Demystifying productivity with financial ratios – what it all means for your business!
Trading Economics has mapped Singapore’s productivity ratios since 1985 (http://www.tradingeconomics.com/singapore/productivity). Over the past 5 years, Singapore’s productivity index has not increased; in fact, by the end on 2014, Singapore’s productivity level has been the second lowest level, the lowest level being July 2010.
How can this be, if the government has been pouring in so much money to train its workers, to focus on new innovations, and to raise productivity? Have Singapore companies lost the plot, or could it be that they have never even been on the same boat as the government? It is difficult to understand why companies would not want to increase productivity, but it could be that they don’t really understand what it is fundamentally. Labour productivity is more than just doing more with less; working longer hours for the same amount of output. It is about impacting the business better; about finding new markets and launching new products; about keeping costs down while ramping up revenue. Productivity in essence is about working smarter, not working faster. In this article, we will uncover the financial ratios used to calculate labour productivity, and what that means to running a business.
Revenue per employee
The first financial ratio is revenue per employee. This is the total revenue divided by the number of staff. At its simplest form, therefore, productivity is about driving revenue. So a company would be more productive if it delivered more revenue per person. As a matter of comparison, in 2013, Apple reported their revenue per employee at US$2.13 million, while Singapore Airlines Group reported theirs at S$642,769. Of course these are two different types of companies in two different countries, but it does give us a sense of the disparity in Singapore’s productivity with other first-world countries.
In addition, what this ratio also means is that while many companies say that they are looking to invest in technology to improve labour productivity, the key question to ask is whether that technology can lead to more revenue. If it does not, then would it deliver the same revenue with less people? That opens up another question: would a company that invests in such technology be able to redeploy their people to grow more revenue, or to let the people go. If either of these two does not result from an investment in technology, then there is really no use in spending that money! Technology for technology’s sake is money down the drain!
Value add per employee
The next level of financial ratios is the value-add per employee. While it is linked to the revenue per employee score, it is different because it tracks how much value-add each employee brings to the business. There are two ways to calculate value add – the addition method or the subtraction method. For the sake of discussion, we will use the addition method. Value-add is calculated as
Operating profit/loss + total staff costs + interest + depreciation + taxes
Since operating profit (or loss) has taken out the cost of goods sold and operating expenses, when we add the staff costs into it, we are basically calculating how much extra value each staff has contributed to the business.
Therefore, when we divide the value add by the number of employees, we are calculating how much more each staff contributes over his costs. This ratio should be seen in tandem with the revenue per employee, and over time. If we see that there is a widening gap between these two scores in percentage terms over time, it means that staff costs have gone up without a concomitant increase in revenue. This means that the company must look to increasing revenue while keeping staff costs down; all with the same number of people, or less.
Operating income per employee
The operating income per employee score must also be seen over time, and if there is a larger percentage drop vis-à-vis the value-add per employee, it could be an indicator that staff costs have gone up. In order for us to be sure, we need to see if the cost of goods sold (COGS) has risen or not; as well as rental, which tends to be another huge expense. If these big-ticket items have not risen, and the operating income per employee has declined by a greater proportion than value-add per employee, then you can be sure it is your staff costs that are contributing to a lowering of productivity.
Labour cost competitiveness
The last ratio you could use is the labour cost competitiveness ratio, which is calculated by dividing value-add by labour costs. This calculates how many times your value-add is over your labour costs. Depending on the industry you are in, some people expect it to be twice, some three times, some even more. Obviously, if you were anything less than 1.0, you must work to drastically improve your productivity immediately!
What do all these mean to businesses?
You can see that productivity is not simply about doing things faster, or even about spending on technology or innovation. If you cannot bring these to bear on increased revenue, and if you cannot bring these to bear on reduced costs, there is no real productivity. For Singapore, the productivity levels are decreasing simply because labour costs are increasing. With the inflow of foreign talent curtailed, and the need to use local talent is forced onto companies, there is a natural increase in labour costs. This impacts those businesses that are highly dependent on labour like construction, shipbuilding and repair, cleaning, security guards, F&B, and retail. But this is only the first line of impact.
Next, increased productivity can come by way of reduced costs; not just of labour costs, but total costs as well. If a company can work better with their suppliers and get better quality products at a reduced rate; if a company could reduce rework or warranty issues by increasing quality; if a company could eliminate the use of traditional methods of working and move them to the cloud for faster retrieval and reduced raw material costs, these are all ways to decrease costs, and that would lead to an increase in productivity.
Another impact is the need to offer greater value-added products and services. There is a need to go into the high-end market, to offer greater value services, to be plugged into the high-margin product supply chain.
In other words, there is a need to re-engineer ourselves to offer better quality, better value and at better prices; all this while keeping labour cost increases down. If you were a CEO, COO or CFO, these are therefore your marching orders. And you had better start today!