The Productivity-Quality-Profit Connection in Business

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The Productivity-Quality-Profit Connection in Business

Business Essentials · Chapter 8: Operations Management and Information SystemsSection 8.2 · lesson 43 of 10513 min · free with a free account

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In this lesson

Why getting it right the first time shows up in profit.

  • Define productivity and explain how it is measured
  • Separate productivity, efficiency, and effectiveness
  • Explain when quality raises or lowers cost
  • Trace a quality failure through to profit

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Operations Management and Information Systems

The Productivity-Quality-Profit Connection in Business

Productivity, quality, and profit are often managed as three separate goals. This section argues that they're really one connected system. We'll start by defining productivity, and looking at how it's measured. Then we'll separate three terms people routinely blur: productivity, efficiency, and effectiveness. We'll look at five routes to improvement, including the one that's used least. Next comes quality. What it means, what it costs, and whether it costs money at all. Finally, we'll trace a single wiring defect all the way through to profit. Keep one idea in mind as we go. A defect isn't only a quality problem. It's lost productivity.

Measuring Productivity

Output Divided by Input

Productivity is the ratio of output to input. Put simply, it's how much an operation produces, relative to the resources it uses. Two families of measure follow from that definition. Partial productivity relates output to a single input. Units per labor hour, units per machine hour, or units per kilogram of material. It's simple to calculate and easy to explain, and it's the measure most managers use. Total factor productivity relates output to all the inputs combined. Its advantage is that it captures a substitution, using less of one input by using more of another. In the United States, the Bureau of Labor Statistics publishes national measures of both kinds. Labor productivity is output per hour worked. Multifactor productivity relates output to a combination of inputs, such as labor and capital.

Illustrative Figures

When a Partial Measure Flatters

An illustration shows why the difference between the two matters. The figures were constructed for the exercise. Bramley Metalworks, a fictional workshop, makes four hundred brackets a week, using one hundred labor hours. So its labor productivity is four brackets per hour. Then it buys an automatic machine. Now it makes six hundred brackets a week, using only sixty labor hours. Labor productivity has jumped to ten brackets per hour. That looks like a striking improvement. But think about what the labor measure leaves out. The machine carries a weekly cost of ownership. It also uses power and maintenance that didn't exist before. A total measure, counting the machine, the energy, and the labor together, might show a much smaller gain. Or no gain at all. So a partial measure can overstate a gain, if it ignores what was spent to obtain it.

Counting Output

When Output Resists Definition

Both kinds of measure share some practical problems. The first is that output must be counted in comparable units. That's easy for identical bolts. It's difficult when the product changes in quality, or in mix. In service and knowledge work, the difficulty is much greater, because the output itself resists definition. Ask how many units a lawyer produced this week. Or a teacher, or a software designer. You could count documents, lessons, or lines of code. That's possible, but misleading. Those counts reward volume, without regard to whether the work was useful, or right. So measures of such work tend to rely on proxies, stand-ins for the real output. And here's the trap. A proxy that's treated as the goal will distort the very behavior it's meant to measure. Make lines of code the target, and the incentive becomes more lines, not better software.

3 Terms

Efficient at the Wrong Thing

Three terms are routinely mixed up, and they're worth separating. Efficiency is the ratio of output to input. It's the productivity of the way something is done. Effectiveness is the degree to which an activity achieves the right result. In short, doing the right thing. And productivity is the measurable output-to-input ratio. Why does the distinction matter? Because an organization can be highly efficient at the wrong thing. Take Corley Press, a fictional print shop. It might produce thousands of brochures per hour, at very low cost. That's efficient. But suppose the brochures carry the wrong price, or reach the wrong audience. Then the effort has produced nothing the business needs. That's ineffective. Efficiency only means something once the output is worth having. So ask two questions, in order. Is this the right work? And is it being done economically?

Routes to Improvement

5 Ways to Raise Productivity

There are five broad routes to higher productivity. The first is working harder. It does raise output per hour, but human capacity limits it. Pushed too far, it costs quality and morale. So it's the weakest route, and the least durable. The second is better methods, redesigning how the work is done, for example through the task analysis of section seven point one. Third, better technology. Equipment or software that does more per unit of input. Fourth, better inputs. Materials or people more suited to the task, so less is lost along the way. The fifth route is eliminating work that need not be done at all. Steps that exist only to check or repair the errors of earlier steps. Reports no one reads. Handoffs that add no value. In many operations, this is the largest source of improvement. It's also the least used. Why? Partly because work that exists is easy to see, and easy to defend. Work that's been removed leaves nothing behind to be counted.

Defining Quality

3 Senses That Can Diverge

Before connecting quality to cost, we need to be clear what quality means. It has several senses. Conformance to specification is how closely a product or service matches its design. In this sense, a part is good quality if its dimensions fall within the stated tolerance. Fitness for purpose is whether it does what the user needs it to do. And customer perception is the customer's own judgment of the value received. The three can point in different directions. A part can conform perfectly to a specification that was written wrongly. It fits the drawing, and fails in use. Equally, a product can fit its purpose, and still be seen as poor. Unattractive packaging or rude service is enough to do it. So the business case depends on which sense is meant. A manager should know which one is being measured.

Figure 8.2.1

The Later the Defect, the Higher the Cost

The cost of quality framework, from section seven point five, sorts quality costs into four categories. Here we apply it to the business case. Prevention costs stop defects from occurring. Training, process design, and supplier selection. Appraisal costs are the costs of measuring and inspecting, to find defects. Internal failure costs come from defects found before the product reaches the customer. Scrap and rework, for example. External failure costs come from defects the customer finds. Returns, warranty repair, and lost business. The framework claims a pattern of escalation. The later in the process a defect is found, the more it costs to deal with. So external failure is the most expensive category, and prevention is the cheapest. Picture the four as bars rising from left to right along the process. The heights show relative order, not measured amounts. The economic point is that a prevented defect costs a fraction of one the customer discovers. That's the case for putting effort early in the process.

2 Positions

Does Quality Cost Money?

So, does quality cost money? There are two positions. The traditional view says yes. Better materials, more inspection, and more skilled labor all raise expenses. So there's an optimum level of quality. Beyond it, further improvement costs more than it returns. This view is strongest where customers won't pay for extra quality, and low price wins orders. The quality movement's view, linked to the philosophy in section seven point five, says the opposite. Improving quality reduces cost, because defects require rework, scrap, warranty, and complaint handling. Remove the defects, and you remove those costs. This view is strongest where failure costs are large. The empirical question is when each one holds. Quality improvement tends to lower cost when the operation produces a lot of waste to begin with. And when the improvement comes from better processes, rather than from extra inspection. It tends to raise cost when the defect rate is already very low, and gains need expensive materials or equipment customers don't value. How much quality to offer is a normative choice, set by a firm's customers and strategy. So there isn't one correct answer. The two positions describe different stretches of the same relationship.

Rework and Profit

A Quality Failure Is a Productivity Loss

The link between quality and productivity is direct, and it runs through rework. Rework is output that had to be produced, repaired, or handled a second time, because it wasn't right the first time. It consumes input without adding to good output. So a quality failure shows up as a fall in productivity. Suppose one hundred units are started, and ten must be reworked. The operation has used the labor and material for one hundred ten units of work, to get one hundred good units. And capacity lost to rework isn't available for new orders, so the volume it can deliver falls too. Poor quality, then, is one of the routes by which productivity is lost. Quality and productivity reach profit by two routes. On the cost side, there's less rework, less scrap, fewer returns, and less capacity spent fixing errors. On the revenue side, quality supports repeat purchase, favorable word of mouth, and in some markets, a price premium. Poor quality does the reverse. Lost customers take their future purchases with them. Honest analysis needs one caveat. Quality is necessary for profit, but not sufficient. A business can deliver excellent quality and still fail, because its costs are too high, its market too small, or its product unwanted.

Table 8.2.1

Verano Lighting: A Defect Traced to Profit

Now a worked analysis, with figures constructed for the exercise. Verano Lighting, a fictional company, assembles lamps. A poorly specified crimping step causes a wiring defect, in five percent of the ten thousand lamps built in a month. That's five hundred lamps. Four hundred are caught at final inspection, and reworked at six dollars each. That's two thousand four hundred dollars of internal failure. The other hundred reach customers, and each return costs thirty dollars in shipping, replacement, and handling. That's three thousand dollars of external failure. Then there's the hidden cost. Reworking four hundred lamps uses two hundred hours of assembly capacity. Those hours could have built three hundred new lamps, each earning eight dollars of contribution. Contribution means the revenue from a unit, minus the variable cost of making it. So the lost capacity is worth another two thousand four hundred dollars. In total, the failure costs seven thousand eight hundred dollars a month. Prevention would cost one thousand two hundred dollars to redesign the crimping fixture, and four hundred for training. That's one thousand six hundred dollars, paid once, against a failure cost that recurs every month. And the table understates the truth. Lost future sales are left out, because they're uncertain and hard to value. The pattern is general. Most of the cost arrives after the point where it could have been avoided.

Case Vignette (Composite)

The Record Output

We close with a common failure, the measurement trap. A part's measured productivity improves, while the whole gets worse. Here's a composite case. The organization and the person are fictional. Farid is a production manager at Ashdown Cabinets. He's evaluated on cabinet frames completed per labor hour. To improve the number, he speeds up the line, and cuts the time given to checking joints. Measured productivity rises for three months in a row, and he's congratulated. Downstream, though, the finishing department must re-glue and re-clamp more frames before sanding and coating. That rework starts to crowd out new work. And customer returns for loose joints rise. Farid could defend his figures. He could restore the checking time, and accept a lower number. Or he could ask to be measured on good frames delivered to finishing. But his review depends on the current measure. The measure counted his department's output, but not the rework it caused elsewhere. So it rewarded behavior that hurt the whole. It's the bottleneck lesson of section eight point one again, and the local optimization of section seven point six. The sound decision is to measure good output at the end of the process, where the customer receives it. Or at least, charge the rework back to its source, so the department's incentive matches the organization's result.

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FAQ

Questions students ask us

About The Productivity-Quality-Profit Connection in Business

What is the difference between partial productivity and total factor productivity?
Partial productivity relates output to a single input, such as units per labor hour or per machine hour, while total factor productivity relates output to all inputs combined. Partial measures are simple and widely used, but they can overstate a gain. A new machine may sharply raise output per labor hour while adding ownership, energy, and maintenance costs that only a total measure would count.
What is the difference between efficiency and effectiveness in business?
Efficiency is doing something economically, getting more output per unit of input, while effectiveness is achieving the right result. An organization can be highly efficient at the wrong thing: a print shop that turns out thousands of cheap brochures carrying the wrong price is efficient but ineffective. The sensible order is to ask first whether this is the right work, then whether it is being done economically.
Does improving quality raise or lower costs?
It depends on where an operation starts. The traditional view holds that better materials, more inspection, and more skilled labor raise costs, so there is an optimum level of quality. The quality movement's view holds that removing defects cuts rework, scrap, warranty, and complaint costs. Improvement tends to lower cost when an operation has a lot of waste and the gain comes from better processes, and to raise cost when defect rates are already very low.
How does poor quality reduce productivity and profit?
Poor quality reduces productivity because rework consumes labor and materials without adding good output. If 100 units are started and 10 need rework, the operation uses resources for 110 units of work to get 100 good ones, and capacity spent fixing errors cannot fill new orders. Profit suffers on the cost side through scrap, rework, and returns, and on the revenue side through lost repeat business and word of mouth.

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