Every company is trying to produce more goods with the lowest cost possible, right? Do you know what is the biggest cost in most companies? You're right! It's the workforce also called labour. In this article, you will learn about labour productivity and labour cost per unit, which are very important indicators used by managers to make business decisions.
Labour definition in business
In order to understand labour productivity, we need to define what is labour in the business context.
Labour in business context is defined as total work, physical and mental, put into producing goods and services by a company
Labour productivity can be defined as the amount of output each employee in a business produces.
The reason why labour productivity is important is that labour is usually one of a firm's most considerable costs. Labour productivity has a continuous month-by-month cost attached to it. Firms want to check and ensure that they are gaining as much work and productivity from their labour force as they possibly can.
Fig. 1 - Each labourer contributes to the overall productivity
This can be measured in different ways. Typically, labour productivity looks at the volume of output measured in units produced by each employee or occasionally the value measured in currency produced by each employee in the organisation.
How to calculate labour productivity?
Labour productivity is calculated by measuring the amount of output that an employee is able to produce. This could be measured on an hourly basis in a company that has quite a high output volume, or it might be measured over a specified period of time like a day, a month, or maybe even longer, a year. Labour productivity is therefore calculated by dividing the output produced during a period by the number of employees working during that same period.
Most businesses aim to increase their productivity as this would indicate more units are delivered by the same number of staff or the same quality is delivered by fewer workers and so the cost of labour is reduced.
Labour productivity formula
Labour productivity is calculated by dividing produced output by the number of employees: \(\hbox{Labour Productivity}=\frac{\hbox{Output per period (units)}}{\hbox{Number of employees per period}}\)
Labour productivity examples
Assume Company A's output in a given month is 20,000 units and 50 people are employed during that month to produce goods.
\(\hbox{Labour Productivity}=\frac{\hbox{20,000}}{\hbox{50}}=400\)
Labour productivity will be 400 units per employee per month.
Now let's assume that new technology has been developed. What happens to labour productivity?
Assume the same 50 employees are employed, however, due to new technology they are able to produce 30,000 units of output in a month.
\(\hbox{Labour Productivity}=\frac{\hbox{30,000}}{\hbox{50}}=600\)
Labour productivity is now 600 units per employee per month. This is because technological developments have made the production process more efficient.
However, if Company A wants to keep their production levels at 20,000 units per month, they would have to employ fewer employees, as each employee can now produce 600 units/month. Let's take a look at how many employees they would now need to produce 20,000 units per month.
\(\hbox{600}=\frac{\hbox{20,000}}{\hbox{Number of employees needed}}\)
\(\hbox{Number of emplyees needed}=\frac{\hbox{20,000}}{\hbox{600}}= 33.33\)
Company A would now only need 33.33, or in other words, 34 employees to produce 20,000 units per month, instead of the 50 they needed previously.
As indicated in the examples of the calculations above, a rise in labour productivity means that the output can rise by using the same number of staff, or less staff can produce the same level of output.
Labour cost per unit
The key thing to consider is how to improve labour productivity. If a business has got lower levels of labour productivity than its competitors, it may leave the business at a unit cost disadvantage so it needs to do something about it. Commonly it's not an easy task as it involves a variety of measures.
One factor strongly linked to labour productivity is labour cost per unit.
Labour cost per unit is the average cost of labour per unit of output produced.
Here's the formula labour cost per unit:
\(\hbox{Labour cost per unit}=\frac{\hbox{Total labour cost}}{\hbox{Total level of output}}\)
Suppose the output of Company A is 1000 units this year. The number of workers employed is 100. Workers are paid £20,000 per year. Calculate the labour cost per unit.
\(\hbox{Labour cost per unit}=\frac{\hbox{20,000}}{\hbox{1000}} = £ 20\)
What would happen to the labour cost per unit if the productivity increases?
In the example above, the labour productivity is:
\(\hbox{Labour productivity}=\frac{\hbox{1000}}{\hbox{100}} = 19 (units/worker)\)
If the labour productivity increases to 12 units per worker, with the same number of workers employed, the total units produced per year is:
\(12=3\times100=1200 (units)\)
The labour cost per unit is:
\(\frac{20,000}{1200}=£1200\)
The labour cost per unit has been reduced by £3.33 (£20 - £16.67)
As labour productivity increases, the labour cost per unit decreases. Alternatively, the decrease in the labour cost per unit will lead to an increase in labour productivity. Either way, your organization will benefit from lower costs and more competitive prices on the market.
Below are some ways to reduce labour costs and increase productivity:
Make sure employees are sufficiently trained and know exactly what to do within the organisation.
Have the correct equipment and facilities in place to ensure that employees are able to do their job properly.
Enhance skills and attitudes through the additional training of existing employees.
Improve work ethics, which could mean increasing the involvement of employees in making decisions to improve their motivation and commitment.
Invest in new technology, as innovation and technological advancements oftentimes increase labour productivity due to more efficient processes.
One problem when trying to increase labour productivity is the resistance from employees, especially if it involves automation. Employees might be worried that their jobs are going to change or disappear due to automation. In order to reduce the impacts of resistance - which could decrease labour productivity - from employees, companies need to make sure to reassure and motivate employees accordingly.
Labour Productivity - Key takeaways
- Labour productivity can be defined as the amount each employee in a business produces.
- Labour productivity is calculated with the following formula:\(\hbox{Labour Productivity}=\frac{\hbox{Output per period (units)}}{\hbox{Number of employees per period}}\)
The overall profitability and the efficiency of the business are often linked to how productive the labour force is.
Labour productivity can be increased by sufficiently training employees, having motivational systems in place, having an efficient operational process and investing in new technology.
Labour cost per unit is the average cost of labour per unit of output produced.
Labour cost per unit is calculated with the following formula:\
\(\hbox{Labour cost per unit}=\frac{\hbox{Total labour cost}}{\hbox{Total level of output}}\)
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