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

Purpose - The purpose of this paper is to present 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 QP 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. standard input- or adjusted total factor productivity-based ones). Originality/value - The paper contributes to a more accurate performance measurement approach, as researchers and practitioners better understand the components of profitability and productivity change.