Labour productivity definition
Labour productivity is the value a business adds in goods, services or both and is calculated by the hours or employees required to produce that value. It’s key to determining a company's competitiveness and financial success.
At the macro-economic level, economists use the term “labour productivity” to refer to the amount of real gross domestic product (GDP) produced by an hour of labour in a given country. For businesses (and at the micro-economic level), labour productivity is a performance indicator that measures how much value your workers create per hour worked. This latter definition is more relevant to entrepreneurs.
Businesses that become more productive will see the results in their valuations.
Why is labour productivity important?
Productivity is closely linked to financial performance, making it vitally important to any business owner.
“Businesses that become more productive will see the results in their valuations,” says BDC Senior Economist Sylvie Ratté, who explains that labour productivity is a key metric for success when looking at Canada’s top firms.
According to a BDC study on the financial performance of Canadian small and medium-sized enterprises (SMEs), the top 10% of the most productive businesses generate six times more sales and five times more profit than industry peers with a similar number of employees. Earnings before interest, taxes, depreciation and amortization (EBITDA) is also four times higher in the most productive firms, supporting greater business valuations.
“The numbers speak for themselves,” says Ratté. “There’s a clear link between high productivity and business success.”
A dip in labour productivity usually signals that some area of your business requires attention; your operations may need to be optimized or your training programs may not be up to par. Regularly measuring your labour productivity is a great way to see how your business is trending and whether the changes you are making are having an effect on efficiency.
Measuring your labour productivity can also offer insight into how your business is doing compared to others in your industry. If your revenue or profit per employee falls below the average, it’s time to act, says Ratté. “If you don’t keep up with the competition, and the increased productivity and efficiency expectations in your industry, your business will not survive.”
If you don’t keep up with the competition, and the increased productivity and efficiency expectations in your industry, your business will not survive.
How to measure labour productivity?
To measure your labour productivity, take the value added by your company (in goods, services or both) and divide it by the labour required to produce that value.
Say you’re in manufacturing and it takes 40 hours for your staff of five to produce $5,000 in goods (net of raw material cost). The following calculation would measure your labour productivity:
Added value = $5,000
Hours worked or number of employees = 40 hours or five employees
Generally, businesses measure labour productivity in terms of annual revenue or profit. This can then be compared to the previous year’s ratio to evaluate your operations, and identify areas for improvement and steps to take to raise productivity.
How do you compare labour productivity?
Benchmarking tools allow you to compare your productivity with those of competitors in the same industry.
For instance, BDC’s free business performance benchmarking tool lets you compare your annual revenue and profit per employee to others in your industry based on Statistics Canada data. This tool was designed to be simple and easy to use.
Advanced tools offer more precise insights and increasingly granular comparisons. Such tools can calculate the exact value added per hour, differentiate between productive and administrative hours, and compare business performance not only within your industry but between economic sectors, subsectors and industry groups.
“Imagine you own a bakery,” says Ratté. “A simple tool would compare your business to all others in the food processing industry, which is a pretty broad field. An advanced tool could compare your labour productivity to other bakeries in your area.”
How to increase labour productivity
A variety of factors can help increase labour productivity, from your processes and software to your workforce and culture. Given this, the path to higher labour productivity will look different from business to business.
That being said, there are certain principles that apply to all companies. We recommend the following steps:
4 steps to improve your company’s productivity
1. Regularly measure and benchmark your business productivity
The first step is to measure your current performance, ideally by choosing measures that will assess the company’s most strategic activities.
For example, a company that has on-time delivery as an integral part of its business plan should measure the performance of the processes that make up delivery time. The time it takes to complete each step, as well as internal waiting times, could be monitored to achieve that proposed on-time delivery to clients.
2. Optimize your processes
Look for opportunities for improvement, including inefficient operations, poor quality and misused resources. Waste and inefficiencies can drag down your productivity. A poor warehouse layout, for example, can impede worker movement and increase the time it takes to complete routine tasks.
3. Digitize your processes
Invest in technology to digitize and automate certain processes. That might mean upgrading your accounting software, or switching over to a more sophisticated customer relationship management platform or enterprise resource planning system. According to a BDC study, highly productive firms invest nearly twice as much in digital technologies compared to less productive companies.
4. Continuously improve
The battle against waste and inefficiency is a never-ending fight. Foster a culture of continuous improvement to help drive productivity gains across your business. Set a goal to be one of the most productive firms in your industry—and do what it takes to make that happen.
Get advice on your labour productivity
Many businesses measure their labour productivity in an informal way. They may not be using the right metric or the right combination of metrics, giving them an unreliable picture of their productivity. And when it comes to improving things, such as procuring and implementing new technology, not every business owner will have the expertise to identify the best way forward.
"When you work in a business day in and day out,” says Ratté, “it’s easy to lose sight of the big picture.”
An outside perspective can make all the difference. BDC Advisory Services can offer expertise you might not have in house, helping you track your productivity over time, pinpoint the right areas for improvement, and make the necessary changes to boost your productivity.
Learn the fundamentals of operational efficiency by downloading Create a Leaner Business, our free guide on the subject.