Many companies operate with sub-optimal profit margins and returns, leading to sustainability challenges and increased risks. Reflect on the history of corporate acquisitions, takeovers, and bankruptcies, along with the impacts of financial crises, pandemics, or wars on large businesses. The potential failure of companies deemed ‘too large to fail’ poses significant concerns. In this context, productivity emerges as a crucial defence against diminishing margins.
The accompanying graph presents five profit margin scenarios, each depicting a different production cost relative to a fixed output and revenue. It reveals that an increase in production costs against steady revenue leads to shrinking profit margins, eventually approaching a net loss. Profit margins do more than just measure financial success; they influence operational efficiency. Higher profits buffer against inefficiencies and sub-optimal production, serving as a performance margin. When a company's profit margin declines, so does this buffer, intensifying pressure on the workforce to maintain performance and emphasising the need for productivity enhancements. Often, limited margins constrain the resources available to implement necessary changes, potentially leading to stagnation, takeover vulnerability, or insolvency. The key question is: How can we bolster profit and performance margins to avoid reaching a point of operational infeasibility?
One approach to enhancing revenue via output levels is to either expand total productive capacity or improve the efficiency of existing capacity. Expanding capacity requires output to be increased to meet the new potential, a process that requires fine-tuning the ‘output dial.’ However, if the effort needed to boost output surpasses the gains from expansion, overall productivity suffers. Conversely, efficiently utilising additional capacity through new processes and technology can enhance productivity. This expectation, which drives companies to expand continually, is based on economies of scale. In this concept, spreading operational costs over a greater output yields efficiency. But this strategy is not without its challenges.
The capacity to expand while maintaining or improving productivity is far from guaranteed. Growth brings added complexity in management, along with potential issues and inefficiencies, including bureaucratic hurdles. If growth exceeds the availability of skilled labor, raw materials, or capital, it can result in increased costs and operational challenges.
Alternatively, increasing productivity without corresponding growth means generating more output with the same inputs. If a business has untapped productivity potential, it shows technical inefficiency, presenting an opportunity for improvement. However, even technically and financially workable expansions require a foundation of operational excellence; without it, expansion risks exacerbating existing inefficiencies.
So, what does optimal operation entail?
Practical optimisation must efficiently yield sustained results, balancing current needs with future sustainability.
As businesses strive for practical optimisation, questions arise about the most effective productivity initiatives. Which approaches are popular, and which are most successful in achieving long-term, sustainable improvements? Identifying and implementing the right strategies is critical for navigating the delicate balance of growth, profitability, and operational efficiency.
The Productivity Problem Part 1: Defining the Problem Series