How blindly chasing 'Productivity' can lead to lower profitability

Construction productivity has continuously fallen further and further behind other industries over the decades we are told.

And in order to improve the industry we need to improve productivity, apparently.

And whilst there is something in this, it can also be a dangerous idea, that, if we are not careful, will lead the industry in totally the wrong direction.

Don't believe me?

This can be clearly seen in this worked example, based on the profit and loss statement of a ficticious construction contractor.

They currently make $5M profit whilst spending $25M on people. Let's call that 20% "productivity".

In a drive to increase their productivity they have reduced their direct labour, and increased the 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)! Great Job!

But in reality they have not made a cent more money. Their clients have not received a faster, lower cost or better project.

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%.

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

Is that what we really want?

So what to do instead?

Labour productivity was introduced as a proxy measure, back in the days when the main business costs were direct labour, supply chains were flatter, and getting other data was harder. And change happened very slowly, so if you made more with the same labour, it was very likely that your bottom line went up.

But these assumptions are no longer valid.

The true measure of productivity is how much money you make in proportion to the resources that you tie-up in the business, in particular compared to the money you have tied up. It doesn't matter whether you spend money on salaries, machines, or purchasing goods and services from another company, what matters is the bottom line.

The issue for construction in improving is not the very localised measure of how much they make compared to the salary bill. And trying to make this ratio higher, simply distracts management attention from potentially more important work.

The productivity we really need is more quality project outputs for our money.

If you are a client you want more hospital beds per dollar spent, more km of road, more houses and apartments per dollar. 

If you are a contractor you want to make a greater return on your investment - on the cash you tie up in running the business, and in the people you have working there. But as the above example shows, you need to be very careful in maximising this latter measure - you cant just set targets and sit back. You need to understand what drives the return you make, and what you need to do for your people to be able to deliver more without simply overloading them.

And whether you are client or contractor, a more productive system would produce these results faster than it did yesterday.

Isn't that the kind of productivity we need from capital and construction projects?

This article is based on a longer post, published on Ian's blog. You can read the full article here.

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Ian Heptinstall is an independent coach and advisor on improving capex projects.

If you are interested in how you can manage projects and project portfolios at higher levels of productivity, read Ian's report "The 2 Changes that will Transform the Performance of your Capex Projects".