BUSINESS MANAGEMENT

Business Management: Measuring Productivity

Measuring Productivity

Measuring Productivity

The chairman of the Federal Reserve, Wall Street bankers and assorted chief business executives explained the enormous gains in the 1990s stock market as the consequence of rising investments in information technologies that were to deliver sustainable superior profits from steadily rising productivity gains. Accordingly, the build-up of computer applications would enable companies to offset increased payrolls with more efficient processes so that incomes could rise without fueling inflation, while keeping stock market valuations rising indefinitely. The optimistic forecasts about sustainable productivity growth were based almost exclusively on the government's macroeconomic data about productivity that turned out to be misleading.

Why Measuring Productivity

The Need for Information Productivity Metrics

Corporations rarely report about productivity in their annual reports, even though productivity is frequently touted as one of the firm's objectives. Part of the reason is that conventional accounting is more concerned with the interests of the holders of debt than with the concerns of those who would like to understand how the company could grow and prosper. The holders of debt like to know a great deal about the ratios of current assets to current liabilities, debt coverage and book value. All of these measures represent a banker's view of credit-worthiness in case of failure and subsequent liquidation of assets.1 In contrast, the purpose of productivity measurement is to judge whether a firm is succeeding in the creation of new wealth. Rare attempts to report on productivity, such as the Forbes annual ranking of corporations, measure it in terms of revenue per employee.

Leading information-age firms, such as IBM, for many years reported to shareholders and to financial analysts revenue per employee as an indicator that its productivity was increasing even though it was accumulating huge under-utilized plant capacity while losing market share. The most frequently used revenue per employee ratio is not only inconclusive but also misleading for making productivity comparisons. For instance, in a mature industry — food processing — the sales per employee for comparable six firms are practically identical:

Figure 1 - For Similar Revenues/Employee Performance Differs

Although the revenue/employee indicator would suggest comparable performance, by any other measure (such as Return on Equity or Net Income) the results delivered by employees are different. The highestranking firm in terms of return-on-equity (Allied Domecq, with an ROE of 56%) has a 245% higher ROE than the lowest-ranking firm. The companies also differ in terms of the net assets employed. For instance, the net assets (shareholder equity for Coca Cola) per employee are 233% greater than net assets per employee for Allied Domecq. These firms differ in how many assets they deploy per employee, how their compensation varies and the extent to which they pursue different policies with regard to purchasing packaging materials and transportation services from suppliers.

Relevance of Productivity

The stakes in debates how to measure productivity of the information workforce, now accounting for 60% of total employment and an estimated 71% of wages, are enormous.6 The performance of the stock market, the prospects of ...