Productivity and Efficiency Calculations for Business

As business professionals, we take some important business concepts for granted. Today, we’ll explore two that are often confused with each other and see if I can offer a perspective that I hope will add some clarity or, at the very least, add some value to the conversation and debate.

Today we’ll discuss the difference and see how they are different through the evaluation of productivity and efficiency calculations.

Consider the following:

Productivity Example
Quantity $/Unit
Car X 4000 $8,000
Car Y 6000 $9,500
Labor Hours for X 20,000 $12/Hour
Labor Hours for Y 30,000 $14/Hour


Worker Productivity

Part of managing processes is to measure their performance.

This article will discuss 2 basic process measures: Productivity and Efficiency.

For instance,

Simply, productivity is measured like this:

Productivity = Outputs / Inputs

What is the labor productivity in Hours for each car type?

Car X: (4,000 cars / 20,000 Hours) = 0.2 Cars / Hour
Car Y: (6,000 cars / 30,000 Hours) = 0.2 Cars / Hour

How about in labor Productivity in Dollars?

Car X: [(4,000 * $8,000) / (20,000 * $12)] = $133.33 / Car
Car Y: [(6,000 * $9,500) / (30,000 * $14)] = $135.71 / Car

So, based on the data set above, it appears that Productivity by Hours, both Car X and Car Y are the same; but, Productivity by Dollars, Car X is cheaper to make given the labor hours and hourly rate.

How is this practical?  Below is a direct citation from the Harbour Report, 1998:

Labor hours needed for stamping, power train, and assembly operations:

Harbour Report
(100% Nissan 27.6 hours
(168%) GM 46.5 hours
(126%) Ford 34.7 hours

If GM could operate at Nissan’s level of productivity, they’d save themselves about $4.4 Billion Per Year.  Measured another way, GM has about 55,000 more workers than it needs.

Worker Efficiency

Efficiency is measured with the following equation:

Efficiency = [100% * (actual output / standard output)]

Standard Output in the equation above is a number that is arrived at by looking at historical data for the job and by experience.  One would hope that that number is not an arbitrary one, but a number that is derived by looking at a historical time series.

Here’s an example:

Shmula’s Bodywork does automotive collision work.   An insurance agency, using actuarial data, has determined that the standard time to replace a fender is 2.5 hours (ie, “standard output” = 0.4 fenders per hour), and is willing to pay Shmula $50 per hour for labor (parts and supplies are billed separately).  Shmula pays its workers $35 per hour.

Suppose Shmula’s workers take 4 hours to replace a fender.  What is Shmula’s labor hour efficiency?  Given Shmula’s labor costs, will Shmula make money on the job?

Using the equation and the data above, we get:

(1 fender / 4 hours) / (1 fender / 2.5 hours) = .625 * 100% = 62.5% efficiency

2.5 hours * $50 = $125 paid by insurance
4 hours * $35 = $140 costs

Shmula will lose $15 per fender.

Economic Profits are important to Shmula; Given the answer above, how efficient does Shmula need to be to break even?

[($125) / ($35/hour)] = 3.57 hours to Break Even

We know that, Efficiency = 100% * (actual output / standard output).  So,

(1 fender / 3.57 hours) / (1 fender / 2.5 hours) = .7003 * 100% = 70.03% efficiency.  Shmula will need to improve efficiency to 70% or better to make money.

Often times, I hear people use the phrases “productivity” and “efficiency” carelessly, not completely understanding what they mean.  These terms have technical definitions and are very practical for business.  Still, given the explanation above, one must excercise good judgement in detemining which processes ought to be measured by Productivity and Efficiency and balance these measures with other items that might be important to the individual, firm, and industry.  Some measures might make sense for some activities, but not others.

Comments

  1. Andres Naranjo says

    I agree on these having standard definitions that people try to recreate. Nothing like a gorup trying to reinvent the wheel.
    Based on my experience however, I would say that productivity and efficiency are measures of an overall operation that comprises a set of processes.
    Specific business processes, at strategic, core or supporting level are best measured around their time, cost, and quality drivers. Their “measure types” need to be around result measures (that show a completed cycle) or activity measures, which are linked to a specific activity within the process.
    There are also extended process dimensions beyond time, cost, quality; which include data, compliance, risk, ownership, benefits. These might need to be measured as well.
    Great blog btw.
    anv – http://www.andresnaranjo.com

  2. hector says

    I think your post is quite wrong as productivity is just another name for efficiency: pls read some definitions or wikipedia for example.
    the particular RATIO OF ACCOMPLISHMENT you mention (“actual output / standard output”) has nothing to do with efficiency. It is actually closer to EFFICACY: which is “accomplishment” ie WHAT IS ACHIEVED; vs efficiency : HOW it is achieved: how many resources are being used for the given result(ie productivity). Nevertheless besides of the name given to your ratios, your reasoning seems good

  3. nospam says

    I’m not sure these terms have ever really been defined in the context of business. I’ve googled everywhere for the difference, because I figured there should be a difference. The problem is that your post contradicts at least 4 other blogs on the internet trying to explain the difference. Just google for ‘productivity v.s. efficiency’ and see how everyone is saying something different.

    So given the fact that no one seems to know, I have no reason to trust what you say. Wikipedia is not a valid cite for something controversial like this. Go to google books and find a definition; now that would be acceptable.

    If you can find a proper citation from a business text or process management I would be grateful and I would be happy to propagate that knowledge. As it stands now however, I see no reason to believe your definition over anyone else’s

  4. Paul says

    Hi,

    I like your article, but I’ll throw forward a slight variation. I’d be grateful for any comment.

    The formula for efficiency and and productivity look very much the same. Basically it is output/input.

    However, my interpretation is that efficiency relates output to a given mix of inputs whereas I see productivity as relating output to the cost of a mix of inputs.

    For example, if Fred and Joe perform the same task in the same manner and achieve the same quality of output, but Fred produces 20% more output than Joe then Fred could be said to 20% more efficient that of Joe.

    However, if Fred and Joe use different types of machines to perform the same task then the mix of resources is not the same and one must divide the output by the cost of the resources used. For example, let’s say that for every $100 of resources consumed (including labour cost) that Joe produces 10% more output than Fred then it could be said that Joe is 10% more productive than Fred. One could even compare the productivity of two people who perform different tasks by dividing the dollar value of their output by the dollar value of the resources consumed (incl their labour cost).

    That is, efficiency relates to the amount of output created by a given mix of resources whereas productivity is measured by the value of output relative to the value of the resources consumed.

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