A paper published in theHarvard Business Reviewpoints 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 5 500,000 Operat ing cos ts : Personnel costs 300,000 Other costs 100,000 Operating profit 5 100,000 Operating profit before personnel costs (OPBPi 5 400,000 Investment {capital} 51,000,000 Cost of capital , rate 0 . 05 Capital charge 5 50,000 Economic profit - Operating profit - Capital charge 5 50 , 0 00 Part 2 : Economic Profit Calculated Using Employee Productivity Number of employees 10 , 0 00 Employee productivity: Operating profit before personnel cost per employee ($400,000f10,000) 5 40 Capital charge per employee [550,000!10,000) 5 Employee productivity 5 35 Less personnel cost per employee [5300,000110,000} 30 Economic profit per employee - Productivity - Cost 5 Total economic profit, all employees 5 50,000 Note: All numbers in thousands except for number of employees The next step is to decompose economic profit using employee productivity To do this we first determine operating prot before personnel costs [OPBP): OPBP - Operating profit + Personnel costs $400,000 - $100,000 4- $300,000