| Process Time (sec) | 250 |
| Product Sales Price | $5.63 |
| Project Quantity | 10,000 |
| Project Runs Per Month | 5 |
| Labor Cost / hour | $25.00 |
Next, this model illustrates the effect of productivity on the profitability of one manufacturing process, produced five times within one reporting period.
Profitability
| Productivity |
50% |
60% |
70% |
80% |
100% |
| Revenue |
$281,250.00 |
$281,250.00 |
$281,250.00 |
$281,250.00 |
$281,250.00 |
| Labor Cost |
$173,611.11 |
$144,675.93 |
$124,007.94 |
$108,506.94 |
$86,805.56 |
| Manufacturing Cost (50%) |
$140,625.00 |
$140,625.00 |
$140,625.00 |
$140,625.00 |
$140,625.00 |
| Gross Profit |
$(32,986.11) |
$(4,050.93) |
$16,617.06 |
$32,118.06 |
$53,819.44 |
This model demonstrates how powerful productivity is, as a factor in profitability. While developing processes to track productivity outside financial reporting mechanisms, can be cumbersome and complicated, there is opportunity for a substantial ROI on these efforts. We can begin to reap these additional profits by following this five-step process.
- Define processes and sub processes
- Perform time studies and line balance
- Implement consistent training methods and train supervisors and line employees to the process
- Set productivity goals
- Monitor output and measure against goals
Practicing these steps is a great place to start unlocking the hidden profitability opportunities within our manufacturing processes!
A good place to begin removing complexities in our manufacturing operations is in our secondary processes. Often there is a clear delineation between a primary manufacturing process and a secondary process. For example, an organization that produces plastic widgets may identify its primary manufacturing process as injection molding, the conversion of plastic into a widget. Processes such as separating, assembly, packaging and finishing are considered its secondary processes.
A great way to minimize labor expenses and maximize sales revenues is to improve our processes. Strategies such as, Business Process Improvement (BPI) and Total Quality Management (TQM), encourage organizations to change, to communicate and to involve the whole organization in meeting the business objectives set in strategic planning sessions.
Yes, yes and yes, lean manufacturing principles do apply to new product launches. In our journey to launch new products, how many times have we faced one or more of the seven wastes identified in Lean Manufacturing such as:
“A Corporation is a living organism; it has to continue to shed its skin. Methods have to change. Focus has to change. Values have to change. The sum total of those changes is transformation.”
