1512

1. Productivity profile:
2006 ................................
Change I ..........................
Change II .........................
Optimal ...........................

Materials
1.67
1.43
2.00
2.50

Labor
0.83
1.25
1.00
1.25

Change I shows an improvement in labor productivity and a decline in material

productivity. For Change II, both material and labor productivity ratios improved. Which
change should be implemented depends on the value of the productivity trade-offs of
Change I versus the value of the productivity improvements of Change II. Profile analysis
does not reveal these values.
2.
2006:
Change I:
Change II:
Optimal:

(33,000 $60) +
(38,500 $60) +
(27,500 $60) +
(22,000 $60) +

Cost
(66,000 $15)
(44,000 $15)
(55,000 $15)
(44,000 $15)

= $2,970,000
= $2,970,000
= $2,475,000
= $1,980,000

Cost of productive inefficiency:

2006:
$2,970,000 $1,980,000=$990,000
Change I:
$2,970,000 $1,980,000=$990,000
Change II:
$2,475,000 $1,980,000=$495,000
Potential improvement for 2007:
Change I:
$2,970,000 $2,970,0000
= $0
Change II:
$2,970,000 $2,475,000=$495,000
Change I improves the technical use of labor but does so by trading off materials for labor
inputs. The optimal combination defines the relative mix ratio as 1:2. The mix ratio for
Change I is 7:8. Notice that the 2006 mix ratio is 1:2. Thus, moving to Change I decreases
allocative efficiency while improving technical efficiency (by using less laborin fact, the
amount of labor used corresponds to the optimal level). Change II, on the other hand, has a
mix ratio of 1:2, which is the same as the 2006 and optimal input combination. Therefore,
there is no reduction in trade-off efficiency, and reducing the amount of each input
required to produce the same output is all attributable to improving technical efficiency.
3.

The profit-linked measurement approach will provide the same outcome without requiring
knowledge of the optimal input combination. Since the output is the same for both years,
the inputs that would have been used in 2007 without any productivity change are the
same as 2006 usage. Thus, the profit-linked measure is simply the difference between the
cost of the inputs for the two years:
Change I:
Change II:

$2,970,000 $2,970,000
$2,970,000 $2,475,000

=
=

$0
$495,000

1514
1.

Productivity profile:
Materials ................
Labor ......................
Capital ....................
Energy ....................

2006a
1.000
0.250
0.025
1.000

2007b
1.500
0.600
0.012
0.400

50,000/50,000; 50,000/200,000; 50,000/2,000,000; 50,000/50,000.

60,000/40,000; 60,000/100,000; 60,000/5,000,000; 60,000/150,000.

Since the ratio changes are mixed, no statement on overall productivity improvement can
be made. Valuation of the trade-offs is needed.
2.

Profit change:
2007:

Revenues ($65 60,000) .........................

Materials ($10 40,000)..........................
Labor ($12 100,000) ..............................
Capital (0.10 $5,000,000) ......................
Energy ($2 150,000) ..............................
Profit ..................................................

$ 3,900,000
(400,000)
(1,200,000)
(500,000)
(300,000)
$ 1,500,000

2006:

Revenues ($70 50,000) .........................

Materials ($8 50,000)............................
Labor ($10 200,000) ..............................
Capital (0.15 $2,000,000) ......................
Energy ($2 50,000) ................................
Profit ..................................................

$ 3,500,000
(400,000)
(2,000,000)
(300,000)
(100,000)
$ 700,000

Total change

= $1,500,000 $700,000
= $800,000

1514

Concluded

Profit-linked measurement (expressed in thousands, where P = $10, $12, 10%, and $2,
respectively):
Materials .......
Labor .............
Capital ...........
Energy ...........

PQ*
60
240
2,400
60

PQ P
$ 600
2,880
240
120
$ 3,840

AQ
40
100
5,000
150

AQ P
$ 400
1,200
500
300
$ 2,400

(PQ P) (AQ P)
$ 200
1,680
(260)
(180)
$ 1,440

*60,000/1.000; 60,000/0.250; 60,000/0.025; 60,000/1.000.

Productivity-induced profit change: $1,440,000 increase
Price recovery = $800,000 $1,440,000 = ($640,000)
This means that without the productivity improvement, a loss of $640,000 would have
been realized.
3.

2006 per-unit input cost = $2,800,000/50,000 = $56

2007 per-unit input cost = $2,400,000/60,000 = $40
Yes, the per-unit cost has been reduced by $16, much more than the needed $5. The
divisions continued existence was brought about by improved productivity. Productivity
improvements can maintain competitive ability by reducing the cost of producing. They
also may permit a company to achieve a sustainable competitive advantage and ensure its
long-term survival. Thus, productivity is an important competitive tool. In this case,
because the cost reduction per unit is $16, the company could take a more aggressive
stance and decrease prices even more than $5with the possibility of increasing market
share and profitability.