The term productivity means different things to different people. To an economist, it is a relatively dry economic term that compares the output of entire countries relative to each dollar invested. However, for the purpose if this article productivity will be defined as a measure of efficiency with regards to the use of human resources within a firm. In either case, productivity is simply the value of the outputs a firm produces divided by the costs of producing those outputs. The formula for productivity is simply:
Productivity = Outputs / Inputs
To increase productivity, outputs must increase more than costs. There are two basic ways to accomplish this, decrease costs while maintaining output, or increase output while maintaining costs. The first scenario (cutting costs) is something most HR departments are fairly familiar with.
HR Traditionally Focuses On Controlling Costs Rather Than Increasing Revenue
Increase revenues or cut costs?
There are two components detailed in a profit and loss statement, revenues and costs. In HR, most of the focus has historically been on the cost side. HR has repeatedly found that it is relatively easy to cut costs. Firms can hire workers with fewer skills more cheaply than they can those with superior skills. When workers demand more pay, they can be replaced with cheaper, albeit less effective workers, or the costs of any increase in pay given offset by modifying the other benefits employees receive. The amount of training employees receive can be cut back, or the delivery method changed to lower total cost. In most cases, ad hoc actions are taken, and new programs implemented, without ever determining the impact on firm productivity.
It is critical that HR alter its focus away from costs and start to demonstrate an ability to design and implement HR programs that positively impact productivity. While generating revenue is more difficult than controlling costs, HR must step up to the plate as other functions have. Increasing revenues demonstrates that you have elevated your firm’s ability to meet customer needs, because you have done one of two things. You have either increased the volume of products being sold, or produced a higher quality product that customers are willing to pay more for. In contrast, when you cut costs you are not focusing on developing increased customer satisfaction or product quality.
I'm not saying that costs are unimportant, but obviously pleasing customers, increasing sales and providing superior products that can be sold at a premium are more rewarding activities. Remember, if you fired every employee your employee costs would decline but so to would your sales, productivity and product development efforts. Any accountant can determine how to cut costs but it takes real management insight and talent to increase productivity and revenue. Books like Built to Last and Good to Great have demonstrated that increasing customer satisfaction and revenue are superior long-term survival strategies than simple "cost-cutting."
HR Must Take Responsibility For Productivity
HR has traditionally taken an "it's not my concern" view towards productivity. HR managers don't measure or track employee costs (often called labor costs) as a percentage of production costs. When HR is confronted about their lack of "accountability" with regards to employee productivity, they respond by stating that they "don't have control over all the factors that contribute to productivity," or that "it’s too complex of an issue for HR." This refusal comes from the same HR that constantly asks managers to consider them "strategic partners." Well, what can be more strategic than helping to increase the productivity of the workforce?
When HR does decide to become more accountable for productivity, the next step will be to move beyond the current "doing things" and "running programs" approach and instead provide managers with easy to use tools that will ultimately enable them to more accurately manage employee productivity. HR should reposition itself as a "productivity consulting center" where managers can come for productivity improvement answers. Some of the questions HR must be able to answer for managers include:
- How to motivate employees to increase their output
- How to provide employees challenge and an environment that reduces the risk of top performer turnover
- How to assemble a workforce capable of increasing innovation and product quality at industry "disrupting" levels
- How to increase customer satisfaction throughout the organization
- How to increase the percentage of projects that are completed on time and under budget
How To Measure Productivity?
Once you have bought into the need for HR to assume responsibility for employee productivity the next step is to learn how to measure productivity. As mentioned earlier, the formula for productivity is simply:
The goal is to maximize the differential between outputs and inputs. In the case of HR, we're looking at only the segment of productivity that relates to employee output. There are other aspects of productivity that other functions must address, including the productivity of plant and equipment as well as the productivity of capital investments. Both plant and equipment and capital financing are important, but it’s interesting to note that the productivity of employees is generally the most impactful of the three on company profitability. This is true for variety of reasons, the largest of which is that for most firms nearly 60 percent of all variable costs are people costs, including salaries, benefits and HR administrative costs. While it is true that HR does not control all aspects of corporate life that impact employee costs, it is also true for almost every other functional department, yet everyone else accepts accountability. HR must accept that it is their job to influence others within the organization to increase the productivity of our employees.
Reporting Productivity Gains
There are three ways to highlight or report your organization's productivity. They include:
- % Change — The positive or negative change in productivity between two time periods (Example – Productivity was up 10% in Q2 when compared to the same quarter last year.)
- Ratio — The dollar value of the outputs produced by 1 dollar of inputs (Example – Each dollar invested produces $2.80 output; 2.80:1)
- Comparisons — You can directly compare your productivity to that of your closest competitors, market, or industry. To determine optimal placement of operations, compare the productivity between countries. For example, if you compare the output of US workers for every dollar invested to the worker output in China you find that U.S. workers are as much as 20 times more productive than workers in China.
Calculating HR Productivity Measures
There are several ways that HR can demonstrate its firm’s productivity. Some of the measures I recommend are listed below:
The 3 Very Simplest Measures:
- Revenue Per Employee As A Presumptive Measure Of Productivity
A good starting metric, and one fairly easy to calculate is revenue per employee. The two pieces of date required to calculate this measure, total current revenues and current employee count, are often easily available. This metric is a very good indicator of efficiency when comparisons are made between firms of similar size in the same industry.
If HR is successfully impacting the workforce, managers should expect revenue per employee to increase each year. The major weakness of using revenue per employee is that it fails to include the cost of the employees in the calculation. This is important because firms with a large number of highly paid employees would on the surface, report the same ratio of revenue per employee as a low paying firm even though the actual cost of employees would be significantly higher.
Revenue per Employee = Total Revenues / Average # of Employees
- People Cost to Total Cost Ratio
Another simple ratio to calculate is to identify what percentage of total variable costs are people costs. Effective management strategies reduce costs while simultaneously improving employee output. The very best firms keep the ratio of labor costs constant and they use technology and productivity tools to increase output.
People to Total Cost Ratio = Total Labor Costs / (Cost of Goods Sold + SG&A Expense)
- People Cost To Output Value And Units
The last simple ratio to calculate is to identify the ration between people costs and the dollar value of the firm’s output. A similar measure calculates the labor cost per unit of production.The ratio of people costs to the value of the firms output ($) = Value of Firm Output / People Costs
Labor costs per unit of production (Units) = Number of Units Produced / Labor Hours Used
More Complex Productivity Measures:
- Profit Per Employee
Similar to the revenue per employee calculation, but the major difference here is that profit is substituted for revenue. For most firms, profit is a more accurate reflection of company success than revenue.Profit per Employee = Gross Profit / Average # of Employees
- Revenue Per People Dollar
Another measure of productivity is a ratio between revenues and total employee costs.
Revenue per People Dollar =Total Revenues / Total People Costs
When calculating total people costs, include the cost of all wages, benefits, and HR administration.
- People Profit
- The ultimate measure in productivity is called "people profit." It is a ratio between profit and total employee costs. Firms that generate more dollars of profit per dollar spent on employee costs are the most productive.
Total People Costs
When calculating total people costs, include the cost of all wages, benefits, and HR administration.
Final Notes On Comparing Productivity Measures
Comparing your productivity results to other firms may be difficult if either you or your competitors are privately held firms because most private firms are unwilling to share how well they do on these important ratios. Comparisons to firms outside your home country can also be complicated, due to varying tax laws regarding the amortization of R&D, an expense. However, you can use estimates or other available indicators for data you cannot get your hands on. While firms do not always report total labor costs, most report something called SG&A Expense, which incorporates total labor costs. You can use a percentage of SG&A expense as an estimate for total labor costs when the actual data is unavailable.
It is worth noting that many productivity formulas and their related benchmark numbers are available from the Saratoga Institute. The Institute has a long established reputation for tracking HR metrics. In addition to external comparisons, internal comparisons you might want to make include "this year's performance compared to last year's performance or a multi-year trend.
Things HR Can Do To Increase Productivity
Once you do the initial assessment of how productive your employees are the next step is to determine how to increase that productivity without, at the same time, increasing costs proportionally. Although the answers vary with every organization, HR tools that usually have the highest impact on employee output and productivity include:
- Retention tools
- Referral programs
- Metrics (to increase accountability) and rewards that are tied to performance and productivity
- Identifying what motivates, challenges and frustrates employees
- Performance management programs that drop poor performing managers and employees
- Incentive systems that focus on rewarding managers for great "people management" performance
- On the job learning and growth opportunities (job rotations and special projects)
- Rewards for sharing best practices between managers
- Measures and rewards that Cross functional lines in order to increase cooperation
- Forecasting and workforce planning
Things HR Often Does That Have Little Impact On Productivity
There are many traditional HR programs that on the surface may seem like good ideas but often end up having little actual impact on productivity. Some of these low impact HR activities include:
- Implementing competency programs
- Improving existing performance appraisal programs
- Training for their "next job"
- Mentor programs
- Increasing employee benefits
- Outsourcing HR activities
- Increasing the number of generalists in the field
If HR expects to have a dramatic and continuing strategic impact on a firm’s profitability, it needs to rethink its current approach. It must start by shifting its emphasis away from the traditional cost cutting approach and instead focus its time and budget on increasing revenue and productivity. Should HR accept that perspective, then the next step is to become a "consulting center" where HR professionals can quickly become experts on the effective tools and approaches to increase employee productivity. Once HR understands which "people tools" have the desired impact on quality, output, customer satisfaction and motivation, HR needs to provide those tools to managers in such a way that they are easy to use and understand. Next, HR needs to define a set of productivity metrics and measures so it can continually refine and improve the productivity tools it offers to managers. And finally, HR must build up its credibility among senior managers and convince them that HR is an expert in productivity improvement. Once this expertise is established, managers will come to HR first (rather than external consultants) when they need an increase in their department's productivity!