A paper published in the Harvard Business Review points out a new way to calculate economic profit that could be more appropriate for service firms and other people-intensive companies. Instead of focusing on investment and return on investment, the focus is on employee productivity, both in terms of generating revenues and reducing costs. The approach is to first determine economic profit in the conventional way, except that we ignore taxes, so that economic profit is before tax, as follows: Economic profit Operating profit - Capital charge Assume the following information for a hotel chain that wishes to adopt the new method. The firm has $100 million in operating profit, has $1 billion in investment, and uses a cost of capital rate of 5%, so the capital charge is $50 million and the economic profit is $50 million. Relevant calculations are contained in Part 1 of the following schedule: Part 1: Economic Profit (in thousands, except cost of capital rate) Revenue Operating costs: Personnel costs Other costs Operating profit Operating profit before personnel costs (OPBP) Investment (capital) Cost of capital, rate $ 500,000 300,000 100,000 $ 100,000 $ 400,000 $1,000,000 Capital charge Economic profit Operating profit - Capital charge Part 2: Economic Profit Calculated Using Employee Productivity Number of employees Employee productivity: Employee productivity Operating profit before personnel cost per employee ($400,000/10,000) Capital charge per employee ($50,000/10,000) Less personnel cost per employee ($300,000/10,000) Economic profit per employee Productivity - Cost Total economic profit, all employees. Note: All numbers in thousands except for number of employees 0.05 $ 50,000 $ 50,000 10,000 40 5 $ 35 30 3 50,000 The next step is to decompose economic profit using employee productivity. To do this we first determine operating profit before personnel costs (OPBP): Dansonnel costs