Productivity and how to improve it: II – Profit = Customer value – Cost

I said I would be posting on this topic way back here. Perhaps that says something about my personal productivity but I have been being productive on other things. I have a day job.

I wanted to start off addressing customer value and waste. Here are a couple of revealing stories from the press.

Blue dollars and green dollars

File:Lemon.jpg

This story appeared on the BBC website about a pizza restaurant transferring the task of slicing lemons from the waiters to the kitchen staff. As you know I am rarely impressed by standards of data journalism at the state owned BBC. This item makes one of the gravest errors of attempted business improvement. It had been the practice that waiters, as their first job in the morning, would chop lemons for the day’s anticipated drinks orders. A pizza chef commented that chopping was one of the chefs’ trade skills. Lemon chopping should be transferred to the chefs. That would, purportedly, save the waiters from having to “take a break from their usual tasks, wash their hands, clear a space and then clean up after themselves.” The item goes on:

“Just by changing who chops the lemons, we were able to make a significant saving in hours which translates into a significant financial saving,” says Richard Hodgson, Pizza Express’ chief executive.

This looks, to the uncritical eye, like a saving. But it is a saving in what we call blue dollars (or pounds or euros). It appears in blue ink on an executive summary or monthly report. Did Pizza Express actually save any cash, as we call it green dollars (or …)? Did the initiative put a ding in the profit and loss account?

Perhaps it did but perhaps not. It is, actually, very easy to eliminate, or perhaps hide or redeploy, tasks or purchases and claim a saving in blue dollars. Demonstrating that this then mapped into a saving in green dollars requires committed analytics and the trenchant criticism of historical data. The blue dollars will turn into green dollars if Pizza Express can achieve a time saving that allows:

  • A reduction in payroll; or
  • Redeployment of time into an activity that creates greater value for the customer.

That is assuming that the initiative did result in a time saving. What it certainly lost was a team building opportunity between waiters and chefs and a signal for waiters to wash their hands.

The jury is out as to whether Pizza Express improved productivity. Translation of blue dollars into green dollars is not easy. It is certainly not automatic. Turning blue dollars into green dollars is the really tricky bit in improvement. The bit that requires all the skill and know-how. It turns on the Nolan and Provost question: How will you know when a change is an improvement? More work is needed here to persuade anybody of anything. More work is certainly needed by the BBC in improving their journalism.

Politicians don’t get it

I asked above if the freed time could be translated into an activity that creates greater value for the customer. The value of a thing is what somebody is willing to pay for it. When we say that an activity creates value we mean that it increases the price at which we can sell output. The importance of price is that it captures a revealed preference rather than just a casual attitude for which the subject will never have to give an account. Any activity that does not create value for the customer is waste. The Japanese word muda has become fashionable. It is at the core of achieving operational excellence that unrelenting, gradual and progressive elimination of waste is a daily activity for everybody in the organisation. Waste, everything that does not create value for the customer. Everything that does not make the customer willing to pay more. If the customer will not pay more there is no value for them.

John Redwood was a middle ranking official in John Major’s government of the 1990s though he had frustrated ambitions for higher office. He offered us his personal thoughts on productivity here. I think he illustrates how poorly politicians understand what productivity is. Redwood thinks that we are over simplifying things when we say that productivity is:

ProductiviityEq1

or, a better definition:

ProductiviityEq2

Redwood thinks that, in the service sector, “labour intensity is often seen as better service rather than as worse productivity”. It may be true but only in so far as the customer sees it as such and is willing to pay proportionately for the staffing. Where the customer will not pay then productivity is reduced and insisting that labour intensity is an inherent virtue is a delusion. I think this is the basis of what Redwood is trying to say about purchasing coffee from a store. The test is that the customer is willing to pay for the experience.

However imperfect the statistics, they do seek to capture what the customers have been willing to pay. The spend at the coffee stand should show up on the aggregated statistics for “customer value created” and so the retail coffee phenomenon will not manifest itself as a decrease in productivity. Redwood has completely misunderstood.

Of course there are measurement issues and they are serious ones. There is nothing though that suggests that the concept or its definition are at fault.

What is worrying is that Redwood’s background is in banking though I certainly know bankers who are less out of touch with the real world. Redwood needs to get that the fundamental theorem of business is that:

profit = price – cost

— and that price is set by the market. There are only two things to do to improve.

  • Develop products that enhance customer value.
  • Eliminate costs that do not contribute to customer value.

UK figures

I could not find a long-term productivity time series on the UK Office for National Statistics website (“ONS”). I think that is shameful. You know that I am always suspicious of politicians’ unwillingness to encourage sharing long term statistical series. I managed to find what I was looking for here at www.tradingeconomics.com. Click on the “MAX” tab on the chart.

That chart gave me a suspicion. The ONS website does have the data from 2008. There is a link to this data after Figure 3 of the ONS publication Labour Productivity: Oct to Dec 2015. However, all the charts in that publication are fairly hideous and lacking in graphical excellence. Here is the 2008 to 2015 data replotted.

Productivity1

I am satisfied that, following the steep drop in UK productivity coinciding with the world financial crisis of 2007/08, there has been a (fairly) steady rise in productivity to the region of pre-crash levels. Confirming that with a Shewhart chart is left as an exercise for the reader. Of course, there is common cause variation around the upward trend. And, I suspect, some special causes too. However, I think that inferences of gloom following the Quarter 4 2015 figures, the last observation plotted, are premature. A bad case of #executivetimeseries.

I think that makes me less gloomy about UK productivity than the press and politicians. I have a suspicion that growth since 2008 has been slower than historically but I do not want to take that too far here.

Coming next: Productivity and how to improve it III – Signal and noise

 

 

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2 thoughts on “Productivity and how to improve it: II – Profit = Customer value – Cost

  1. Anthony, Thanks for another well written blog.
    However it raise the question – how do you separate the effects of inflation/deflation from true productivity improvements?
    Politicians like Mr Redwood love to distort the truth by manipulating economic argument.

    • Phil – good point. I asked myself this question. The figures given by the ONS are inflation/ deflation adjusted so that deflation shouldn’t show up as a decrease in productivity. I do have to take the ONS figures in good faith, for all their limitations.

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