Ian Heptinstall
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Who cares about productivity?

The Economist recently published an article highlighting the poor productivity of the construction industry.  They in turn reference work by McKinsey published earlier this year.

But neither of these august bodies explained WHY productivity is important.  Or more precisely, why labour productivity is so important.  Although the Economist article discussed the US, the McKinsey report was global.

Don’t get me wrong.  I believe that the construction industry could make dramatic improvements in both its effectiveness and efficiency, and I am co-author of a book that outlines exactly what I would do to make the improvements.

There are a number of aspects of the article I take issue with, such as the belief that construction is “a low margin industry”, and that trying to emulate manufacturing will make a big difference.

But this post challenges the idea that labour productivity is important.

Who cares about productivity, and why using it as a KPI can drive your construction business to failure?

Who cares about productivity, and why using it as a KPI can drive your construction business to failure?Click to Tweet

Example 1 – Productivity v ROA

McKinsey’s report, referred to in the Economist article, highlights the so-called poor productivity trend of construction.  This is dramatically shown in this chart.

So over 20 years manufacturing has doubled its productivity, and the total economy up by about 70%.

But let’s look at some other data, this time looking at industry return on assets, this time from Deloitte.

Mmmm.  Looks a bit less impressive now.  Over the same 22 years, return on assets has fallen by over a half.

Meaning that businesses make more profit per dollar spent on people, but much less profit per total dollar tied up in the business.

Example 2- The unintended side-effect of improving productivity

This example looks at a simplified construction company profit and loss statement, figures are $M.

So they make $5M profit whilst spending $25M on people.  Let’s call that 20% “productivity” (5/25).

In a drive to increase their productivity, they reduce their direct labour, and increase bought-in goods and services.

So they now make the same profit, whilst spending $15M on people, making their “productivity” 5/15 – 33%.  Wow, aren’t they doing well, a whopping 65% improvement (20 -> 33)?

Bonuses all round!

But in reality they have not made a cent more money.  Their clients have not received a faster, lower cost or better project.  Nothing of any significance has changed.

But it gets worse…

Whilst you have fewer people to manage, you now have 16% ‘more’ contracts to manage.  And in this industry, contracts do need closely managing.  So you have to add to your resource some additional commercial people, say $1M worth.

But your labour productivity is still higher than the 20% we started with, at 25%, so as far as productivity is concerned we are better.

Mmmmm.  Productivity is up by 25%, but profits are down by 20%!

And in reality it is very unlikely that you can subcontract work that cost you $10M in staff, for just $10M.  Your suppliers and subcontractors are businesses too, and they will want to make a return for the risk you are passing to them.  Let’s assume they add 10% as a risk premium.

So your productivity is back to where we started – 19% is virtually 20%.  But you are making 40% less profit.

So how is the industry on Return-on-Assets?

Remember the Deloitte research on return on asset performance that I referred to earlier?  It was from their report “Success or struggle: ROA as a true measure of business performance” published in 2013.

I analysed the results of 24 construction companies from 2013-2015.  In total they represented about £100 billion in revenue.  Their average ROA was 5%.  500% higher than the US economy average.  No so shabby after all?…

“Brilliant process management is our strategy. We get brilliant results from average people managing brilliant processes. We observe that our competitors often get average (or worse) results from brilliant people managing broken processes.”

 

Katsuaki Watanabe, the CEO of Toyota

Construction is NOT manufacturing.  It requires much less investment in fixed assets, and requires very little product R&D or working capital to make it successful.

Each project is unique, and the processes used to deliver efficient and effective processes are not the same as producing a car or a phone. There is nothing wrong with this, it is just different.

And if you want your productivity to improve, stop trying to improve productivity.  Take a leaf out of Toyota;s book, and identify your “brilliant process”.  If you use the same process as your main competitors, don’t complain that the only thing you can compete on is price!

So remind me again, why is labour productivity is such a good thing?

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Who cares about productivity, and why using it as a KPI can drive your construction business in the wrong direction?

Who cares about productivity, and why using it as a KPI can drive your construction business to failure?Click to Tweet

Footnote:

Labour productivity is an example of a local performance measure.  Its use began at the start of the industrial revolution when labour was by far the highest cost, and change happened at a much slower pace than today.  That meant is was an easily-accessible, good-enough, measure of how well a business was being run.  More output per person equals “good”!

Today though, things change much more quickly, and direct labour is a smaller part of total costs.  There are much better ways of measuring our efficiency than the proxy measure of labour cost.  With a good modern computer system you don’t need the proxy measure that is labour productivity – you can get at cost, P&L, and balance sheet data directly.

Businesses and projects are not simple linear systems.  Each part is interconnected, and you can’t reduce labour cost in isolation and assume your other costs and your income are not impacted.  In my simple example above, it is obvious.  In real organisations it is less obvious and you can’t see the impact.  But that doesn’t mean it isn’t there.

About the Author Ian

Ian is a consultant who helps clients to improve the performance of their capital projects and programmes. Before becoming an independent consultant, his experience included 15 years working as a project manager on capex projects, 10 years in procurement, including being chief procurement officer for a large construction company, and 10 years management consulting with niche consultancies in supply chain and procurement.

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Leave a Comment:

Henry Camp says 29 September 2017

Well done Ian. Keep pounding away! You are helping people not be so sure that efficiency is the solution they should be looking for. They can’t spend a % at the grocery store. Try it, if you don’t believe me.

Reply
    Ian says 30 September 2017

    Exactly Henry. Thanks.

    Reply
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