Gargiulo, Granville R.

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Management Adviser Volume 11 Number 1 Article 3 1-1974 Productivity Analysis: Prerequisite to Meaningful Financial Planning Granville R. Gargiulo Follow this and additional works at: https://egrove.olemiss.edu/mgmtadviser  Part of the Accounting Commons, Business Administration, Management, and Operations Commons, and the Management Sciences and Quantitative Methods Commons Recommended Citation Gargiulo, Granville R. (1974) "Productivity Analysis: Prerequisite to Meaningful Financial Planning," Management Adviser: Vol. 11: No. 1, Article 3. Available at: https://egrove.olemiss.edu/mgmtadviser/vol11/iss1/3 This Article is brought to you for free and open access by the Archival Digital Accounting Collection at eGrove. It has been accepted for inclusion in Management Adviser by an authorized editor of eGrove. For more information, please contact egrove@olemiss.edu. Close year-by-year study of an industrial plant re­vealed one glaring oversight in its planning; by tak­ing too long a time span for many of its calculations, the company was, in effect, masking a sharp drop in productivity —PRODUCTIVITY ANALYSIS: PREREQUISITE TOMEANINGFUL FINANCIAL PLANNINGby Granville R. GargiuloArthur Andersen & Co.The complex and competitive environment of most indus­trial organizations requires a man­agement team that can deal effec­tively with change. Such a task normally requires the development of a sound financial or business plan which evolves from a plan­ning process characterized by:• The establishment of manage­ment objectives in a quantified measurable form together with the assumptions on which the plans are to be predicated.• An identification of the strong and weak points of the organiza­tion and a determination of the op­portunities to exploit the strengths and eliminate the weaknesses which would enhance goal achieve­ment.• The identification of specific alternative courses of action and the evaluation of these alternatives in terms of their impact on key cri­teria such as return on investment, earnings, and other performance measures related to management’s objectives.Factors to be weighedThis planning process and the realistic financial projection needed to adequately assess alternatives requires consideration of many factors and interrelationships. To be meaningful as a basis for deci­sion making, the company’s plan­ning capabilites should enable comprehension of the full effects of financial interrelationships, op­erating characteristics, and govern­ing management policies. In this regard, many companies have uti­lized computers to provide an im­proved planning capability and, in particular, the development of fi­nancial planning models.Building a financial planning model involves extensive use of historical data and past perform­ance. The specific format or logic of the interrelationships contained in a model will more than likely be based on an evaluation of such relationships in prior years of a company’s operations. The para-January-February, 1974 23Addition of workers to a raw material processing area resulted in an actual decrease in productivity . . .meters of these relationships are generally established from corre­lation studies and similar statisti­cal analyses.The heavy reliance on historical performance and related data as a basis for building a financial plan­ning model and for supporting as­sumed effects of alternative man­agement actions in the future, sug­gests the need for a clearer under­standing and evaluation of what truly constitutes past performance. While the accounting and man­agement information systems of a company may provide an identifi­cation of financial and operating problems on a relatively short- range basis, there is limited capa­bility in most organizations to identify and isolate the trends in productivity which have a cumula­tive impact on profitability. Rich­ard Gerstenberg, chairman of the Board of General Motors Corpora­tion, stated, “I regard productivity as a measure of management’s ef­ficiency, or lack of efficiency, in employing all the necessary re­sources—natural, human, and finan­cial.” If this measure is not used to diagnose the gradual forces af­fecting performance—good or bad —then the reliance on historical in­formation as a basis for developing a financial model poses risks of per­petuating capital and human pro­ductivity in the future which may be well out of line with maintain­able levels.Elaboration of this real danger is illustrated by the following case example.A case exampleThe company represented by this example produces consumer non-durable products in a con­tinuous production process en­vironment. The initial phase of the investigation focused on a com­parison of the company’s two plants to industry averages at the four-digit Standard Industrial Clas­sification code level.* In order to take advantage of the available methodology and published data*Federal classification.. . . since expected increased demand was not realized. Productivity per worker declined sharply.Management Adviser24EXHIBIT IPRODUCTIVITY INDEX (output per all-employee man hour)Comparison of 7 and 5-Year Average Annual TrendsA and B PLANTS vs. INDUSTRY1958-1964 1965-1969on productivity, output per man­hour was used to compare to the industry averages published by the Bureau of Labor Statistics.Exhibit 1, this page, graphically portrays the results of this anal­ysis. As a basis for comparison of both Plant A and Plant B trends, productivity ratios were devel­oped for two distinct time periods, 1958 through 1964 and 1965 through 1969, the latter time frame to take account of the startup of Plant B in 1965.As presented, the average an­nual trend for this early period showed Plant A gaining at a rate of 3.7 per cent, which is substan­tially higher than the industry average for this period. The trend for the 1965 through 1969 period showed a markedly different rate for Plant A, namely, a decline of —3.3 per cent compared to a neg­ative 0.8 per cent trend for the in­dustry. Plant B, on the other hand, showed a significant positive trend of 5.0 per cent. This experience for Plant B was not surprising since the plant was constructed more re­cently with substantially greater emphasis on automation and im­proved plant layout relative to Plant A.Two distinct phasesThe trends for the operation of Plant A indicate that there were, in fact, two distinct productivity averages: a period to the mid-six­ties in which productivity rose at a rate substantially higher than the industry, and a second period, since the mid-sixties, in which pro­ductivity declined more rapidly than the industry. These trends were particularly surprising since, in most recent years, the company had experienced increasing levels of sales growth. Further compari­sons of the company’s plants-to- industry statistics showed that la­bor compensation had increased substantially faster than the in-GRANVILLE R. GARGIULO is a principal in the ad­ministrative services divi­sion of the New York office of Arthur Ander­sen & Co. He is also the firm's director of techni­cal competence in opera­tions research. Mr. Gar­giulo is an adjunct pro­fessor at the Fordham University School of Business Administration. He has held positions with Kollsman Instrument Corporation, Chas. Pfizer & Co., and System Development Cor­poration. His articles have appeared in this and other professional publications.January-February, 1974 25EXHIBIT 2PRODUCTIVITY TRENDS (output per production worker man hour)PRODUCTIVITY INDEXdustry average with a resulting in­crease for the company in unit la­bor costs relative to competition.The unfavorable productivity trend at Plant A led to a detailed cost center analysis in a raw ma­terial processing operation and the Finishing & Packaging Department of both Plants A and B in an at­tempt to isolate the causal factors contributing to the significant dif­ferences in performance. The pro­ductivity trends for the Raw Ma­terial I processing areas at Plants A and B are illustrated in Exhibit 2, above, for the period of anal­ysis, 1958 through 1971. As shown, the productivity index for Plant A reached a high point in 1961 and output per man-hour declined steadily ever since. On the average, for the entire period, the trend had been a 2.0 per cent decline. Plant B, on the other hand, had an an­nual improvement of 5.1 per cent for the period 1966 through 1971. Plant A’s trend for this more re­cent period was 2.0 per cent, the same as for the entire period 1958 through 1971.The relationship between changes in total output and labor hours is illustrated in Exhibit 3, page 27. The high point in productivity trend in 1961 relates directly to the data for that year in terms of hours and output. More specifically, the area between the “labor hours” line and “pounds produced” line was at its smallest in that year. The sub­sequent increase in the area be­tween these lines in later years re-26 Management Adviser. . . while demand for raw material dropped, no review of operating needs was made . . .fleets the steady decline in produc­tivity. This expansion resulted from the addition, between 1961 and 1964, of the equivalent of 12 people in various departments comprising the Raw Material I processing area of Plant A.Attempts were made by the com­pany to identify the causes of this increase in personnel. However, neither operating management nor accounting records could identify a change in operating require­ments, cleanup, etc., which might account for this drastic change in the area’s basic labor complement. While there were a few minor changes in the operation, the asso­ciated increases or decreases in labor seem to cancel themselves out and could not account for the increase of 12 people. The phe­nomenon is even more interesting since, once the expansion in work force had taken place, the relation­ship between hours and output re-EXHIBIT 3 mained fairly constant, i.e., the labor line moves relatively parallel to the output line.In general, it appeared that ad­ditional labor was added to the area in the early sixties in antici­pation of increased demand. While demand for intermediate raw ma­terial dropped significantly in later years as a result of reductions in raw material content of the finished goods, no review of the operating requirements of the area was madeTOTAL OUTPUT AND LABOR HOURSMillions ThousandsJanuary-February, 1974 27EXHIBIT 4RAW MATERIAL I PROCESSING AREAACTUAL LABOR HOURS vs. ESTIMATED LABOR HOURSThousands ofto reduce the labor complement accordingly. The impact of this failure to adjust the labor content is placed in some perspective by Ex­hibit 4, above. An analysis of out­put per hour for selected periods was made and the highest quar­terly level of output per hour dur­ing 1961 was determined. Actual output for each year was then divided by this quarterly value of output per hour to develop an esti­mate of labor hours which would have been required to produce the actual output if the area’s 1961 out­put per hour level had been main­tained. Exhibit 4 shows the signi­ficant differences between actual hours and the estimated hours at 1961’s demonstrated efficiency lev­els. The differences in estimated and actual hours was then ex­tended by the average plant labor rates in each year to estimate the cost of this excess labor. On aver­age, this represents approximately $150,000 per year.Similar productivity comparisons were developed for the Finishing & Packaging areas at both plants. The relative comparisons between Plant A and Plant B showed Plant A productivity trending upward at a gradual rate of 3.5 per cent per year, which reflected the introduc­tion of automated equipment over a 12-year span. Plant B, on the other hand, was opened in 1965 and its Finishing & Packaging op­eration fully automated within several years thereafter. Conse­quently, the productivity improve­ment at Plant B was 20 per cent per year.Exhibit 5, page 29, provides fur­ther detail on the relationship be­tween output and labor hours for the Finishing & Packaging area at Plant A. As is clearly illustrated, the record of continued produc­tivity improvement through 1971 was the result of fairly steady in­creases in output with drastic re­ductions in the levels of labor in­put required. As mentioned ear­lier, this was largely the result of the introduction of automatic fin­ishing and packaging equipment. Not surprisingly, as shown on the insert graph, particularly high lev­els of productivity were achieved in those years which corresponded to the periods in which various28 Management Adviser. . . particularly high productivity was achieved when automated lines became operational . . .automated lines became opera­tional, specifically 1958-59, 1963- 65, and 1969-70. It is also of some interest to note that the impact on productivity resulting from these installations moved in a lag of about one year from the actual in­troduction of the new equipment, reflecting the natural learning curve, and the startup problems associated with new equipment.What can we conclude?This case study described pro­vides ample evidence that one par­ticular element of a company’s his­torical performance which has a more gradual impact on profitabil­ity is productivity. If so much of the value of financial planning and the effectiveness of financial mod­els to facilitate planning is based on a proper reflection and under­standing of historical interrelation­ships, then management must have considerably greater insight into the factors contributing to produc­tivity performance. The methodol­ogy of productivity measurement and comparison at the company orEXHIBIT 5 plant level provides initial insight into the factors at work which af­fect profitability, both past and in the future. Detailed productivity analysis of major or key operations of a business reveals how specific decisions in the past impact pro­ductivity and profitability and, thus, pave the way for judging the reasonableness of building such impacts into the logic of a plan­ning model and/or assumptions about the future. Without produc­tivity analysis, the validity of the model, and even perhaps the plan­ning process, may be suspect.— TOTAL OUTPUT AND LABOR HOURSMiIlionsJanuary-February, 1974 29

Productivity Analysis: Prerequisite to Meaningful Financial Planning

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Productivity Analysis: Prerequisite to Meaningful Financial Planning

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