Download A PUZZLE FOR BUSINESS?

A PUZZLE
FOR BUSINESS?
TANG YAU HOONG
Economists seem alarmed by productivity
levels, and why UK workers toil 16% more
hours to match their German counterparts.
Should this really worry FDs? Martin
Wheatcroft offers an accountant’s take on it
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SEPTEMBER 2015 FINANCE & MANAGEMENT
COVER STORY
DOES IT MATTER?
A
re you
worried about productivity? As it happens, I am
deeply worried, but not for the reasons that you
might imagine. After all, for all the agonising about
the productivity gap, most businesses do not spend
much time thinking a lot about it.
Profitability, return on investment, quality,
customer service and delivering on our strategy are
what I worry about, as I am sure most of you do too.
Outputs are what count – in terms of the financial
returns we are generating and our ability to generate
even better financial returns in the future.
Yes, productivity and efficiency are important.
But they are just two of the many ways we look
to optimise our cost base in order to maximise
financial returns. It is not a primary objective, or
even necessarily an objective. Business is more
nuanced than that. We might choose to reduce
efficiency or productivity in order to meet our
strategic goals more quickly. Or to improve customer
service and hence customer retention for the
long-term good of the business.
Indeed, unless you are working in a professional
services firm, where billable hours are an important
metric, productivity is unlikely to be one of your key
performance indicators. Or possibly even a
performance indicator that you study at all.
I might go so far as to suggest that, in general,
productivity has little place in much of the business
world anymore, other than in the occasional
challenge to your senior managers: “Do you really
need all those people?” The era of the time and
motion study has gone. Productivity is no longer a
critical success factor.
FINANCE & MANAGEMENT SEPTEMBER 2015
Before I go further, it probably makes sense to explain
what is meant by productivity and why many businesses
don’t tend to worry about it. The economic definition is
straightforward: it just means the level of financial
output per unit of input.
In this case, we are talking about employee
productivity, so the unit of input is labour. You may have
some measures such as revenue per head or profit per
full-time equivalent (FTE) that provide some data about
this in your business. The government uses either GDP
or gross value added (a component of GDP) divided by
labour hours to give it a handle on what is going on
across the whole economy. The equivalent measure for
an individual business would be employee contribution
(profits before employee and related costs) divided by
the total number of hours worked.
And, of course, this leads to the principal reason why
most of us don’t worry about productivity, even
if we are worried about margins or other efficiency
measures. Financially, if the output is the same, then
it makes no difference to most businesses as to whether
we employ three people costing £10 an hour or two
people costing £15 an hour. And recently, with wage
growth constrained, we have been able to do just that.
That is not to say that businesses do not look at
productivity in some contexts: for example, in optimising
critical processes – whether that is the average time it
takes to clean a hotel room or the quantity of widgets
produced per direct labour hour. But at the level of the
overall business? It is unlikely that you even know how
many hours your salaried employees are actually
working, let alone that you will attempt to calculate their
hourly productivity.
This may seem surprising given how management
is driven by measurement. We calculate margins and
returns on investment. We survey our customers about
product quality and customer service. We keep a beady
eye on costs and clamp down on wasteful spending. We
count the number of development plans and how many
development actions have been undertaken. We stress
test our level of gearing. We obsess about employee
engagement scores.
But most of us don’t worry about the overall
productivity of our employees across the entire business.
Even for those of you who do track a productivity metric,
such as revenue per FTE, when was the last time you
took an action specifically to improve that metric?
If business doesn’t particularly care, why does
everyone keep going on about it so much?
The simple answer is that some people are really
worried. They are concerned that productivity in the UK
is very low compared with the other major developed
Productivity and efficiency
are important. But they are
just two of the many ways
we look to optimise our cost
base and maximise returns
19
14
%
The amount output per
hour worked is below
where it would have
been if pre-recession
trends had continued
73.3%
The current employment
rate, back to prerecession levels –
although this includes
more part-time and
self-employed people
countries– the productivity gap. It may not be
Fermat’s Last Theorem, but trying to work out what is
going on keeps many economists gainfully employed.
They are concerned that productivity has fallen
during the economic recovery rather than risen, the
so-called productivity puzzle. Even though for many
this has been good, with the UK being spared the
pain of high unemployment seen in other countries,
there is a ‘but’. Productivity is even lower now than
it was before and that can’t be a good sign, can it?
But perhaps the main concern, the one that has
policymakers and economists really worried, is that
low productivity might be a sign of something that
could have really damaging long-term implications
for the UK economy.
And that’s underinvestment: underinvestment in
capital equipment, in productive capacity, in skills
and in technology.
If they are right, then our low productivity level is
definitely something to sit up and take notice of.
With productivity in the US, Germany and France
all substantially higher than ours, are we heading
for a big fall as they power ahead?
ARE WE ALL DOOMED?
The case seems clear. We know that businesses have
struggled to get finance to fund investment and
expansion. We put less into research and
development than other countries. As a country, we
put a lot of money into old bricks and mortar
in the hope of the next property price boom, and
much less into seed capital.
Investment is too low: productivity puzzle solved.
But is our entire economy really full of businesses
that don’t understand the need to invest if they are
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to grow in the future? Are investors abandoning
equity investment? Have businesses not noticed the
availability of (relatively) cheap finance? Have they
lost the ability to put together an investment case
and persuade their boards of the need to invest?
No, of course they haven’t. So why are companies
returning funds to investors rather than investing in
future growth? Is this all about short-term gain at
the expense of long-term value?
One potential and plausible answer is that
perhaps we can still grow without needing to invest
as much as we did in the past. There is a
fundamental shift in the nature of capital
investment, driven by technology. Not just from
improvements in technological capabilities at ever
decreasing prices, but by the cloud revolution.
For many SMEs, they are increasingly likely not
to need to incur capital expenditure on many
systems ever again. Need a sales system? Sign-up
to a cloud-based CRM for a monthly subscription.
Need a HR, supply chain or even an accounting
system? There’s no need to invest up front, just
sign up online.
Larger businesses are starting to move in the
same direction, as cloud-based services start to
appear that can provide economies of scale
across whole industries, while improving
performance from the older customised and less
flexible systems of the past.
In addition, where companies are investing in
technology, they are getting better at delivering
more targeted and effective investment. Output
per pound of investment continues to improve
significantly. Today’s systems are more flexible and
capable. And they tend to work and deliver the
efficiencies that were claimed.
As businesses, we are getting smarter at investing
and benefiting from economies of scale without
having to scale up ourselves. Profitability and
returns on investment are up.
All without worrying about productivity.
Or, apparently, increasing it either.
WHY AM I WORRIED?
In many ways, there are several arguments
for not worrying at all. Business seems to be
doing OK even without getting too focused on the
issue of productivity.
Perhaps we should just leave it to the economists
to worry about their productivity puzzle in peace.
We have better things to do, such as generating
strong returns, building value for our shareholders
and polishing costs so that the margins squeak.
Is our entire economy really
full of businesses that don’t
understand the need to
invest if they are to grow
in the future?
SEPTEMBER 2015 FINANCE & MANAGEMENT
COVER STORY
THE SKILLS AND PRODUCTIVITY
REPORT
The Finance & Management Faculty
published the work of Robert Joyce and
Helen Miller of the Institute of Fiscal
Studies in June. Here’s a summary
Employment has recovered strongly since
the recession, but the amount that each
worker produces has not. The reasons for
disappointing productivity performance are
the focus for our attention.
The employment rate is back above its
pre-crisis level, at 73.3%, but more people
are working part-time, or are self-employed.
The proportion of workers aged 16 to 59
with a higher education qualification has
risen rapidly too, from 33.7% in 2007 to
42.6% in 2014. The earnings of those in
work are lower, in real terms, than before
the crisis. We expect median household
incomes for those of working age are about
FINANCE & MANAGEMENT SEPTEMBER 2015
FIGURE 1: INTERNATIONAL COMPARISONS OF PRODUCTIVITY
PRICE GDP PER WORKER, G7 NATIONS
NOTE: INDEX, UK=100
160
2012
2013
108
107
115
114
116
115
80
104
103
100
100
100
120
119
120
140
139
140
UK (=100)
CANADA
GERMANY
FRANCE
ITALY
90
88
However, there is one implication of low
productivity that I believe the economists do
have right. It is a sign that we are underinvesting
in our people.
If we are to survive and thrive in the long term
and not lose out to less efficient, but more
productive, competitors then we need to
maximise the output of all of our employees.
And that leads to what really worries me.
Have we spent too much time measuring how
engaged our teams are? Is being cheerful and
ticking off actions on their development plans
enough to make them better employees?
Yes, these are all worthwhile metrics,
but in reality they are all about inputs. Wouldn’t
it be better to measure outputs?
And there is a metric
available for that. It’s
called productivity.
So if you do one thing this
month this could be it –
introduce a productivity
measure into your monthly
report and start tracking
Martin Wheatcroft
how much value your people is managing
are really adding.
director of Pendan
60
40
20
0
JAPAN
G7 exc. UK
US
SOURCES: OECD, OFFICE FOR NATIONAL STATISTICS
2% lower in real terms in 2014/15 than
before the recession.
There is evidence, too, that labour supply
has been more robust in this recession than
previously. Changes to benefits policies
linked them more closely to work, an
increase in the female state pension age,
substantial reductions in expected wealth
and a fall in the proportion of workers who
are members of trade unions are potential
factors at play.
Labour productivity fell substantially in
2008, and while it had been recovering in
the years to 2011, it has been stagnant since.
The latest figures show that output per hour
worked is at 14% below where it would have
been had the pre-recession trend continued.
This poor performance has become known
as the productivity puzzle.
What is especially puzzling is why we
have seen growing output and employment
since 2012 but no growth in productivity.
Falling real wages in response to the crisis
provided an incentive for firms to switch to
a more labour-intense form of production.
Low wages may therefore have directly
contributed to low labour productivity.
A possible explanation of both low output
per hour and low hourly wages is that
workers are not as well utilised as before
the recession. Firms may still be operating
with spare labour capacity because they
needed to keep a certain number of
employees even when demand was low.
A low demand environment may also
lead to lower productivity if it means that
workers have to work harder to win
business, or firms choose to invest in
intangible, knowledge-based assets.
Two important determinants of growth in
labour productivity are the amount of
capital that workers have at their disposal
and how that capital is allocated across the
economy. There is evidence that both have
been impaired since 2008.
Business investment fell sharply at the
start of the recession and was slow to pick
up. There is some evidence that in the early
stage of the recession some types of firm
were constrained by the cost of credit or
access to it. Greater caution over investment
decisions may have also played a role.
In his Budget speech, chancellor George
Osborne pointed out the UK was growing
50% faster than Germany and seven times
faster than France. What he didn’t add was
that for every hour worked in the UK, the
same amount of output takes only 53
minutes to produce in France and Germany.
The UK has had lower productivity than
these countries since the 1970s. But prior to
the recession the productivity gap had been
slowly closing; it has now increased back to
near 1991 levels. It is also bad news for living
standards. Until a more educated and
experienced workforce becomes a more
productive one, living standards are unlikely
to increase meaningfully.
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