I would like to start this module on productivity by sharing a little quote with you. I will read the quote and you'll have to guess the person who said this. Here we go. The conservation of our national resources is only preliminary to the larger question of national efficiency. I'll give you a hint, it was a U.S. President. Obama? George W.? Ronald Reagan? Turns out the person who said this was Theodore Roosevelt. More than a hundred years ago, Frederick Winslow Taylor wrote a wonderful book known as The Principals of Scientific Management. This was the opening line of the book. Productivity was a major theme a hundred years ago, and is still a very current topic today. We will start out our module on productivity with this first session in which I will introduce some more academic definitions of productivity. What I love about Taylor's work though, it's very much driven by observing people in action. And so the rest of module, I promise you, will be much more hands on. As mentioned previously, we can define productivity as the ratio between the units of output produced and the input that is used. For example, we can define labor productivity as 4 units per labor hour. Units might be insurance claims, it might be vehicles or it might be patients. And so that you can think about the output produced, the vehicles, the insurance claims, or the patients per labor hour as a productivity measure. Notice that those are exactly the processing time that we discussed previously. The beauty of this example is that the only input is labor time. If you think about affirmative very high level perspective, there are many other input factors including capital, labor, materials, services that the firm uses and energy. People refer to the multifactor productivity as the output divided by the dollar values of all of these input factors. Now stick with the example for labor productivity a little longer. What keeps us from having a perfect productivity? Think about the output in the productivity definition as productive time or value add time and the input as the total time. Productivity is then simply the percentage of labor time that is spent productively. Now clearly, you cannot have a productivity in this case of higher than 100%. You can never get more than 60 productive minutes out of a worker per hour. Similarly, if you think about the energy efficiency of your house, you might measure the output as the temperature gains that you have in your living room and the input as the amount of oil or gas that you burn in the basement in the heater. Again, you will never generate more heat in the living room than you have consumed in terms of primary energy in the basement. The interesting question on both of these examples are really what we'd use as the productivity. This gets us to the idea of waste and inefficiency. Wastes are those things that are driving down productivity and are really at the heart of understanding the productivity in an operation. With the concept of inefficiency in mind, let's revisit the example from the introduction. This was a group of call centers that we benchmarked along the dimensions of responsiveness and productivity. For a call center, it is easier to achieve a high productivity. Just staff so that your utilization is really, really high. Now the problem with that of course, is that your responsiveness will be very poor if you have a very high level of utilization. On the other hand, you can increase your responsiveness if you keep your utilization very, very low. Good for your responsiveness, bad however, for your productivity that there exists a tension between those two forces, responsiveness and productivity. Now consider call centers A, B and C. All of these call centers are in a line that we've previously defined as The Efficient Frontier in the industry. This means that there is no player, no company, no call center that dominates competitor A, B or C. When I say dominates, I mean firms that are both faster than we are, and at the same time also cheaper. Now you notice that competitor D is not on the frontier. For competitor D we have a distance to the frontier, and that is what an inefficiency looks like at this very high level perspective. Let's bring the concept of the efficient frontier to life by looking at some data from The US Airline Industry. What I'm showing here is on the X axis, I'm plotting the efficiency of the major U.S. carriers. Here efficiency is measured by how much it costs an airline to produce a certain number of seat miles. On the Y axis I'm showing what the airline is able to command in terms of its prices for these miles. Observe the Frontier. Observe how these airlines are lining up on a line that looks like this. On the one extreme, you have Hawaiian, which is not able to get high prices, but because of its very focused route structures, able to provide an amazing efficiency. On the other extreme, you have US Airways. The company is clearly able to command high prices, but has a horrible efficiency. You notice here how Southwest has been able to break that Frontier and shifted upwards to a new level. Southwest entered this market in many routes by providing its superior operations, allowing it to charge almost the same prices as these legacy carriers, yet operating at an amazing level of productivity. Now the data that I just showed you was data for the year 1996. Let's take a look what has happened in the airline industry since then. This is updated data from 2011. We have the same X axis, the Efficiency, and the same Y axis, the Yield. Notice how Southwest, previously a star on the productivity side, is now simply in the middle of the pack. We'll explore the reasons of Southwest's decline in productivity later on in this module. You'll also notice how the legacy carriers, American, United, US Airways, Continental, Delta, have basically suffered an enormous loss in pricing power. They have kept more or less efficiency, but they have dropped down on the revenue side. The new darlings from an operational perspective are companies such as JetBlue and Virgin America. They have redefined the Frontier and the operations of the airline industry. We define productivity as the ratio between output and input. We will pick up that definition later on in this module when I introduce a concept of productivity ratios, which is a very powerful tool that can help you analyze aggregate firm-level data and compare your productivity with the productivity of peer companies in your industry. We also observe the enemy of productivity, inefficiencies and waste. We defined inefficiencies and waste as the distance between your operational performance and the efficient frontier in an industry. At present, these inefficiencies, this waste looks like a very abstract almost ivory tower-like concept. I promise you that in the next session this will become much more tangible and hands on.
