Productivity and the Firm

Suppose you were stranded alone on a desert island. Because you were alone, you would be responsible for finding your food, building your shelter, making your clothes, etc. In short, you would be responsible for your own production and consumption.

Carrying this little though experiment a little further, it is not hard to see that your standard of living would be directly related to your productivity – how well you use your own labour to produce what you need to survive.

It is little different with a firm (or even an economy, for that matter). A firm’s productivity is a key determinant of its “standard of living”.

When we consider a firm’s productivity, we are really talking about stocks and flows. The firm’s physical capital, human capital, and technological knowledge represent the stock of inputs with which the firm has to work. How efficiently and effectively these stocks are combined, used, and transformed in flows which produce the outputs is what we really mean when we talk about productivity.

Firms which are inefficient have lower productivity. They either do not produce as much output from a given stock of inputs as rivals, or the value of the output they produce is less.

Process improvement seeks to improve a firm’s stock of technological know-how – its production technology, if you like. A firm which has a superior production technology, represented by superior methods, skills, and competencies, will be more productive. Such a firm will enjoy a “higher standard of living” than rivals because it will produce at less cost and greater profit. This fact alone should be enough to motivate firms to continuously innovate and improve their internal processes and systems.

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