Understanding the components of profitability and productivity change at the micro level

Purpose
This paper presents a refined framework providing clarity in terms of the components of profitability and productivity change from the perspective of the firm level.

Design/methodology/approach
The literature is analysed with a scoping study and a systematic literature review. Productivity measurement approaches are compared using data at the product level.

Findings
The definition of total factor productivity (TFP) in the literature negatively affects the accuracy of profitability and productivity measurement. In the usual case of a dynamic output mix, TFP change encompasses biasing output mix effects relating to profitability, but not to productivity change. Therefore, this paper defines changes of a ratio of output quantities to input quantities not as TFP change, but as quantitative profitability (QP) change. A framework is proposed decomposing profitability change into price recovery and quantitative profitability change, whereas the latter comprises of valid productivity change (encompassing technological, technical efficiency, and productivity-related scale effects) and output mix change (encompassing proportion, quality, output switching, and profitability-related scale effects).

Research limitations/implications
Future research should include literature from the industrial organisation field of economics. The presented framework should be transferred to the standard production function framework used in economics.

Practical implications
The paper can help preventing faulty decision-making or distrust due to the use of biased profitability or productivity indicators. TFP-based productivity indicators are unsuitable for most firms. To measure productivity meaningfully, firms should use adequate approaches (e.g. SI- or ATFP-based ones).