Productivity is the ratio of inputs to outputs—the value of what we put into the process compared with what we get out of the process. A production process has three main inputs: labour, capital (equipment and buildings), and purchased inputs (goods and services bought from other companies). The numerator of the productivity equation is value added (output minus the purchased inputs); the denominator, costs (capital costs plus labour). Labour productivity (value-added output per employee) and capital productivity (value-added output per dollar of capital stock) can be examined separately. Labour productivity is highly relevant to high-tech sub sectors, particularly software and services, because much of their productive capacity resides in people.
A company that has higher productivity will enjoy greater profitability with all else equal in a given market. A more productive company can either produce the same output with fewer inputs and thus enjoy a cost advantage or produce more or better output with the same inputs and command a price premium. Over time, the higher profitability of more productive companies will attract competition, and profitability will tend to converge. Profitability is thus a transient reward for improvements in productivity.
