The Truth About Productivity

This piece by Gene Marks pushes the point I've been trying to make about productivity in a much clearer way than I can:

Preliminary third-quarter productivity figures for the U.S. came out Thursday, and it seems businesses are getting more whimper than bang for their buck. Productivity gains clocked in around 1.2%, lagging behind the first two quarters of 2008; at non-durable goods manufacturers, productivity decreased by 7.3%.

Productivity is to the economy what gas is to an engine. It is what drives corporate earnings and thus stock prices. But there's more to it than that. The real key to productivity--and thus performance--is not maximizing it at all costs. It is maintaining a level of consistency.

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Take it from Haig Nalbantian, labor economist at Mercer, the giant human resources consulting firm. A few years ago, Nalbantian ran a study looking at the link between plant-level productivity and the market value of U.S. manufacturers. The goal was to determine if companies with the highest employee productivity also returned the most value to their shareholders.

"What we found was surprising," says Nalbantian. "It wasn't the companies with the highest productivity that were most profitable. It was those companies that consistently maintained their productivity that built the most value."

Great businesses can't crank through a job at record pace this month only to fall down on the next. Options traders may love volatility, but customers, vendors and shareholders decidedly do not.

"High productivity is not about finding some best practice," says Nalbantian. "At best that gets you to competitive equilibrium."

Mercer studied the correlation between plant-level productivity and financial performance at 993 companies (with a total of 11 million employees and $2.7 trillion in sales) over a 30-year period. I won't bore you with the particulars, but here is the wisdom: Higher productivity essentially acts like an intangible asset that carries significant market value.

Put another way, companies that maintain a decent level of productivity are rewarded more than those that hit higher highs but can't sustain them.

"If you figure out how to manage your operations more effectively and maintain that advantage, investors perceive that and value you more highly," says Nalbantian.

How much higher? "There's a two-to-one relationship," he adds. "In other words, a 10% higher productivity at the plant level converts into a 5% higher market value." Translation: a bigger payday when you decide to cash out.

I didn't have to look far for more proof of that premise. My friend who works in a college admissions office offers this example: A high school kid submits a transcript pock-marked with As and Cs, while another posts solid Bs. In the end, the average grades are about the same, but all else equal, who do you think gets the nod? The solid-B producer, says my friend. Even schools eschew volatility.

How to measure productivity? There are two approaches, says Nalbantian.

The first looks at output (number of widgets, billable hours, service calls, whatever) per dollar spent to generate it. Just make sure the numerator and denominator are measured over the same timespan. If you care about output per hour, make sure to divide by the hourly wage. Simple, but crude.

A more honest picture of productivity looks at the total invested capital needed to achieve a given level of output. Example: Your customer service rep may resolve 50 calls a week, but that same rep may have drawn on additional internal or external resources to handle those calls. Those other costs have to be captured in that ratio, too.

No matter what method you choose, remember that the key is consistency. Says Nalbantian: "Companies get obsessed on reaching a level of productivity, when they should really be focusing on how they're going to sustain that level."