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Hemera/Thinkstock
Enhancing Productivity
Learning Objec�ves
A�er comple�ng this chapter, you should be able to:
Define produc�vity.
Describe why produc�vity is the key to an increasing standard
of living.
Discuss how the rela�onship between produc�vity and the
nature of work has changed over �me.
Explain labor, capital, and material produc�vity.
Calculate produc�vity in single and mul�ple factor cases.
Discuss important trade-offs among the factors of produc�vity.
Explain the rela�onship between wage rate and produc�vity.

Describe ways to enhance produc�vity.
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Produc�vity improvements have a profound impact upon
living standards for people around
the world. Although completely cut off from society, a
group of people stranded on a
tropical island would likely employ these same
improvements to increase their quality of
living.
John Foxx/Stockbyte/Thinkstock
3.1 Understanding Productivity
Produc�vity is a term that is men�oned o�en in the
news. It is a term that many believe is important, but
they are not sure why. Produc�vity is o�en associated
with increasing efficiency and lowering costs, which have
posi�ve connota�ons. In fact, increasing produc�vity is
an essen�al factor for improving living standards.
Produc�vity is the level of output achieved from an
ac�vity divided by the inputs consumed to make the
output. While produc�vity is defined by a mathema�cal
equa�on, efficiency is a general descriptor of the �me or
effort required to complete work. Generally, efficiency is
used to mean achieving an outcome with a
minimal amount of effort, that is, no waste; it has a
similar meaning as produc�vity.

Produc�vity = Output/Input
The above defini�on, while accurate, does not convey the
central role that produc�vity and produc�vity
improvements have in determining living standards for
people in the United States and around the world. To
understand this impact, imagine that seven people are
stranded on an island, completely cut off from the rest
of society. The island has abundant natural resources. The
immediate problems are ge�ng fresh water to drink and
gathering fruits and vegetables to eat.
Appropriate shelter and clothing come next. The amount of
water that seven castaways are able to drink (the output)
depends upon how much effort (the input)
they place on loca�ng, collec�ng, transpor�ng, and
storing it. As the group becomes be�er at gathering an
adequate supply of water with less effort, members of
the group have more �me for gathering food, building
shelters, and making clothes. For example, rather than
going to the water source each �me a person is
thirsty, the group could build buckets and barrels to
transport and store large amount of water that is easily
and quickly accessible. This investment in designing
and building tools to make collec�ng water faster and
easier frees �me for other ac�vi�es. Eventually, as
shelters are built, they could be designed and constructed
so that the roofs could collect rainwater and funnel it
into water barrels. This system would eliminate the labor
required to collect water, thus providing more �me
for other ac�vi�es, such as growing a large variety of
food, building transporta�on devices, swimming, and
devising forms of entertainment.
As the seven castaways become more produc�ve, they
meet their basic needs

(outputs) with less �me and effort (input). This provides
free �me, which can
be used to create new products, develop be�er ways to
make exis�ng
products, and enjoy leisure ac�vi�es. Put in the simplest
terms, the seven
castaways can only consume what they produce. The more
they produce, the
more they must consume. In this simplis�c example, the
castaways clearly
benefit by finding ways of "doing more with less," which
is a phase that is
synonymous with cost cu�ng, and may have a nega�ve
connota�on. Doing
more with less is the way to achieve an improved living
standard.
A 21st-century economy with more than six billion people
is similar to the
castaway economy because the concept of produc�vity
does not change.
Produc�vity s�ll measures the ability to produce goods
and services (outputs)
compared to the inputs or resources used in the process.
The primary
difference is that most work in the economy is done by
groups of people
working in organiza�ons. As discussed earlier in this text,
organiza�ons exist to
meet the needs of society that people working alone
cannot. It is through
these organiza�ons that people achieve the coopera�on
and coordina�on to
produce the array of services and goods consumed each
day. First,
organiza�ons allow individuals to specialize in work, such

as produc�on,
engineering, and sales. Second, they support the
development and
implementa�on of technology and automa�on to achieve
greater produc�vity.
Third, organiza�ons provide a mechanism to coordinate
work toward a
common set of goals. Examining and redesigning
organiza�onal processes and
ac�vi�es is a key source of produc�vity improvement.
The following examples
illustrate these points.
1. Specializa�on—Product design for life insurance requires an
es�mate of life
expectancy. This effort is cri�cal to se�ng the terms and
condi�ons of the
policy, including the premium. Actuaries are sta�s�cians who
specialize in
making this es�mate. Their produc�vity (ability to make the
es�mate quickly and accurately) is greatly enhanced by
specializa�on. They are well trained in the
techniques required to do the job. An employee of the life
insurance company with training and educa�on as a general
manager, sales manager, or accountant
would require significantly more �me and effort to do actuarial
work, and the es�mate would probably be much less accurate.
Similarly, the actuary would likely
make a poor accountant or manager.
2. Technology and Automa�on—At today's universi�es,
students have the op�on of paying fees using electronic funds
transfer (EFT) via the Internet rather than
standing in line at the cashier's office—the approach used a
genera�on ago. Not only is EFT more convenient for the
student (improves the student's produc�vity

by requiring less �me to make the payment), it also increases
the produc�vity of the workforce at the university. From the
university's perspec�ve, each transac�on
that shi�s from paying in person to paying using EFT reduces
the amount of �me university employees spend accep�ng the
payment and entering informa�on into
the computer system. This presents an opportunity to cut costs
and to do more value-added work.
3. Process Redesign—In many organiza�ons, marke�ng and
sales are responsible for gathering informa�on about customers
and their orders. When a customer
makes a request that requires special processing, such as a
special finish on a piece of steel or a major change to a
so�ware module, that informa�on is relayed
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from the customer through sales to the people who do the work,
and takes extra �me and effort, thereby increasing the risk of
errors. Changing the process so that
the customer can communicate directly with the people doing
the work increases the produc�vity of all par�cipants. This can
be accomplished in a number of
ways, including having the customer visit the facility and meet
with the employees, or sending employees to meet the customer.
It can also be done by sharing
feedback from customers in a video format and providing "made
by" informa�on so the customer know who made the product.
Providing customer with the

employees' email or other points of contact is helpful.
Employees tend to respond be�er when the contact with the
customer is personal.
Real World Scenarios: Procter & Gamble Work With Walmart
Some�mes, process improvements involve working across
organiza�ons. In many cases, retailers are working with
suppliers to develop innova�ve ways to
improve the replenishment process and reduce the
resources devoted to manage this rela�onship.
Procter & Gamble (P&G) supplies Walmart with disposable
diapers—a bulky, inexpensive, high sales-volume and low
profit-margin commodity—so Walmart
must keep inventory low and product availability high. To
accomplish this, Walmart has changed its replenishment
process. Rather than placing orders with
P&G, Walmart provides sales data for each individual
store. It is P&G's responsibility to track inventory,
schedule produc�on, and deliver diapers to the store.
How does this shi�ing of responsibility improve the
process? P&G receives sales data from Walmart each day.
P&G uses the data, along with orders from
other customers, to schedule its produc�on processes more
effec�vely and generate orders for its suppliers more
quickly. P&G can more easily balance its
produc�on process to reduce spikes in produc�on, which
can lead to higher costs through the need for over�me
produc�on and similar effects. P&G suppliers,
in turn, can improve their response �me and reduce their
in-process inventory. Walmart spends less �me tracking
inventory, deciding how much and when to
order, and placing the order. As responsibili�es shi�
between P&G and Walmart, overall costs decline, product

availability increases, and the amount of
unnecessary communica�on and interac�on between
organiza�ons is reduced.
Money Versus Productivity
Produc�vity is more important than money when
improving the standard of living, because produc�vity
determines the level of output and, therefore,
consump�on, whereas money measures the value of the
output. Money in the form of revenue, profits, and income
is a way for organiza�ons and individuals to
track performance. Refer to the castaway example
men�oned earlier. Suppose that each castaway landed on
the island with $1 billion in gold. The money does not
create a single glass of water or one bit of food. It is
only through the work of the castaways that these
commodi�es are gathered and produced. Methods to
increase produc�vity, such as specializa�on of labor,
automa�on, technology, and process improvement, create
be�er living condi�ons and a society with a higher
living standard.
Ini�ally, the small island economy may use a barter
system in which a castaway gathering water would trade
water for food with another castaway gathering or
growing food. As the economy grows in complexity, a
currency will likely emerge to facilitate the exchange of
goods and services, because bartering can be
cumbersome. Suppose a currency is in place, and it is
based on the gold that the castaways brought with them.
Now suppose the castaways discover gold on the
island. They divide the gold up evenly, so now each
castaway has twice as much gold as before and wants to
buy more goods and services. The immediate impact
is to increase the price for items because the quan�ty of

available goods and services has not changed. There would
be no increase in the goods and services
available unless produc�vity is improved or the castaways
work more hours at the same level of produc�vity. For
the island economy, it does not ma�er whether
or not more gold is found, the castaways could do either
of these ac�vi�es: increase produc�vity or increase the
number of hours worked.
As the popula�on grows and the island economy develops,
income for each individual would be determined by the
value of the work they could do. If medical
care, for example, is determined more valuable than
educa�on, doctors would receive a higher income than
teachers. This would allow a doctor to consume more
than a teacher because the value of the doctor's labor is
judged to be higher. If an individual in a developed
economy finds $1 million worth of gold in his or her
backyard, that s�ll does not generate more output. It
does, however, allow the person to outbid others for the
outputs of the economy and consume more.
Someone else, in turn, must consume less un�l
produc�vity increases.
Productivity and the Nature of Work
Many individuals believe that produc�vity applies
primarily (or exclusively) to the blue-collar workforce.
People think of the number of laptop computers produced
by workers on an assembly line, or the amount of paper
produced in a mill as key produc�vity data. While the
produc�vity of blue-collar workers is important,
blue-collar workers represent a small and declining por�on
of the workforce in developed countries.
During the 20th century and con�nuing today, there has

been a substan�al shi� in the nature of work. Early in
the 20th century, nearly 80% of the workforce in
the United States performed manual work, with the
balance doing intellectual work, such as designing,
planning, and managing. Today, that percentage has
reversed. In addi�on, about 80% of the workforce in the
United States is employed in service organiza�ons. Of
those employed in manufacturing, many work in
management, sales, and other staff ac�vi�es, such as
quality control and engineering. Like the seven castaways,
the produc�vity of everyone is important because
each impacts the living standard of all. Because a large
por�on of the U.S. workforce does intellectual work, its
impact upon living standards is very important.
Table 3.1 presents some examples of people doing
intellectual work, key measures of their produc�vity, and
possible methods to improve that produc�vity.
Table 3.1: Produc�vity measures and methods of
improving produc�vity
Worker Ac�vity Measure Method of Improving Produc�vity
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University
faculty
Educates students or
educates them be�er

Student credit hours taught. This does not take into
account what
students have learned or other du�es of faculty, including
curriculum design, research, and service.
Increasing class size leads to more
student credit hours
Assigning more sec�ons per faculty
also leads to more student credit
hours
Distance learning provides access to
educa�on that may not otherwise
be available
Innova�ve teaching methods can
improve the quality or the quan�ty
of what is learned
Postal
worker
Oversees the
opera�on of an
automa�c sor�ng
machine
Number of pieces of mail sorted in an hour Equipment
improvements that
speed up the sor�ng process
Job training
Case worker
for
children's
services

Manages the care of
children in foster
homes
Number of cases under management at any �me. This
does not
consider the degree of difficulty of the cases, or the
quality of the
service provided.
Informa�on systems, including
databases that support care
Communica�on technology that
gives access to foster parents,
service providers, and support
services
Productivity in Service Organizations
Through the last half of the 20th century, as the U.S.
economy shi�ed from a manufacturing-based economy to a
service-based economy, produc�vity
improvements lagged because produc�vity gains in the
service sector were more difficult to achieve. With rapid
advances such as the Internet, telecommunica�on,
and mobile devices of all types, the ability to improve
the produc�vity of the intellectual labor force has
increased dras�cally. Companies that are able to apply
these technologies are gaining a compe��ve edge. For
example, Northwestern Mutual has a processing cost of
$.063 cents for each dollar of premium collected
from its policyholders while its compe�tors' costs range
from $.15 to $.20. It is logical to argue that these
companies have not managed their resources and
technology effec�vely. Costs for telephone access, both
wired and wireless, are declining as technology is applied

to reduce equipment and labor costs.
The Quality Condition
While the importance of quality may be obvious, it is
worth discussing. Produc�vity calcula�ons are based on
the assump�on that quality levels are maintained. If
an organiza�on produces more output with the same level
of resources, but the quality of the output is lower, then
produc�vity may not increase. If a company
produces more computer so�ware, but the so�ware is
defec�ve and must be corrected, then the company has
gained li�le. In fact, produc�vity may actually have
been reduced. If a lower quality product reaches the
consumer, and the product's value to the consumer is
reduced, or the consumer must spend addi�onal
resources to prepare the product for use, produc�vity is
affected. The same ideas apply to a research laboratory or
an inner-city mission. If researchers' output is
higher quality, the people that use their work will benefit
because the output has more value. If the mission
provides be�er nutri�on and preven�ve health care
screening, the people using the services will feel be�er
and the cost of health care should decline. This frees
health care resources for others.
Conversely, quality may be another way to boost
produc�vity. If firms find ways to make a higher-quality
product, using the same or fewer resources, then
produc�vity increases because the output has greater
value. Following the so�ware example, if a firm purchases
new so�ware development tools that are easier to
use and result in fewer errors, the produc�vity of its
programmers and analysts increases.

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It is essen�al to define and measure the inputs and the
outputs of an ac�vity to calculate
produc�vity. If a manufacturing opera�on makes a single
product on an automa�c machine,
it is simple to calculate the produc�vity of that machine.
iStockphoto/Thinkstock
3.2 Assessing Productivity
To calculate produc�vity, it is essen�al to define and
measure the inputs and the outputs of the ac�vity. In the
simplest cases, measurement is a trivial problem. If
a manufacturing opera�on makes a single product on an
automa�c machine, calcula�ng the produc�vity of that
machine is simple. The output over a given period
of �me is measured. It is usually be�er to measure a
rela�vely long period of �me, days or weeks rather than
minutes or hours. The reason is that the outputs
may be greatly affected by a short-term occurrence such
as a machine breakdown.
Example: Machine Produc�vity
If a machine can make 200,000 roofing nails in 40 hours,
then the produc�vity of the machine is 5,000 nails per
hour. This is a single-factor produc�vity
calcula�on because only the machine is considered.

Machine Produc�vity = 200,000 roofing nails/40 machine hours
Machine Produc�vity = 5,000 roofing nails/machine hour
The resul�ng data become a benchmark that the firm
seeks to improve. Suppose the firm invests in a new
piece of equipment that automa�cally feeds metal
to the machine so the machine can run faster. Now, the
machine is able to produce 210,000 nails in the same 40-
hour period. Produc�vity has increased from
5,000 nails per hour to 5,250. Produc�vity has increased
by 5%. Change in produc�vity is the produc�vity a�er
the new equipment minus the produc�vity
before the new equipment divided by the original
produc�vity �mes 100. Make sure that the sign of that
number is kept so it can be determined if
produc�vity increases or decreases.
Percent Change in Produc�vity = (New Produc�vity – Old
Produc�vity)/Old Produc�vity (100)
Percent Change in Produc�vity = (5,250 – 5,000)/5,000
(100)
Percent Change in Produc�vity = 5%
Inputs and Outputs
While this simple example illustrates the method for
calcula�ng produc�vity, it does not consider that most
opera�ons have more than one input and more than
one output. Economically, the inputs are:
1. Labor by managers and workers (either internally or
externally)
2. Capital for land, facili�es, and equipment
3. Materials, including energy requirements
The importance of these factors varies widely for

companies producing different products. For example, steel
mills require large amounts of energy while Children's
Services, a social service agency, uses very li�le. In a
steel plant, the significant inputs include managers,
laborers, land, facili�es, equipment, energy, and raw
materials. The inputs for Children's Services include
management and caseworkers. For Children's Services, the
investment in land and facili�es would be small
compared to labor costs. Equipment investments may be
relevant for informa�on technology. Energy and raw
material costs would be very small. Material costs
would also be low with only small quan��es of office
supplies required.
Outputs can be more difficult to define and measure. For
example, how
would the produc�vity of a fast-food restaurant be
measured? Would it be
measured by customers served per hour? If so, that
calcula�on is
problema�c because customers may order different things.
Measuring
output as the number of items sold also can be
misleading because these
restaurants sell various items (such as drinks, sandwiches,
and ice cream)
that have different value to each customer, which is,
therefore, reflected in
the prices charged.
These examples illustrate two important issues that can
complicate how
produc�vity is measured: (1) How can mul�ple inputs
with different
economic values be included? In the fast-food example,
how does the

produc�vity of labor relate to the produc�vity of capital
or materials?; (2)
How can mul�ple outputs with different economic values
be calculated?
Con�nuing the fast-food example, a pizza shop may
produce hot
submarine sandwiches, chicken wings, and bread s�cks.
How does it value
those outputs compared to a pizza? Even if the pizza
shop sells only pizza,
there are different sized pizzas with different toppings that
have different
economic value. In cases where there are mul�ple inputs
or outputs with
different values, dollars rather than item counts or hours
worked are used
to measure both inputs and outputs.
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Materials and energy are o�en cri�cal inputs to
manufacturing
processes, but may be insignificant within service
opera�ons. For
example, laboratory supplies purchased for universi�es and
hospitals represent a very small part of the inputs
required for
the organiza�on.
Comstock Images/Thinkstock

Labor Produc�vity
Labor is the most obvious input in the produc�vity
equa�on. In fact, some businesses are concerned only with
measuring labor produc�vity because it is easy to
calculate and many managers believe it is one factor
under their direct control. For many service opera�ons,
labor is the largest input. In service opera�ons, such
as banks, hospitals, and universi�es, labor is o�en 70%
or more of total costs. For manufacturing firms, however,
it is important to note that direct labor, people
who work in producing goods, usually accounts for a
small percent of total input costs—10% or less. Indirect
labor, which is labor that supports produc�on such as
quality, supervision, and maintenance, can be two or three
�mes the cost of direct labor cost. If indirect labor,
management costs, and outside services are added
to direct labor costs, the total is usually below 50% of
the cost of all inputs. Some service opera�ons may be
able to func�on minimally with only labor
produc�vity, but a broader perspec�ve on produc�vity
may be relevant.
The simplest way to determine labor produc�vity is to
measure output per labor-hour. This approach does not
account for varia�ons in pay rates among workers.
To calculate such rate differences, many companies use
labor costs as a measure of inputs. The equa�on for
labor produc�vity is:
Labor Produc�vity = Quan�ty or Value of Units
Produced/ Labor Hours or Labor Cost
The equa�on for any other individual factor of
produc�vity differs only by its �tle and its divisor. For

example, to calculate material produc�vity, use material
quan�ty or material costs as the divisor.
Capital Produc�vity
Another major component of produc�on is capital, which
includes all money invested in land, facili�es, and
equipment, as well as working capital, such as
inventory. Capital produc�vity can increase when firms
invest in new facili�es and equipment that increase
output. Capital produc�vity can also be increased if a
company can produce the same level of output as it
previously had while reducing its inventory levels or other
working capital requirements. Many firms invest in
new facili�es and equipment in order to reduce labor
costs; however, the benefits of making a capital
investment may greatly expand labor produc�vity and
capital
produc�vity may instead decline. These trade-offs are
discussed later in the text.
Service and manufacturing firms o�en have very different
capital requirements. Service opera�ons o�en have
rela�vely small investments in capital. For example,
insurance companies require office space, furniture,
informa�on systems, and working capital, which represent
a small part of their input costs. Hybrid service
opera�ons, such as retail, o�en have large investments in
retail outlets, distribu�on centers, and inventory in their
network of retail outlets and distribu�on centers.
Manufacturers usually have very large capital outlays to
build produc�on facili�es.
Material Produc�vity
Materials and energy are o�en cri�cal inputs to

manufacturing processes, but may be insignificant in
most service opera�ons. For manufacturing companies,
materials o�en represent more than 50% of the
input costs. A university may purchase office and
laboratory supplies as materials. A hospital's primary
materials include medicine, linens, and food for the
cafeteria. For universi�es and hospitals, materials
represent a very small part of the inputs to the
organiza�on.
Trade-Offs in Productivity
Produc�vity can increase by maintaining the level of
output while decreasing inputs, or by increasing
output without increasing any input. This is difficult to
achieve, so trade-offs are necessary. Companies
must contend with trade-offs among the various inputs in
order to achieve increases in overall
produc�vity, called mul�ple-factor produc�vity. In this
case, some individual factors of produc�vity may
decrease while others increase.
Trading Capital for Labor
For thousands of years, producers of food and goods have
traded capital for labor. These trade-offs date
back to the �me when our early ancestors first began
using tools to make life easier. The wheel and
axle allowed people to carry heavy loads across greater
distances. Instead of making many trips to
move a certain load, a person could make one trip in a
wheeled cart. This trade of capital, the
investment in designing and building a wheeled cart, for
less labor resulted in substan�al produc�vity
increases that are s�ll occurring today. This is why
research and development ac�vi�es that design and

develop new technologies and devices are important for
economic health and improving living
standards. In the development and applica�on of the
wheel and axle to industrial and transporta�on
uses, someone or a group of people had to take the �me
to research the concept, create a design,
build and test prototypes, and put the idea into
produc�on. This investment required a shi� of
resources from the labor associated with doing the actual
work of moving the item to be transported,
to research and development on how to move the item
more efficiently. This meant that someone had
to take a significant risk, but the benefits have been
tremendous. The impact of this investment on
living standards can be seen everywhere.
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Robo�c Technology in the Workplace: Inves�ng Trade-offs
involving capital and labor have focused primarily on
automa�ng ac�vi�es
previously performed by people. In the construc�on
business, trucks and bulldozers move
large quan��es of dirt and other materials on
construc�on sites. In the automo�ve industry
many boring, unpleasant, or dangerous tasks are performed
by robots and other automated
devices. In retail opera�ons, checkout systems are
becoming completely automated as
customers check out their items using a scanner, and pay

by credit card or cash. The result is
high capital costs, low labor costs, and greater overall
output—which generate an overall
produc�vity increase. Higher capital costs pay for research
and development as well as
equipment produc�on.
At some retail stores, cashiers are being replaced by
technology that allows customers to scan
items and make payments themselves. While these jobs are
lost, other jobs have been
created to design the new checkout equipment, develop the
so�ware, manufacture the
equipment, and install the system. In addi�on,
produc�vity has increased, and the cost of
doing business has declined. New, be�er-paying jobs are
created, and the economy con�nues
to grow. Produc�vity improvements lower the total number
of jobs required. The labor saved
can be used to increase leisure �me, u�lize more people
working fewer hours, or design and
create new goods and services. This is how economies
grow and become stronger.
Trading Capital for Material or Energy
It also has become common to make capital investments
that improve material or energy produc�vity. The concept
and issues are similar to those discussed in the
prior sec�on. For example, a plas�c injec�on molding
company produces parts for Hewle� Packard's laser
printers. By inves�ng in new injec�on molding equipment
that reduces scrap, the company can produce the same
number of plas�c parts (output) from a smaller number of
plas�c pellets (inputs). In addi�on to leading to
an increase in material produc�vity, the investment also

reduces the amount of energy consumed because
substan�al energy is used to melt the pellets prior to
injec�ng them into the molding machine. Because fewer
pellets are used to make a given number of plas�c parts,
less energy is used and energy produc�vity has
increased. It is not always the case that both
improvements can be achieved with a single investment,
but it is not uncommon.
Subs�tu�ng Materials for Labor
In some instances, there may be advantages to spending
more for materials in order to achieve a reduc�on in
labor costs. Some�mes it makes sense to have a
supplier do extra work, which is reflected in the price of
the materials. This reduces labor costs or processing �me
for the manufacturer. Outsourcing work has
become a common prac�ce in both manufacturing and
service opera�ons. Apple's approach to manufacturing is to
concentrate produc�on to achieve economies of
scale and to outsource produc�on to keep costs low and
produc�vity high. Economies of scale refers to the ability
to produce more goods at a lower cost by be�er
u�lizing the same fixed costs. This can be achieved by
making facili�es larger, which requires less fixed costs
per unit produced. Health care providers use
disposable medical supplies to avoid the cost of collec�ng
and cleaning. It is more economical to incinerate or
recycle these items than it is to clean and reuse
them. In some instances, such as vehicle produc�on,
assembly plants want a completely finished subassembly
delivered by its supply so that the plant's employees
only insert the assembled part into the vehicle. An
instrument panel is only one example of this. The cost of
the component purchased from the supplier is higher,
but the in-house assembly costs can be greatly reduced.

The net impact for suppliers and manufacturers is greater
produc�vity and lower costs. Many service
opera�ons will purchase supplies that cost more, but
increase the produc�vity of their workforce.
Improving Produc�vity Through Be�er Maintenance
Any�me equipment is involved, whether it is mechanical
devices making automobiles, furniture, or
telecommunica�on equipment moving voice or data, failure
in
the equipment leads to lower levels of equipment and
labor u�liza�on. When a pizza oven is not working
because it was not properly maintained, the pizza shop
loses the ability to make and sell pizza pies. The
equipment cannot be used and the labor is idle; therefore,
produc�vity declines. When a so�ware developer must
wait for informa�on because equipment is not working,
both the developer's �me and the equipment are unused.
As a result, a lack of effec�ve preven�ve
maintenance could lead to a reduc�on in both labor
produc�vity and equipment produc�vity. Performing
preven�ve maintenance when equipment is idle is cri�cal;
otherwise produc�vity is disrupted.
Multiple-Factor Productivity
To cope with the trade-offs that can occur when
produc�vity improvement efforts are made, mul�ple-factor
produc�vity must be considered. Mul�ple-factor
produc�vity accommodates more than one input factor and
more than one output factor when calcula�ng overall
produc�vity. For example, if the owners of a
pizza shop want to increase the produc�vity of their
ovens, they may consider decreasing the �me that a pizza
cooks in the oven. To compensate for the reduced

�me, the oven's heat is increased. A single-factor
produc�vity calcula�on based on oven u�liza�on would
show an increase in capital produc�vity because more
pizzas are moving through the oven in a given period of
�me. However, there would also be an increase in energy
consump�on, which would not be factored into
the calcula�on. With mul�ple-factor produc�vity, the
outputs can be measured in dollars or the number of units
produced, provided that all the units have
approximately the same value.
Mul�ple-Factor Produc�vity = Quan�ty or Value of
Output (Units Produced)/
(Labor + Capital + Materials + Energy + Other (Measured
in Dollars))
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Example: Life Insurance
Freedom Insurance Company processes claim applica�ons.
The average output in one week is 600 applica�ons.
Currently the staff includes six full-�me
employees who work 40 hours per week and earn $24 per
hour including benefits. Management has invested in
computer technology, which has a weekly
cost of $1,200. Materials and energy are not used in
significant amounts. What is the produc�vity of the
applica�on process?
Mul�ple-Factor Produc�vity = 600 applica�ons/ ((6
employees) (40 hrs/wk) ($24/hr) + 1,200)
Mul�ple-Factor Produc�vity = 600 applica�ons/$6,960
Mul�ple-Factor Produc�vity = 0.086 applica�ons/dollar
In this case, the units of produc�vity are applica�ons-
per-dollar. The number of applica�ons can be used
because the value of each applica�on is
approximately the same. The inverse of this number,
$11.60 per applica�on ($6,960/600 applica�ons), is the
cost of processing each applica�on. Suppose
Freedom decides to invest in addi�onal computer
equipment that will drive the weekly cost of informa�on
technology to $1,800. One of the applica�ons
evaluators is leaving the company and will not be
replaced. The remaining five processors should be able to
complete 650 applica�ons per week with the new
technology. What is the impact upon produc�vity?
Mul�ple-Factor Produc�vity = 650 applica�ons/ ((5
employees) (40 hrs/wk) ($24/hr) +1,800)
Mul�ple-Factor Produc�vity = 650 applica�ons/$6,600
Mul�ple-Factor Produc�vity = 0.098 applica�ons/dollar of

input
With the new investment, produc�vity increased from
0.086 to 0.098 applica�ons per dollar of input costs. The
gain in produc�vity is 14%, which is a
substan�al gain. The inverse of this number, $10.15 per
applica�on ($6,600/650 applica�ons), is the cost of
processing each applica�on. To provide a point of
comparison, a 3% to 4% increase in produc�vity per year
would be considered strong growth for a developed
country.
Percent Change in Produc�vity = (New Produc�vity – Old
Produc�vity)/ Old Produc�vity (100)
Percent Increase in Produc�vity = (0.098-
0.086)/(0.086)(100)
Percent Increase in Produc�vity = 14%
Positive Impacts of Increased Productivity
Some have argued that produc�vity has a nega�ve impact
upon jobs and the economy because fewer people are
needed to complete the same amount of work.
This leads to a loss of income for the worker, and high
unemployment costs and lower tax revenues for the
government and the economy. This would be an
accurate assessment if there was no growth in the demand
for goods and services and there was no demand for new
and innova�ve products. Developed na�ons
such as the United States have seen substan�al growth in
demand for goods and services and for new, innova�ve
products. Developing countries including the BRIC
countries (Brazil, Russia, India, and China) have rapidly
growing economies. Countries such as Vietnam and
Thailand are poised for substan�al economic growth.

The impact of produc�vity improvements upon cost can
easily be illustrated using the investment in computer
technology in the prior example. Produc�vity
increased by 14% because more work was completed using
fewer workers due to the new technology. As a result, the
cost to process an applica�on was reduced
by $1.45 from $11.60 to $10.15 (1.45/11.60), a reduc�on
of 12.5%.
The impact on workers is not as clear. If a worker is
re�ring, that worker has more leisure �me and the work
that was being performed is s�ll ge�ng done, at a
lower cost, by another worker. The result is posi�ve for
the worker, the company, and the economy. If the same
worker resigns to take another job, the worker, the
company, and the economy s�ll benefit. The worker
moves on to a be�er job, processing costs decline for the
company, and the work is s�ll being performed.
If a worker does not voluntary leave a firm, the situa�on
is not as clear. The company s�ll benefits because
processing costs decline. What effects impact the
worker and the economy, though? If the right economic
circumstances are in place, they will benefit as well.
When the business environment is conducive to
innova�ons and an overall growing economy, this job loss
is posi�ve rather than nega�ve because it creates slack in
the labor force, or unemployment in the
economy. Slack in the labor force can be put to work
crea�ng new ideas, new products, and new companies.
Slack can be used to staff businesses that must hire
and train new employees because a company is growing
faster than its produc�vity growth rate. At a macro level,
this is precisely what has happened many �mes
as the U.S. economy transi�oned from an agricultural, to
a manufacturing, to a service-based economy. Informa�on

technology, the Internet, cloud compu�ng, and
mobile devices are the forces driving the current
transforma�on under which more people will work from
home and will change jobs more frequently as the
process for crea�ve destruc�on accelerates. Crea�ve
destruc�on is when new ideas or technologies replace
outdated ideas or technologies, as in the case of online
video streaming replacing DVDs and DVD rental shops.
Typically, during crea�ve destruc�on, jobs are gained in
one area and lost in another. To help with such
transi�ons, governments offer unemployment insurance and
federal and state retraining programs. Some colleges and
universi�es reach out to non-tradi�onal
students in an effort to increase the educa�on and skills
needed to compete in a new job market.
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Cloud compu�ng companies offer ways to reduce
investment in IT equipment and facili�es,
while providing a flexible and inexpensive pla�orm
through which to engage and serve
customers.
iStockphoto/Thinkstock
Importance of HR Management: Human Resource
Func�on
3.3 Current Trends in Productivity

Over �me, produc�vity growth in the U.S. economy has
been inconsistent. There was strong growth in the 1960s,
followed by low and in some cases nega�ve
growth in the late-1970s and early-1980s. As the 1990s
began, produc�vity growth began to accelerate and has
con�nued to show posi�ve growth. The rate of
growth in produc�vity tends to be stronger when the
economy is strong and weaker when the economy slows
down.
Increasing produc�vity o�en drives business performance.
As organiza�ons
achieve more output with the same resources, the economy
grows. Refer
to the island example men�oned earlier in the text; more
is produced so
there is more to consume. At the same �me, profits
expand even if the
selling price of the product does not increase. For Apple,
profits grow
dras�cally even when the selling price of its products
declines because the
quan�ty sold increases. The cost structure of the firm (at
least the labor
por�on) does not change, and there is more revenue from
increasing
sales. Therefore, bo�om-line profits can expand
dras�cally. For example,
as Microso� finds ways to produce and distribute more
copies of its
so�ware while maintaining the same resources used in
these ac�vi�es, it
will generate greater revenue and profit.
In many cases, produc�vity improvements are driven by

investments in
technology, and these investments drive economic growth.
For example, as
retail companies such as Walmart invest in Internet
applica�ons for sales
transac�ons, repair parts and service, and adver�sing,
demand for
technology from companies such as Cisco Systems and
Intel accelerates.
Cloud compu�ng companies such as Salesforce.com and
Brocade offer
ways to reduce investment in IT equipment and facili�es
while providing a
flexible and inexpensive pla�orm to engage and serve
customers. As the
U.S. economy con�nues to shi� away from manufacturing
and toward
services, investments in informa�on technology for service
opera�ons become more important for produc�vity growth
and economic expansion.
Productivity and Wage Rates
Generally, wage rates and produc�vity are posi�vely
correlated. This posi�ve correla�on means that
organiza�ons with high produc�vity can afford to pay
their
workers be�er wages because their workers produce more
output. This correla�on has implica�ons for companies
that are selec�ng loca�ons for their opera�ons.
A country with a low wage rate does not necessarily have
low unit labor costs because workers in the country may
have low produc�vity. For example, if someone
was asked to move a pile of dirt from one point to
another and was given a shovel and a wheelbarrow to do

the work, the produc�vity would be rela�vely low. On
the other hand, if the person was given a bulldozer and
proper training, produc�vity would be much higher. The
bulldozer operator is paid a higher wage because
the operator moves more dirt faster. Wage rate is not the
sole determinant of unit labor cost. The other important
factor is produc�vity, or the number of units
produced.
To provide a context for the dirt-moving problem, suppose
that a person with the wheelbarrow and shovel is paid $2
per hour and can move 1 cubic yard of dirt in
one hour. The bulldozer operator makes $24 per hour and
can move 20 cubic yards in one hour. The labor cost to
move the dirt by wheelbarrow is $2 per cubic
yard ($2/hr) / (1 cubic yard/hr). The labor cost to move
the dirt by bulldozer is $1.20 per cubic yard ($24/hr) /
(20 cubic yard/hr). The owner of the construc�on
company is able to pay higher wages and achieve lower
costs because the investment in equipment and training has
boosted produc�vity dras�cally. A�er paying
the higher wage, the owner is able to save enough labor
cost to pay for the bulldozer, buy fuel to operate it, and
pay to train the employee.
Productivity and the Workforce
Some people would argue that produc�vity improvements
such the one described in the previous sec�on take jobs
away from workers. A construc�on company
that once employed 20 manual laborers employs only one
bulldozer operator with the introduc�on of the new
technology. Their claim is based on the fact that the
construc�on company now employs one bulldozer operator
who does the work of 20 laborers. While this is true, it
is only one component of produc�vity. Refer

once again to the example of the castaways; they could
only consume what they produced. The same is true for
society. If wheelbarrows and shovels had been
used to build highways, there would not have been
sufficient labor to build the vast interstate systems and
other road networks unless workers were taken from
appliance manufacturing, teaching, medicine, and other
occupa�ons to move the dirt. In addi�on, the highway
system would have cost much more to build.
Produc�vity improvements, such as earth-moving
equipment, are essen�al for designing and building more
goods and services at a lower cost, which increases the
standard of living.
In addi�on, the net job loss in this example is not equal
to 19 jobs because new jobs are
created to design and manufacture the bulldozer. Jobs are
also created to sell and service the
equipment. Workers and equipment are needed to transport
the bulldozer from one job
loca�on to another. As a result, new jobs are created,
and most of these jobs require higher
levels of educa�on than moving dirt with a wheelbarrow.
Will this subs�tu�on generate
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enough new jobs to make up for the 19 that were lost?
The answer to this ques�on is easier
to understand when viewed broadly. Society would not

have a net produc�vity gain if the
same or more work is required to design, build, sell, and
service the bulldozer than was saved
by the subs�tu�on of capital (the bulldozer) for labor.
Society benefits because more work is
completed with fewer total resources. Also, the remaining
bulldozer operator is paid
substan�ally more than wheelbarrow operators. The jobs
created to engineer, manufacture,
and sell the bulldozer are also likely to carry higher
salaries than the wheelbarrow operator.
Higher wages must offset the savings generated from
increasing produc�vity. As a result, there
are displaced workers who become available to create new
products that grow the economy.
Productivity and Leisure
Produc�vity increases do not always result in greater
output. As produc�vity in the United
States increases, some of the benefits include more leisure
�me for workers. In the United
States, the "nominal" workweek has been 40 hours for
several decades. In the first half of the
20th century, however, the workweek was much longer—50
to 60 hours and a six-day
workweek was not uncommon. During that �me period,
�me off for holidays and vaca�on was
substan�ally less than what is considered normal today.
Drama�c increases in produc�vity
allowed the U.S. economy to experience an expanding
living standard and a contrac�ng workweek.
Today, employees in many countries in Europe have
shorter workweeks and more generous vaca�ons than
employees in the United States. However, such choices

have implica�ons for the people in these European
countries. If they want to work fewer hours, there is less
for them to consume unless they can find ways to
increase produc�vity.
Importance of HR Management
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Health care produc�vity can be increased and quality
enhanced
when hospitals specialize in different areas such as
pediatrics or
neurology. In this way, they avoid duplica�ng expensive
equipment, highly trained staff, and administra�ve
overhead.
Ryan McVay/Digital Visions/Thinkstock

3.4 Enhancing Productivity
Produc�vity increases sound ideal, but how can a
company achieve them? Some managers view
produc�vity improvements narrowly and a�ribute
improvements to a�en�on to the details of the
produc�on process. For example, changing the height of a
desk so that an administra�ve assistant
has easier access to the keyboard may increase
produc�vity. This adjustment can be an important
contribu�on in elimina�ng physical stress and reducing
fa�gue, which could lead to greater output.
This narrow view, however, is far from the whole picture.
Produc�vity is affected by:
Design of opera�ons including the number, size, loca�on, and
capacity of the facili�es providing the
service or producing the good.
Equipment and methods used.
Detailed analysis of the individual jobs and ac�vi�es.
Productivity and the Design of Operations
The first issue is not as simple as saying that fewer,
bigger facili�es will result in higher produc�vity
and lower costs, although that tends to be true and is
what conven�onal economic theory conveys.
This is generally referred to as the economies of scale
argument. Effec�vely designing opera�ons
matches the capabili�es of the facili�es to the needs of
the customer. For example, health care
produc�vity could be increased and quality could be
enhanced if hospitals specialize. Currently, many
hospitals are merging or forming alliances. These unions
permit one hospital to specialize in some
areas, such as pediatrics and obstetrics, while another

hospital specializes in other areas, such as
neurology and psychiatry. In this way, each hospital
avoids duplica�ng the cost of expensive
equipment, highly trained staff, and administra�ve
overhead.
Real World Scenarios: Shouldice Hospital
Shouldice Hospital in Ontario has specialized in the repair
of hernias since 1945, when Dr. Shouldice experienced a
large number of hernia cases and a
shortage of doctors and medical facili�es. Specializa�on
allowed the hospital and the doctors to find innova�ve
ways to perform hernia repair surgery. The
hospital reduced resource requirements and increased
produc�vity.
The objec�ve of the surgery is successful repair of the
hernia(s) with as li�le discomfort as possible for the
pa�ents so they can return to their normal life
quickly. Pa�ents frequently return to work in a few days;
the average total �me off is only eight days.
The hospital's success has been the benchmark for the
medical profession interna�onally. The hospital has
repaired more than 270,000 hernias with a success
rate greater than 99%. Shouldice pa�ents can walk out of
the opera�ng room, and their postopera�ve recovery is
rapid. By the following morning, most
pa�ents can par�cipate in a gentle exercise program. The
process, from surgery to recovery, is fast and effec�ve
for both the hospital and the pa�ent.
Productivity and Equipment and Methods
The equipment and methods used to provide a service or

produce a good can also have a substan�al impact upon
produc�vity. Providing the company's sales force
with so�ware to iden�fy prospects, determine their needs,
and track sales makes it a more produc�ve work force,
just as providing a factory worker with a newer
and faster piece of produc�on equipment. Providing
faculty with so�ware to manage instruc�onal materials
improves produc�vity as well; the tool should fit the
job. For example, if an employee is asked to move 1
million gallons of water from one point in a facility to
another, an electric pump and a hose is much be�er
than a bucket. In turn, neither the bucket nor the pump
would be appropriate for moving small amounts of water
to make coffee at the corner restaurant.
Real World Scenarios: Segway Personal Transporter
The Segway PT is an example of a technology that could
revolu�onize work and dras�cally increase produc�vity. It
is the first self-balancing, electric-powered
transporter and is designed to enhance the produc�vity of
people by increasing the distance they can travel and the
amount of goods they can carry. Segway
uses electronic gyroscopes for balance and microprocessors
to measure the rider's intent (leaning forward or leaning
backward) for forward and backward
mo�on. Dean Kamen and a group of talented engineers
and designers inspired this innova�on.
More than 1,200 police departments and public safety
organiza�ons around the world use the Segway PT. The
Segway PT allows these officers to create
innova�ve community programs, connect be�er with the
residences they serve, and patrol more area in less �me.
The Segway improves visibility as the officer
can see surroundings be�er and people can see the officer

be�er, and it is flexible enough to be used inside
buildings, such as airport terminals, as well as
outside. It also has zero emissions.
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When comple�ng tasks, most people will use only their
dominant hand. With a small
amount of training, a person can be taught to use both
hands, enabling the task to be
completed in about 70% of the �me it takes using only
one hand.
Roger Wright/The Image Bank/Ge�y Images
Segway PTs are currently used to patrol military bases,
allowing soldiers to inspect buildings on the post in less
�me. The Segway PT can cover a variety of
terrain, is versa�le and maneuverable, and provides
effec�ve crowd control.
Paramedics with the Chicago Fire Department use the
Segway PT to enhance response �me. They provide
shorter response �me for medical emergencies, can
carry enough equipment to provide lifesaving treatment
before an ambulance arrives, and can access upper floors
in high-rise buildings.
Segway PT also enables enhanced security in shopping
malls in Sonae Sierra, Portugal. The patrols are done

more quickly and effec�vely on a Segway PT than
on foot, thereby increasing the produc�vity of security
personnel who patrol the company's large shopping centers.
In turn, shoppers and storeowners no�ce
the security personnel, and feel safer and more secure.
Productivity and Detailed Analysis of Work
Detailed analyses of individual jobs and ac�vi�es focus
on making people more
produc�ve. Analysis may suggest a be�er way to
complete more work. For
example, most home dishwashers have a removable
silverware rack so the rack
can be moved to a convenient loca�on and the silverware
can be easily
removed. When given a task such as this, most people
will use only their
dominant hand. With a small amount of training, a person
can be taught to
use both hands. This enables the task to be completed in
approximately 70% of
the �me it would take for a person using only one hand.
When ideas like this
are applied to the billions of repe��ve tasks performed
each day in service and
manufacturing firms throughout the world, produc�vity
improvements and cost
reduc�ons could be enormous.
Summary of Methods
Innova�on and automa�on change the way work is done
and provide
important methods to increase produc�vity. When
organiza�ons increase the

number of customers served, there are opportuni�es to
achieve lower cost and
higher produc�vity through economies of scale.
Addi�onally, as organiza�ons
gain experience by serving more customers, they learn
how to do the work
be�er. This is o�en called con�nuous improvement. There
are also
opportuni�es to improve how work is done through
redesigning business
processes, improving how individual jobs are designed, and
enhancing a firm's
human resources. The following discussion focuses on
several approaches that
can be used separately or in combina�on to increase
produc�vity
Technology Innova�on—Brings new ideas, methods, or
equipment to the process of making a product. In banking,
computers and informa�on technology have
changed the process for reconciling checking account
transac�ons and have greatly increased produc�vity. Using
technology in distribu�on centers and
warehouses has enabled retailers to increase produc�vity and
reduce costs.
Automa�on—Subs�tutes capital for labor. Automa�on is
different from technological innova�on because exis�ng
automa�on is merely applied to a new
situa�on. Using conveyors to move parts between points in a
packaging opera�on can increase produc�vity. Conveyor
technology has been available for decades,
but it is constantly finding new applica�ons.
Economies of Scale—Allow firms to increase produc�vity by
making opera�ons larger. Both service and manufacturing
opera�ons take advantage of this tac�c to
improve produc�vity and lower costs. Consolida�on in the

banking industry is being driven by the need to spread fixed
costs, such as informa�on systems, credit
card processing, bank infrastructure, and management, over a
broader range of opera�ons. This consolida�on is also
occurring in accoun�ng firms, brokerage
houses, and credit card companies.
Learning and Experience—Enable firms to achieve produc�vity
improvements because the workforce gains knowledge about the
product and work processes.
From this knowledge, workers find be�er ways to organize
work. This concept was first applied in the aircra� industry so
firms could es�mate the cost of future
orders. The produc�vity improvements and the cost reduc�ons
were substan�al.
Business Process Redesign—Focuses on the understanding and
redesign of processes that already exist within and between
companies. For example, how can a
company streamline its product development process to create
more and be�er product ideas in less �me than the exis�ng
process?
Job Design and Work Measurement—Enable firms to examine
work at a detailed level so that it can be inves�gated and
improved. This examina�on o�en occurs
at the level of the individual worker or the interface between a
worker and a machine. The approach tends to examine
individual movement to improve
produc�vity. For example, the kitchen setup in a fast-food
restaurant is laid out so the cook can make items on the menu
with ease. This is the same overall
objec�ve used in a manufacturing firm to organize the assembly
area to put together a speaker or a keyboard.
Human Resources—Enable produc�vity improvements without
inves�ng in facili�es and equipment, buying high-quality
materials, redesigning jobs and
processes, or spending for employee training. In many
organiza�ons, the rate of produc�on is labor constrained. If

labor is mo�vated to do more work,
produc�vity can increase without addi�onal investments or
cost increases. For example, when faculty members sign
addi�onal students into their classes, they
have increased produc�vity with no addi�onal costs. When
sales managers add another sales territory to their workload,
their produc�vity increases without
increases in costs. Mo�va�on is a powerful tool that can be
used to increase produc�vity in any job that is labor intensive.
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Chapter Summary
Produc�vity is the ra�o of the outputs achieved from an
ac�vity to the inputs consumed to make those outputs.
Produc�vity is a key to increasing the standard of living.
Produc�vity is more important than money when driving
economic growth.
During the 20th century, the nature of work shi�ed from
primarily manual to primarily intellectual. As a result, the
produc�vity of managers, designers, and

planners is as important as or more important than the
produc�vity of blue-collar workers.
Calcula�ng produc�vity involves: (1) assessing the outputs
either by coun�ng the number of outputs, or by determining the
economic value of the outputs; and
(2) assessing the inputs by determining their value. Single-
factor produc�vity is used when only one input factor changes.
Mul�ple-factor produc�vity is used
when more than one input factor changes.
Primary inputs are labor (managers, workers, and externally
purchased services), capital (land, facili�es, and equipment),
and materials, including energy.
In many cases, when firms seek produc�vity improvement,
trade-offs between the inputs occur. Managers may be trading
capital for labor, capital for energy, or
material for labor in order to get an overall increase in
produc�vity.
Wage rates and produc�vity are posi�vely correlated.
Organiza�ons with high produc�vity can pay higher wage
rates.
Produc�vity improvements have two impacts on jobs. First,
they tend to shi� jobs from hands-on labor to behind-the-scenes
labor. The hands-on jobs usually
require manual work, and the behind-the-scenes jobs tend to
require intellectual work. Second, they free labor to seek
opportuni�es to create new services and
goods.
Technology innova�on, automa�on, economies of scale,
business process redesign, learning and experience, job design
and work measurement, and
improvements in human resources are all methods of enhancing
produc�vity.
Case Studies
All-Right Manufacturing Company

Nancy Nelligan just received the following memo from her
boss, the president of All-Right Manufacturing Company.
TO: Nancy Nelligan, V.P., Finance
FROM: Leo Everi�, President
RE: Produc�vity Improvement Program
I am sure you are aware of the importance of
produc�vity within manufacturing organiza�ons, and All-
Right is no excep�on. However, I am not sure
that our company's produc�vity is as good as it could be.
As such, I would like you to serve as coordinator of a
produc�vity improvement program.
As our newest execu�ve, I think this would be a great
opportunity for you to become involved and have a
substan�al impact upon this organiza�on.
I have already sent memos to the other vice presidents
and division managers direc�ng them to cooperate with
you on this ac�vity. Please report
back to me in two months indica�ng the ac�ons you
have taken and the results you have achieved.
Nancy just started working for All-Right one month ago.
She had previously held a posi�on in the corporate
finance department of a Fortune 500 company. In that
posi�on, Nancy was extensively involved in securing
capital for expansion and acquisi�on.
In her previous posi�on, Nancy had not been directly
involved in any produc�vity improvement ac�vi�es,
although she was aware of the produc�vity reports
produced by her previous employer and knew how the
data were collected and analyzed. To the best of her
knowledge, All-Right does not collect any data or
perform any calcula�ons to determine produc�vity. The

president's vague feeling that produc�vity could be be�er
supported Nancy's belief that All-Right was not
calcula�ng produc�vity.
Since joining All-Right, Nancy has met most of the other
vice presidents and managers. Some of them she knows
fairly well, although Nancy is s�ll regarded as the
"new kid on the block." She has learned from discussions
with the vice president of opera�ons that the company
had made an abor�ve a�empt at implemen�ng
ISO-9000 a few years ago, an a�empt which had ini�ally
been mandated by a memo from the president. She
wondered whether the produc�vity improvement
program would end the same way.
1. Was the president's approach to produc�vity improvement
the correct way to implement such a program?
2. Was the �me frame the president gave reasonable for
achieving meaningful results?
3. Pretend you are Nancy and dra� a memo to the president
sugges�ng the course of ac�on that you think should be taken
to achieve useful results. In the memo,
include a summary of the types of data needed to calculate
produc�vity.
Wholesome House Restaurants
Wholesome House Restaurants operates a chain of health-
food restaurants located in suburban shopping malls. The
company has tried to capitalize on increased
public awareness about healthy ea�ng by offering low-
calorie, low-fat cuisine to its customers. Instead of the
usual fare available at fast-food restaurants,
Wholesome House offers its customers dishes that include
fish and chicken cooked without fat. In addi�on, the

company's restaurants provide fresh fruits and
vegetables and whole-grain breads. Since it opened, the
company has been doing quite well. However, like most
start-up companies, Wholesome House is
concerned about its future. The restaurant business has
become increasingly compe��ve, and many chains that
started out well have gone bankrupt.
Wholesome House's management is concerned about rising
opera�ng costs and the company's produc�vity. Presently,
its restaurant opera�ons are labor intensive
because of the cuisine it offers. Using only fresh fruits
and vegetables requires extensive �me and effort for food
prepara�on. In addi�on, the sandwiches and most
other meals on the menu are assembled by hand.
Wholesome House has not adopted any of the assembly-
line techniques for producing mass quan��es of food
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that fast-food restaurant chains such as McDonald's and
Taco Bell use. On the other hand, Wholesome House is
able to charge more for its products because of its
market niche and because most of the restaurant's
customers have average or above-average incomes.
Wholesome House has collected the following data
concerning its opera�ons.
Two Years Ago Last Year

Net sales and opera�ng revenue $473,286,000 $631,987,000
Labor costs 120,470,000 203,405,000
Material and supplies 150,032,000 206,783,000
Services 35,991,000 45,276,000
Capital 127,486,000 250,478,000
1. Based on the informa�on provided, comment on the
company's produc�vity.
2. Can you iden�fy inputs in which produc�vity has not
followed the company's overall change in produc�vity?
3. Which areas do you think need a�en�on for future
produc�vity improvements?
4. Can you suggest how the company might improve
produc�vity?
Discussion Ques�ons
Click on each ques�on to reveal the answer.
1. Define produc�vity and describe why it is important.
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Produc�vity is the ra�o of the outputs achieved from an
ac�vity to the inputs consumed to make those outputs.
Produc�vity = Output/Input. For example, the
produc�vity of a machine that makes compact discs could
be determined by dividing the number of CDs produced
divided by the hours the machine worked.
Organiza�ons should strive to increase their produc�vity
because it keeps prices low and makes the organiza�on
more compe��ve in world markets.
Employees benefit because their wage increases are non-
infla�onary, which means they can buy more with the

extra money they earn.
2. Describe why produc�vity is more important than money.
Produc�vity is more important than money, because as
produc�vity increases, more products are available for
consump�on. This allows the real standard of
living to increase. Money, or increases in the amount of
money available without a corresponding increase in
available goods and services leads to high prices
for the same amount of goods and services. Real
consump�on does not increase, but prices do.
3. Explain how the nature of work has changed, and describe
how that affects produc�vity.
Over the past 100 years, the U.S. economy has shi�ed
from primarily manual labor to primarily intellectual labor.
Early in the 20th century, managers focused
on the produc�vity of the blue-collar workforce. Today,
that part of the workforce is s�ll declining as
organiza�ons focus on methods to enhance their
produc�vity. Today, most of the workforce is clerical,
staff, and managerial (white-collar). To further increase
produc�vity, it is essen�al that organiza�ons focus
on the produc�vity of this large and growing segment of
the economy.
4. What is the difference between single-factor and mul�ple-
factor produc�vity?

Single factor produc�vity has only one input factor. Labor
produc�vity is a single factor produc�vity measure.
Mul�ple factor produc�vity includes more than
one input factor; such as labor, materials, and capital. In
most cases, more than one input factor may change. As
companies invest in equipment, their capital
costs increase but labor and/or material costs may decline.
When this happens, inputs are usually transformed into
dollar costs. In this way, labor, material,
and capital can be added to form the denominator of the
produc�vity ra�o.
5. Describe labor produc�vity. What are its components?
Labor produc�vity is a single factor produc�vity measure
that assesses the output, o�en units produced, compared to
some measure of labor inputs, o�en
labor hours. Labor includes workers on the shop floor,
managers, staff, clerical, and externally purchased services.
It is important to realize that direct labor
accounts for the people who work in producing the goods
or services, and indirect labor accounts for the people that
supports produc�on such as quality
control, supervision, and maintenance.
6. Describe capital produc�vity. What are its components?

Capital produc�vity is a single factor produc�vity
measure that assesses the output, o�en units produced,
compared to some measure of capital inputs, o�en
machine hours or capital dollars. Capital includes
investments in land, facili�es, and equipment.
7. Describe material produc�vity. What are its components?
Material produc�vity is a single factor produc�vity
measure that assesses the output, o�en units produced,
compared to some measure of material inputs,
o�en materials costs. Materials include items used to
make the product as well as energy.
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8. What are the important trade-offs involving the inputs to
produc�vity?

For centuries, businesses have made a series of trade-offs
to improve overall produc�vity. The most significant of
these is trading capital for labor. This trade-
off has focused on automa�ng ac�vi�es previously
performed by people. In both service and manufacturing
opera�ons, this shi�s effort from opera�ons to
the development of equipment and so�ware that support
opera�ons. This has led to a fundamental change in the
nature of work. Organiza�ons have also
made significant investments in capital equipment and
facili�es to save material and energy costs. Finally,
organiza�ons trade material costs for increases in
labor produc�vity. Some�mes organiza�ons are willing to
increase the cost of incoming materials if they can
achieve higher output rates from the labor force.
9. How are wage rate and produc�vity related?
Wages rates and produc�vity are posi�vely correlated.
This implies that as a worker's produc�vity increases, the
organiza�on can afford to pay the worker
more because the worker is genera�ng more output. This
allows the pay increase to be non-infla�onary.
10. What are the impacts of produc�vity upon the workforce?
The largest impact of produc�vity improvements on the
workforce is to shi� the work from manual to intellectual
work. Building roads has shi�ed from many

workers using shovels to fewer workers using bulldozers.
These jobs are replaced in part with white-collar jobs that
design equipment.
11. How does quality impact produc�vity?
If produc�vity gains are to be meaningful, the quality
level of the output must be the same or increase.
Producing more output of lower quality means that
the value/usefulness of each item produced is lower. This
is not the proper way to increase produc�vity.
12. Describe five ways that produc�vity can be enhanced.
There are a variety of ways that produc�vity can be
enhanced. Technology innova�on brings new ideas,
methods, and equipment to the process of making a
product. Automa�on allows firms to subs�tute capital for
labor. Economies of scale allow firms to increase
produc�vity by making opera�ons larger. In this
way, more output is achieved from the same investment in
fixed costs. Business process redesign focuses on
understanding current processes and changing
them so they produce more output faster and with fewer
resources (people and equipment). Learning and experience
enables firms and people to work
smarter. In quality management this is o�en called
con�nuous improvement. Carefully examining jobs at the
detailed levels with job design and work
measurement allows firms to eliminate wasted mo�on in

assembly and clerical jobs. Human resources can enable
produc�vity improvements without inves�ng
in facili�es and equipment, buying high-quality materials,
redesigning jobs and processes, or even spending for
employee training. Because the rate of
produc�on is labor constrained, labor could be mo�vated
to do more work. Mo�va�on allows the workforce to do
more even when other elements such as
capital investment are unchanged. They want to do more
for reasons of self-sa�sfac�on or helping the organiza�on
do be�er. Economies of scale allow firms
to increase produc�vity by making opera�ons larger,
which allows firms to produce more at a lower cost per
unit. Job design and work measurement enable
firms to examine work at a detailed level so that it can
be inves�gated and improved.
Problems
1. A junior accountant working for an accoun�ng firm earned
$40,000 last year in wages and benefits. The work this person
performed was billed to clients at
$200,000 for the year. What is the junior accountant's labor
produc�vity?
2. A certain machine makes various-sized screws that have a
market value of $50,000 per year. Materials used to make those
screws cost $5,000 per year. The annual
cost of owning and opera�ng the screw-making machine totals
$25,000. What is the produc�vity of that machine? What is the
produc�vity of the materials? What
is the overall produc�vity?
3. A company that manufactures radios had sales of $3,750,000
last year. Total labor costs for the year were $1,500,000, capital
costs were $1,275,000, and materials

costs were $750,000. What was the company's produc�vity
based on this informa�on?
4. The New City Hospital has recorded its pa�ent billings and
labor costs during the last two years. How has the hospital's
labor produc�vity changed?
Total billings $10,230,000 $12,450,000
Labor costs 4,375,000 5,200,000
5. The Electro-Lite Electronics Company has recently
automated part of its produc�on process. The labor, capital
costs, and value added by this process for the last
two years are shown below. Compare the produc�vity of labor
and capital for these years.
Value added $1,365,000 $1,425,000
Labor costs 870,000 375,000
Capital costs 160,000 924,000
6. The company men�oned in Problem 3 is considering
subs�tu�ng capital for labor by purchasing automated
equipment to perform an opera�on previously done
manually. This new equipment will cost $200,000 per year to
own and operate. What must the labor savings be in order to
produce an increase in overall
produc�vity?
7. Michael's Manufacturing wants to determine the overall
produc�vity of its opera�ons. The company has data for one
month last year and good current data. The
sales price of the product is $40.00, the wage rate (including
benefits) is $18.00 per hour, the resin cost is $.60 per pound,
and the energy cost per BTU is $.50.

These costs can be applied to both years. What was the
produc�vity then and what is it now? At what rate is
produc�vity changing?

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Last Year This Year
Produc�on (units) 2,000 2,150
Labor hours 600 550
Resin (pounds) 100 90
Capital (dollars) 20,000 23,000

Energy (BTUs) 6,000 5,700
8. Suppose the company in Problem 7 wants to increase
produc�vity by 5%. How much labor savings must occur to
achieve this?
9. Witkowski Tax Services processes federal income tax forms.
This year in April, the company's busiest month, the company
prepared 4,500 income tax returns with
an average revenue of $60 each. In April last year, they
completed 3,750 returns with an average revenue of $55 each.
Below are the average costs, adjusted for
infla�on.
Last Year This Year
Labor hours $3,000 $3,200
Management costs 25,000 28,000
Computer technology 15,000 20,000
Rent for office 2,000 2,200
Office supplies 3,000 3,600
a. What is the produc�vity this year and last year for each
factor and overall?
b. How has the produc�vity changed for each factor and
overall?
c. What can be done to further improve produc�vity?
Click here to see solu�ons to the odd-numbered problems.
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_solu�ons.pdf)
Key Terms
Click on each key term to see the defini�on.

crea�ve destruc�on
44.13.2/sec�ons/cover/books/AUBUS644.13.2/sec�ons/cover/b
oo
When new ideas or technologies replace exis�ng products,
such as when sales and jobs decline in exis�ng companies
and grow quickly in the companies with new
ideas.
direct labor
oo
People who make a product or provide services; the
hands-on workforce.
economies of scale
oo
The ability to produce more goods at a lower cost by
be�er u�lizing the same fixed costs. There is a most
efficient size for a facility and there is a most efficient
size for a firm; building sufficient sales and produc�on
volume is necessary to maximize the fixed costs of an
organiza�on.
indirect labor

oo
Labor that supports the produc�on of a good or service
such as quality, supervision, and maintenance.
produc�vity
oo
Output from an ac�vity divided by total input to the
ac�vity.
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4
Andy So�riou/Photodisc/Thinkstock
Quality Management
Learning Objec�ves
A�er comple�ng this chapter, you should be able to:
Define quality from both an internal and an external
orienta�on.
List the dimensions of service quality and quality for
manufacturing.
Understand how to gather customer expecta�ons to ensure that
the firm has captured the voice of the
customer.
Summarize the philosophies of W. Edwards Deming, Joseph
Juran, Philip Crosby, and Genichi Taguchi.
Explain how quality is built into a good or service.
List and explain the components of total quality management
(TQM).
Describe the purpose and use of quality func�on deployment.
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From electronics and automobiles to clothing and produce,
quality control is important to
ensure that only the best items reach the consumer.
©Adrian Burke/The Image Bank/Ge�y Images
4.1 Introduction to Quality Management
Price and quality are two cri�cal dimensions when
deciding to purchase a good or service because these are
key elements in the value proposi�on. That is, what
does the buyer give up versus what does the buyer
receive? When value proposi�on is high the benefits to
the buyer substan�ally exceed the costs. Quality is a
cri�cal element in the purchasing decision because quality
involves cri�cal factors such as the safety of an airplane
flight, the effec�veness of a surgical procedure,
or the performance of an automobile. Quality is
mul�faceted because the quality of a service or good is
judged on several factors. For example, the quality of an
airplane flight not only includes the safety factor; it also
includes depar�ng and arriving on �me, the comfort of
the surroundings, and baggage handling. For an
automobile, quality is not only performance; it also
includes safety and specific features such as video
entertainment systems and global posi�oning devices.
While quality is essen�al for organiza�onal success, for
many companies it
is difficult to use quality to differen�ate their products
from their
compe�tors' products for two reasons. First, customers

may not consider
products for purchase that do not have high quality.
Second, compe�tors
have recognized the value that customers place on quality,
and are striving
for high quality by con�nuously monitoring customer
expecta�ons,
inves�ga�ng and implemen�ng new technologies that
enhance quality,
and quickly imita�ng compe�tors' improvements in
features and
performance. To use an analogy from poker, high quality
has become the
ante, or minimum bet, to play at the table. Despite these
challenges,
companies such as Apple, FedEx, and Google have been
able to develop
and maintain very strong reputa�ons for high quality
while some of their
compe�tors have not. RIM has fallen behind Apple;
FedEx has taken
package delivery from the U.S. Postal Service; and Google
is well ahead of
Yahoo!. Simply put, companies that have a strong
reputa�on for quality
have been able to integrate quality throughout the
organiza�on, adop�ng
an approach that infuses quality into company decision
making. This
approach has a variety of names; the one used here is
quality
management. The purpose of this chapter is to explain the
nature of
quality and how an emphasis on quality can be spread
throughout the

organiza�on.
Perspectives on Quality
When asked, customers can ar�culate some of the criteria
that determine whether a product has high quality. For
example, a hotel room should be clean and
comfortable, and the guest should feel safe. A washing
machine should get the clothes clean. However, defining
quality is not always that simple. The factors
included in quality assessment of a hotel room depends, at
least in part, on its use. For a resort hotel, the pool,
restaurants, beaches, and workout facili�es are
part of the quality decision. For a person who is stopping
for one night at a hotel while driving on the interstate,
the ameni�es included in the resort hotel do not
ma�er. Traveling guests only care whether or not the
room is clean, comfortable, and convenient. In the earlier
example of the washing machine, one customer
may want a large capacity washer that minimizes water
use, while another may want a small, stackable washer-
drier unit that is quiet. As a result, it is not possible
to fully define quality, because quality is determined by
the customer and how the customer will use a product.
As a result, the defini�on of quality has both an
internal orienta�on—quality from the company's
perspec�ve, and an external orienta�on—quality from the
customer's perspec�ve.
Internally Oriented Defini�ons of Quality
Defini�ons of quality that have an internal orienta�on
directly measure characteris�cs of the product, such as the
number of packages delivered on �me or the
thickness of an engine part. Two examples of internally
oriented defini�ons of quality are:

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