Productivity Component of Change in Operating Income

The productivity component of the change in operating income uses 2020 input prices to measure how costs have decreased as a result of using fewer inputs, a better mix of inputs, and/or less capacity to produce 2020 output, compared with the inputs and capacity that would have been used to produce this output in 2019.

The productivity-component calculations use 2020 prices and output because the productivity component isolates the change in costs between 2019 and 2020 caused solely by the change in the quantities, mix, and/or capacities of inputs.^*

Using the 2020 data given in section Strategic Analysis of Operating Income and the calculation of units of input required to produce 2020 output in 2019 derived when discussing the cost effects of growth (see section Growth Component of Change in Operating Income),

Chipset’s quality and yield improvements reduced the quantity of direct materials needed to produce output in 2020 relative to 2019.

To calculate the cost effect of productivity for fixed costs, we use the 2020 price data (see section see section Strategic Analysis of Operating Income) and the analyses of capacity required to produce 2020 output in 2019 conducted when discussing the cost effect of growth (see section Growth Component of Change in Operating Income).

Cost effects of productivity for fixed costs are

Chipset’s managers decreased manufacturing capacity in 2020 to 3,500,000 square centimeters by selling off old equipment and reducing the workforce using a combination of retirements and layoffs.

In summary, the net increase in operating income attributable to productivity improvements equals:

The productivity component indicates that Chipset was able to increase operating income by improving manufacturing quality and productivity and by eliminating capacity, all of which lead to reductions in costs. The appendix to this chapter examines partial and total factor productivity changes between 2019 and 2020 and describes how management accountants can obtain a deeper understanding of Chipset’s cost-leadership strategy. Note that the productivity component focuses exclusively on costs, so there is no revenue effect for this component.

Exhibit 13-6 summarizes the growth, price-recovery, and productivity components of the changes in operating income. Generally, companies that have been successful at cost leadership will show favorable productivity and growth components. Companies that have successfully differentiated their products will show favorable price-recovery and growth components. In Chipset’s case, consistent with the organization’s strategy and its implementation, productivity contributed $1,912,500 to the increase in operating income and growth contributed $2,820,000. Price recovery decreased operating income by $1,757,500 because even as input prices increased, the selling price of CX1 decreased. Had Chipset been able to differentiate its product and charge a higher price, the price-recovery effects might have been less unfavorable or perhaps even favorable. As a result, Chipset’s managers plan to evaluate some modest changes in product features that might help differentiate CX1 somewhat more from competing products.