building a better mousetrap

EPISODE #255 TRANSCRIPT

What is productivity?

The classic definition of productivity in macroeconomic terms is The per capita amount of gross domestic product (GDP) that a country generates.

So, what's GDP? The total monetary value of all finished goods and services produced within a country. It's used to measure the size of the economy, and its year-on-year growth rate. It's really a universally accepted measure of prosperity. GDP is calculated by combining four things:

1. Consumer spending

In the US this accounts for almost two-thirds of gross domestic product. Consumer spending, of course, is influenced by consumer confidence and inflation.

2. Business investment

This is critical, because it increases the overall economic capacity to generate GDP. This is where we create a virtuous cycle.

3. Government spending

Government spending can be used to prop up lower consumer and business spending, but it has its own problems. If it's funded from debt, it pushes up interest payments, which are a drain on the system. And if the government is just printing money, it pushes up inflation.

Government spending can make the economy look better in the short term, for example, by hiring more government employees, but there's no real discernible difference in output.

4. Net exports

This is the difference between the value of goods made in the country and exported, and the goods purchased in the country that were imported from somewhere else.

Productivity in many OECD countries has been in gradual decline for some time, and things aren't looking particularly rosy for the near future.

Businesses are facing higher costs and, although the rate of inflation is decreasing, it's still above the historical highs of recent decades. We also see some companies hiring more people as they find the post-COVID staffing levels unsustainable. Hooray for that! But this means more input labor for the same economic output.

Productivity is directly linked to living standards. The per capita GDP (our proxy for productivity) increases as GDP grows faster than the workforce that produces it.

Higher wages and more business investment into productivity and growth are obvious benefits. Individual consumers have more to spend, and governments can invest more in healthcare and social benefits. It's good for everyone, and an essential marker of a healthy economy.

This is why good old competition is so important. Without it, companies become fat, dumb, and happy. Lack of competitive pressure from imports comes when protectionist policies offered by trade tariffs reduce competition. Even though it sounds like a good idea to protect homegrown industry, it's not necessarily in the best long-term interests of the economy.

Technology also has a positive impact on productivity. It allows us to increase GDP without an equivalent increase in labor. Technology-driven productivity advances go all the way back to the printing press, but it was greatly accelerated in the automation of factories in the First Industrial Revolution. A more recent example is the adoption of IT in the 1990s and 2000s, which gave us a fantastic productivity boost. But this has slowed in the last decade.

It's also going to be incredibly interesting to see the impact of artificial intelligence. I listened to a podcast interview fairly recently with Mo Gawdat, the former chief business officer of Google X. He gave an incredibly scary assessment of artificial intelligence, indicating that we're going to be unable to stop its impact, not in 10 years, but in two to three years, and this is going to have some serious implications for society.

I'll give the last word though to the author of the McKinsey article, Kweilin Ellingrud, "Productivity is the fuel that makes the economic engine hum, and it's one of the keys to sustaining growth in living standards. It comes from continuously improving the performance, quality, or value of products, in short, from building a better mousetrap."

So, what's the “better mousetrap” all about?

Let's talk innovation, and how innovation affects productivity. I've done a couple of podcast episodes in the past few years on various aspects of innovation. The first was Ep.115: Does Innovation Create Value, and the second was more recent, Ep.203: Defending Against Disruptive Innovation. If you're interested in the practical application of innovation and strategy, it's well worth 45 minutes of your life to listen to both of those episodes.

We know that innovation can lift productivity, and there are two fundamental types of innovation: disruptive innovation and sustaining innovation.

Sustaining innovations are those day-to-day efficiency improvements that don't necessarily create a splash in the market. Typically, these innovations come from adding new product features that improve the product, and enable you to either charge more for it or create a bigger profit margin.

Sustaining innovations can also come through greater efficiency--the better, faster, cheaper type of innovations. These can absolutely be a source of productivity improvement. Rational, mature companies do sustaining innovation really, really well.

Disruptive innovations, on the other hand, actually change the market in one of two ways:

1. New market disruptions

These are products that compete against non-consumption. They're totally new categories of products and services. They rely on different measures of performance.

For example, the smartphone was a new market disruption. It was a new type of product that revolutionized a number of separate but related categories: mobile phones; digital photography; and GPS devices.

But, in order to be truly successful, this disruptive innovation relied on a whole range of sustaining innovations--in telecommunications and app development--to create the ecosystem that made it really take off.

2. Low-end disruptions

These satisfy an overserviced customer. As the large incumbents are improving their products and charging more for them, this creates an opportunity for other companies to introduce lower-end products that satisfy the needs of the basic customer at a lower price point.

So, in effect, you get less performance than the all-singing, all-dancing version of the product, but the value lies in the fact that the product can do the same job at a lower cost.

The question then becomes, "Does building a better mousetrap give you the market advantage and productivity benefits that you expect?"

Well, not necessarily. 

If I'm catching a mouse, I just want something that performs that basic function. The original mousetrap does that job pretty well, and it doesn't matter how innovative your new design is, I really doubt that you're going to find a new market disruption. It's still a device for catching a mouse!

All you can do is to improve the original product design until it has features that I’m no longer willing to pay for. I'm totally happy to get a two-pack delivered to my door by Amazon for $1.69!

Building a better mousetrap doesn't deliver the type of innovation that drives productivity improvement, but working out how to produce the same mousetrap more efficiently can: finding supply chain innovations for delivery of cheaper raw materials, for example; or, investing in new equipment to manufacture them more efficiently at greater capacity.

So, if I'm still paying $1.69 in five years’ time, because the company I buy from is beating inflation through incremental sustaining innovation, well, that's a huge win for productivity and for me as a customer.

Is greater productivity just screwing the workers?

Okay, let's talk about the elephant in the room.

There's a common misconception that when a company chases productivity improvements, that it's just trying to screw the workers to get more out of them, with all the rewards flowing back to the employer. Nothing could be further from the truth, and it doesn't matter what context you operate in.

I believe that productivity improvement is the obligation of every leader. Believe it or not, productivity improvement creates positive outcomes for all stakeholders, even employees. So, for example, if you're a company operating in competitive markets, the answer is pretty obvious: you want to be able to compete, so your products and services have to have the right combination of function, cost, and quality. Anything you can do to improve this will help you to compete.

If you do this adequately, you'll be able to stay in business, and that (correct me if I'm wrong) is good for employees. They still have a job.

If you do better than adequately, you'll be able to invest in new product innovations, higher wages and bonuses, and business growth.

But what if you're working for, say, a government agency? You might feel that productivity isn't as important. Let's face it, you can get away with being less efficient, because success measures tend to be less quantitative and less stark. Revenue comes pretty much no matter what (in the form of taxpayer funded budgets), and even though these might wax and wane on an annual basis, survival is pretty much assured.

But in my view, there should be every bit as much drive from leaders in government to improve productivity. It's about being a good steward of the resources that have been entrusted to you: that is, other people's money.

It's about being able to deliver the best outcomes possible to the communities that you're there to serve, and it's a privileged position that should require high levels of integrity and diligence. More productive government results in better services, more effective use of scarce resources (taxpayers’ money), and less friction in the system.

Not-for-profit (NFP) entities can be particularly tricky. Because they're purpose-driven, there are a few unique dynamics at play. The first is that they rely in large part on people's goodwill. The main stakeholder groups are volunteers, donors, and customers. Because of the volunteer culture, I've seen many NFP leaders who are reluctant to drive any sort of productivity improvement.

I had a conversation about this a couple of years ago with a group of country CEOs, who were working for a global charity. I said to them, "If you don't lead for efficiency and productivity, you are robbing your customers of the opportunity to benefit from what you do."

In this case, their customers were terminally-ill children. For example, in one country you might serve, say, 500 customers a year right now. But what if you could find 10% more efficiency? You could serve 550 customers. That's 50 terminally-ill children that would otherwise not have benefited from your incredible service.

 Is that worth it?

PRODUCTIVITY IN ACTION

I just want to give you one reasonably complex example of productivity improvement before we finish, so that you can see how all the pieces fit together.

When I led the Capital Productivity initiative at Aurizon (ASX:AZJ), the rail freight business, the lion's share of savings were found in the rail infrastructure part of the business: tracks, bridges, signaling systems, and the like. This part of Aurizon’s business was a regulated monopoly, which means that there was no competition, and we could effectively charge customers whatever the regulator would allow.

Our revenue in this business was calculated based on the size of the asset base. So, if the rail assets were valued at, say, $5 billion the annual allowable revenue was calculated as a percentage of that.

This actually incentivized the infrastructure part of the business to be inefficient. The more infrastructure we built and the greater the value of that infrastructure, the higher the revenues we earned. It was, as I used to say, a victimless crime. And the only thing standing in the way of that monopoly power was the smarts and strength of the regulator–so you can imagine how that worked out!

I was tasked with getting greater productivity outcomes from the capital we were spending both in the monopoly business and in the non-regulated business. So it’s not surprising that I encountered huge resistance from the people who'd lived in the monopoly part of the business for many years.

They knew how it worked, and they were happy to keep putting the customer's money into growth. There was almost no thought of efficiency and productivity and, look, that would've been okay except for one thing: our customers, the major global mining companies, had what I described as monopoly rage. They hated the fact that they were beholden to an inefficient business that clearly had no economic incentive to do better.

I realized pretty quickly that the value of any efficiency and productivity improvement would flow almost exclusively to the customer… but that was everything.

The obligation to provide better outcomes wasn't just right ethically. It was also the best outcome for our business. As our customers became more aware of the efficiency measures we were taking in our capital infrastructure spend, they became less angry. We were able to satisfy the basic relationship platform that said to our customers, "Hey, we're in this together, and we're working hard to try to achieve better outcomes for you."

The serendipitous flow-on effect of this was that, with less emotion and angst on the monopoly infrastructure side of the business, our customers were more likely to want to do business with us in the competitive, non-monopoly business.

The competitive business was all about carrying trainloads of coal from the customer's mines to the port, so that it could be shipped overseas to a global customer base. This set the mood for a more productive working relationship, and it was a critical factor in gaining the credibility we needed to compete in a fairly cutthroat market for non-regulated services.

So sure, the initial productivity benefits went mainly to the customer, but the whole system improved as a result. Greater throughput at lower cost even meant higher royalties to the state government, which benefited every taxpayer, and we were even eventually able to extinguish the monopoly rage.

HOW DO WE IMPROVE PRODUCTIVITY?

There are a thousand ways to improve productivity, and it's absolutely not about screwing the workers.

You can choose how to direct the benefits from any productivity improvement:

• Higher wages and bonuses for your employees;

• Lower priced or higher quality products for your customers;

• Increased investment in growth and innovation; and yes,

• Higher returns to shareholders.

Without capital to reinvest into the business, productivity declines and innovation is stunted. And eventually, we’re all going to suffer from that for generations to come.

No matter what context you operate in, improving productivity should be a part of your daily thinking as a leader: doing higher value things; making sure you stop all the marginal activity that just creates workload and noise; looking for ways to make your work ecosystem fit-for-purpose, by eliminating low value and bureaucratic controls; improving operational efficiency.

Any productivity improvement is a no regrets move and, far from being predatory, if you're smart you'll use it to instill a sense of pride, motivation, and purpose into your people.

RESOURCES AND RELATED TOPICS:

• Diary of a CEO interview with Mo Gawdat - Listen Here

• Ep #115: Does Innovation Create Value - Listen Here

• Ep #203: Defending Against Disruptive Innovation - Listen Here

• Buy the NO BULLSH!T LEADERSHIP BOOK - Here

• Explore other podcast episodes - Here

• Take our FREE Level Up Leadership Masterclass - Start Now

• Check out our 8-week online leadership program, Leadership Beyond the Theory - Learn More

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